Why a carbon tax alone isn't enough to beat climate change

Krugman uses a power company to exemplify this. If a power company was emitting sulphur dioxide from a coal burning power plant, the power company should have to pay a price for those emissions because sulphur dioxide causes acid rain. This would follow the theory that the most efficient way to deal with an externality is to make the, in this case, company imposing the externality to pay the cost. The cost would be collected via a tax, like a carbon or emission tax, which would put a price point on the emission.

“The textbook reason why that's a good thing which is not wrong is that it's flexible, says Krugman. “It doesn't say here's how you should reduce the pollution. It also doesn't say who should reduce pollution because if you apply it broadly, everybody has a stake in it. It exploits all the possible channels.”

This is one the reasons why a carbon tax is generally accepted as an effective public policy tool by most economists in countries around the world.

“Pricing carbon is pretty simple as long as governments agree,” says fellow economist and Nobel Laureate Jean Tirole. “Just imagine that for example you price carbon at 40 euros per ton in Europe which is actually smaller than it should be according to computations, coal will disappear from Europe.”

Taxing carbon would create incentives for power plants to find low carbon solutions and there would also be an incentive to consumers to avoid carbon-intensive products. Economist and laureate Michael Spence believes that new technologies are crucial to combating climate change, but that without a carbon tax, any new clean or renewable energies will always be at a disadvantage.

“If we don’t manage to get around to putting a price to carbon, then we can’t solve the problem,” say Spence. “New technologies that are clean are competitively disadvantaged because one output of the old technology, the fossil fuels, is not being priced probably, in this case negatively.”

This is one reason why Krugman also believes a carbon tax on its own won’t solve the problem. Implementing a carbon tax without a more holistic view of what else needs to happen in order to drive real change remains in his view incomplete.

“If we're talking about something really major like trying to decarbonize the economy, then a lot of that is going to involve developing new technologies and maturing those new technologies,” says Krugman. “Technological development is itself something that is full of externalities. Getting the price of carbon right is going to lead to the optimal amount of investment in new energy technologies. So, this is a situation where you really want public support for technological change as well.”

The assumption could be made that any change that comes with incentives to both the corporation and the consumer would drive that public support but as an economist with more than four decades of experience under his belt, Krugman is wary of relying on the market to do the right thing, which is why public support and public investment are key components to solving this puzzle.

 “It's not just the technologies, it's things like networks,” says Krugman. “If you're going to try to electrify the economy and make the electricity depend much more on renewables, then there's a power grid and you don't count on the private sector to be able to develop a power grid efficiently. So, there's a lot of room for public investment there.”

Another reason why a carbon tax alone may not be enough to tackle pollution is the process needed behind the policy. A carbon tax, and other environmentally focused policies, have become so highly politicized it can create a catch 22.

“If an economist says here's the optimal policy, you should go do it without dealing with the questions of political feasibility, without making it possible for people to get people on board, then Congress really hasn't done their job,” says Krugman. “They need to talk about ways that you can make this thing more likely to actually happen.”

“Sure, we want to try to create a price on carbon, but we know that has a very difficult political lift. We also know that it's incomplete in terms of the economics. So, you want an omnibus approach. It's not wrong to throw climate change policy together with infrastructure policy that creates jobs because that's how you get it done,” he continues.

 For Krugman, the importance of implementing a carbon tax coupled with private investment, public support, and better communication politically is not just important, it comes with a warning.

“The climate change issue has always been scary and it's not getting any less scary over time,” says Krugman.