Rerouting taxes to price carbon in a socially and ecologically just manner

With its mixed record, Germany is no longer at the forefront of climate policy. What is missing above all is a clear price tag on carbon emissions that encourages climate-friendly behaviour among consumers and manufacturers. By Constanze Haug, Johannes Ackva, Toby Bernstein, Alexander Eden and Andreas Schneller.

On the eve of the climate conference in Katowice, the German climate footprint looks anything but rosy: Germany is not meeting its climate targets for 2020, there is no date for phasing out coal, and the German government's announced climate action law is still on shaky ground.

Experts agree on an effective and cost-efficient remedy: a clear price signal for carbon emissions. Currently, taxes and levies are imposed on transport and heating fuels independent of climate damage. In contrast, a carbon tax (or carbon component in taxation) would link prices to climate damage and thus send a clear price signal to manufacturers and consumers throughout different sectors.

It is therefore hardly surprising that German climate economist Ottmar Edenhofer and RWI chief economist Christoph Schmidt have received broad attention throughout Germany with their proposal for a carbon tax. At the same time, the protests of the "Yellow Vests" in France show what effects tax increases in the transport sector can have on social welfare and how sensitively politicians must act and communicate in this area.

Four success factors drawn from the experiences of other countries show how carbon pricing can become politically feasible, effective, and maintain the social balance:

1) A cautious start with a moderate tax rate that gradually increases

Climate action champion Sweden imposed a carbon tax as early as 1991, initially at a rate of around EUR 20 per tonne. After several increases, the Swedes now pay the highest carbon price in the world for almost all fossil fuel uses that are not subject to emissions trading, at around EUR 120 per tonne. A moderate initial tax rate created political acceptance and enabled industry and consumers to adapt their investment behaviour.

There is clear evidence on the effectiveness of the tax: In Sweden, it has played a key role in ensuring that the EU member state has the lowest carbon emission intensity today (carbon emissions measured per unit of GDP) and the second lowest per capita emissions in Europe. While emissions in Sweden have fallen by 26 percent since 1991, gross domestic product has risen by almost 90 percent. All in all, a Swede creates only about half as much carbon pollution as a German, a clear example of the much-cited and urgently needed decoupling of economic growth and climate damage.

2) A wide application of the tax that covers different sectors

A broad application of the carbon tax is particularly important for the future. If electric cars and power-based gas are to play important roles (the so-called sector coupling), then the price signals for carbon will have to converge so that distortions between different sectors do not make it more difficult to find effective mitigation options. After all, the climate does not care whether a tonne of carbon is generated in transport, heating, or industrial production.

3) Redirecting taxes instead of increasing them

In Sweden, the introduction and subsequent increases of the carbon tax were often coupled with cuts in income and other energy taxes, thus preventing a net additional burden on Swedish citizens. A similar approach was taken in the Canadian province of British Columbia. With the introduction of the carbon tax in 2008, income taxes for low-income earners and companies were reduced simultaneously. Surveys show that this approach of revenue neutrality has ensured that acceptance of the tax has increased significantly over time.

4) Special attention to social responsibility

The debate in Germany is increasingly focusing on how the carbon tax burden can be socially just. In the wake of the Energy Transition, numerous proposals have been repeatedly discussed as to how social concerns must be considered when achieving climate targets. The debate was sparked above all by the question of what costs private households should bear and what the "red environmental policy" (red is the colour of Social Democrats in Germany) described by the Federal Environment Minister could look like.

The experience of the forerunner countries also indicates the way forward: In Switzerland, the income from carbon pricing directly benefits all sections of the population through the redistribution of income via health insurance. The Swedish government is also using part of the revenue from the carbon tax to reduce the tax burden on low and medium income earners.

New momentum for German climate policy

The pressure is on for a return to effective and efficient climate action. In the last nine years, greenhouse gas emissions in Germany have hardly changed and have even risen again in households and the transport sector. Germany will fail to meet its national climate action target for 2020, and will also likely fail to meet the EU target for sectors that are not subject to emissions trading (where a carbon tax would make the most sense).  It is time to look ahead and take action to ensure that the targets for 2030 can be met. A clear carbon price through a carbon tax would help pave the way for a reliable climate policy that not only serves the planet but, if properly implemented, can be socially equitable for all citizens.