Is a carbon price a conservative solution to climate change?

Last weekend, the Financial Times reported that a number of large energy generators have been lobbying the Treasury to retain the UK’s carbon price. It might seem counter-intuitive that Drax and SSE, who themselves have to pay the tax, are advocating its retention. But businesses like a stable and predictable policy framework in which they have the confidence to invest. A long-term trajectory for the carbon price can provide that.

Carbon pricing puts a charge on fossil fuel users for every tonne of carbon they emit into the atmosphere. It is advocated by many on the centre-right as a market-based mechanism for reducing emissions and tackling climate change. It sends suppliers a clear signal to invest in clean energy, fully prices in the social cost of carbon emissions, and leaves markets to find the cheapest clean energy solutions. But the system has its critics. They point to the financial impact on consumers, arguing it raises household bills for low-income groups and harms business competitiveness.

The UK’s carbon tax regime

There are two principal mechanisms for pricing carbon in the UK: the EU’s Emission Trading Scheme (ETS), and the UK’s domestic Carbon Price Support (CPS). Sector-specific taxes, such as Air Passenger Duty (aviation) and Fuel Duty (road transport), could also be viewed as carbon taxes.

The EU’s ETS provides countries with a limited number of carbon permits that allow them to emit a certain amount of CO2. Those permits can be traded, creating in effect a market that sets the price of carbon. This is an example of a ‘cap-and-trade’ scheme. ETS is widely regarded to be failing and in need of reform. Between 2008 and 2013, around a year’s worth of allowances were accumulated across the EU, creating an oversupply and depressing the price of carbon. As a result, the scheme has failed to drive any meaningful carbon abatement. Moreover, the UK’s continued membership of the EU’s ETS is now uncertain, following the result of the EU referendum.

To increase incentives to invest in low-carbon generation, the previous Chancellor George Osborne announced a domestic ‘top-up’, the Carbon Price Support, in the 2011 Budget. Unlike the ETS, this is a straight ‘carbon tax’, and is levied on users of fossil fuels in the power sector. It came into force in April 2013, and was set to rise each year. In the 2014 Budget, the CPS was frozen at its 2016/17 level (£18 per tonne) until 2019/20, in response to political pressure over high bills. A decision is expected in next month’s Autumn Statement on the future of the policy.

The future of the Carbon Price Support

The person who will be announcing this decision, the new Chancellor Philip Hammond, has previously given strong support to a carbon tax. As Foreign Secretary, he gave a speech to the American Enterprise Institute in November 2015, saying that putting a price on carbon “is completely in line with conservative economic values”.

However, there is a significant coalition lined up against carbon taxes, and lobbying to scrap it will be intense. Some have drawn attention to the regressive nature of carbon taxes, pushing up the bills of those who already struggle to heat and power their homes. During the steel crisis, carbon taxes came under fire for increasing production costs of ‘energy intensive users’. This case was overstated: a Carbon Brief analysis showed that once the government’s compensation scheme was taken into account, less than 1% of the production costs of steel were caused by climate policy.

Some suggest overcoming these negative effects by making carbon taxes revenue-neutral. The tax receipts from carbon taxes could be spent on compensating low-income households and energy intensive users. While this would probably boost public support for carbon taxes, it would have to be funded by additional tax rises or spending cuts, as carbon tax revenue is currently spent elsewhere. It would also complicate the tax system by introducing more hypothecation, to which the Treasury is historically averse.

David Cameron’s former energy advisor recently wrote in a blog post that he favours reducing the CPS once coal-fired power stations have been phased out. He argues they add unnecessary costs to businesses and fail to provide investor certainty because of the abundance of cheap fossil fuels. In reality, the Contracts for Difference, which is his preferred tool for encouraging low-carbon energy, also add costs to bills by guaranteeing a fixed price to generators of low-carbon power. Moreover, the overall costs of these Contracts for Difference would increase if the CPS was removed.

Aurora Energy Research believe that the CPS can be removed given that coal-to-gas switching in the power sector is already well progressed, with the coal phase-out completed by straightforward regulation. They find that EU-wide emissions would fall in the medium-term, as the UK would import less coal-powered electricity from overseas via interconnectors and so generate more power through its own newly built gas plant. However, they add significant caveats that the UK’s own emissions would increase and that there could be a long-term impact on investment in renewables and other low-carbon electricity.

Carbon taxes are clearly not a perfect policy tool. Nor are they the only policy required to decarbonise the economy. A recent OECD report found there was a sizeable gap between the real price of carbon and the level of carbon taxes around the world. With the Paris Agreement likely to come into force before the end of the year, this gap can be expected to narrow. Countries like France are already considering increasing a unilateral carbon tax.  

If the UK does scrap the CPS at the forthcoming Autumn Statement, the government will need to assess carefully the impact on clean energy investments. The biggest long-term threat to UK competitiveness and living standards is failing to be a world-leader in low-carbon technologies.

Sam Hall is a researcher at Bright Blue