A new study from energy and environmental policy researchers at the University of Illinois finds that a global carbon tax on fossil fuels would generate winners and losers among countries of all income groups, with low-carbon economies earning the biggest advantages. The authors find that countries with more hydropower and nuclear sources in their energy portfolios will have the greatest competitive advantage in the face of a worldwide tax on fossil fuels, regardless of the country’s income level. For example, France, which generates 75% of its electricity from nuclear plants, would have an economic advantage over other high income countries that are more reliant on fossil fuels such as the United States and the United Kingdom. Lower income countries, like Ethiopia, which rely heavily on carbon-free energy sources like hydropower could actually benefit from a carbon tax by gaining the ability to lower prices of goods and capture more of global demand. Likewise, countries whose economies heavily rely on carbon-intensive exports, like in the Middle East and Russia, will face higher costs and a disadvantage on the global market for fossil fuels. Poorer countries with high dependencies on fossil fuels like Haiti would be the most negatively impacted by a carbon tax, facing higher costs and less power to export goods on the global market.
The idea of a carbon tax is not new and has a deep foundation in economic principles. Essentially, we can combine the economic theory of taxes with that of negative externalities and extend this onto the world stage to develop an economic understanding and analysis of this potential environmental policy. Economists generally favor taxes specifically on carbon itself (rather than on output for example) as they more directly address the non-pecuniary externality of pollution and environmental degradation from fossil fuels without disentivizing production. Theoretically, we would like the size of this tax to be equal to the level of marginal environmental damages we would experience at the socially optimal level of fossil fuel production to perfectly internalize the external environmental costs into market decisions. In reality, this is a difficult number to quantify and will likely vary across countries where environmental regulations and firm behavior differ. As the paper suggests, the greatest determinant for the impact of a carbon tax on a given country is its initial level of carbon dependency. Countries who derive more of their energy from non-carbon sources will face lower costs from the marginal tax and thus earn competitive advantages (the ability to lower prices) over other countries in the global trade for fossil fuel related goods.
While taxes are an appropriate and often suggested method to internalize externalities like pollution, they do not do so without consequences. Fossil fuel producers worldwide will obviously face higher costs due to the establishment of a carbon tax, and in the long run economic theory suggests that they will pass the entirety of these costs onto consumers in the form of higher prices. This will result in not only reduced consumer surplus but also negative political repercussions (as we’ve seen recently in France, higher gas prices from taxes are often vehemently opposed by the public and therefore often considered politically infeasible). As the demand for electricity and gasoline is generally very inelastic (people are less willing to lower their consumption even in the face of higher prices), the effect of a carbon tax on consumers will be large, with low-income and vulnerable communities in a given country suffering the most. This is partly why less efficient economic policies to promote the transition away from fossil fuels such as subsidies and tax benefits for investments and production for renewable energy are often favored. A possible policy remedy for this issue is for governments to allocate some of the tax revenue generated from the carbon tax to provide rebates or tax benefits directly to those communities most affected by price increases
The global scale of this carbon tax proposal helps further minimize some of these inefficiency concerns. Implementing a carbon tax on the international rather than the country level allows us to internalize the environmental externalities of fossil fuels on the global scale with which the impacts are actually felt and helps prevent countries from avoiding carbon abatement by simply increasing imports.
A global carbon tax has the ability to help advance the transition to a clean energy economy while internalizing environmental damages from the current production of fossil fuels. While many believe carbon taxes would be most burdensome to low income countries, this recent research suggests that countries with cleaner energy portfolios
(regardless of income group) will garner most of the benefits cost-wise and on the international trade stage. Thus, carbon-dependent countries would be incentivized to reduce their use of fossil fuels and meet more of their energy demand from renewable sources in response to the carbon tax. Distributional concerns within a country can be effectively addressed through government allocation of tax revenues to affected groups. While the actual implementation of a worldwide carbon tax, particularly in today’s political climate, seems impossible, research and economic analysis shows it has the potential to be a powerful way to curb emissions while promoting economic efficiency.