Last month, 196 countries reached a landmark consensus agreement in Paris to reduce greenhouse gas emissions in order to slow global warming, agreeing to work toward capping a global temperature increase to 2 degrees Celsius.
The risks of climate change are real. The Intergovernmental Panel of Climate Change forecasts increases in weather extremes and, by 2100, a possible sea level rise of 0.6 meters (2 feet). However, the temperature increase may trigger the collapse of major ice sheets that would lead to a 20-foot rise over hundreds of years that would put much of Boston under water.
We need meaningful actions that will dramatically decrease carbon emissions at the lowest possible cost. Numerous industries, including six major oil companies, have asked for a carbon pricing system to be initiated at the national, regional, and, ultimately, international level. Many economists argue for a cap-and-trade scheme, where carbon emission is capped but emitters can trade emission allowances to harness market forces that can lower costs. The price of carbon emissions would increase as the cap is progressively lowered, thus providing economic incentives to industries to reduce emissions.
The European Union adopted a cap-and-trade policy in 2005 but, from 2009 onward, the allowance price was about $16 per metric ton of CO2 and about $10 per ton since 2012. Most experts agree that the price needed to fully stimulate a widespread switch from fossil fuels is more in the range of $78 per ton. Furthermore, there is little monetary incentive to capture carbon from power plants, or from petrochemical, cement, and steel industries, without a significant price on carbon. I also see no credible scenario to minimize the climate risks without large-scale carbon capture, recycling, and sequestration.
In hindsight, too many carbon credits were given away in the EU trading scheme. The method of assigning allocation limits for each country is a regulatory headache, open to gamesmanship, and the will to aggressively lower the cap on carbon remains politically challenging. California began a cap-and-trade program in 2013, and China will launch a nationwide carbon market in 2017. If these programs are to succeed, there must be a transparent march toward progressively lower caps and a concomitant increase in the price in order to stimulate investments.
As an alternative to a cap-and-trade system, my colleagues and I came out in favor of a revenue-neutral carbon tax. A simple carbon tax maximizes transparency, minimizes market manipulation and regulatory complexity, and provides investment certainty.
A carbon tax will raise the cost of energy; hence the need for a revenue-neutral tax. The refunds should be progressive, as an antidote to the antiprogressive nature of a carbon tax. No new bureaucracies should be created to return the proceeds, and refund mechanisms can be done through decreases in withholding, or payroll, taxes.
The price on carbon can begin at $12 per ton, close to the current trading price in the EU and California. ExxonMobil proposes that the tax rise gradually to $60 per ton by 2030, and $80 by 2040, to allow industries and individuals time to adjust. A cap-and-trade system with an auction price that follows this ramp-up will have the same effect as long as the electricity-generating sector is required to purchase allowances. Subsidies that directly reward the use of carbon-intensive energy sources should be eliminated, and as the carbon tax internalizes the full cost of fossil fuels, the subsidies for renewable energy should be proportionally phased out.
Global carbon emissions need to be capped below 3.7 trillion tons of CO2 if there is a 50 percent chance of staying below the 2-degree target. More than half of this allotment has already been used up since the beginning of the industrial revolution, and at our current emission rate, the remainder will be gone in about 30 years. Clearly, the remaining carbon budget is a precious resource, but cap-and-trade allocations start from existing levels of emissions. It is prima facie unfair to allow developed countries to pollute more because they were historically the biggest polluters.
A global carbon tax avoids the intractable problem of how to allocate carbon-emissions credits between developed and developing countries, and levies the highest taxes on the biggest emitters. If countries are unwilling to levy a cost on carbon, the playing field can be leveled with suitable border tariffs on goods imported into participating countries. In addition, the wealthiest countries still need to help less developed countries in this transition.
The most important aspect of a carbon tax that rises inexorably is that it will unleash scientific ingenuity, innovation, and market investments that are still needed to combat climate change. In the last six years, the cost of solar modules plunged to 20 percent of 2008 prices, and, in many areas of the world, the life-cycle cost of wind and solar energy is dropping below the cost of fossil energy. However, the cost of decarbonizing the first 25 percent of the world economy is far less than the cost of decarbonizing the last 25 percent. A meaningful, and timely, global price on carbon is essential to get us to where we have to be in the coming decades. Otherwise, to quote Martin Luther King, “There is such a thing as being too late.”Steven Chu is a Nobel laureate in physics and former US secretary of energy. He is professor of physics and molecular and cellular biology at Stanford University and a member of the board of Inventys, a carbon capture company.