Yes, carbon taxes work. But that doesn’t mean they’re fair

One of the more controversial tools available in the fight against climate change is carbon taxes. Proponents argue that these discourage the use of fossil fuels, shifting us instead to cleaner technologies.

Opponents claim that in the absence of alternatives to fossil fuels, carbon taxes do nothing to reduce emissions and merely inflict extra unjustified costs on the poorest households. Opponents often recommend subsidising cleaner technologies rather than taxing carbon. In other words, carbon tax is a stick and instead we should use a carrot. Who is right?

My answer is that, in fact, the carrot-and-stick idea represents a misunderstanding of what a carbon tax is supposed to do. Some taxes, including carbon taxes, are indeed intended to change behaviour – but this does not mean we should characterise such taxes as a stick. Rather, they provide a way to reveal privately-held information from different stakeholders in society.

The only choice we have is who bears the cost of climate change, or (far preferably) the cost of stopping it

The idea of using prices to reveal and gather information is generally unfamiliar to non-economists. In this case, it stems from the fact that there is a cost to emitting carbon as those emissions cause global warming. The cost in this case does not refer to a monetary burden per se, but simply to the fact that we would rather climate change not happen and would pay money to stop it, if that were possible.

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Society has no choice in whether this cost exists. The only choice we have is who bears the cost of climate change, or (far preferably) the cost of stopping it.

The reason carbon taxes are so powerful is that some people can avoid emitting carbon more easily than others. However, it is often unclear who those people are, as the costs and benefits of emitting carbon for each household or business are private information. By putting a price on carbon, we allow that private data to become public information. In this way, we move information around society.

To understand how, consider two different businesses, a pharmaceutical factory and a teapot shop, both of which emit carbon. The pharma factory can buy a more efficient machine, which will cost €40,000 and will save 500 tonnes of carbon. This machine, therefore, can abate carbon at a cost of €80 per tonne. The teapot shop, on the other hand, can invest in solar panels, which will cost €8,000 and save 40 tonnes of carbon. This will abate carbon at a cost of €200 per tonne.

If we set a carbon tax at €100 per tonne, the factory will invest, as they are better off buying the new machine than paying the carbon tax. The teapot shop won’t invest at this point, but may in the future, if the price of carbon is high enough. A carbon tax guides both businesses and society to the right solution: we have saved carbon at the lowest cost.

If, instead, the government decides to subsidise solar panels but not new pharma machines, the teapot shop will get solar panels, saving 40 tonnes of carbon – but the factory will continue to pump out carbon using their machine.

Extrapolating from the two-business-two-technologies example, we can see that there are hundreds if not thousands of ways of abating carbon. The costs and benefits of each are different from household to household and so there is a wide range of abatement costs of carbon.

The Irish tax and welfare system is perfectly placed to compensate households most affected by carbon taxes

Far from being no more than a simplistic stick with which to beat people, carbon taxes are an extremely powerful way of unifying all these costs and benefits into one societal solution. They allow those with a low abatement cost to reduce carbon emissions, and those with a high abatement cost to continue emitting, for now. By gradually increasing the carbon tax over time, more and more people shift from the latter category to the former category.

None of this is to say that carbon taxes alone will solve the climate crisis. The arguments above show that carbon taxes are efficient, but this does not mean they are fair. They must therefore be accompanied by other policies to ensure fairness. The Irish tax and welfare system is perfectly placed to compensate households most affected by carbon taxes, and numerous academic studies have been carried out in Ireland and internationally showing that carbon taxes, when accompanied by a package of taxation and welfare measures, leave the poorest households better, not worse, off.

Second, in order for carbon taxes to work, people must be able to invest in alternative technologies. These often have a large up-front cost. For this reason, grants and loans are required to ensure that those for whom abating makes economic sense right now can invest. Progress has been made on this front, but more is required. Finally, the non-financial barriers, such as behavioural barriers, to climate action require greater understanding.

Carbon taxes reduce emissions – the empirical evidence backs this up. Proper compensation ensures that they do not impose unduly on households or businesses. Simplistic carrot-and-stick analogies miss the point and the power of carbon taxes: they are a necessary, but insufficient, tool in the fight against climate change.

• Muireann Lynch is an economist at the Economic and Social Research Institute