The World with Carbon Tax: Impacts and challenges to businesses, consumers and governments
The world is getting warmer 🔥
The world is getting warmer, and has been for 46 consecutive years.
We, humans, are the main cause of the change. We cause climate change by emitting greenhouse gas (GHG) from activities like burning coal or flying airplanes. Climate change matters because it affects the lives and safety of all living organisms on earth. People have already had to relocate due to a rise of sea-level or droughts, and animals and plants face the danger of going extinct. With an ongoing emission rate, the United Nations expected that the number of “climate refugees” will further increase.
In December 2015, countries signed the Paris Agreement to limit global warming and to reduce greenhouse gas emissions (most commonly tracked as carbon emissions) as soon as possible. According to the IMF, 140 countries (accounting for 91 percent of emissions) have already proposed or set carbon net-zero targets for 2050.
While government support is vital for hitting carbon reduction targets, continual subsidies are not sustainable. Market mechanisms like carbon taxes and trading systems are arguably among the easiest and most cost-effective ways to achieve the targets by shifting the burden to those who are responsible for it.
Carbon taxes provide economic incentives 🤑 to reduce emissions
Large-scale capital and financing is required to significantly reduce emissions. The Intergovernmental Panel on Climate Change (IPCC) reported that all countries are massively short on decarbonization funding. Carbon credit markets, where carbon credits are bought and sold, could solve this issue by shifting funds from heavy emitters to people and organizations decarbonizing the economy. Broadly, there are two types of carbon credit markets: compliance (regulatory requirement e.g. cap-and-trade in which factories are allowed to emit specific amounts of emission and trade emission-reduction to others) and voluntary (to issue, buy and sell carbon credit on a voluntary basis). A carbon price stimulates clean technology projects and innovation. However, building integrity in carbon markets is key, as the ultimate goal is to reduce emissions, not just force emitters to pay for it.
Illustration A: Carbon credit market allows reallocation of capital to carbon-reduction projects
Source: Beacon VC
Generally, carbon credits are generated from verified carbon or GHG reduction projects, and can be traded to a carbon emitter who wishes to offset their carbon emissions. For example, solar panel deployment or tree planting projects are converted into tonnes of carbon dioxide equivalent or tCO2e. Those offsets are priced in USD or Euro per tCO2e for trade. There are two main types of offsets: carbon avoidance (reducing emissions from existing or future operations) and carbon removal (removing carbon or equivalent GHG from the atmosphere).
Under a carbon tax, emitters must pay for each ton of greenhouse gas emissions they emit. Taxes act as financial incentives for corporations and individuals to reduce emissions, switch fuels, and adopt new technologies to reduce tax burden.
According to the World Bank’s carbon pricing dashboard, carbon pricing (carbon tax and emission trading system) initiatives have been implemented globally (see Illustration B). As of April 1, 2022, 103 national jurisdictions have initiated carbon pricing, covering 24.30% of global GHG emissions. Of those, 47 have implemented or considered implementing carbon tax. In Europe, carbon credit pricing ranges from less than €1 per metric ton of carbon emissions in Poland to more than €100 in Sweden. The tax rate and tax scope can vary based on the types of GHG and countries’ policies; for example, while carbon tax in Spain only applies to fluorinated gasses, other countries cover most types of GHG emissions.
Illustration B: Carbon Pricing Implementation Globally
Source: State and Trends of Carbon Pricing 2021. (World Bank, 2021)
In Thailand, more progress has been made on carbon markets than on taxes. In 2014, Thailand Voluntary Emission Reduction Program (T-VER), a voluntary carbon credit market, was introduced by the Thailand Greenhouse Gas Management Organization (TGO), a public entity set up by the government to promote sustainable low-carbon economy and society. Since 2015, T-VER has issued and certified (to measure and verify carbon reduction) 141 projects. The amount of GHG reduction from the projects grew at 45% CAGR from 2015 to 2022.
Most T-VER projects are carbon avoidance projects, which commonly replace coal energy with green energy such as wind or biomass. Other projects such as forestation are nature-based carbon removal projects. There is also growing interest in technological solutions for carbon removal such as direct air capture technology. This technology pulls carbon dioxide from the air and safely stores it. For example, Climeworks AG captures carbon and stores it underground. Carbon Limit produces cement that absorbs carbon from the air. However, the challenge for technological solutions is scalability, which could lower the cost of adoption and encourage mass deployment.
On the one hand, the timing and scope of carbon taxes in Thailand are still being debated, though there are positive signs that Thailand will implement a carbon tax economy. Mr. Ekniti Nitithanprapas, ex-Director General of the Tax Revenue Department said that “Thailand cannot avoid collecting carbon tax because many other countries have already started doing it. If Thailand does not collect carbon taxes on these goods, exporters will have to pay the tax at the destination EU nations. If we collect the tax in Thailand, we will negotiate with the EU to exempt the goods from double carbon tax.” It seems likely carbon taxes will be implemented, but the big questions are when and how.
Illustration C: Statistics of Issuance of T-VER
Source: TGO, adjusted by Beacon VC
Carbon Post Tax Economy 🌏
Carbon tax will drive higher costs of energy-intensive goods and shift the way consumers and businesses make decisions. However, the quantifiable effect of the carbon tax is still debatable. While it is believed that carbon tax would positively impact emissions, policy makers may have concerns about a negative impact to the economy. However, most economists who have analyzed the situation argue that there will not be a negative impact on the economy.
Since carbon taxes will drive costs of energy-intensive goods, The National Institute of Economic and Social Research expects carbon taxes to drive inflation in the short term and lower GDP by 1-2% in carbon-intensive countries. In the longer term, the effect on the economy depends on how revenues from the tax are used. The UN’s ESCAP is also optimistic that the tax revenue will have a positive effect on GDP in the long run by increasing economic activity and reducing poverty and GHG emissions. Other economists believe there will be little or no impact on GDP and unemployment. They believe that long run GDP growth rates are driven more by fundamentals than by policy variables such as tax rates, and therefore unlikely to face negative impact from implementing carbon tax policies.
GDP measures production capacity and economic growth; however, it does not explain the market trend and behavioral shifts. Carbon tax could potentially accelerate changes of consumer behavior. Consumer behavior changes overtime and changes fast. Robert H. Frank wrote in The New York Times about behavioral contagion that even though the carbon tax could affect a small group of consumers, the behavioral change could spread like “infectious diseases.” Similar to cigarette taxes, carbon taxes affect a small group of people which could expand rapidly by network effect. In turn, consumer preferences impact business decisions.
With or without a carbon tax, businesses will already face various risks ranging from climate change, price of raw materials, consumer preference and regulation. Carbon tax would likely increase administrative burden and costs of running business especially in carbon-intensive industries such as oil and gas, power generation, transportation, and construction. The costs may translate into higher prices to end customers, so businesses must identify the risks and design strategy going forward.
The big challenge is to align incentives to truly reduce emissions. Carbon credits (especially in Thailand) focuses on monetizing existing projects, not building new ones. Those credits, therefore, do not contribute to carbon reduction. Additionally, with different tax policies, businesses may seek to move to operations with less stringent policies and, as a result, increase total emissions. Other complex issues include double-counting of emission reduction, and greenwashing (companies falsely market their green credentials).
Stakeholders are trying their own ways to solve those issues. Some startups are trying to solve these problems. ImpactScore and Good on You provide a “green” score for shoppers to check and help alleviate greenwashing issues. Companies are looking to create data solutions such as IoT devices for greater traceability and apply ESG information disclosure and standards. Governments, together with non-profit organizations, are working on policy alignment to reduce emissions worldwide. Financial institutions are designing mechanisms to alleviate initial high ESG adoption costs to businesses and consumers.
It is abundantly clear that global warming poses a major threat to society. Nations worldwide have agreed to slow down and ease the threat of global warming, leveraging various initiatives to incentivize reduction of the GHG emissions which are the cause of global warming. Carbon tax policies may be a catalyst for speedier adoption of green energy and technology to reduce or avoid carbon emissions in the private sector. Consumers and businesses are also paying more attention to carbon reduction and ESG risks. Based on the shift in consumer preferences, it is expected that more goods and services labeled ESG will be sold, though the challenge of how to prevent greenwashing and ensure that consumers can effectively express their preferences remains.
Beacon VC is excited and ready to support its parent company, Kasikornbank, across a wide variety of impact initiatives, particularly with regards to sustainability and net zero carbon targets. Beacon VC has recently launched the “Beacon Impact Fund” to invest in startups seeking to create a positive impact on ESG issues. The Beacon Impact Fund is part of Kasikornbank’s overall sustainability strategy and leadership vision in the field of ESG finance. Both Beacon and Kasikornbank are committed to upholding ESG principles and paving the way for Thailand’s transition into the new world.
Author: Panuchanad Phunkitjakran (Pook)