Addressing COP26 in one of her final appearances as German chancellor, Angela Merkel on 1 November issued a plea for a price on global CO₂ emissions, as part of an urgent need to develop much more ambitious instruments against climate change this decade.

Writing in the FT a few days earlier, economist Tim Harford likewise argued strongly for carbon taxation as one of the most efficient instruments to cut emissions, noting that a carbon tax “makes the climate impact as real a cost as any other”.

“It sends a signal along all those supply chains, nudging every decision towards the lower-carbon alternative. A shopper may decide that a carbon-taxed T-shirt is too costly, but meanwhile the textile factory is looking to save on electricity, while the electricity supplier is switching to solar. Every part of the value chain becomes greener.”

Notably, he also argued that even with a high tax of circa UK£100/tonne (well above the IMF’s recommended USD75/tonne), the day-to-day pain would be less than most people expect – albeit the burden certainly would be spread unevenly; and that’s where government policy would need to come into play.

While other economists are much less sanguine about the social and political costs of carbon taxation, Merkel is correct in that it is an obvious tool to deploy in support of rapid decarbonisation.

According to the head of our Environment and Climate Change Research team, Will Nichols, while carbon taxes must play a key role in any cogent emissions reduction policy, by themselves they are not a silver bullet.

In the first place, he argues, it’s impossible to envisage a tax at a sufficiently high level.

To date, only 64 carbon pricing initiatives have been implemented globally, covering less than 22% of the world’s GHG emissions. Only the EU and China have explicit carbon pricing initiatives, with their Emissions Trading Systems (ETS), along with national carbon taxes in EU states. 

And while EU carbon prices have climbed, they remain below USD70/tonne, and that’s very much at the higher end – the global average is around USD24/t.

China’s new trading scheme, for instance, which accounts for a third of all emissions covered by carbon pricing, has started at just USD10/t.

Rory Clisby, also of our Environment and Climate Change team, likewise notes that while other APAC carbon pricing mechanisms are quite comprehensive in scope, they are still far too low to be effective.

While the IMF has urged the G20 to adopt a carbon floor price as a critical first step towards an international carbon pricing scheme, our Senior Markets Analyst Franca Wolf, who tracks global carbon pricing for Verisk Maplecroft, is very doubtful that global agreement on carbon pricing is on the cards at all this decade.  

And with the row about the EU’s Carbon Border Adjustment Mechanism (CBAM) continuing to fester in Glasgow this week, she has a point.

So, the political difficulties of getting a tax close to USD250/t mark, where some studies put the social cost of carbon, are immense.

And beyond this, Nichols notes, while we all think about power in terms of a carbon tax, we need to transition all sectors of the economy – heating, transport, agriculture, industry – where direct taxes can be extremely difficult to implement.

Addressing these more complex sectors would require a host of policy levers, ranging from tax breaks and credits to energy/emissions standards, technological innovation, infrastructure improvements, and support for jobs left behind in the transition.

These will be the nuts and bolts of the energy transition. A carbon tax can go some way to supporting those policies, but can’t simply replace them, Nichols says.

No-one ever said it would be easy, or pain-free. But as Harford concludes, “it seems like a huge leap to decarbonise the world economy, but it is better understood as a trillion tiny steps”.