A Carbon Tax by Any Other Name Would Smell “Tax”

By Richard Gilmore, President/CEO, GIC Group

Special to The Digest

A carbon tax is a tax on everything except carbon. Arguments in its favor seem to accept that climate change is a real threat to economic growth and that the best remedy to staunch future bleeding is to tax carbon emissions at the wellhead or the coal pit: the higher the tax, presumably, the better the chance that fossil fuels would remain in the ground.

The carbon tax alliance is led by prominent Republicans along with some fence sitting Dems and their respective linesmen from public policy think tanks. While seemingly counter-intuitive in light of the Administration’s rejection of any causal links between increases in carbon or greenhouse gas (GHG) emissions and climate change, the enduring interest in a carbon tax coincidentally could very well figure into the drive for tax reform before Congress. In other words, you don’t have to believe in climate change to latch on to the benefits of a carbon tax as a heretofore untapped source of public revenue.   Then, presumably, corporate and individual tax rates could be cut, the unpopular border adjustment tax officially abandoned, and Trump’s budget kept at non-inflationary levels. In 2013, the non-partisan Congressional Budget Office estimated that a modest tax of $20 per ton of CO2 could generate 1.2 trillion dollars over a decade. Since then, analysts have projected higher carbon tax rate scenarios with greater benefits to lower income families.

Now, arguing against a carbon tax built on a revenue generation model could be taken to be as foolhardy as Don Quixote leading the fray. However, a closer look at the arguments leads to an impression that the case in favor of the carbon tax is built on an array of straw man assumptions. Putting aside the revenue projection models and the inequitable taxes placed on lower income drivers, the tax more importantly is likely to do little to reduce carbon and greenhouse gas emissions. Arguably companies are doing more today through shadow pricing of carbon– internal pricing of the costs of their carbon inputs–than they would be fiscally incentivized to do under a new carbon tax regime. Based on ample precedent, the tax could have the perverse effect of raising fossil fuel prices without dampening demand. After all, conservative carbon tax boosters maintain that it is the best strategy to preserve the free workings of the market; hence, no prohibition is placed on passing the tax on through the value chain or on regulatory curbs on sources of carbon emissions.

Small wonder that politicians reach for the “quick fix,” a carbon tax to reduce emissions by as much as 13 per cent according to some estimates. Bad idea. Inequitable, inefficient and ineffective. Carbon taxes do more harm than good. All they produce is more regulation without the necessary reforms needed to seriously reduce carbon emissions impacts. And it draws us farther away from well-designed risk mitigation strategies that could produce tangible results. Proponents argue that the Paris climate accord provides a global framework to reach attainable reduction levels. That argument proved unconvincing to the Trump Administration which announced its withdrawal from the Agreement. Now the best strategy to reduce GHG is a market solution. Leave it to industry to cost carbon in their own production. They don’t need any other incentive than the fact that the highest growth markets are the “green” markets so if they don’t go green, they will be walking away from business opportunities.

Far from a quick fix, the earlier default solution of trading carbon credits on futures exchanges has not done much when it comes to reducing emissions with, perhaps, the exception of California. They were created to provide competitive pricing platforms for carbon allowances. But these markets have either closed or are in the doldrums and the future for carbon futures remains grim. Carbon credit futures prices still haven’t recovered and the prospects for a single or even any number of trading systems for carbon credits are possibly more illusory than ever. Meanwhile, temperature levels continue to climb.

What better place to start than with a new instrument for carbon reduction in agriculture, where climate change is likely to have the most dramatic impacts. A climate risk hedge against weather vulnerability could offer dynamic protection of real consequence, instead of tired old carbon credit futures with their sketchy track record. And what about trying some of the newer futures contracts for commodities that measure carbon reductions in crops and in food, feed and biofuel products. The reductions, written into each futures contract, would be certified and traded at a higher value than the standard futures contract. If the premium price holds, then the new CPC (commodity plus carbon) futures contracts will create revenues along the agricultural value chain. The additional income will go, as intended, to agriculture and not to IRS. Instead of putting faith in a carbon credit that lacks intrinsic value, a CPC contract enforced by a tight certification and verification system can reward good agricultural practices through the use of new technologies and strategies that result in measurable and lasting carbon reductions.

CPCs can be written along the same procedures that now are in place on exchanges or less traditional electronic exchanges where new futures contracts are introduced reflecting new market conditions and acceptance by industry and traders. Estimates of “green” market CAGR (compound annual growth rates) rates average 13% between 2015-2020, which should favor CPC whose principal feature is measuring the carbon reduction value in producing or processing a given commodity, The architecture for measuring and certifying carbon reduction levels is already in use in California and can be adapted to CPC- eligible, bulk commodities like sorghum and processed products like corn-based ethanol.   As with any commodity futures contract, the deliverable commodity would also be subject to verification, but in this case the verification would include a certification of reduced carbon derived from good agricultural practices (GAP) and the introduction of new carbon and other GHG abatement technologies.

The next step for CPC is a trial protocol to test the extent of their savings from cutting back on inputs like nitrogen fertilizer and then, selling the crop priced under the new CPC contract at a likely premium. Today, a sorghum grower in the US has no option but to sell his/ her crop priced off a corn futures contract since there is no futures contract for sorghum in the US. For other parties in the supply chain, the reward would be the prospect of securing at origin a premium quality product that can satisfy consumer demand for greener products. In a survey of the Carbon Disclosure Project, 39% of participating companies realized monetary savings from their own emissions reductions activities, and 34.5% benefited from new revenue streams or financial savings as a result of their suppliers’ carbon reduction activities.

While production agriculture in certain crops and under prudent practices sequesters a level of emissions, it still accounts for 11-15 percent of annual GHG emissions in the US and 1/5 of total emissions worldwide according to FAO (UN Food and Agriculture Organization). When scaled through the food and feed supply chain, the estimated consolidated annual emission level can reach as high as 50 percent of the national total. GAP (good agricultural practices) standards result in a lower carbon footprint and serve to mitigate climate change risks. CPC contracts for crops is the change agent from waste and environmental abuse to an agriculture system that rewards premium quality product and satisfies 21^st century consumer demand. In a 2014 survey conducted by the Carbon Disclosure Project, 39% of participating companies realized monetary savings from their own emissions reduction activities, and 34.5% benefited from new revenue streams or financial savings as a result of their suppliers’ carbon reduction activities.

The market is ready and can accommodate these new futures contracts which offer an effective and equitable route to achievable carbon reduction in agriculture, a strategic source of emissions. CPC can be replicated for other industry sectors but starting with agriculture is enhancing the sector’s contribution as a steward of the earth and returns the focus for a clean environment to the most tested risk mitigation instrument in economic history—the futures contract.