Jerome Mayhew: The carbon proposal that the Government should put at the heart of its plan for COP26

12 Jan

Jerome Mayhew is MP for Broadland.

We keep being told that we have to reduce carbon emissions to net zero by 2050 – and have even made this a legal requirement. We normally expect the market to sort out the allocation of scarce resources by matching supply with demand, but have you ever wondered why this is not working for carbon?

We know that carbon emissions are expensive to society as a whole but, as consumers, we don’t pay that cost: it just disappears into the atmosphere. A functioning market would price in the cost of carbon in every purchase, incentivising lower carbon products and solving the carbon challenge in the most market-efficient way. But without a realistic cost of carbon, the market cannot do its vital job.

Instead of enabling, and then trusting, the market the Government has resorted to committing large amounts of taxpayers’ money to support emerging low carbon technologies, such as Green and Blue Hydrogen and Carbon Capture and Storage.

As a Conservative, I feel queasy when I read of the Government “picking winners” in low carbon technologies, and setting five-year plans for industrial sectors. It feels more like 1930s-style Soviet practice than a free market dynamo of innovation and growth.

But by setting a strong market signal through a meaningful carbon price, the dynamic is changed: instead of trying to replace the market, we free it to solve the problem of carbon emissions, and without spending a penny of taxpayers’ money.

Carbon taxation is a phrase that has been doing the rounds for decades: set a price for carbon, either by an emissions trading scheme (ETS) or by straightforward taxation of fossil fuel use, and the market can find the way to a lower carbon future.

The theory is that the cost of carbon emission is raised to a point where it starts to change consumer behaviour. Carbon heavy production processes lose out to lower carbon alternatives, which become relatively cheaper. The EU introduced an ETS scheme a decade ago and, here in the UK, we supplemented this by introducing a “top up” Carbon Floor Price (currently £18/t CO2).

In one key area, this has been successful: coal has effectively been priced out of our domestic energy market, with our last coal fired electricity generation due to come offline by 2025.

But what about the rest of our economy? Not so good. The problem is that increased energy costs, which is what we are talking about, make UK manufacturing more expensive and so less competitive. The result, the argument goes, is not reduced carbon emissions, but the destruction of domestic manufacturing, and the jobs that go with it, replaced by high-emitting imports: not carbon reduction but carbon leakage abroad.

Fear of this outcome has led successive governments to fall between two stools: setting the carbon price high enough to disadvantage our manufacturing base (c.$0.26/kWh for electricity in the UK vs $0.08/kWh in China and India), but not high enough to change purchasing behaviour.

So how do we fix this? The good news is that we can. At its simplest, put a Border Carbon Adjustment (BCA) tariff on imports that is equal to our domestic cost of carbon. At one stroke, you remove the competitive disadvantage of our domestic manufacturers against imported competition, since the unfair advantage of cheaper, high carbon, energy is equalised.

With the risk of carbon leakage removed, the Government is free to build up the price of carbon to a level that actually starts to change behaviour, allowing the free market to come to the rescue, and feel out the most efficient way to reduce our carbon dependency.

Foreign companies would no longer have an unfair trade advantage. In fact, it would provide them with an incentive to reduce carbon usage in order to avoid the corrective tariffs, spreading the carbon reduction benefits beyond our shores. After all, climate change knows no borders.

The BCA would also help our exporters and our balance of trade. When exporting to a high carbon economy, our businesses would receive a cash rebate to compensate them for the additional carbon cost of manufacturing in the UK, making their products cheaper and more profitable.

Post-Covid, Government finances will be in the most parlous state, with national debt forecast to rise to an unimaginable £2.8 trillion and counting, the tax take down and a strained economy. Whilst we still need economic stimulus to help get out of recession, most economists warn that taxes are going to have to rise in the medium term, and yet the key tax areas, income tax, VAT, National Insurance, have been protected by manifesto commitments.

The Treasury desperately needs a significant new source of tax that will be politically acceptable. Carbon taxation could provide the novel tax take that it so desperately needs. Supported by a BCA, studies suggest that a gross tax take of as much as £36 billion a year could be recovered from a carbon price,rising to £75/t by 2030, before any smoothing or compensatory rebates were applied. This is cash that can either be recycled into growth enhancing projects, or used to get borrowing back under control.

Not surprisingly, the Treasury is interested in exploring this policy, but there is concern about going it alone. If the UK were the only economy to apply a BCA, the fear is that it might be isolated, accused of protectionism, penalised with retaliatory tariffs and challenged at the WTO.

Leaving aside the new spirit of can-do Brexit, the solution lies in Glasgow with COP 26. With the UK presidency of this global climate policy conference in 2021, we have the opportunity to set the political agenda. Making the global adoption of BCA a key negotiating objective of COP 26 would show true global economic leadership, bringing together disparate policy proposals from around the developed world into a unified set of commitments.

In the USA, Joe Biden has already spoken about a “carbon adjustment fee against countries that are failing to meet their climate and environmental obligations.” And in July last year, the European Union launched a formal consultation on implementing a BCA. With the traumas and strained relations of the EU trade agreement now behind us, what better way to mend fences than to unite over a mutually supportive policy of BCA?

Politics is full of missteps and compromise. Very rarely do the stars align in favour of a truly inspiring act of political and economic leadership – one that can transform the future of our country, and the world, for the better. The stars have aligned for Border Carbon Adjustment. It just needs a catchier name.