To face social and environmental problems generated by fossil energies, market-based solutions have emerged to tackle these challenges on a broader scale. These proposals are often also framed as a “green” approach to economic growth. They include e.g. regulatory disincentives for emitting CO2 through a form of carbon pricing or more specifically, emissions trading systems (ETS) and carbon taxes. Although their rationale sounds adequate, their design and implementation are flawed from different points of views and subsequently result in a minimal decrease of CO2 emissions. The following analysis will focus on the main causes of this (political) deficiency with a focus on Latin America. Maximiliano Proaño has the details.

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 The role of carbon pricing

Carbon pricing has been defined as: “an instrument that captures the external costs of greenhouse gas (GHG) emissions—the costs of emissions that the public pays for, such as damage to crops, health care costs from heat waves and droughts, and loss of property from flooding and sea level rise—and ties them to their sources through a price, usually in the form of a price on the carbon dioxide (CO2) emitted”. The two more common carbon pricing approaches are emissions trading system (ETS) and carbon taxation. ETS is “a system where emitters can trade emission units to meet their emission targets”. A carbon tax “directly sets a price on carbon by defining an explicit tax rate on GHG emissions or—more commonly—on the carbon content of fossil fuels”, according to a definition by the World Bank.

As the World Bank assesses in the same dashboard, carbon pricing is an extensively used instrument in Europe. However, only 30 countries around the world have adopted any model of carbon taxes and 31 countries have ETS. In Latin America, only Argentina, Chile, Colombia and Mexico have a carbon tax, and none use ETS.

National tax systems can play an important redistributive role either to generate incentives to certain economic activities or to discourage others, for example when these activities produce economic, social and/or environmental negative effects. However, in the case of the carbon taxes, the majority of the few countries which apply them in Latin America have set a very low tax rate. That way, they clash with their original intentions and do not actually discourage economic activities that are high in CO2 emissions, coming for instance from burning fossil fuels in thermoelectric plants. As stated by Joseph Stiglitz and Nicholas Stern, co-chairs of the High-Level Commission on Carbon Prices, adequate carbon taxes are key for a successful implementation of the Paris Agreement. According to them, the price of coal should fluctuate between US$40-80 per ton of CO2(tCO2e) in 2020 and US$50-100/tCO2e in 2030. Analysts from the International Monetary Fund have stated that “a carbon price floor of $50 and $25 a ton in 2030 for advanced and developing G20 countries respectively would reduce emissions 100 percent more than countries’ current commitments in the 2015 Paris Agreement on Climate Change”.

 

Carbon taxes in Latin America

Taking a closer look at carbon taxes in Latin America, one has to acknowledge the sobering level of the current rates: Argentina US$6/tCO2, Chile US$5/tCO2, Colombia US$4,24/tCO2 and México between US$0,38/tCO2 and US$3/tCO2. These prices place Latin American countries in the group with the lowest rates and far from what is recommended to meet the goals of the Paris Agreement on Climate Change. At the other end of the spectrum, some European countries have rates going as high as in the case of Sweden (US$119/tCO2), Switzerland (US$99/tCO2) and Finland (US$68/tCO2 for transport fuels and US$58/tCO2 for other fossil fuels).

In these cases, carbon taxes have gained significant relevance and become a primordial aspect to consider when weighing policy options targeted at reducing CO2 emissions. However, in many countries the regulatory frameworks of carbon taxes include offsets and exemptions specifically for fossil fuels. This in turn highly affects their effectiveness and impact on CO2, making them much weaker in terms of a climate mitigation tool.

The Argentinian carbon tax was implemented in 2017 and applies to liquid and solid fuels, but not to natural gas. In the case of Chile, an offset mechanism was established for those generating units whose total cost of unit is greater than or equal to the marginal cost. This offset mechanism must be paid by all generating companies that inject electricity into the system, thus including electricity generators using fossil fuels as well as those using renewables. In 2019, the carbon tax collection was US$210 while the total amount to be compensated was US$29 million. Colombia has had a carbon tax since 2016 which does not apply to coal and natural gas unless used by refineries or the petrochemical industry. The carbon tax in Mexico applies to fossil fuels, including when used to generate electricity, however, natural gas is zero-rated under the CO2 tax.

But it is not only the low rate of the carbon tax and the problems in its design in the different countries that have been criticized. Also its actual effectiveness in reducing emissions has been questioned even in the countries with the highest rates. At an earlier implantation stage of the tax, Finland had obtained moderately positive results in reducing emissions, but countries such as Sweden or Denmark saw practically no reduction in their CO2 emissions. Later, Sweden redesigned and increased the tax, which generated a 6% decrease in emissions, mainly from the transport sector.

In a nutshell, the impacts of a carbon tax in different countries stem mainly from the rates set, the scope of the tax exemptions as well as the use given to the tax revenues. Nevertheless, carbon taxes alone are not sufficient to address the enormous challenge posed by climate change but, if properly designed and implemented, they can play an important role in reducing CO2 emissions and accelerating the processes of decarbonization of countries’ energy matrices. However, the real challenge is to acknowledge that the energy transition is not only about replacing fossil fuels with renewables, but in a much more complex process that contests the way energy decisions have been made and implemented.