Carbon tax essential for decarbonising our economies

Emissions trading scheme ran aground when recession made permits worthless

Emissions build-up: In 1992, the EU proposed a tax on emissions which would have risen over time. If it had been introduced as planned, emissions would be much lower than they are now. Photograph: John Giles/PA Wire

Emissions build-up: In 1992, the EU proposed a tax on emissions which would have risen over time. If it had been introduced as planned, emissions would be much lower than they are now. Photograph: John Giles/PA Wire

 

A decade ago, as part of its commitment to tackling the problem of global warming, the European Union introduced a scheme to force a reduction in emissions of greenhouse gases from electricity generation and heavy industry. This policy instrument is the emissions trading scheme.

The scheme sets an upper limit on European emissions of greenhouse gases from all firms it covers, and the limit declines over time. Firms are either allocated an allowance or can buy an allowance on the open market. Either way they must have allowances to cover all of their emissions. This ensures emissions fall in line with the limits enshrined in law.

In 1992, the EU proposed a tax on emissions which would have risen over time. If it had been introduced as planned, emissions would be much lower than they are now. However the scheme was opposed by many firms and by a number of countries including Ireland. The then Irish government felt any attempt to agree a harmonised tax, such as a carbon tax, could threaten our corporate tax regime.

The emissions trading scheme, as implemented by the EU, has not worked well, even though the limit on emissions has been observed. The problem was that, because of the great recession, emissions fell faster than expected. The result was emissions permits became almost worthless. This outcome had two consequences.

Firstly, it meant Europe could have cut emissions a lot more at a relatively low cost. However, because of the way the scheme worked, any outperformance by one country would have just made life easier for other EU countries, leaving greenhouse gas emissions unchanged.

If, instead, there had been a carbon tax, all firms would have had an incentive to do even better and we would now be further along the essential path of decarbonising our economies.

Secondly, many countries and many firms believed the scheme would have resulted in a high and rising price for carbon. As a result, they planned to shut coal-fired plants and invest in renewables, or at least invest in gas-fired electricity generation, to reduce emissions (gas produces less greenhouse gases than coal). The out-turn has been that many such investors have lost money because the price of polluting has turned out to be low.

Failures

These twin failures have resulted in a loss of faith in the scheme. Companies across Europe, because they have no certainty that the price of polluting will rise, have reduced investment in clean technologies and are even investing in some new coal-fired electricity generation, adding to greenhouse gas emissions.

To try and counter this loss of confidence in the emissions trading scheme and to encourage investment in clean technologies, the European Commission has agreed a complicated scheme which would involve a “reserve” of emissions permits that would be varied in size to try and maintain an appropriately rising price. However, given the failure of the current scheme and the complexity of the proposed remedy, companies remain uncertain as to whether investing in clean technologies makes sense.

To try and counter this uncertainty and relaunch a drive to decarbonise the electricity sector, the French government has suggested the EU scheme be amended to include a minimum or floor price for greenhouse gas emissions. The floor price should begin at a sufficiently high level to encourage substantial investment in clean technologies, and it should rise over time to help move the European economy on to a sustainable path. This suggestion would encourage more rapid investment in clean technologies across the EU.

For this reason the Irish Climate Change Advisory Council, of which I am chairman, has advised the Government that a proposal to introduce an EU carbon floor price should be supported as it would give greater clarity to investors. A higher EU price for carbon would also encourage further investment in renewable forms of electricity generation.

While a higher price for carbon would raise electricity prices across the EU, also encouraging increased energy efficiency, the increase in prices in Ireland would probably be lower than in countries that depended more on coal-fired generation: the UK, Germany, Poland and Spain. In the Irish case, the investment in the last 15 years was mainly in gas rather than in coal because investors believed coal would have been penalised by the emissions trading scheme. Hopefully any change in policy will relaunch the EU economy on a path towards decarbonisation.

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