I was sitting in a hot tub in Leningrad in the summer of 1990 when I realised the Soviet Union would fall.

There were five of us, in our backpacking hostel’s back room, in a makeshift tub.  The hot water poured in ceaselessly and poured out over the edge.  Brought up in a household where hot water was strictly rationed, I was moved to ask who paid.  And the answer of course was that it was free.  Free energy, so you could have as much as you liked.  In the meanwhile, the shops were empty, and the system was broken.  There were no economic signals to enable people to allocate resources correctly.

And this is the situation in which we find ourselves today with regards to carbon dioxide.  We fly to Spain for £20,[1] we use a plastic spoon for 5 seconds and throw into landfill for 500 years, we burn low-VAT gas in our homes and untaxed coal in our industries, and pay nothing for the pollution.  And society picks up the tab.  There is simply no way for us to understand and make the best use of carbon.  And this leads to a system which does not work to maximise the utility of our carbon usage.  We are all sitting in the carbon tub, the taps are open full blast, and we have no idea how to turn them off.

And yet the use of fossil fuels has a real cost in terms of both air pollution and global warming.[2]  The latest data from the Centre for Research on Energy and Clean Air[3]  indicates that 4.5 million people a year die as a result of the air pollution from fossil fuels, with a total cost of $2,900bn a year, 3.3% of global GDP, or $87 for each of the 33 billion tonnes of CO2[4] emitted by the energy sector.

Meanwhile, we are already seeing the effects of global warming:  longer wildfire seasons, increased flooding, stronger hurricanes, and millions of climate refugees.  All of this is happening at one degree of warming; as it gets hotter, the costs will only rise, making large parts of the earth uninhabitable, and reducing GDP per capita by 80% in South Asia, sub-Saharan Africa and Southeast Asia according to Burke.[5]   The externality cost of global warming (the Social Cost of Carbon) was calculated under Obama at $52/t for 2020,[6]  although Lord Stern argues that this approach fails to account for many issues and that the true cost is far higher.[7]

Add up health costs and global warming costs and you have a total annual cost of nearly $5 trillion, or $140 per tonne of carbon dioxide.  You might expect this cost to be taxed, but at a global level, fossil fuel taxes are nearly matched by fossil fuel subsidies.  The world gave the fossil fuel industry $428bn in subsidy in 2018 according to the IEA ,[8] while total direct and indirect taxes on energy were €517bn in 2018 according to the OECD.[9]  The OECD numbers are startling: 83% of all energy taxation is for the 15% of emissions that come from vehicles.  But we tax the remaining 85% of energy emissions at just €3 per tonne.  Flying and shipping are almost untaxed; industry and electricity pay €2 and € 1 per tonne of CO2.  The UK is better, but not by much.  We tax our road usage (a quarter of the total) at €262/t and everything else at €10/t.

It is not prohibitively expensive to tax carbon.  The average person in the UK emits 12 tonnes of carbon dioxide a year.  Tax that at say £30 per tonne (more on price below) and you are talking about £360 a year, or just over 1% of GDP.  Carbon taxation would add only pennies to the price of a coke or a sandwich.  And it is possible to implement carbon taxes without causing societal revolution; Sweden taxes 96% of their emissions,[10] and it regularly ranks as one of the best places to live.

So if we accept that there is a problem, the question is how best to solve it.  There are three main ways to tackle an externality – tax, subsidy and regulation.  At present we have a mish-mash of all three, the result of many compromises over the years, and no doubt some laudable ideas before we realised the gravity of the problem.  So the solution is the same as everywhere else in life: if you want to reduce usage and maximise the utility of what you have, you put a price on it.  The impact of a universal price with an upward sloping price curve should not be underestimated in a system which never thought to do this before.  You encourage people to cut usage, you drive businesses to find new solutions, you incentivise entrepreneurs like Elon Musk to come up with low carbon innovations.  The IMF calculates that a tax of $75 per tonne on carbon dioxide would save 725,000 premature deaths in 2030 in the G20, curtail emissions by 35%, and be the most effective tool to achieve the goals of the Paris agreement.[11]

The immediate and legitimate concern is that taxing carbon would be a regressive tax and that people will be out on the street to resist it.  Incumbents love to invoke the gilets jaunes as if this were a universal antidote that will save them from having to pay for their pollution.  But the gilets jaunes were protesting against poorly explained taxes on road transport where they were indeed already high; taxes on the rest of fossil fuel usage are low.  And there is a solution,  one being advanced by Ted Halstead in the US right now with the Baker Shultz carbon dividends plan.[12]  The solution is simple – you pay the money raised in carbon tax back to everyone as carbon dividends.  On the one hand, this encourages societal buy-in, because everyone can see the money as it hits their bank accounts; £90 per quarter cash up-front is a powerful motivator.  On the other hand, it is progressive because the poor spend a lot less than the rich on carbon.  The US Treasury Department calculates that the biggest beneficiaries would be the lowest decile of earners, with an 8% increase in income.  And for the richest decile it would reduce income by around 1%.[13]

The carbon tax should by definition be levied on every area of usage.  It makes no sense to tax one area and not another when that both distorts the system, sends the wrong message, and fails to provide the right economic incentives.  As we sat in our hot tub in Leningrad we ate caviar, recently arrived in a large consignment, and available on the black market for $10 for half a kg.  That is what happens when you have distorted incentives.

Some argue that carbon labelling will do the job instead.  Give consumers the right information and they will make the right choices.  The problem with this approach is that it is just too complicated.  Mike Berners-Lee takes a look at the issue,[14] and what is most striking is how complex it is.  According to him, a disposable nappy actually has a lower carbon footprint than a reusable nappy washed at 90 degrees.  And a strawberry eaten in January has a carbon footprint 12 times higher than one eaten in July.  Nobody can carry around all these numbers in their head, and they don’t need to.  We have a perfectly good system, called price.

There is scope for debate on the level of price.  Implementing the total cost of carbon of over £100/t immediately would be too aggressive.  To have a meaningful impact, you need a price of at least £20 per tonne, the level that pushed coal out of the UK electricity mix.  The right starting point is somewhere between these two, and the Baker Shultz plan for example is advocating a starting price of £30.  But they also have a ratchet mechanism over time, whereby the price rises by 5% above inflation.

The idea of carbon taxes is not new.  It has been the default solution of economists for years, and organisations such as the Carbon Pricing Leadership Coalition have done an excellent job of making the case for it.[15]  However, two things have changed in the last five years.  First the level of societal awareness of climate change has sparked much greater pressure for action.  And second, the price of the renewable alternatives has fallen dramatically and to below the price of energy from fossil fuels in the electricity sector and is about to fall below in transport.  We have options that we did not have before.  Emerging markets, lacking fossil fuels, swamped by pollution, and worried about energy security, have new ways to get their energy.  Renewable electricity is cheaper, cleaner, faster, and local; the emerging market energy leapfrog started in China, has spread to India, and is now moving to the rest of the world.  What this means is that it is now possible for politicians to have their cake and eat it.  They can increase taxes on carbon and improve the health of their constituents without necessarily increasing the prices to the end consumer.

This brings one further advantage to those countries which seize the opportunity.  They can get their societies ready for the new world of higher carbon taxes which are spreading round the globe.  Inefficiencies can be reduced, and systems can be reconfigured.  UK companies can find interesting new niches in the rising green economy and take advantage of them for global success.

Opponents of the tax like to present themselves as the champions of the poor and as defenders against the nanny state.  But it is the rich that burn the fossil fuels,[16] and the poor that suffer most from the global warming and the pollution.[17]  The average American produces 8 times as much carbon dioxide as the average Indian, but India is far more vulnerable to climate change.[18]  Moreover, to tax pollution is not a socialist idea but a very standard neoclassical tool, and one of the core functions of the state.  It was Mrs Thatcher who called for an international co-operative effort to tackle climate change.

Parts of the Conservative party are far too close to the various shameful climate deniers. [19]   They risk ceding the argument to those on the left who would love to use it to shoehorn in a series of more radical socialist solutions.    Anatol Lieven in his latest book[20] argues that the challenge of climate change is one that should force both sides to an accommodation.  The left needs to ditch its commitment to intersectionality, and the right needs to abandon its defence of uninhibited capitalism.  This problem is bigger than both of them.

The Soviet Union eventually collapsed because its leaders reacted too late to solve its internal contradictions.  The risk facing our own society is that it too will come under intolerable strain from global warming, and that the reaction will be very aggressive and late.  Far better to get our society and our businesses ready for a change that will inevitably come[21] than to keep our head in the sand and pretend the problem does not exist.  It is better to address this problem like adults and to have a real debate on the price, than to rely on our bureaucrats to engineer every more complex ways of charging carbon without offending people whipped up by fossil fuel propaganda.  This is at heart a very simple issue: unpriced carbon will destroy the market economy upon which rest our wealth and freedom.  It is time to change if we want to keep that market economy.


[1] Source: Ryanair website 11 March 2020 from London to Madrid in April

[2] To be clear these are separate costs and are looked at separately.

[3] Quantifying the Economic Costs of Air Pollution from Fossil Fuels, CREA, 2020.

[4] CREA calculate the costs for each of the main areas of damage, from particularates to ozone and NOX.

[5] Source:  Large potential reduction in economic damages under UN mitigation targets, Burke,  2018

[6] Technical update of the social cost of carbon for regulatory impact analysis,  United States government, August 2016.  At a 3%cost of capital, the cost is $42 in 2007 dollars, which is $52 in 2020 dollars.

[7] Source: The missing economic risks in assessment of climate change impacts, Stern, 2019.

[8] Source: Global fossil fuel subsidies, IEA, 2019

[9] Source:  Taxing energy use, OECD, 2019.

[10] Source: Supplement to effective carbon rates, OECD,  2018.  For emissions excluding biomass.

[11] Source: How to mitigate climate change, IMF, 2019.

[12] Source: Bipartisan climate roadmap, The Baker Schultz carbon dividends plan,  2020

[13] Source: US Treasury Department 2017.  Presented by the Bipartisan climate roadmap, 2020.

[14] Source: How bad are bananas. The carbon footprint of everything,  Mike Berners-Lee,  2010

[15] Source: The pricing advantage, Carbon Pricing Leadership coalition, 2019.

[16] The OECD accounts for 17% of the global population and 36% of CO2 emissions according to the BP Statistical review of world energy, 2019.

[17] Source: Socioeconomic disparities and air pollution exposure: a global review, Hajat et al, 2015

[18] Source: Climate change vulnerability index, Verisk Maplecroft, 2019.

[19] Source:  Big oil’s real agenda, Influence Map, 2019.

[20] Source:  Climate change and the nation state, Anatol Lieven, 2020.

[21] Source: Avoiding the Storm, Bank of England , 2019.  Or The Inevitable Policy response, UNPRI, 2019


A version of this piece was posted to the The Institute of Economic Affair‘s website on 6 April, 2020.