Carbon Taxes for Abu Dhabi? An Oped draft...

Heading to the lecture by Prof. Esty of Yale University I was expecting it to be interesting but uncontroversial. I was not disappointed on the former but I was certainly proven wrong on the latter during the question and answer session. Prof. Esty was invited by HH Sheikh Mohamed Bin Zayed to speak on the competitive advantages gained by firms that commit resources to improve their environmental performance at the Abu Dhabi Majlis. Responding to a question at the end of his lecture, he proposed the introduction of a carbon tax in Abu Dhabi. This was a stunner proposal and I believe an eminently good idea. Unfortunately, since his talk I have not heard of any further discussion on the topic and I am afraid that is being passed by without consideration. It is worthwhile to revisit this issue, by opening a discussion on the merits and potential disadvantages of a carbon tax for the UAE. Before proceeding, I will briefly define the concept as a basis for the discussion.

An environmental tax is one possible policy measure for internalizing the externalities of activities that damage the environment. Translating the econospeak, it means that a polluter pays a fee for the pollution he or she causes which otherwise would come at no cost. By putting a price, the usage of a public good is controlled and an incentive is provided for more efficient use of that resource. The collected fees could be used as a government income but ideally they should be used to remediate the damage, channeled to activities that provide equivalent service, or if no alternatives are yet available to fund research for their discovery. A proximate equivalent of an environmental tax from everyday life in the UAE is the Salik toll - the toll price (tax) disincentivizes some drivers from driving their car (action that reduces road capacity which is a public good) and thus avoiding congestion while it provides necessary revenues for maintaining the road infrastructure.

Alternative methods for mitigating pollution include command and control regulations and tradeable permits in markets. Command and control methods are laws that expressly prohibit or limit the polluting action. The transportation equivalent to this would be prohibitions to parking on the highway (parking reduces capacity) but in the same setting it would mean allowing only certain cars on the road at certain times. Tradeable permits allow the distribution of a predetermined amount of the resource (i.e. pollution) among interested users. These users can then trade among themselves putting a price on the permit. Some polluters find that selling the permit they own and pocketing the money rather than polluting provides a higher utility. In a transportation setting it would mean that all car users are allowed to drive a limited amount of time. Some drivers decide to take the Metro or bus for their needs and sell the "extra" hours to those who really need to drive more.

All three approaches could lead to the same positive results of curbing undesired pollution but they cannot be applied equally successfully to all situations. Command and control requires policing which is expensive and also significantly limits freedom (think of the case of driving hour restrictions for certain drivers - how would the enforcement know whether a driver exceeded the allowance?) while tradeable permits require low transaction costs for a functioning market. They need ways to measure pollution, verify reductions, and buy and sell in a market. Compared to these, an environmental tax can be quite simple if the sources of pollution are limited.

The most urgent environmental challenge faced by humanity today is without reservation anthropogenic global climate change. Our modern civilization relied heavily -and still does- on the abundant availability of energy from fossil fuels; coal, oil, natural gas. The unfortunate side effect of their combustion is that it releases carbon dioxide which is the most prevalent atmospheric gas that contributes to global warming.

Every time that a UAE resident turns on an electric light, switches the AC, drives a car, or uses water to irrigate a lawn, he or she contributes directly to climate forcing emissions. Individually every action's emissions are minute, but collectively they add up to significant quantities. So much so that they push UAE to the dubious honor of being among the countries with the highest carbon footprint per capita in the world. Since UAE and Abu Dhabi realized this, the leadership has made commitments and declared policies to reduce carbon emissions like the Masdar Initiative, the goal of 7% renewable generation capacity by 2020, and the strong commitment to the International Renewable Energy Agency (IRENA) . An environmental tax on carbon emissions - a carbon tax - would go a long way in complementing these efforts and putting the UAE in the forefront of countries that actively work in mitigating climate change. Saving money, supporting the economy and allowing sustainability-oriented projects to cost less to the government without disturbing every day life are added bonuses.

By now it should start becoming clearer why a carbon tax would be the best fit for reducing UAE's climate change emissions; regulating individual actions (command and control) would be too pervasive and impossible to enforce as it would apply to most actions of everyday life. Creating a market of tradeable permits would face similar problems if done at the individual level while if done at the institutional level (i.e. asking ADEWA, DEWA, DUBAL, EMAL, etc to start a permit system within and across their organizations) would be fraught with complexities and subject to institutional inertia. It is no wonder that the European Emissions Trading Scheme, one of the first active climate change tradeable permit system only includes large stationary emitters like power plants, smelters and refineries but not smaller mobile sources like car driving. A carbon tax on the other hand is simple, it can be imposed at the source of the fossil fuel supply chain (i.e. on the sale of gasoline or natural gas), it covers any and all activities that emit carbon, can be collected easilty and does not require additional adjustments.

Now that we have established that a carbon tax is a pertinent measure we need to discuss why it should be implemented, what would be the benefits to the UAE, what would be its expected impact on government spending and whether there would be any disadvantages.

I will start the "why" discussion by borrowing a quote from Dr. Sultan al Jaber, Masdar's CEO; "because we can and because we should." This was his response to the question of why should Abu Dhabi be involved in renewable energy and I believe that it is equally valid here and for the same reasons. As we will see shortly, the costs of a carbon tax are relatively limited and can be easily absorbed by a country with the UAE's affluent population. The imperative part requires more discussion and is open to interpretation but in the end it is a moral position; if UAE's residents and leaders believe that we owe to future generations to provide them with a climate that is livable then the time for action is now. Morality aside, by instituting a carbon tax, the UAE would become a leader of the non-Annex I Kyoto protocol signatories (countries that have signed the global agreement that set global reduction targets known as the Kyoto Protocol and which expires in 2012 but with no obligations of reduction imposed). By voluntary working towards mitigating its emissions, UAE would demonstrate that there is strong leadership and desire to stop being among the highest per capita polluters, while positioning the UAE economy in a prepared state prior to any post-Kyoto commitments.

The implementation of a carbon tax is a simple process; akin to a price increase of gasoline or electricity. In simplified terms, the country's leadership decides on a starting carbon price - a reasonable starting value could be set to AED20 per tonne of CO2. In 2006, the UAE emitted approximately 33 tonnes of CO2 per capita which would work to an additional cost of AED55 per month per person. Another way to visualize this is by considering its impact on the cost of gasoline or electricity; a 60 liter fill-up of a medium car that currently costs AED90 would cost under such a levy AED93.

Despite its seemingly low impact on individuals, the measure would generate close to AED2.8 Billion in revenue if it had been implemented in 2006 year which if extrapolated at the same carbon price and rate of emissions would be 3.8 Billion AED in 2015. If implemented for 10 years to 2020 and with an AED3.33 increase in the carbon price a year to reach AED50 by year 2020 the total revenue from the measure would be AED 62 Billion. If this revenue was invested in solar photovoltaic installations with conservative assumptions, it would lead to slightly more than 10% of the total UAE electricity generation capacity being renewable - significantly in excess of Abu Dhabi's regional target for 7% without any need for additional government funding. If a domestic industry like Masdar is involved, then the benefits to the country are multiplied. Finally, in addition to the above, renewable energy installations allow for the conservation of natural gas which if in excess can be exported or its import be avoided.

So if there are such benefits to a carbon tax why is there resistance to its institution? Firstly and unfortunately, there is a gut reaction against imposition of any type of taxation. We can certainly call it environmental levy if that would ease some of these fears. Another fear is a reduction in economic growth; this could be more founded if not for multiple studies that discredit such fears conducted for the European Union and the United States. Intuitively, given the low cost of implementation to individuals equivalent to less than a modest meal at a restaurant a month and of the facts that (i) the revenues will be reinvested in the economy in the form of renewable energy projects, (ii) there will be incentives to reduce inefficient and wasteful consumption thus increasing economic efficiency these fears seem unfounded. More fundamentally, by implementing a carbon levy system, UAE will gain the high moral ground and justify its leadership in environmental causes while supporting its economy and sustaining resources for the future generations.