We must face the true cost of our net zero goals | Mint

We must face the true cost of our net zero goals

One of the strategies economists at the IMF devised for a “representative advanced economy” to reach net zero by 2050, relies entirely on carbon pricing. (Photo: Reuters)
One of the strategies economists at the IMF devised for a “representative advanced economy” to reach net zero by 2050, relies entirely on carbon pricing. (Photo: Reuters)

Summary

  • Governments cannot really spend their way to carbon neutrality. The policy folly of opting for subsidies over carbon taxes must be called out.

At CoP-28, this year’s climate summit, governments are gathering to advance ambitious plans to transform their energy economies. But there are two big problems with this global effort. The measures in place fall short of what’s needed. And many governments aren’t yet facing up to their true costs.

Both failings arise from the need to make climate policies more politically appealing. Policymakers resist taxes to make fossil fuels dearer because it creates losers. Subsidies to cheapen clean power make everyone feel like a winner, for a while anyway. Yet, this choice leaves many incentives for high carbon emissions undisturbed, which slows the transition. It also ignores the fiscal consequences that’ll likely catch up.

Some countries have explicit or implicit carbon taxes to align the price of fuels with the costs their emissions impose on the planet. But this is going slowly. Even now, around 15% of global emissions are actually subsidized. Another 65% are neither subsidized nor taxed. Only 20% are taxed, typically at rates far lower than their costs.

The cost of renewables has fallen sharply in recent years, but so long as fossil fuels remain underpriced, they’ll be overused. Globally, the average price of carbon is about $5 per tonne. According to plausible calculations, to get emissions on the path to net zero by 2050, it would have to be about $75 a tonne (and $130 a tonne in rich economies) by 2030, and then rise thereafter.

The US leads the world in ignoring the price of carbon. Its so-called Inflation Reduction Act is subsidy-first: It spends roughly $400 billion over 10 years on schemes including support for green energy and EVs. Other things equal, and assuming optimistically that other constraints on electricity-grid infrastructure don’t delay things, this will hasten the adoption of low-carbon technologies. Yet, unlike the EU, the US lacks anything like a comprehensive carbon-pricing system. So Americans can and will continue to run their factories, heat their buildings and power their oversized vehicles using fossil fuels at prices that fail to capture the cost of emissions. Regulation can close some of this gap—but with limits set by politics.

The drastic fiscal consequences of this subsidy-first strategy needs urgent attention. Economists at the IMF have devised scenarios with different policies for a “representative advanced economy" to reach net zero by 2050. One strategy relies entirely on carbon pricing. A second assumes a “well-sequenced package" that mixes higher spending and higher revenues through carbon pricing, subsidies and targeted transfers to households squeezed by dearer energy. A third, call it ‘politics as usual,’ assumes that carbon prices won’t rise much more over the next few decades, leaving subsidies to do it all.

The carbon-pricing approach to net zero cuts public debt by roughly 3% of GDP between now and 2050. If this seems modest, remember that carbon pricing raises less revenue as time goes by because it works as intended [this tax base shrinks as the economy goes green]. The balanced package has more government spending, so raises debt by a little over 10% of GDP. But politics as usual—subsidies or bust— raises debt by roughly 50% of GDP.

Even assuming no new energy-subsidy programmes, the trajectory of public debt is already unsustainable in the US and many other countries. As a practical matter, persisting with subsidies-first is therefore likely to be impossible. The most plausible forecast, given these numbers, might be that net zero just won’t be achieved by 2050. But if governments sincerely want to hit that target, they’ll have to take subsidy-first back to the drawing board and start being honest with voters about the costs of fighting climate change. It can’t be halted on a promise that everybody wins except producers of fossil fuels—the fiction that makes subsidies-first ‘politically realistic.’ Government borrowing only delays the inevitable. Using subsidies instead of carbon taxes will demand big increases in other taxes and/or cuts in other government spending.

Even an intelligently mixed policy—with carbon taxes rising as they should, some of that revenue applied to well-designed subsidies (such as for clean-energy R&D) and some spent on cushioning lower-income households from the resulting financial stress—will require other taxes to rise, albeit more modestly.

In the US, as things now stand, getting fiscal policy back under prudent control is going to require higher taxes and lower public spending than currently planned. The recent rise in long-term interest rates hints at what’s coming if Washington still insists on spending its way to net zero. At some point, not far off, so-called political realism and implacable fiscal reality will collide. ©bloomberg

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