Cap and Trade's Failing Grade: A Deeper Look Inside Europe's Emissions Trading Scheme (ETS)

In Europe, the demand to tax carbon dioxide and other greenhouse gas emissions has increased. Debates surrounding taxation, cap and trade, as well as renewable energy investments are vigorous, and consensus, which translates into tangible actions, has been slow. During his eight-year tenure as president of the European Commission, Jacques Delors spent much of his time arguing for the creation of an EU carbon/energy tax. Unfortunately, in Europe, taxation measures required unanimous approval by the Council of Ministers, as well as the majority of member states. Throughout this reign, many member states, including the UK, vigorously opposed Delors proposal on ‘subsidiarity’ grounds, arguing that tax jurisdiction resides with national governments, rather than the EU. Additionally, other member states less politically opposed to EU integration, such as Germany, quietly opposed Delors' proposals due to the economic impact a tax would have, particularly on coal reliant industries. Having failed creating a universal carbon tax, the European Commission focused instead on creating a cap and trade plan, currently known as the EU's Emissions Trading Scheme (ETS). Unfortunately, this approach, while promising from a policy standpoint, has yet to deliver many tangible results.

The EU cap and trade ETS was introduced in 2005. From its inception, the proposal has struggled to significantly impact business operations, primarily because national governments have continued to allocate too many permits, reducing the permit price per tonne of carbon below a noticeable material threshold. This price reduction, has effectively allowed businesses to continue operating as they always have, under a pretense of action. In Italy for example, at a time when the world’s top climate experts agree that carbon emissions must be rapidly reduced, Italy’s major electricity producer, Enel, is converting its massive power plant from oil to coal, generally the dirtiest fuel on earth. Over the next five years, Italy will increase its reliance on coal to 33 percent from 14 percent. Power generated by Enel from coal will rise to 50 percent. And Italy is not alone in its return to coal. Driven by rising demand, record high oil and natural gas prices, concerns over energy security and an aversion to nuclear energy, European countries are expected to put into operation about 50 coal-fired plants over the next five years, plants that will be in use for the next five decades.

While the cap-and-trade approach continues to be ineffective, one question that needs to be addressed is the issue of alternatives. What can a viable substitute for the European cap and trade scheme be? One solution, similar to what was recently explored by the Rudd government in Australia, is the imposition of a universal carbon tax. Such a tax, applied to oil, gas and coal at the mine or port of entry, would arguable be the fairest and most effective way to reduce emissions and transition to the post fossil fuel era. It would assure that unconventional fossil fuels, such as oil shale and tar sands, stay in the ground, unless an economic method of capturing the CO2 is developed. Furthermore, a carbon tax is arguable one of the best ways to encourage behavioral change. While such a tax would increase energy prices, low and middle income people would arguably be motivated to reduce carbon emissions to ensure their tax burden remains low. In such a scenario, the rate of infrastructure replacement, as well as economic activity, could then be modulated by how fast the carbon tax rate increases. Effects would permeate society. Food requiring large amounts of carbon emissions to produce and transport, would become more expensive, while local, more sustainable foods would be cheaper. These pricing impacts could encourage families and communities to support local, sustainable food resources, reducing reliance on imports.

Before jumping to support the imposition of a carbon tax, it is important to recognize the political risks that politicians face leading and supporting such endeavors. This is especially true when such measures directly impact the daily cost of living for all citizens. In Australia, Kevin Rudd faced tremendous pressure for proposing the Carbon Pollution Reduction Scheme (CPRS), pressure that ultimately ended Mr. Rudd’s Prime Ministerial career. Unfortunately, Prime Minister Rudd lost his nerve in the face of an Opposition onslaught, realizing too late that voters would have responded to a strong lead on the issue. The CPRS was in fact the primary reason why voters chose Rudd over John Howard three years ago. Still, while one cannot help but be surprised regarding the rapid turn of events in Australia, the campaigns against the CPRS reinforce the difficult challenge politicians face developing firm timetables for climate change action.

Despite pessimism, it is important to recognize that progress has been made in Europe relating to carbon and energy taxation, particularly within Scandinavia, the Netherlands and Germany. Many of the revenues derived from small scale carbon taxes have been used to reduce taxes on income or employment. Still, more must be done. Climate change threatens to be one of the most serious issues humanity has ever faced. Thus, it must remain high on the public political, media and business agendas. Unfortunately, as we have seen over the last decade, too much discussion has focused on what societies and governments should be doing to create change, rather than focusing on solutions that will change corporate behavior and provide governments adequate compensation for emissions impacts. Moreover, significant global shifts must occur in human behavior. Going forward, governments and individual must be open to policy that challenges their dominant worldview, particularly relating to energy. While renewable energies are becoming more competitive economically, the absence of comprehensive sustainable energy policy threatens the entire sustainability movement. In history, some of the great historical movements, such as the anti-slavery, anti-apartheid, as well as the Suffragettes, have contained a clear and powerful message reinforced by behavior changing policy. Climate change, sustainable investment, and renewable energy movements must be approached no differently.