Efforts to control emissions of carbon dioxide in Britain are in a muddle. Until we sort this out, it will be needlessly difficult to meet our national goal of a 60 per cent cut in emissions by 2050.
Almost everybody accepts that a financial penalty must be attached to CO2 emissions, because mere exhortation is not proving to be enough. There are two main ways of attaching that penalty: the direct way, through taxation, where the emitter pays a tax for each tonne of CO2 emitted, and the indirect way—the so-called "cap and trade" approach.
Under a cap and trade system, the government (in our case Brussels because it's an EU-wide scheme) sets the cap—the maximum overall tonnage of CO2 (and other greenhouse gases) that can be emitted in any given period. The cap is then divided into permits, each allowing the bearer to emit one tonne of CO2. The permits are then distributed to each country in the EU, and the countries then allocate them to their main emitting companies. Any company not needing all of its allocation is free to sell its surplus to a company that needs more. The emissions trading scheme (ETS) provides the marketplace for the trade of these permits.
Politicians like the cap and trade system because it spares them having to impose yet more taxes. Economists like it because it is economically efficient. Those companies that can reduce emissions easily will do so, and profit from selling surplus permits. Companies for whom cutting emissions would be expensive can buy those permits. Overall, the cap is met at the lowest economic cost.
By contrast, the tax system fixes the price of CO2 emissions—a tax of so much a tonne being applied to all sources of emission—but does not guarantee that emissions will be less than the desired cap. So that's the choice: fix the tonnage cap and let the price fluctuate, or fix the price and let the tonnage fluctuate.
Economists and politicians may like the cap and trade system, but consider the miserable power company executive. His job is to build a power station that will come on stream in 2017, and he has to decide which technology to use. Should he opt for today's lowest cost alternative (gas turbines that emit plenty of CO2), or should he choose more expensive technology (solar, coal with carbon capture, nuclear) that emits no CO2? That depends, of course, on the value that society is going to place on the elimination of a tonne of CO2 in 2017 and beyond. The cap and trade system gives him no help, for three reasons. First, the prices in the ETS are very volatile (last year the price plunged from almost £20 per tonne to less than £7 in just a few days). Second, the ETS has a short time horizon—its next phase will only cover the years 2008-12, not too useful to a power company executive with a 2017-30 investment horizon. Third, if he remembers the common fisheries and agricultural policies, how much confidence can the executive have in Brussels being able to withstand lobbying to relax the cap? A tax-based system has none of these shortcomings. When it comes to making long-term investment decisions, it is far preferable to cap and trade.
The EU is wedded to cap and trade, but the British government also imposes three carbon taxes: vehicle fuel duty, the climate change levy (CCL) and the airline passenger duty (APD). Of course, they weren't necessarily imposed for environmental motives, but they are nonetheless direct taxes on CO2 emissions. And if you accept that a subsidy is the same as a negative tax, there is a fourth tax—the renewable obligation certificate (ROC).
As the table shows, the tax for emitting a tonne of CO2 varies widely. The CCL is paid by industrial users of fuels, but they pass it on to consumers. The CCL is paid to the treasury—it is not a subsidy to the fuel producers. By contrast, the ROC is a subsidy—paid to wind farmers and various other producers of renewable electricity. It is paid by the vast majority of us who are consumers of non-renewable electricity, although because it's rolled into our overall bill, the size of this cross-subsidy is disguised. APD is levied per person and is paid to the treasury. Equating APD to a per-tonne emission figure requires assumptions about the type of aircraft, distance flown, load factor and so forth, but the two examples in the table are typical. It's interesting to note that the new APD rates introduced in February 2007 are taxing carbon emissions at quite a high rate, even without a duty on aviation fuel.
The figures in the table send out conflicting messages. The ETS allowance price tells us that CO2 is not very important and saving a tonne will only be worth £14 next year (this year's figure is a derisory 70 pence). But on the garage forecourt the message is totally different—at £200 per tonne, CO2 emission is almost a hanging offence. The table says that making electricity generation carbon-free is not worth doing unless it's renewable, in which case it's extremely worth doing. Air travellers must pay a lot for their carbon emissions, but really heavy emitters—domestic gas and electricity users—need pay nothing for their tonnes of CO2 emission.
A widely discussed alternative is to replace ETS and the mish-mash of existing carbon taxes with a single "level playing field" tax for every tonne of CO2 emitted, whatever its source. Today's muddle suggests that the time has come to start moving in that direction. A charge of £47 per tonne would raise £26bn a year for the treasury and would be essentially tax-neutral—replacing £24bn of fuel duty, £0.8bn of CCL and £0.9bn of APD.
Imposition of a tax of £47 per tonne would add about £19 to the cost of a megawatt-hour (Mwh) of electricity—increasing the wholesale price from £25 to about £44. Generators emitting CO2 would have to pay that extra £19 straight to the treasury in settlement of their emission tax liability. Generators using zero-carbon technologies (nuclear, carbon capture and storage, wind and so forth) would be able to charge the same £44 per Mwh for their electricity but—having no emission tax obligation—would be able to pocket all of it. This mechanism would provide low-carbon generating technologies with such a substantial, reliable and long-term incentive that, well before 2050, we could be looking at a zero-carbon electricity generating sector, or something very close to it.
Although a "level playing field" charge of £47 per tonne of CO2 emission would be tax-neutral in overall terms, there would be substantial redistribution effects. To give two examples: first, the price of motor fuel would fall sharply, as the present £200 per tonne tax was replaced by the £47 per tonne tax. (This might or might not lead to a lower cost of motoring, depending on the magnitude of future road-pricing charges). Second, the £47 emission tax would feed through to a rise of something like 20 per cent in domestic electricity and gas prices. Consumers would need at least a decade to adjust to these big redistributions. No doubt that decade would also be needed to get the agreement of our EU and WTO trading partners.
Of course, there is no guarantee that the tax-neutral charge of £47 per tonne will be sufficient to reach our goal of 60 per cent reduction by 2050. Power generation now accounts for 32 per cent of the nation's CO2 emissions, so even the total greening of the generating sector will not, by itself, achieve that goal. Greening of the sector is a necessary but not a sufficient condition. Experience will show whether the £47 figure will be enough, or whether tax-neutrality will have to be sacrificed and the figure increased to achieve the national goal.
