The problem is two-fold, neither of which are explicit in your example:

1. To what degree does the price of a ton of CO2 emissions pass through to the fuel? Let’s say we put a tax of $20/ton on the fuel, but only $10/ton ends up showing up at the consumer level (e.g., because the remaining $10 is passed through by some other means – like airlines raising the costs for extra bags rather than passing fuel costs along, or because shareholders “eat” part of the total).

2. How certain are investors that the government tax will remain at a known level in the long term?

The first makes it hard for investors who seek to lower CO2 emissions to know what the value of their reduction will be, while the second makes it hard for those same investors to know how permanent that income stream will be. The net result is that while a CO2 tax induces a penalty on CO2 sources – a stick – it provides no clear carrot to those who do the right thing. And given the scale of investment required, those carrots are critical. In your example, the need is not for the consumer to shift, but for the industrial to decide to produce, distribute and market the ethanol. Because absent that decision, the consumers’ choice doesn’t exist.

As an example, I will draw your attention to Sweden’s carbon tax, where gasoline has a tax of 0.85 SEK/litre and diesel has 1.049 SEK/litre. If consumers had a choice, ethanol (relatively the same market price as gasoline) would have a price advantage, therefore shifting behaviour to purchase the cheaper fuel and cleaner fuel.

I agree with you that this cannot be the main driving policy for GHG emission reductions, but at the same time it creates a society that will acknowledge carbon in our products. If everyday, you see on your receipts of purchased goods or services a line indicating Carbon Tax, you can wonder how to beat it. Nowadays, stores in my area have promotions of Tax-Free Days, which people take advantage. This is the enlightening that I foresee with a carbon tax.

The point is broadly true of any investment to lower carbon, whether from the perspective of a zero-carbon source, a low-carbon source or simply a downstream activity that lowers carbon indirectly (e.g., efficiency). In all cases, the challenge faced by a carbon tax – and, indeed, by any carbon regulation that places the regulatory burden upstream of the point of CO2 release – is that the linkage between the cost of carbon emissions and the price of the carbon-containing good/service is indirect and imprecise. (Not to mention always under political pressure to unwind.)

We see this in plenty of other venues. When fuel prices rise, airlines do not suddenly raise their fares to recoup their costs; their profits fall. Ditto for copper prices in the plumbing industry, silicon prices in the PV industry or any other sector. Cost increases only translate into price increases to the degree that businesses can pass those prices along without losing unacceptable market share. (In electricity markets, there may also be a legal component, since some have argued that utility commissions should not let utilities pass carbon prices along to their customers through rates, but should instead “eat” them as shareholders.)

The net effect of any regime in which the cost of carbon is not reflected in the price of the good is that there is no market signal to shift behavior (or at best, one that is diminished relative to the cost of the carbon), thereby removing the incentive to shift behavior – exactly the thing the tax is supposed to do! To use your words, the consumer in that instance is no more enlightened about their consumption than they are enlightened about fuel costs on airlines.

A final note – I’d argue that the goal is not to lower GHGs from the bottom up, but rather to lower GHGs as quickly and as cheaply as possible. From whence that reduction comes is a tactic rather than a strategy. If consumers push, that’s great – but the scale of infrastructure change required is such that we better make sure that we create an investment thesis for carbon reduction at the point in the economy where investments can be made. If the only lever is at the consumer, the pace and scale of GHG reduction will be blunted.

Your analysis seems to come from a non-carbon emitting business point of view. Isn’t carbon taxes just a way to enlighten a consumer about their carbon consumption? The goal to lower greenhouse gases is therefore pushed from the bottom up, using the consumer as a signal for businesses to change their operations.

Albeit, carbon tax is just a part of the the greater package.

Keep on writing. I really enjoy your posts.

Darklamp