A Market Fix to a Market Failure? Carbon Pricing Policy that Works for Consumers

Climate change is a market failure. Climate change’s ongoing acceleration due to the overuse of fossil fuels is a market failure, more precisely. That’s how Dr. James Boyce, an economics professor emeritus at the University of Massachusetts-Amherst whose research focuses on environmental ethics and climate policy, sees it.
To Dr. Boyce, who spoke to me over Zoom in December 2022, the investments the United States , Europe and China have made to promote clean energy miss the point. They allow pollution to grow, he says, by failing to engage a broad swath of individuals in lower-carbon behaviors. “You can allocate a chunk of money to public investment in solar and that's a great thing.  But it’s not addressing the fundamental deformation at the heart of the market system, where you've got [fossil fuel] prices that don't reflect the full social cost of what people are buying,” explains Dr. Boyce.
Implementing a fix for this market failure, he argues, becomes realistic when people see low carbon behavior paying off economically.
Dr. Boyce works to  advocate for cap-and-dividends policy, a policy he believes will allow governments to effectively implement carbon pricing while also protecting lower-income consumers.
Cap-and-dividends policy uses the principles of carbon pricing,  an economic mechanism that accounts for the social costs of fossil fuels. Currently, 40 countries and over 20 regional governments use carbon taxing mechanisms. Cap-and-dividends is a policy in which a  government caps carbon emissions, auctions permits to carbon emitters, and returns auction profits to residents via cash dividends. Cap-and-dividends act like a carbon tax but offsets the increased energy prices by rebating consumers a dividend of permit funds raised. For Dr. Boyce, this flow of cash to consumers can capture the social cost of fossil fuels during the time it takes for cleaner fuels to prevail in most economies.
Dr. Boyce uses United States gas prices to show how this works in practice: “When people talk about $1.00 per ton of [carbon], what that translates into is 1 cent per gallon of gasoline.”
This means that the global average of $3/ton of carbon increases gas prices by only  $.03/gallon. According to Dr. Boyce this is nowhere close enough to changing consumer behaviors.
“If you have a carbon price that is robust enough, to really play that more fundamental role of acting as a strong incentive for pushing forward the clean energy transition on a scale and at a pace commensurate with the need, you're going to get a huge public outcry against higher gas and energy prices.”
Dividends offer a pathway to correct potential consumer outcry. Dr. Boyce’s research suggests that most lower and middle-income households come out ahead–receiving more back from the dividend than they pay in via higher energy costs.
Cap-and-dividends policy is  widely supported by economists, yet the policy remains unproven. Cap-and-dividend policies introduced in the United States Congress in 2009, 2015, and 2019 failed to gain traction.
Internationally, several countries have had more success in implementation. Switzerland has the longest history with cap-and-dividends, introducing a limited carbon tax in 2008 which redistributes two-thirds (⅔) of proceeds via health insurance premiums. Voters rejected measures to increase carbon taxes in 2021.
In 2019, Canada implemented a cap-and-dividend policy, with 90% of funds given directly back to citizens. The other 10% is used to support Indigenous groups and small businesses. While initially configured as a tax credit, beginning this year, Canadians will receive quarterly dividend disbursement checks. Through this program, 8 out of 10 households receive more money back than they pay from increased energy costs.
Because the purpose of carbon pricing and dividends policies is to change consumer behavior, optics matter. According to recent research, the two international cap-and-dividends policies–in Canada and Switzerland– are failing on that front. Researchers found that public support of carbon dividends was more a factor of partisan identity rather than economic interest.
Dr. Boyce is excited to see how Canada’s switch from tax rebate to the “proverbial check in the mail” plays out.
“Initially they made the huge blunder, in my view, of giving dividend money back through an income tax adjustment. You'd submit your income tax and you'd get, you know, $100 taken off and that's your dividend. Well, people don't even see it. They see the higher prices. The price of gasoline is higher, but they weren't seeing the dividend because it's buried in their income tax,” Dr. Boyce explained.
Despite the unclear program efficacy, recent polling in Canada suggests that consumers see clean energy as both more affordable and secure than fossil fuels.

The price of gasoline is higher, but they weren't seeing the dividend because it's buried in their income tax.
 

In addition to Switzerland and Canada, Austria began disbursing climate dividends in October 2022. Austria has also faced challenges with program optics, as  the roll-out of Austria’s policy coincided with energy disruptions and increased energy prices caused by the Ukraine war. These increased energy costs may make it difficult for consumers to see the increased costs associated with carbon pricing, so the government increased the climate dividends for this year, to cushion the overall energy cost increases.
But why is carbon pricing important to consider now, when the Biden Administration just passed the Inflation Reduction Act (IRA), one of the largest investments in clean energy the United States has ever seen?
Dr. Boyce points to the rising emission count as the American government works out specific guidance for the IRA’s credits and incentives. “It's great that [the IRA] happened. However, what it's not going to do is actually put us on track to meet the carbon reduction goals,” says Dr. Boyce.
Policymakers and investors alike predict the IRA will facilitate a boom in clean energy investments. Yet, even with significant investment in climate change mitigation efforts, by the Biden administration’s own calculations it’s unlikely that the IRA will spur the necessary reductions in greenhouse gas emissions to meet Paris Agreement goals.
While the IRA puts forth a pathway to reduce 40% of pre-2005 emissions by 2030, the 2015 Paris Agreement the United States renewed its commitment to in 2019 requires a drop to 50% of pre-2005 emissions.
“As the political environment becomes more conducive to further action on climate change with already a big chunk of public investment in the pipeline  I think it's possible, and perhaps even likely, that carbon pricing will reemerge in the United States at the federal level as a topic of discussion,” Dr. Boyce explains. And, Dr. Boyce believes discussions on carbon pricing must come with discussions of dividends.
Dr. Boyce remains optimistic that consumers will be eager to participate in a market solution to address climate change, if given a nudge. He speaks not only from a policy perspective, but also personal experience: he recently bought a plug-in electric vehicle.