What is the problem of solving the climate problem? Insights from implementing carbon pricing in Germany and the EU

by Thomas Mendoza and Chao Zhang

The problem of solving the climate problem

Climate change poses enormous challenges for society and decision makers, which calls for rapid action. However, given the severity of the issue and availability of technological solutions to hit the 1.5 degrees target, it seems somehow surprising that insufficient action has been taken until now - which Dr. Michael Pahle called the “non-action paradox”.
The underlying problems are multifaceted and to mitigate climate change he suggested that it is better to take an incremental approach where, rather than starting from preset goals, actions are built upon existing situation and are adjusted stepwise. The reasons are that: firstly, there exists basic disagreement on objectives or values within larger society and decision makers; secondly, regulators often do not know how properly rank different and conflicting solutions; and thirdly, the prioritization of essential social objectives vary a lot in changing circumstances.

Options for Carbon Pricing Reform

In the second part of his talk Dr. Michael Pahle gave an overview of options suggested by him and his colleagues and explained the rationale behind them. When it comes to the assessment of carbon pricing instruments, Dr. Michael Pahle underlined that there exist four instruments (regulation, carbon tax, DE-ETS, EU-ETS), each with advantages and disadvantages. He further stressed that it is not the instrument itself that matters - for example when comparing carbon tax with the emission trading scheme - but rather how the instruments are implemented and how policy makers design them institutionally. Since setting up sector specific targets would hinder the goal of a single economy-wide carbon pricing system, Dr. Michael Pahle argued that it is more desirable to have not only a national, but also EU-wide target independent of sectors. To achieve this conception, Dr. Michael Pahle suggested that Germany should start with a na-tional scheme first and take a coordinating role within EU member countries to reach a conver-gence point in the future. This transnational coordination would however require stakeholders from different sides to overcome larger barriers.

Distributional effects of carbon pricing instruments as key lever to reduce societal burden

For a successful implementation of carbon pricing, the distributional effect of such carbon pric-ing instruments should also be taken into account. In order to reduce the accompanying finan-cial burden on the low-income households, Dr. Michael Pahle suggested that 100% of the reve-nues from carbon pricing should be paid back to the society through redistribution, for example via a “per-capita lump sum transfer”.

Assessing the Climate Action Program 2030

After the “Options for carbon pricing reform” was presented and discussed in the German Cli-mate Cabinet and Germany adopted a new carbon pricing scheme, Dr. Michael Pahle and his colleagues published another paper called “Assessment of the German climate package and next steps” in response. In the third part of the presentation Dr. Michael Pahle compared their initial recommendations from the first paper with the actual policies that came into force and provided explanations for the appearing discrepancies.
The first main recommendation was that governments should define a long-term price path with a carbon price starting at 50€ p. tCO2 and increase it to 130€ p. tCO2 in 2030. However, the final policy starts at a much lower price of 10€ p. tCO2 and increases it to 35-70€ p. tCO2, where only the path till 2025 is definite and the variability afterwards can be very high. The dis-crepancy can be mainly explained by existing legal barriers for implementing a carbon tax, the political challenges that energy taxes pose as well as CDU’s preference to implement ETS not until 2025.

The second main recommendation suggested that the German government should fully use all revenues from carbon pricing to compensate the burden imposed on the low income. However, in the actual policy, due to legal and cost barriers related to direct transfers and other reasons, only 20% of revenues is used for redistribution in the form of reducing EEG levy and tax credits for long-distance commuters, which is, according to the assessment paper, too low to offset the burden for the low income once the price reaches as high as 60 Euros per ton, besides, an-other issue might have been that the carbon price level itself was discussed independently from the redistribution, therefore the assessment paper suggests that government should create favorable conditions for putting higher percentage of revenues into redistribution in the future and could consider the redistribution scheme first.
The third recommendation stated that a floor price should be introduced to the EU-ETS, and that the German government should aim to gear the carbon pricing policies towards a direction where it is possible to integrate them into a European-wide emissions trading system across all sectors. Both of these were accepted and written into the act, the latter of which was consid-ered as a paradigm shift moment in German climate policy since it strategically oriented cli-mate policy on the European level.

Implications for policymaking process

Finally, Dr. Michael Pahle shared his personal thoughts and reflections along the way. He sug-gested that policy making often involves many stakeholders and solutions are subject to legal and administrative constraints. In this regard research is only decision-relevant when it appeals to at least one of the decision makers and it should respect the conditions at which decisions are made.

We would like to thank Dr. Michael Pahle for his insightful presentation.