The future of carbon pricing in the UK

The UK government has set itself an unprecedented challenge in legislating to reach net-zero greenhouse gas emissions by 2050, the first major economy to do so. It now faces the task of actually reaching that goal – tougher targets do not themselves reduce emissions. Yet as the UK is also in the process of leaving the European Union (EU), its participation in the country’s main carbon pricing mechanism – the EU Emissions Trading System (EU ETS) – is at risk. This is a significant plank of UK climate policy, so ensuring a smooth transition to alternative arrangements is critical in order to avoid jeopardising achievement of the net-zero target.  

Which pricing scheme?

While the preference of the UK government is to continue pricing carbon through the EU ETS or a domestic emissions trading scheme linked to the EU ETS, rather than a carbon tax, a ‘no deal’ scenario would change these options. In such an eventuality, the UK government will initially meet its existing carbon pricing commitments via the tax system, which would take effect from 4 November 2019 – assuming no further delays with the Brexit negotiations. Such a move would represent a significant departure from current UK policy. Under the government’s no-deal planning, the tax will apply to all entities currently participating in the EU ETS. A rate of £16 would apply to each tonne of CO emitted over and above an entity’s emissions allowance, calculated based on the number of free allowances previously held under the EU ETS.

With this in mind, in the policy brief Global Lessons for the UK in Carbon Taxes we highlight what design elements contribute to the successful implementation of carbon taxes.  

Differences in tax design

The experience of countries such as Norway and the UK show that a carbon tax is effective in reducing emissions, but the scale of emissions cuts depends on the proportion of greenhouse gas emissions that are covered and the price level. Our research shows both of these dimensions vary considerably between countries that tax carbon. For example, in terms of coverage, 70% of greenhouse gas emissions are covered by the British Columbia carbon tax in Canada, in contrast to France’s scheme, which covers just 35% of emissions. Price levels also vary widely, with Poland’s carbon tax set at just £0.06 per tonne of CO2, while Sweden sits at the other end of the spectrum at £100.30 per tonne.

Carbon taxes have been shown to succeed when they are designed transparently and with fairness in mind. British Columbia introduced its carbon tax in 2008 and by 2011 public support for the tax had increased to over 50%. The tax has reduced emissions by 5–15%, with negligible impacts on the economy. Its success is due particularly to:  

• Slow phase-in and raising, to give businesses and households time to adjust  
• Giving all revenues back to low-income households and trade-exposed industry  
• The Ministry of Finance communicating the use of the revenues clearly and transparently  

Lessons from abroad

However, taxing carbon can be challenging on several fronts. First, a lack of cross-party political support can hinder efforts to set a long-term price signal; this happened in Australia where a change of government saw the country’s carbon tax repealed after two years, despite it reducing emissions.

Second, a lack of public support can arise from tax increases that are perceived to be too high or otherwise unfair. The French Gilet Jaunes movement arose in part due to the poor design of the French carbon tax, which was coupled with tax rebates for high-income households.

Third, success rests on ensuring major emitters pay for their emissions. However, while the phase-out of coal power in the UK has been attributed in large part to the carbon price support, the large number of exemptions from carbon pricing among major industrial entities have seen limited emissions reductions in that sector. For transboundary industries such as aviation, an effective tax requires international agreement, which often results in a lowest common denominator approach.  

A pragmatic approach is crucial

For carbon pricing to continue to be successful in the UK, there are lessons that can be learnt from British Columbia. Careful communication, gradual scaling up and transparent earmarking of tax revenues, including for disadvantaged households and businesses, are crucial.

But deep decarbonisation in the UK also requires a pragmatic approach to carbon pricing. The level of pricing that is politically feasible is likely to differ by sector. The availability of zero-carbon solutions, their costs, their public acceptability and the political economy background in which they are proposed will differ. Therefore, varying the tax level across sectors may be necessary. Departing from the uniform carbon price across firms and fuels (which is advocated by economic theory) is a major concession to pragmatism – a viewpoint echoed by Joseph Stiglitz, who recently championed a departure from the recommendation of a single carbon price for all uses in all 
places and times.

The UK’s future carbon price needs to be ambitious, but political realities and the significant technological and behavioural change required across the economy mean a carbon price on its own will not be enough. Complementary policies aimed at innovation and behavioural change, tailored to each sector of the economy, will be needed if the UK is to reach its net-zero target by 2050.  

By Joshua Burke, Policy Fellow, and Rebecca Byrnes, Policy Analyst, Grantham Research Institute

Picture Credit | Getty