Welfare cuts versus carbon tax

Having accidentally won the election outright, our Conservative government is now scratching its head as to how to fulfil its commitment to cut £12 billion/year from the welfare budget [1]. Well here's an idea - how about raising at least some of the shortfall from a carbon tax instead? I have been reading a World Resources Institute Working Paper about carbon pricing for US policy makers [2]. Apparently economists think that carbon taxes are much better for the economy than income taxes. (This is from a survey of 40 'prominent' economists of various political colours back in 2012. Of course you shouldn't really believe a theory just because lots of economists support it (ironical comment)). They also list a range of other good things that governments can do with revenues such as: reduce deficits, give money to householders or consumers, invest in research and development or climate change adaptation. For example one could use some revenues to improve flood management systems that will be needed more and more because of climate change. All of these are good but perhaps protecting vulnerable citizens from the worst effects of austerity measures is more important at the moment.

I have done some back of the envelope calculations.

There are about 27 million households in the UK [3]. That means £12bn in cuts is an average £444/household. However, since these are welfare cuts they will affect people who rely on welfare most. Conversely a carbon tax would affect wealthy people more - people with big houses they can afford to heat, big cars and who travel a lot.

The overall carbon emissions from the UK in 2013 was about 570 million tonnes [4]. To raise £12 billion would mean a carbon tax of £21/tonne CO2. However we also have to take into account that we already have a carbon tax of a sort - the Carbon Price Floor (CPF) which is £18/tonne [5]. Currently this only affects electricity generators accounting for a quarter of our overall emissions. To raise an extra £12 billion over and above this, we would need to raise the CPF to £25/tonne and make it cover all emissions.

A carbon tax would affect all of us directly, via our energy bills. The table below shows the impacts.

	Gas	Electricity	Diesel
Increase in price	0.5p/kWh	0.4p1/kWh	6.7p/litre
Average annual cost	£75/household2	£16.50/household3	£51/car4

¹ Increasing the CPF from £18/tonne to £25/tonne
² Based on a typical bill of 15,000 kWh/year for gas
³ Based on a typical bill of 3,300 kWh/year for electricity
⁴ Based on 6 litres/100km and 12,700 km so 762 litres/year
Data from my book and from [6][7][8]

These impacts do not add up to £444 and obviously there would be indirect impacts too, through increased costs for goods and services that we buy. However, whereas welfare cuts are regressive a carbon tax is not.

I have concerns about the relative impacts of a carbon tax on particular sectors of the population such as households using electricity for heating, or who live in rural areas poorly served by public transport. These people could be given extra help where necessary. However, even without this, I think a carbon tax would be less worse than welfare cuts.

Of course, assuming that the carbon tax is successful, carbon emissions will decrease and revenues will be lower than I have estimated here. The WRI report cites the example of British Columbia where the government introduced a tax that was meant to be balanced by reductions in other personal and business taxes. In practice, emissions reduced faster than expected so the carbon tax revenue was a bit lower, leading to a net deficit. By the way, this tax did not impact on economic growth. GDP growth in British Columbia kept up with the rest of Canada. However, personal and corporate taxes in that state are now among the lowest in North America.

Carbon pricing is increasingly becoming the norm. The WRI says: Nearly 40 countries and over 26 sub-national jurisdictions have implemented either a carbon tax or a greenhouse gas cap-and-trade program... Together, these programs cover approximately 12 percent of global [GHG] emissions.'

I favour carbon taxes rather than cap and trade systems mainly because they give a more direct signal to business to encourage investment. The trouble with cap and trade is that there is a lot of guesswork involved in predicting the carbon price and hence the level of investment justified to reduce emissions. The WRI report says: 'Regulated entities might prefer [carbon taxes] to the less stable prices of a cap-and-trade program, which can make business planning more difficult.'

I am also quite receptive to the Citizens Climate Lobby proposal of Carbon Fee and Dividend [9] (see also 'Climate taxes can be good for jobs'). This is a carbon tax which is revenue neutral because all the proceeds are returned to householders as dividends. It is fair because the dividend is distributed equally based on the number of people in the household and brings the most benefit to thrifty low consuming households. However this isn't necessarily the optimal way to distribute revenue. I get the impression that the dividend scheme is popular in the US because they don't trust their government to spend it wisely. Things have come to a pretty pass when you don't trust your government to do sensible things with your taxes. Until recently I would have said, thankfully, that was not the case here. Even if we went for a carbon fee and dividend system and still suffered £12bn in welfare cuts, at least the carbon dividend would go some way towards offsetting the regressive effect of the cuts.


[1] Iain Duncan Smith in Cabinet Row over £12bn welfare cuts. (Guardian) 23/May/2015
[2] PUTTING A PRICE ON CARBON: A HANDBOOK FOR U.S. POLICYMAKERS (WRI) April 2015.
[3] Statistical Bulletin: families and households 2014 ONS (2015)
[4] 2013 UK Greenhouse gas emissions
[5] Carbon Price Floor reform (www.gov.uk) March 2014
[6] Annual domestic energy bills (ONS) March 2015
[7] Drivers' annual mileage rates drop to new low (BBC News) 2014
[8] Fuel consumption (www.gov.uk) Table env0103
[9] Carbon Fee and Dividend Explained (Citizens Climate Lobby)