Carbon Comes At A Cost

One of the aftermaths of the Covid-19 breakout is the dropping air pollution levels due to stoppage of industrial activity. However, the economy is fast recovering and the second wave will be soon behind us, recommencement of polluting activities will be done more aggressively than ever and unless strong action is taken, it will prove disastrous for the environment, hence the need for active de-carbonization. India is way ahead in achieving its UN Framework Convention on Climate Change target of meeting 40% of its electricity supply^[3] from non-fossil fuels by 2030 and is investing heavily into solar and wind energy. The country should adopt a bullish approach in its efforts to reduce carbon footprint and aim towards a no-carbon economy by 2050. However, we must also recognize that any efforts by India to contain its emissions would have implications for poverty alleviation & growth efforts. Therefore, from an equity perspective, the world must look at cumulative carbon emissions by various countries since 1960s. This would provide a comprehensive picture of the extent of ecological damage as an outcome of the industrialization process – and can be used to put in place a mechanism for transfer payments which offset the developmental costs of cutting emissions in developing countries.

One of the most effective ways of achieving the above goal is carbon pricing. The World Bank describes carbon pricing^[4] as 'putting a price on carbon' to bring down emissions and drive investments into cleaner options. Carbon pricing takes the 'external cost' of carbon emissions into consideration and follows the 'polluter pays' principle. The external costs are the costs borne by the public due to these carbon emissions and the subsequent environment damage that include increasing health care costs, agricultural losses, loss of life and property caused by natural disasters such as heat waves, floods, droughts, rise in sea level etc. Putting a price on carbon makes the people responsible for these external costs, liable for them. The state allows the people to make an economic decision as to how to spend their resources- they can either reduce their emissions and discontinue their polluting activity or continue their polluting activity and pay an exorbitant price for it. In this way, the market is regulated with minimum interference and at a low cost. This will also lead way for greater innovation in technology that is clean and non-polluting so that they can save money without reducing the scale of business.

There are various ways in which price can be put on carbon. Carbon tax^[5] is a method in which a price is set directly on carbon by putting a definite tax rate on the carbon content of fossil fuels, i.e. a price per tCO2e. The International Monetary Fund^[6] describes it as the 'single most powerful way' to combat climate change. The primary rationale behind carbon tax is that it is an effective tool through which domestic emission mitigation can be met. The taxes increase the price of key resources such as fossil fuels, electricity, general consumer products and for fuel producers- they lower their returns. In turn, they force the industries to shift to lower carbon producing methods to save on their taxes. This can be highly beneficial for the local environment of the places these industries are located. Carbon Taxes can also be a great source of revenue for developing countries like India. These funds can be further used to develop in cleaner-energy infrastructure which requires huge investments to meet other United Nations Sustainable Development Goals. In a country like India, where implementation of complex policies has always remained a challenge, carbon tax does not pose a great threat. It can be integrated in the existing tax and excise system and can be easily administered. This can be seen by examining Canada's successful imposition of the carbon tax. In 2018, Canada^[7] under the Greenhouse Gas Pollution Pricing Act, introduced a revenue-neutral carbon tax, to fulfill its Paris commitment of cutting its carbon pollution by 30% below 2005 levels by 2030. It was feeling the impacts of climate change through factors like "coastal erosion, thawing permafrost, increases in heat waves, droughts and flooding, and related risks to critical infrastructures and food security", hence intervention was necessary. The new carbon tax policy reduced their greenhouse gas pollution by approximately 80 to 90 million tons by 2022. To reduce the negative impact of increasing energy costs to its citizens, it rebated the revenue to the households, which in turn can boost the economy as disposable income with households will increase^[8]. If India imposes a carbon tax, the fiscal gains will be significant. A carbon tax at $35 per ton of CO2 emissions can generate around 2% of the GDP through 2030^[9]. China is also expected to take advantage of the same as an internally recommended price of $40 per metric ton could generate 14% additional revenues. It is in India's best interest to formulate a carbon tax policy soon, especially to deal with the aftereffects of the Covid-19 massacre.

Another way of carbon pricing is installing an Emissions Trading System^[10]. An Emissions Trading System creates a marketable instrument called 'emissions units' which the emitters can trade to meet their emission targets. They create incentives for emitters to reduce emissions where it is cost-effective by setting up a 'cap' on the maximum level of emissions and creates permits, or allowances for each unit of emissions allowed under the cap. The permits can be obtained from the government (the government might give it for free or auction them) or by trading with other firms. Hence, it is also known as the 'cap and trade' system. Firms that fail to possess the required numbers of permits can either cut back on their emissions or buy permits from another firm. Some firms might find it cheaper to invest in cleaner technologies than to buy permits and those who manage to reduce emissions below the average level, can even sell them in the market. Hence, the permit market follows the principle of demand and supply and the market price of these permits will fluctuate. Permits will become expensive when the demand is more than the supply, when the economy is growing robustly, which might happen once the Covid-19 crisis is over and become cheap when the demand is less than the supply. The 'cap and trade' process seeks to ensure that there is a unique price for all the firms in the market and the emissions are driven down to the level allowed under the cap-cost effectively. However, in practice, this may not work as efficiently as power markets are often fully or partially regulated and some power market structures may weaken the carbon pricing mechanism, bringing down the system's effectiveness.

The European Union emissions trading system, commonly known as the EU ETS^[11], is currently the largest trading system in the world. It has operations in all the twenty eight EU member states plus Iceland, Liechtenstein and Norway, covering around 45% of EU's greenhouse gas emissions. It limits emissions from more than 11,000 heavy users of energy, which include airlines, power stations and industrial plants, operating between its member countries. It is reported by the World Bank's State and Trends of Carbon Pricing (May 2018) that there are 51 implemented or scheduled carbon pricing initiatives in the world, including ETSs in several US states, Canadian provinces, and in Switzerland, New Zealand and South Korea. In 2017, China launched a major national emissions trading scheme and with which it aims to become the largest ETS in the world. The value of the current carbon market is USD 277 Billion and the average price of allowances in the European Union is Euro 35/ton.

India should develop an Emissions Trading System which is in line with its other greenhouse gas mitigation objectives and is consonance with its Nationally Determined Contribution to the Paris Agreement on climate change. The country should follow a top-down approach while setting the trading system so that it aligns with its other initiatives to combat carbon emissions. However, in theory, an ETS can hamper with the competition in the industry, leading to lesser investment and job losses. It may also bring down international investment in the country as investors may prefer jurisdictions which have less stringent emissions reduction laws, giving birth to 'carbon leakage'. The country while developing the trading system should keep these concerns in mind and design features that aim at reducing the extra costs imposed on some industries. One way of doing so is transparent and careful identification of industries with highest risks of carbon leakage and competitive concerns, estimating the associated costs and providing them free permits. Then, they can gradually phase down to auctioning- which would help rectify potential market distributional distortions, generate revenue, and increase the mitigation effectiveness of trading systems. The Emission Trading System in India should be simple, transparent, flexible and stable to meet the country's demands.

As experience shows, climate change can be expensive. Studies say that there is a huge possibility of global average temperatures rising by 2 degree Celsius^[12] by the end of this century, leading to frequent natural calamities such as floods and cyclones, ecological degradation, deforestation, and decline in agricultural produce, which will have huge repercussions of the economy. A large increase in global temperatures correlates with an average 5% loss in global GDP, with poor countries suffering the most. There is a need for immediate policy intervention to reduce carbon emissions and mitigate the effects of climate change. It is cheaper and safer to take preventive action by putting a price on carbon and slowing global warming than to pay for increasingly extreme weather conditions and the aftermaths of the disasters they bring.

A rising economy like India, which is the third largest annual emitter of carbon, should use its power of being a large buyer in international trade and impose carbon pricing mechanisms as envisaged by the EU. It should keep both the environment and trade in mind while finalizing such policies as reducing the domestic carbon content of production won't be sufficient if imports remain carbon-intensive. Hence, it should maneuver international diplomacy and establish a climate coalition with other countries, in line with the Paris Agreement a design a policy in India's best interest to tackle climate change.

Views are personal.

[1]https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement