Europe has only 30 years to stop fuelling cars with gasoline, producing electricity from coal, and heating homes with oil, or it will fall short of its agreed contribution to the fight against climate change.
Such a profound shift will require massive political interventions: standards will prohibit certain technologies, carbon taxes will make the use of dirty energy expensive, and public programmes will encourage the deployment of cleaner technologies. Compared to existing climate policies, future interventions will need to be significantly more aggressive. While today’s carbon price is below €10, for example, carbon prices of more than €100 might be necessary to discourage emissions in 2050.
These policies will not only have an impact on the economy, but will also feature significant distributional consequences. Poorer households that cannot afford expensive new electric vehicles will get stuck paying substantial carbon taxes for using their old Dacias. Ironically, governments would then be using the corresponding fuel-tax revenue to subsidise richer households buying a Tesla.
Poorer households typically do not own houses and therefore cannot actively invest in publicly subsidised solar panels, energy-efficiency measures or charging stations. And even if they own houses, they do not have access to capital to finance these investments. Thus, they will pay an increasing share of their low income on pollution penalties while richer households – who anyway use a lower share of their income for energy services – can afford to invest in switching away from fossil fuels to avoid paying increasing carbon taxes. So the cost of increasingly aggressive climate policies would fall disproportionately on poorer households.
By contrast, companies still receive free emission allowances and tax rebates on energy to strengthen them in international competition. These companies often still hand over the full carbon cost to their final consumers. At the same time, the massive investment needed to switch to a low-carbon economy implies a huge demand for capital – the World Bank speaks of an additional US$4 trillion in investments in the next 15 years. Higher capital demand translates into higher capital cost, meaning that capital owners can expect higher returns.
In this way, increasingly aggressive climate policies could make the rich richer while making the poor poorer. Growing inequality will reduce economic growth and political stability. Distributive effects will undermine the political acceptability of climate policies. But the alternatives – ignoring climate change, or not pushing poorer households to reduce their carbon footprint – are not viable. Poorer households are suffering disproportionately from climate change itself, having less capacity to adapt to changing conditions or to insure against climate risks.
It will become increasingly important to address the distributive effects of climate policies going forward, and this starts with the way climate policies are developed. Climate policy discussions are currently dominated by industry representatives (including trade unions from polluting industries) and environmentalists, but social concerns are rarely represented. This needs to change to make all decision-makers and experts think harder about the fairness aspects of climate policies.
One obvious opportunity lies in the redistribution of increasing carbon tax revenues. If a larger share of these revenues can be used to reduce the carbon footprint of poorer households – for example, by providing them with finance to invest in more energy-efficient appliances – they would actually benefit from climate polices. We should also think about how we tax different carbon sources. While electricity taxes are highly unfair for poorer households that traditionally spend a much higher share of their income on electricity, fuel taxes tend to fall more heavily on richer households.
With enough political will, the distributional impact of climate policies can be mitigated. This is crucial, because otherwise the necessary massive interventions – with carbon prices more than 10 times the current levels – will not be politically acceptable.