Intro to Econ: Eleventh Lecture Aside – Why don’t we have a global carbon tax?

If I understood it correctly, we are currently experiencing climate change, climate change is believed to be detrimental to most people, and climate change is to a large extent due to human activity, especially those activities that release CO2 and similar gases into the atmosphere. Moreover climate change is a global problem. Any CO2 released by people’s activities in Asia, this (supposedly mostly negatively) affects not only people in Asia, but also in South and North America, Africa, Australia, Europe, in fact everyone living on this planet. In other words, using the language of a previous post, climate change is a global negative externality of any economic activity that (directly or indirectly) releases CO2 (or similar gases) into the atmosphere.

In the last post I argued that such negative externality problems (that the market typically does not solve because of the logic explained in the advertising example) can often be solved by setting appropriate taxes on the offending (negative externality producing) products. I also argued that one would probably expect that a voting process will in fact lead to a country adopting such taxes. Can’t we just use a similar approach to solve the global climate crisis? I will here explain why this is not so easy.

The easy solution would be to simply (and globally) raise the taxes on petrol and other fossil fuel, often called a carbon tax. Recall that most countries already have a sizeable tax on petrol. In Austria, for instance, this tax is currently almost half of the price of petrol. In many other countries it is even higher. There are probably actually at least two reasons why countries have these taxes already. One is the externality of (the relatively local) pollution that burning fuel causes. Another is that people also perceive such a tax as a reasonably fair way to make people pay for the roads within a country. People who drive more pay more taxes and thus pay more for the roads.

But it now seems that these taxes are yet insufficient to tackle the global climate change problem. This is probably because when a country’s government (or its voters) decide on the level of taxes on fuel they only take into account the negative externality that is imposed on the people within this country (the voters). It seems, however, that any CO2 emitted in one country damages the atmosphere more or less equally everywhere around the world. So any CO2 emitted in, for instance, Austria, damages the atmosphere for all Austrians, yes, but also for the roughly 1000 times as many people that live in other parts of the world. I have the strong feeling that this consideration is not present when people in Austria determine the tax rate on fuel. I also have the feeling that this is true for any country.

Why does a country such as Austria not decide that, in order to help out the whole world population (a tiny bit – well, Austria is actually really small), Austria significantly raises carbon taxes to take into account the damage done to people in the rest of the world? To understand this we need to understand that significantly raising fuel taxes in Austria would have a severe and mostly negative impact on the people of Austria. Imagine a price of petrol of not roughly 1 but 3 Euros per liter. This will lead to all sorts of problems (within Austria). Many people currently rely on their car to commute from home to work and already find it quite expensive. After such an enormous price increase they would find it extremely difficult to keep commuting. In fact they might well riot, as we have seen in the gilets jaunes riots in France. In fact buses and trains would (unless subsidized) also become more expensive. Also almost all other goods would become more expensive, as almost all of them require some transportation and thus some amount of fuel. Moreover, and perhaps most importantly, Austrian companies with production in Austria will find all the “inputs” they use in production more expensive. They would then find it much harder to be competitive with companies in other parts of the world and might have to move or close. In fact, I feel that this would be a disaster for Austria.

Reasons like this, I think, prevent Austria (or any other country in the world) from single-handedly introducing even higher carbon taxes. But this could be different if all countries did this at the same time (and a bundle of other measures are introduced within countries to prevent riots – such as highly subsidized public transport and tax exemptions for the movement of at least certain goods). At least the important argument of the relative company competitiveness across different countries would then be removed. Countries could come up with a treaty (as they have been trying to do for quite some time) that specifies carbon taxes in each country (the money raised by the additional taxes, if any, could stay within this country – or one could agree on some global redistribution of these tax payments). But coming up with such an agreement through a worldwide political process seems to be difficult as we have seen looking at the fairly ineffective Kyoto Protocol and Paris Agreement. Why is it difficult?

I think the main problem is this: How can we make sure every country adheres to the promises it made in the agreement? First one needs to establish a good monitoring system to be able to check whether or not countries do as they have said they would in the contract. Second, and more importantly, what happens when one country does not behave as it should? If you live in Austria and are refusing to pay NOVA, the tax on cars, you will probably be found out, and made to pay in some form or another. There is an effective monitoring system, a police force, and a judicial system in place that, altogether, makes sure that you pay your taxes. Well, I guess, even this does not always happen. But what would be the counterpart of all this on the global scale with countries as actors? Especially when you think about bigger countries there is clearly a limit as to what you can do to them (economically and judicially). There is no independent international police force. Yes, there is the International Court of Justice in the Hague, Netherlands, the judicial organ of the UN. But this court only works as long as countries voluntarily submit to its rulings. And big countries probably wouldn’t. Karl Farkas, an Austrian comedian of the second half of the 20th century, stated it as follows (roughly translated): “When two countries come before the UN with a conflict, the conflict disappears. When a big and a small country come before the UN with a conflict, the small country disappears. When two big countries come before the UN with a conflict, the UN disappears.”

I think that an understanding of this problem (among the diplomats negotiating any potential climate deal) prevents such a climate deal to be put in place.

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