Carbon tax can signal emerald isle is becoming greener

ECONOMICS:The economy will grow faster if revenue from a carbon tax is used to reduce labour costs, writes RICHARD TOL

THE COMMISSION on Taxation proposed a number of tax reforms. Ofthese, only a carbon tax seems likely to be introduced on January 1st, 2010. This would be a positive move for the environment and the economy.

There are good reasons for a carbon tax. It will do little to slow global warming. It will not turn Ireland into an international hub of green innovation, but that is not the point. Climate change is a global problem and, as a good global citizen, Ireland should do its bit, however small, to help solve it.

A carbon tax will not reduce emissions by much at first but over time they will be cut more. The reason for this is simple.

People do not buy a new car or move house because petrol is a few cents more expensive, but if petrol continues to be expensive, they will buy a different type of car when the time comes to change cars and they will move to a place closer to a train station or to work when the time comes to move home.

Businesses will not immediately change their behaviour either, but they will over time.

If they believe the carbon tax is here to stay, companies will bring new energy-saving products to the market and invent more efficient products.

A carbon tax may not reduce emissions by much in the short term but neither does any other policy. It is, however, the cheapest way to reduce emissions.

If other policies seem cheaper, that is because the costs are hidden or borne by someone else. Emission cuts are cheapest if all emitters pay the same price – and a carbon tax is the easiest way to ensure they do.

Some emissions are already covered by the EU cap-and-trade system. The Commission on Taxation rightly proposes that these emissions should be exempt from the carbon tax and that the carbon tax should be equal to the cap-and-trade permit price, so that all emissions are treated equally.

The positive effect of a carbon tax on climate policy is that it signals, to Europe and to the world, that Ireland has moved forward. Only a few countries have a carbon tax, so it could be a powerful symbol – particularly as the emerald isle is not known for being green.

Fiscal policy is the main reason to introduce a carbon tax. The Irish tax system has a narrow base. A few activities pay for most of the tax take. This is unfair. It is also bad for the economy, as lightly taxed activities grow unhealthily large.

The Irish tax system is also volatile. This fuelled the boom and now worsens the recession.

A carbon tax is broad and steady. It is therefore one of the better ways to raise revenue without harming economic growth. If the revenue from a carbon tax is used to reduce labour costs, the economy would grow faster.

Business organisations often argue that high energy prices hurt the international competitiveness of Irish industry. This is nonsense. High labour costs hurt competitiveness. Business lobbyists prefer not to mention this because high labour costs mean high wages for them. If energy costs go up but labour costs go down, Ireland will export more.

Employers’ body Ibec argues that part of the revenue from a carbon tax should be used to subsidise energy efficiency in companies. This is silly. Companies would benefit more if labour costs were reduced.

Besides, the expected revenue of a carbon tax is €400 million a year. A quarter of that revenue would buy gold-plated insulation with fat salaries for consultants on top.

Furthermore, energy efficiency is already stimulated by higher fuel costs. Double regulation of energy efficiency would be acceptable if the carbon emitted by companies would heat the planet twice as fast as other carbon. It does not. Carbon dioxide is carbon dioxide.

A carbon tax would mean many subsidies for energy-efficient home improvements could be abolished. This would save the exchequer another €100 million a year.

The reasoning is the same for households as for companies. A carbon tax would stimulate energy efficiency. There is no need to do this twice.

A carbon tax would not hit everybody equally and two groups in particular stand out. Such a tax would increase the price of fuel for transport and home heating. The average household spends much more on transport than on heating. Consequently, a carbon tax hits commuters.

Long-distance commuters are hit hardest because they tend to drive bigger cars. Households in the commuter belt could pay more than €275 a year in carbon taxes, while those in the city centre could pay less than €25.

The other vulnerable group is the poor. They spend a larger share of their income on heating than anyone else, partly because they often live in old, poorly insulated houses with decrepit heating.

A carbon tax would cost the poorest households more than 2 per cent of their income, while the richest would lose less than 0.5 per cent.

An increase in benefits and tax credits would compensate households across the income distribution. This can be financed easily from the carbon tax revenue, meaning the negative side-effects of such a tax can be remedied.

Richard Tol is with the Economic and Social Research Institute in Dublin and the Vrije Universiteit in Amsterdam