Future of Mobility #20: What economists are saying about Carbon price & Taxes.

Is Carbon taxation an effective instrument for climate mitigation? To succeed in our transition towards a low carbon society, economists spotlight a mandatory balance between private and general interests. We can pray for altruism, we can advocate for a culture of empathy and humanism, we can speak loudly with conjuring and persuasive sentences, but “facts are stubborn things” and, in all circumstances, each one of us will ultimately strive to protect his own benefits. I have been intrigued by the controversial economist William Nordhaus who always refers to pricing as the major factor to influence our individual behaviors. I listened to the voice of other economists, two of which caught my eye. First, Christian Gollier who promotes a higher carbon value with a low discount rate to secure intergenerational equity. Second, Thomas Piketty who alternatively recommends implementing a progressive tax on capital to avoid uncontrollable inequalities. In parallel, during the latest World Economic Forum in January, billionaires and politicians vied to be the most inspirational influencer fighting against climate change and raising unfairness.

1.????Christian Gollier, William Nordhaus, Nick Stern, and others

In the year 2021-22, Christian Gollier held a chair at The College de France handling several lectures and seminars under the following title: "End of the month and end of the world: how to reconcile economy and ecology?". You will find a mix of French and English publications and videos in this link.

Christian Gollier is a lucid economist who has repeatedly said in his conferences that substituting fossil fuels with sustainable energies will be very costly, hard to bear by the population, and have a significant impact on the way we live. He regrets that people still believe in a seamless and peaceful transition to a low carbon society, mainly mistaken by the lack of honesty of politicians who do not want to say that there will be sacrifices to be made. The current trend on fossil fuel cost will not help to make this shift, because prices will remain competitive, so there will be no economic rationale to move to a low carbon society. Our individual cost-benefit analysis will keep us addicted to non-renewable energy sources.

One important reason for this blindness is what economists call “Externality”. It occurs when “a production or consumption of a party causes indirect cost or benefit to uninvolved third parties”. This concept was developed, long time ago in the 1920s, by Arthur Pigou an English economist. In his book, “The Economics of Welfare”, the author illustrated this principle through several positive cases. For instance, the impact of a green area: “when resources are invested in private parks in cities (...), even though the public is not admitted to them, it improves the air of the neighborhood”. Or the advantage of afforestation, “since the benefit effect on climate often extends beyond the borders (...) of the forest”. On the other side, he also emphasized negative externalities, such as the cost of pollution due to the smoke from factory chimneys: “in large towns, this smoke inflicts a heavy uncharged loss on the community, in injury to buildings and vegetables, expenses for washing clothes and cleaning rooms, expenses for the provision of extra artificial light, and many other ways.” ?

If we take the example of automotive, Wikipedia presents a long list of negative externalities: air and noise pollution, traffic congestion, accidents, land occupancy and obesity. ?Only two of them are positives: accessibility and land value. But they can also be negative if we consider the drawback effects of urban sprawl and land artificialization.

William Nordhaus and other economists propose establishing a value to measure the external cost of damage produced by the emission of one ton of carbon (tCO2). With this value, the negative impact of the pollution could be evaluated and potentially charged back to those who contaminate the environment.

This external cost could be collected either through taxes or markets with permits, such as the Emission Trading System (ETS) in Europe. I found the data below from ourworldindata.org and I thank Geoffroy Dolphin for providing it. As we can see, the implementation of this mechanism is limited to a few countries and in 2021 represented only 25% of global CO2 emissions.

Many countries still do not apply any regulation to fight against this effect of externality. This irritating attitude is called “Free Rider”: it refers to an institution (here a country) or a person who will wait for others to take an active role to solve a problem and only enjoy the benefit indirectly without any action. All the countries that are not doing anything (in grey on both of these maps) can be considered “free riders”. This unbalanced taxation system between the different markets is generating another adverse side effect: the industries are incentivized to delocalize their activities to countries without any tax (“Carbon leakage”), hence generating even more externalities in pollution.

Christian Gollier defines this cost in other terms: it could be the value that we want to put today on the climate for future generations. The measurement of this carbon value would be the cost of 1 ton of CO2 emission avoided. For the economist, this cost could help us establish a rationale collective debate on the climate crisis. We are used to putting a value on all the things that matters for us. The climate impact, through this carbon value, would be one of them, and this quantifiable evaluation could enable us to reach a consensus on climate change without bringing emotions into play.

Christian Gollier took the simple example below to explain the impact of cost-benefit analysis. The comparison shows two ways to avoid the emission of one ton of CO2: either by shifting from coal to gas or by replacing the current mix of electricity through solar panels. The avoidance cost of implementing the first option appears to be significantly cheaper (35 euros) than the second one (400 euros). Disclaimer that I am using the data provided by the author back in early 2022, although I did find different updated figures online. More than the end-result, the point here is to highlight the importance of prioritizing our actions.

In order to reduce our CO2 emissions effectively, Gollier recommends focusing on actions which have the best ratio between lowest cost and highest social benefit, in other words, identifying the “low hanging fruits”.

However, this cost-benefit analysis is not ambitious enough to reach the objectives of the Paris Climate Agreement. Then, Gollier and other economists added another evaluation, the cost-effectiveness analysis. Here, we take into consideration the overall objective of Paris Agreement to limit global warming to +2 degrees Celsius. In absolute values, this objective means that our emissions within the 21st century should not exceed 1,150 GtCO2eq from 2020 onwards. As an element of comparison, our annual global level for all GHG emissions was at 59 GtCO2eq in 2019. Therefore, if we don’t drastically reduce these annual emissions, this long-term temperature goal will be overshot by the time we reach the middle of this century.

One of the results from the cost-effectiveness calculation was provided by the French report “The Value of Climate Action”. Their authors recommend establishing a carbon value today at 75 euros/tCO2 and increase it until 775 euros/tCO2 by 2050 (see image below). This represents an annual increase rate of +8% per year. This scenario seems undoable as it minimizes the pain for our current generation and postpones all the efforts to the future. Even if all countries would agree to implement this cost now, it would be impossible to apply such an annual trend. We must balance the effort over time and accept to pay a higher price today. This is the alternative proposed by Christian Gollier of immediately starting at a value of 160 euros/tCO2 to reach 500 euros/tCO2 by 2050. Needless to say that we are far from this objective.

This discussion about the value of carbon for today and tomorrow brings us to a fundamental question: How can we increase the level of responsibility of our current generation towards the future ones? As a touch of humor, in one of his conferences, Christian Gollier referred to a quote from a great American comedian of the first half of last century, Groucho Marx, who was famous for his tasty quips, such as this one: “Why should I care about future generations. what have they ever done for me?”. In fact, this joke has been modified from the original, as Groucho was talking about “posterity” instead of “future generations”, but it was successful, and the audience laughed at loud.

Let’s forget Groucho and come back to Nick Nordhaus whose messages are traditionally less hilarious. To put more responsibilities on the current generation, his advice for many years has been to raise prices of fossil fuel energies. It will encourage consumers to find alternatives to carbon-based products. ?Everyone will make his own cost-benefit analysis and realize that fossil fuels are too expensive and will shift to renewable energies. This would reconcile our private interest with general interest. In addition, by this tactic, we would answer the question above: this would mean that we agree to sacrifice our buying power today in paying more on fossil fuel energies without any reciprocity in our life time, with the expectation that it would benefit the climate of future generations.

Other economists, such as Nick Stern (here), believe that rapid technological change and the increasing competitiveness of low carbon solutions will enable transformation without carbon price or subsidy. He does not deny the necessity of carbon pricing, but he adds that “complementary policies, including city design, regulation and standards, and investments in R&D, will also be needed”. He also goes on to discuss discount rates in more depth and what he calls “intertemporal problems”. Rather than his complicated argument on social discounting factors, I prefer Christian Gollier’s simple explanation which is easier to understand: if we consider that the growth rate will continue at around 2% per year, the future generation in 35 years will be twice as rich as we are now. Therefore, how could we accept to make sacrifices today for a future generation that will be richer than us!

Stern is an advocate to “act strongly now” so he defends a low discount rate (±1%) to ensure a high carbon value for current generation (above 400 euros) which will facilitate the competitiveness of the technological transformation. Nordhaus, on the other hand, goes in the opposite direction with a high discount rate (±5%) and a low carbon value today (less than 40 euros). In this case, no reason to invest in low-carbon technology because they are not competitive, and we penalize largely the future generations. Finally, Gollier’s position is between both with a proposed discount rate at ±3.5% (with a carbon value at 160 euros from now, as we said above).

Stern raises an important point on complementary policies, such a redistribution to low-income householders, which are mandatory to support a high carbon value. Otherwise, it will increase inequalities at an unsustainable level. This is exactly the point that we will review now with Thomas Piketty.

2.????Thomas Piketty, Christian Gollier, and others

To write this chapter below, I re-read Thomas Piketty’s bestseller “Capital in the Twenty-First Century” which I found to relate more with our current times than when it was initially published ten years ago.

Christian Gollier and Thomas Piketty did not study the same domain of research, the first being more focused on environmental economics and long-term sustainable effects, while the second applies an historical approach on wealth and capital trends. Gollier is part of the neoliberal ideology, but he seems more reasonable than his comrades, and I found some similarities with Piketty’s evaluation. Both share a common concern on inequalities for current and future generations. This is the main reason why I was interested to compare their visions.

I found a key difference between these two economists in one of their basic principles. Christian Gollier’s ambition is to “align private interest with general interest”, while Thomas Piketty expects that “democracy can regain control over capitalism and ensure that the general interest takes precedence over private interests” (bold are mine). ?For both, inequality is a risk for the stability of our economic system, but they treat it differently.

Gollier refers several times to the theory of the “Veil of Ignorance” as a way to manage the risk of inequality. This is an interesting concept defined by the philosopher John Rawls (1921 – 2002) in his book from 1971, “A Theory of Justice”. He suggests putting decision-makers in a situation where they will be unaware of their final position in society after the agreement, hence they could end up being rich or poor, powerful or servant... In this context, politicians would endeavor to give well-being resolutions to the least advantaged people just in case it turns out to be for themselves! An interesting consequence of this social contract is that these inequalities would be acceptable only if everybody recognizes that the disparities are still providing some advantage to those in the worst position in the society.

The second concept that Gollier utilizes is the “Theory of Expected Utility”. My understanding is the following: in all our decisions, we apply a kind of mental “weighted average” calculation of all the possibilities regarding our current situation. I found a good example on Investopedia: let’s assume that I belong to the middle class and I buy a lottery ticket with a 50% chance of winning $1 million. Someone else offers to buy my ticket for $0.5 million. I will likely take this safe option, although I might lose 50% of the full winnings. Reversely, a rich person could opt to keep his lottery ticket because he would put more importance on winning the full amount rather than half of it. Each individual takes into consideration their living situation to maximize the Expected Utility rather than maximize the expected gain.

Eventually, Christian Gollier combined these two theories (Veil of Ignorance and Expected Utility) to evaluate the level of sacrifices that our current generation would consent to reduce global warming impact for the future. This methodology is the basis to rationalize his estimations for carbon value and discount rates.

On the other hand, Thomas Piketty has been collecting information for a long period of time (more than a century), which he qualifies as “incontrovertible historical” data, to identify economic trends. His approach is gripping because he always refers to historical, social and political circumstances to justify the evolutions on wealth, growth, income and return on capital. Further, he mentions famous novelists to illustrate his analyses, and I particularly enjoyed his references to authors such as Honoré de Balzac (the encounter of Rastignac and Vautrin in Père Goriot) or Jane Austen (with Sir Thomas’ risky investments in West Indies in Mansfield Park).

He also turns out to be a bit of a polemist by teasing his pairs who use mathematical formulas to justify their theories, as if it was a pure science. It is true that Gollier backs up his ideas with concepts from mathematicians (Harold Hotelling, Bernouilli, Maurice Allais...) and the other economists do the same in their presentation slides with several axioms and graphs (see examples with Thomas R?mer and Jean-Marc Tallon). However, Piketty balances his statement by deploring a similar attitude from social scientists who “flee in horror the minute a number rears its head”! It would be nice to reconcile all these scientists.

This theoretical approach of economists is also the reason why Piketty criticizes the “abstract debate” on discount rate. His view is that experts could debate what the right discount rate to apply is forever, ranging from the status quo position (such as Nordhaus at 5%) to the technology geek (like Stern at 1%), and he adds that, because of that narrow focus, “we are missing the central issue”. All economists agree that there will be a climate crisis, and we will have to make big investments in the future to avoid devastation. So, the main question should be “on which projects should we invest and how should we organize our efforts?”

For Piketty, the capitalism in essence creates inequality because the rate of return on capital tends to overtake the rate of growth. “When growth is slow, it is almost inevitable that this return on capital is significantly higher than the growth rate, which automatically bestows outsized importance on inequalities of wealth accumulated in the past.” Therefore, inherited wealth will continue to dominate income from labor and the disparity will increase by the time. The illusion of rising equality during part of the 20th century was due to a high taxation to cover the cost a World Wars and the need to rebuild societies, but also due to the demographic growth and the significant technical innovation. Piketty expects a low contribution of these latest factors in the years to come.

Since the 1980s and the deregulation, and particularly from the beginning of the 21st century, we are back to a situation where the gap between growth rate and return on capital is continuously increasing and will generate more inequal distribution of wealth. “In a quasi-stagnant society, wealth accumulated in the past will inevitably acquire disproportionate importance. (...) Decreased growth— especially demographic growth— is thus responsible for capital’s comeback.” Piketty is pessimistic about this trend which will get worse, and he hopes for political courage to prevent uncontrollable rising inequalities. He is concerned that “the process of the political secession of the largest fortunes is already well under way” and this evolution will prevent us from organizing our collective efforts.

To protect equality, Piketty insists on the need to heavily invest in the diffusion of knowledge: “the poor catch up with the rich to the extent that they achieve the same level of technological know- how, skill, and education”. But this evolution is penalized by two main forces of divergence: the explosion of “top earners who separate themselves from the rest by a wide margin”, and more importantly “the process of accumulation and concentration of wealth when growth is weak and the return on capital is high”.

Then, after stating this dramatic situation, Piketty’s conclusion is radical. He promotes a progressive global tax on private wealth - an exceptional tax on capital (instead of labor income) - and a system of global social redistribution. Realistically speaking, he suggests limiting the scope to a region, such as the European Community, and then deploying it largely step by step.

I think that both recommendations are both equally difficult to implement: on one side, we have seen that the carbon taxation is limited to a few markets and will not be expanded easily, and, on the other side, it is hard to believe of an agreement between several countries about a common progressive tax on capital which, if it happens, would be counteracted by tax havens. The other difficulty is on the mechanism to ensure a fair redistribution of the fiscal dividends. The fossil fuel price will mainly impact the low-income householders and rural communities, whose budget is particularly penalized by energy costs. So, in that case, the Piketty’s scenario of redistributing the earnings from the rich to the poor to give them a larger welfare would be a more popular solution. This could be a kind of “Robin Hood” model which would comply with one of John Rawls’ principle: disparities are to provide advantage to those in the worst position in the society. However, to make sure that general interest “takes precedence” over private interests, this redistribution should be mainly utilized for public investment to support climate change initiatives and to subsidize sustainable technologies for low-income householders (building renovation, sustainable energy, electric vehicles, carsharing, micro-mobility, public transport development, etc.).

3.????The World Economic Forum, some billionaires, and others

I was working on this article, reviewing works from Christian Gollier, Thomas Piketty and other economists, when the annual World Economic Forum occurred last January. I was surprised to find out that this very focus topic about taxes, inequalities and climate change hit the headlines of this event. I experienced the same emotion that you feel when your voice is echoing throughout the mountains after you stop talking.

Firstly, during the event, some “happy few” multimillionaires published a letter requesting political leaders to tax them right now. This is not me insisting on it, it is written in bold letters in their short text that I urge you to read.

They were only two hundreds, but it’s the thought that counts. They dared to provoke politicians by writing the following: “The cost of action is much cheaper than the cost of inaction - it’s time to get on with the job. Tax the ultra-rich and do it now. It’s simple, common-sense economics. It is an investment in our common good and a better future that we all deserve, and as millionaires we want to make that investment. What - or who - is stopping you?”

This incredible alarm call was strengthened by the recommendations of the “Climate Inequality Report 2023” just published around the same time. This document is providing a similar recommendation to implement a 1.5% tax on extreme wealth ownerships (individuals owning over $100 million) which, given the very high level of wealth concentration, could yield about $ 295 billions of revenue every year. This tribute mirrors what Piketty proposed in his book as a way to take control on the risk of inequalities.

The second matter that got me excited was the session on January 18th entitled “Leading the Charge through Earth's New Normal”. It is worth watching in its entirety as there are several nice moments during the conference such as the introduction by the duo of scientists Joyeeta Gupta & Johan Rockstr?m, also the two speeches from Fawn Sharp and Al Gore that I felt especially invigorating, and the final touching participation of the cellist Yo-Yo Ma.

After reviewing these economists’ perspectives and following what happened during the World Economic Forum, I started thinking of creating an International Convention for multi-millionaires, like a Climate Citizens Assembly. This conference would focus on the two critical topics from this article: the acceleration to a low-carbon society and the reduction of inequalities. We would invite economists, politicians, sociologists, historians, and mobility experts (of course!) to provide insights. Then, under the Veil of Ignorance, we would request the participants to establish a list of recommendations to improve the life of current and future generations focusing on taxes on capital, fair redistribution scheme to lower income population, investments on new technologies, particularly on sustainable mobility solutions... As they will have to behave as if they could end up in a lower position in the society, I am pretty sure that all the proposals from these exclusive members would be well received by the entire global community.

Finally, for our generous billionaires, I will end up with another appropriate quote from Groucho Marx: “While money can't buy happiness, it certainly lets you choose your own form of misery.”

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