Curbing Carbon Emission: Is a Carbon Tax the Most Efficient Levy

About the Project

The objective of this research is to understand how different policy tools could expedite the transition toward a low-carbon economy in a cost-effective manner. This project takes a pragmatic approach to climate change policies, recognizing the need to balance the economic and environmental impacts of these policies. Ignoring the cost of these policies could not only create a substantial economic burden but also lead to a loss of social mandate. This is one of the greatest risks to the successful implementation of sound climate change policy, which by its nature requires clear and predictable government commitment over the long-term.

Key Points

The ambitious environmental objectives of the Paris Agreement imply that, in order to curb carbon emissions, all cost-effective policy options should be considered. These options include carbon taxes, probably the most popular fiscal tool for curbing emissions, and various other taxes on fossil fuels. This study uses Spanish data to assess what are the optimal taxes on oil, natural gas and coal from a welfare perspective, and compares them with a carbon tax in a general equilibrium context. The results of the analysis are as follows:

Among their options for reducing CO2 emissions, policymakers may consider taxing coal heavily. Less punitive taxation of oil and natural gas could also form part of an optimal strategy.

For maximum effectiveness, we found that any planned tax on oil should always be lower than the tax on natural gas, and still lower than that on coal. This counterintuitive result comes about because oil has the highest marginal economic productivity of the three fuels, though natural gas is the cleanest fossil fuel in terms of CO2 emissions. According to standard economic theory, the marginal economic productivity of any fossil fuel should be similar to international prices for it in competitive markets.

Carbon tax has both advantages and disadvantages for policymakers. In the short run, the revenue collected would be higher from an optimal mixture of taxes on the various fossil fuels – but, in the longer term, higher taxes might be seen by taxpayers as unreasonable and could result in a loss of support for the environmental policies they are intended to underpin.