The world is facing a challenge going forward- carbon dioxide induced climate change. Given the challenge, a government might be interested to know as to how it could make its citizen reduce their dependence on CO2 intensive fossil fuels. One possible way to mitigate the impending climate crisis dictates that we collectively organise to artificially ration fossil fuel. In turns out that the price we pay for fossil fuel is a powerful lever in determining how much we consume. It follows that intervening in the market to put an artificial price on carbon in a fossil fuel will induce us to consume less. Here is how a simple scheme might work as illustrated by the story of Ram and Hari.
Ram and Hari live in two different states. Both use 1,000 liters of petrol per year, which coincidentally happens to be the average for all drivers in their areas. Both pay Re one per litre for gasoline, amounting to Rs 1,000 per year each. Ram and Hari’s state governments try to reduce fossil fuel consumption to help combat climate change. To do so, each government will enact legislation to put a price on carbon. Ram lives in a state where the government introduces a revenue neutral carbon tax of Re one per litre, with future promises to offset his pain at the pump with equivalent income tax reductions. On the other hand, Hari lives in a state where the government has also introduced a carbon levy of Re one a litre. However, Hari’s government has appointed a non-profit agency to collect the levy. This agency’s sole mandate is to divide and refund the total amount evenly among all registered drivers of which Hari is one.
Once the tax is imposed, both Ram and Hari start paying Rs 2,000 per year for fuel. Neither is happy. Nonetheless, here the unhappiness is a powerful motivator to make the desired changes: to use less fossil fuel.
Meanwhile, Ram is still waiting for legislation on income tax rebate that lowers his income tax by Rs 1,000 /year. But as he is in a higher I-T bracket, he doesn’t hold out much hope that he will see that deep a cut in the price he pays. Hari, on the other hand, is already receiving his refund check for Rs 83 each month, which almost totally offsets his carbon levy (Rs 83 × 12 = Rs 996). Hari’s cash reward is a powerful motivation. He is certainly in the better frame of mind than Ram.
Now as both Ram and Hari are environmentally savy consumers and want to save money, they embark on a conservation campaign that saves them 10 per cent on their annual fuel usage, that is, each drop to 900 litres of petrol per year. As a result of their conservation efforts, both Ram and Hari are rewarded by an annual savings of Rs 200 each. However, each is still paying Rs 1,800 per year, substantially more than before the carbon tax. Ram is the least happy. He is still spending Rs 800 more on fuel than before his enlightened government introduced the carbon tax (without any luck on the tax rebate legislation). Hari, meanwhile, still experiences the pain when he fills up at the pump. However, he is still receiving his Rs 83 refund check each month. So his net outlay is now Rs 800 per year or Rs 200 less.
Both governments are of the view that to be effective, the price of carbon needs to be escalated in a predictable and scheduled manner. In both cases the next scheduled increase brings carbon tax to Rs two per litre. Both Ram and Hari will now pay Rs 2,700 per year. They are good conservers but they find it difficult to conserve more than the original 10 per cent. Fortunately, now that fuel is Rs three per litre but lots of non fossil-fuel alternatives have become price competitive. Ram and Hari switch vehicles to take advantage of an alternate non fossil-fuel, which is priced at Rs 2.50 a litre.
Ram saves Rs 450 by switching to an alternative fuel. However, he still pays Rs 1,250 more than before the carbon tax was introduced. He is still waiting for his income tax offset to kick in. Hari also saves the same Rs 450 per year by switching to a cheaper alternative. However, he now receives Rs 166 a month in refund from the carbon levy fund. His net outlay has drop¬ped to an amazing Rs 250 or Rs 750 less than before the carbon levy was introduced! What is even more amazing is that Hari’s alternative fuel producer is receiving the full Rs 2.50 outlay at the pump. In fact Hari’s government is able to collect a fair tax on that Rs 2.50 alternate fuel as well. No need for profit or tax holidays to stimulate the acceptance of the alternative fuel.
The purpose of any carbon-pricing scheme is to reduce fossil fuel consumption. The success of any program hinges critically on a buy in from the consumer. The consumer has to actually do the conserving or switching. There are a number of reasons why this simple scheme would have a better buy in than alternatives. Doing nothing about these challenges is also a choice – but probably not a good one for mitigating climate change. Although there are no perfect solutions here, between both ways of reducing fossil fuel consumption, I believe that Hari’s government offers us a better choice.
