Paying for Climate Change with a Carbon VAT

Taxation is a form of insurance where the benefits are inverted.  The intention is that these transfers be investments allowing the poor to improve their prospects and, eventually, become tax-payers.  The reality is that, in most countries, the poor are not so mobile and cash transfers are not so much investments as entitlements.

As politicians incrementally shift the tax burden up the income brackets they include more people as net beneficiaries and fewer people as net payers.  The credit crisis hurt governments so badly because, not only were banks destabilised, but their employees are the high-net-worth individuals who form the bulk of the tax-base.  As banks crashed so did tax receipts.

Such regressive taxation may be popular but it is as dangerous as demanding that a chronically obese, but evidently wealthy, person pay the bulk of everyone else’ health insurance.  Should that man have a heart attack the insurance scheme would lose its biggest payer and have to pay for his treatment.

The problem for climate change debaters is that the extent of the potential damage is very hard to quantify.  The impact is also likely to be asymmetrically distributed; poor countries may be affected more than rich countries and will have fewer resources with which to deal with the problem.

With complex risks, asymmetric impacts and varying needs it makes absolute sense to pool this risk and share the costs amongst as many people and countries as possible.

The obvious way to pay for it is to put a price on carbon dioxide (the primary cause of warming) and so let producers find a way to reduce emissions. 

One way of doing this is “cap and trade” where a fixed level of carbon dioxide will be set and then companies can trade emission allowances for the rest.  The problem with this approach is that no-one can agree on the cap or on how rapidly it should be imposed.  It also allows lobbyists to plead special cause for why their industry should get a preference cap. 

These sorts of fudges are popular with politicians because they fear the reactions of their voters.  Consumers want companies to absorb the costs without passing these on in higher prices.  This is a bit like wanting to enjoy your cake but for the baker to get the calories.

Countries that want to go it alone are limited by the fear that companies will simply move production to countries without such costs.  Conversely, exporting companies are worried that border tariffs will result in anti-competitive protectionism.

All these concerns are valid. 

Most countries want the wealthiest nations to pay.  Within those countries, consumers want the wealthiest companies to pay.  This, like the tax structure, will create tremendous risk if those few companies couldn’t bear the burden.

What must be made clear is that consumers must pay for carbon dioxide produced as a result of their consumption.  Giving subsidies to the worst polluters so that they can keep their prices low will not promote alternative technologies.  Neither will it confront consumers with the financial consequences of their choices.

The best solution for a tax on consumption is Value Added Tax.  VAT only applies to goods consumed within a single market.  It does not apply to production and a carbon VAT would apply only to the amount of carbon dioxide created for a specific good.

Tax officials already have clear guidance on how to deal with imported goods which fail to declare their value so that tax can be levied.  Exporters will not be adversely affected as their exports will be VAT exclusive.  Countries which import these goods can decide on their own carbon tax policies.

As long as the basis for these calculations is transparent and affects all companies equally, whether local or foreign, it will also allow countries to impose carbon taxes unilaterally without waiting for global agreement.