Taxation of carbon is one of the key instruments of the European Union’s agenda focused on decreasing emissions of CO2. A recently introduced European green agreement (European Green Deal) perceives new carbon tax introduction into the tax mix through the lens of all possible benefits: “Well-designed tax reforms can boost economic growth and resilience to climate shocks and help contribute to a fairer society and to a just transition“1.
Many economists2 consider the instrument of the Pigovian tax, which penalizes unwanted behavior (polluting) as an optimal tool, which encompasses the following characteristics:
• punishes undesirable actions (the polluter pays);
• encourages investment to reduce emissions – supporting technological progress, including the development of renewable sources;
• it is nationwide and therefore fair; the same rate applies to all – the government does not choose technology winners by nationwide tax;
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These economists support the introduction of such a tax with the claim that with growing income and wealth, consumers do not decrease their energy consumption, rather on the contrary (the so-called “Jevons paradox”).
Higher efficiency of new technologies leads not only to lower unit prices, but also to increased consumption3. Only increasing costs of consumption, which can be secured by continuously raising the price of carbon, can reduce demand, thus leading to an absolute decline in consumption.
Every Tax Has Negative Externalities
The final effect of the carbon tax is determined by the way in which additional resources are handled. Every tax results in reallocation of scarce resources for purposes less desired by consumers. Not only do taxes diminish the utility of a consumer, but they also have a negative impact on economic growth. These effects are also consequential for the carbon tax.
The most integral part of the market economy is the price mechanism, which provides signals to individual economic agents about the scarcity of resources and their utility. The generated profit, on the other hand, is a sign of efficacy of given production.
The carbon tax disrupts these signals, subsequently reallocating investments from the most desired resources and needs to less effective production.
Electric cars can serve as an example. Nowadays, their manufacturing and operation are still more expensive, even after taking costs of pollution at current prices into account.
Another example would be the rise in prices of basic inputs in construction (worsened availability of housing) due to higher prices (e.g. cement and steel).
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2 https://www.ft.com/content/137b9da8-99c4-11e9-8cfb-30c211dcd229. EU economists call for carbon taxes to hit the net zero goal earlier.
3 For example, declining air transport costs can be mentioned. Higher transport efficiency, new investments in more efficient aircraft have allowed significant price reductions and relatively strong growth in both mileage and passenger numbers.