Fighting global warming with carbon pricing: how it works, field experiments and elements for the Belgian economy
If global economic growth continues to be built on the use of carbon energy sources, the ceilings set in the Paris Agreement will be reached in 15 years and, by the end of the century, the global Earth surface temperature will be around 3 to 4 °C above pre-industrial levels, with enormous implications for the planet and the economy. Stabilising the atmospheric concentration of greenhouse gases means reversing the trend in global emissions to gradually bring them down towards zero. The window of opportunity to reach this target is narrow and the transition needs to be made at an extremely sustained pace. To reach carbon neutrality by the end of the century would require an annual drop in global emissions of 5.5 %, at a time when they are still growing at a rate of 3 % per year.
The European Union has set itself ambitious targets to reduce its emissions by 55 % from 1990 levels, by the year 2030, and is aiming for a zero-carbon economy in 2050. The challenge is both technological and financial. It needs to be accompanied by a public policy of assistance for research and development and public investment into research, energy networks and their interconnections. This may include building insulation and vehicle emission standards, with all the difficulties of control and inspection they may bring, as well as the rebound effect problem. But the economists insist that the most efficient public action is to fix a price per tonne for CO2 emitted to establish the bases for fairer competition between fossil and non-carbon energy sources. Clearly announcing that this price will rise over time according to a pre-established format sends out a clear signal to businesses and consumers about the need to adapt their choices to avoid this cost in future, and enables them to draw up medium- and long-term investment plans. The price signal given to the energy market will feed back into the profits that companies expect depending on the type of energy they produce and/or consume. In this way, it will filter into financial markets and help to direct investment towards sectors producing and/or consuming non-carbon energy sources.
The European Union’s emissions trading programme is a good example of indirect pricing. But it only covers emissions by large companies with the biggest carbon footprints, and neither involves households nor small firms. The carbon price resulting from this type of system turns out to be more volatile. For the moment, it works out at well below the recommendations of the Intergovernmental Panel on Climate Change. For these reasons, some countries have decided to unilaterally impose a tax on fossil fuels. This instrument is both simple to manage and enables a wide coverage of emissions. The amount of the tax and its growth path are fixed and do not depend on a market, and it is conceivable to link this growth to medium-term emissions targets, as Switzerland is doing, for example. The cost incentive helps to reduce emissions efficiently. The principle of a carbon tax is often criticised as being detrimental to the purchasing power of households, especially the poorest ones, and as undermining the competitiveness of the most energy-intensive sectors and the most exposed to international competition. As long as the revenue generated by the carbon tax is redistributed to the most vulnerable households and sectors, existing les experience shows that these criticisms are unfounded.
CO2 emissions in Belgium were as high as 100 million tonnes in 2018, but this was 25 % less than in 2000. Three-quarters of these emissions can be put down to companies and one-quarter to households. Since the beginning of the century, companies have reduced their emissions by 29 % and households by 11 %. The biggest reductions have been observed for the industrial and market services sectors. Although heating-related emissions by households are down by 29 % on the year 2000, per inhabitant, this source is still 57 % above the European Union average. Transport-related emissions by households have also grown by 31 % over the same period. Since 2014, the emissions reduction process seems to have been interrupted. An incentive-based mechanism, notably geared towards households, would undoubtedly make it possible to envisage more ambitious targets.
Tax simulation exercises, carried out on three fronts with the help of the Bank’s macroeconomic models, have helped to understand the channels through which such a tax would affect economic activity in the medium term. Firstly, what is the basic difference between levying carbon tax on emissions by households rather than by companies. Secondly, what are the consequences of Belgium going it alone in this policy area, compared with a synchronised policy at European Union level? And lastly, does redistributing the proceeds of the carbon tax to households and companies effectively make it possible to mitigate the negative consequences of the tax?
In the absence of any redistribution, a carbon tax is identical to an oil shock, with rising energy costs leading to an increase in inflation and loss of real economic activity. If this shock is limited to just households, and if, in line with the logic of the health index, it does not trigger any automatic wage indexation, business competitiveness will not be affected and only domestic demand will fall on account of the loss of household purchasing power. Levying the tax on companies, with no derogation regime, would generate three times as much revenue, based on the breakdown of emissions described above. Firms would pass this cost onto their customers, namely households, other firms and importers from abroad. With an identical fiscal shock, this wider tax base, along with the automatic wage indexation mechanism, would imply a much smaller impact on private consumption than under the first simulation. On the other hand, exports are now affected and corporate investment starts to suffer more. If the tax is levied at European rather than national level, Belgian firms’ competitive handicap compared with their European partners disappears, but, this time, demand for Belgian goods suffers from the European partners’ loss of purchasing power as a result of rising energy prices, as well as the loss of competitiveness of European firms vis-à-vis the rest of the world. Finally, if the proceeds of the tax are fully redistributed to households and firms, the adverse consequences are rapidly erased, even in the case of a tax that is not synchronised at European level. Simulations carried out for Belgium therefore confirm the above-mentioned experiments.