Evaluation of a CO2 Tax as a climate policy

instrument in Germany

Students: Sejla Idrizi, 633299

Nils Sitar, 626754

Professor: Apurva Gosalia

International Marketing Strategy (IMM120)

Date: 05.01.2021
Table of Contents I
1. Introduction ....................................................................................... 1
2. Models for the pricing of CO2 emissions ......................................... 1
2.1 CO2 tax ................................................................................................................. 1
2.2 Emission trading ................................................................................................... 3
2.3 Differences between CO2 taxes and emission trading ......................................... 4
2.4 Use of funds .......................................................................................................... 4
3. Analysis and evaluation of a CO2 tax .............................................. 5
3.1 Evaluation of the implementation of a CO2 tax ................................................... 5
3.1.1 Advantages .................................................................................................... 5
3.1.2 Disadvantages ................................................................................................ 6
3.2 Is the CO2 tax merely greenwashing? .................................................................. 8
4. Conclusion ........................................................................................ 9
References ........................................................................................... 10

I
1. Introduction
The climate crisis is certainly one of the most important issues of this century.
Social movements like "Fridays for Future" are putting more and more pressure on
politicians to take climate policy measures in order to contain the consequences of
climate change to the greatest extent possible. The Paris Agreement1 set the goal of
limiting the increase in average temperature to below 2°C compared to pre-
industrial times. To achieve these goals, the EU has set binding targets in its EU
legislation, such as reducing greenhouse gas emissions by 40 % compared to 1990
until 2030 (European Commission 2021). Not meeting these legally binding targets
will have financial consequences for these states (Frondel 2019, p. 151).

Germany has clearly missed its 2020 target of a 40 % greenhouse gases emission
reduction (Burger et al. 2019, p. 1). There is a very high need for action to achieve
the 2030 target of reducing greenhouse gases from sectors, which are not included
in the European Trading System (ETS), by 38% compared to 2005 (Burger et al.
2019, p. 1; Blum et al. 2019, p. 60). The introduction of a national CO2 tax can help
in this regard. This paper shall illustrate how a national German CO2 tax can
contribute to meeting the greenhouse gas emission targets in the future compared
to emission trading, what its advantages and disadvantages are and if this measure
might just be used for communication in regard to greenwashing.

2. Models for the pricing of CO2 emissions

In order for Germany to meet its 2030 climate targets, a major emissions reduction
is needed. There are various policy measures to implement such a reduction: A
national CO2 tax and emissions trading. In the following chapter these models will
be discussed in detail.

2.1 CO2 tax

A CO2 tax is a tax on the carbon emissions released during the production of goods
(Nedumpara and Pradeep 2020, p. 4). The higher costs of production than create
incentives to gradually reduce CO2-intensive behavior (Bundeszentrale für

1
The first comprehensive and legally binding global climate agreement with a
total of 190 parties (European Commission 2021).
1
politische Bildung 2020). The CO2 tax has many supporters, with more than 3500
US economists advocating the introduction of CO2 taxes (Burger et al. 2019, p. 1).
This measure is already being applied in more than 25 countries, such as Sweden,
Switzerland and Chile. Initial successes already have been achieved in these
countries (Burger et al. 2019, p. 1; Nedumpara and Pradeep 2020, p. 4). For
example, Sweden has been able to reduce emissions in the building sector by about
90 % since its introduction in 1991 (Thöne et al. 2019, p. 43). In Germany, taxation
of emissions has taken place since 2005 through the EU Emissions Trading System,
but only limited to the sectors of power generation, installations of energy-intensive
industries, and intra-European aviation (Burger et al. 2019, p. 1).With a CO2 tax,
the price of emissions per ton is predetermined, so the amount of CO2 is variable
and thus the extent of emissions reduction is not clear in advance (Blum et al. 2019,
p. 60). As a result, the determination of the CO2 price is the crucial factor and must
be intensively considered in advance (Blum et al. 2019, p. 61). A pricing of CO2
emissions can lead to an increase in the price of fossil fuels, e.g. the introduction of
a price of 65 € per ton CO2 would cause an increase in the price of gasoline by 15.4
cents per liter (Frondel 2019, p. 152). However, this would probably not cause
drivers to switch immediately to a more fuel-efficient car in the short term. After
the lifetime of their vehicle, consumers will likely buy a lower-cost vehicle
afterwards. Thus, the increase in the CO2 price over time will lead to an important
consumption-reducing effect in the long run (Frondel 2019, p. 153). The avoidance
costs to mitigate emissions can also serve as a basis for measuring the price of CO2.
Climate policy targets are also a crucial variable in the pricing of CO2 emissions.
For example, achieving the Paris Agreement's 2030 target of 1.5 degrees would
imply a lower limit on the price of CO2 of 135 US-$/ton CO2 under the most
favorable climate change mitigation scenario (Burger et al. 2019, p. 5). The
determination of the price of a CO2 ton has many important influencing factors,
such as the cost development of climate protection technologies, innovations or
socio-economic trends (Burger et al. 2019, p. 5). The price of the CO2 tax must
therefore be well considered and calculated. The advantage of a CO2 tax at the
national level is, above all, its rapid political implementation (Blum et al. 2019, p.
62).

2
2.2 Emission trading

In addition to the CO2 tax, there is another way of pricing greenhouse gas emission.
This pricing takes place within the framework of emissions trading, also known as
a “Cap & Trade” principle. Similar to the CO2 tax, this system aims at the reduction
of climate damaging greenhouse gases. The approach of emissions trading involves
setting an industry-wide limit for emissions (Nedumpara and Pradeep 2020, p. 3).
Furthermore, a fixed number of permits is issued to companies, which in total
equals the amount of the industry-wide limit for emissions. However, this system
allows trading of the issued permits, therefore a market is formed. In this market,
companies can sell their surplus permits at a profit, while those companies that have
already used up their permits have the opportunity to purchase additional permits.
Thus, where an entity finds it cost effective to save up on emissions, it may sell the
extra permits to other entities (Nedumpara and Pradeep 2020, p. 4). Through the set
number of permits, the actual emissions of greenhouse gases are determined.
Thereby, governments can control the reduction of their emissions. In contrast to
the predetermined emissions the prices of the permits are volatile which can result
in huge fluctuations (Pollitt 2019, p. 12). This can be seen on the emission trading
system of the European Union. The initial over allocation of permits in 2007 and
the financial crisis in 2009 led to prices collapses in the ETS. However, the
introduction of an EU wide cap with allocation of auction shares to national
governments, helps prevent the over allocation problem at the national level (Pollitt
2019, p. 12). This system is especially attractive in the early stages of
decarbonization since the market can help with finding the best approach to reduce
the emission of greenhouse gases (Pollitt 2019, p. 6). Since every market participant
has its own self-interests, the reduction will start where it is most cost efficient.
Furthermore, it will incentivize the development of technologies, which are less
harmful to the climate (Frondel 2019, p. 152). Consequently, the trading of permits
helps identify the mix of sectors to decarbonize, the mix of existing low carbon
technologies per sector and the role of demand side reduction and substitution
(Pollitt 2019, p. 7). This pricing system for greenhouse gases is implemented by
different political entities, including the European Union, New Zealand,
Switzerland, South Korea and others (Nedumpara and Pradeep 2020, p. 4). To
summarize, this system is characterized by the limitation and trade of emission
permits, which results in the creation of a virtual market.

3
2.3 Differences between CO2 taxes and emission trading

Carbon markets and carbon taxes are the two standard ways of putting a price on
carbon emissions. The major difference between these two approaches is that
carbon markets set the quantity of carbon to be emitted and let the price vary in the
market for emissions permits, while carbon taxes fix the price but let the quantity
of emissions vary. As such, carbon markets introduce a price risk for those exposed
to the spot price of permits, while carbon taxes introduce quantity risks on the
climate. Carbon markets and carbon taxes share many of the same theoretical
properties and can be identical in many respects (Pollitt 2019, p. 7). However, it
makes no difference to climate protection, in which sector the emissions are reduced
as long as greenhouse gas emissions can be reduced overall. It would be
economically efficient to reduce emissions in those sectors where this is most cost-
effective with the help of current technologies (Frondel 2019, p. 152). For firms
such as fossil fuel-based energy companies a CO2 Tax is more desirable since the
carbon market effectively fixes the overall quantity of permits no matter what the
demand conditions are. This is especially so because to reach climate goals a drastic
reduction of the permits is necessary (Pollitt 2019, p. 7).

2.4 Use of funds

The pricing of CO2 emissions generates funds. The discussion regarding the pricing
of CO2 emissions also centers on how these newly available funds are to be used
appropriately. Various options are conceivable here. In the 25th Economists' Panel,
the reimbursement as a per capita fixed compensation found the most support
(Blum et al. 2019, p. 63). This "climate bonus" is intended to compensate for the
higher financial burden on private households and thus generate a greater
acceptance among the population (Thöne et al. 2019, p. 18). Another option is to
compensate for the increased tax burden by reducing or abolishing the energy and
electricity tax, the EEG2 levy or other taxes/levies. The promotion of climate-
friendly technologies through the money collected is also conceivable and would
have a positive impact on Germany's climate policy goals (Blum et al. 2019, p. 63).

2
The EEG levy is part of the electricity prices and is intended to compensate for the difference between the
costs incurred in the promotion of electricity from renewable energies and the revenues, so that the feed-in of
renewable energies is promoted (Deutsches Institut für Wirtschaftsforschung e.V. 2021).
4
3. Analysis and evaluation of a CO2 tax

3.1 Evaluation of the implementation of a CO2 tax

In the following the advantages and disadvantages of the introduction of a CO2 tax
will be discussed. Alternatives like a so-called Cap & Trade system will be taken
into consideration in order to evaluate the practical advantageousness of this
approach.

3.1.1 Advantages

The reason to price carbon emissions is to reduce them. A carbon tax will be able
to do this to a certain degree. The amount of carbon reduction depends on different
factors like for example the height of the carbon prices, as well as the time interval
the tax is active. Even an introduction of a CO2 price of 65 € for fossil fuels won’t
lead most consumers to prematurely buying a new car or new heating. The
advantages of pricing CO2 through a tax comes in the long term. Consumers and
companies will be aware of the CO2 price and the incremental future increase of it
which will lead them to decide for a less carbon intensive alternative when it comes
to the next buying decision. Therefore, they will decrease the amount of carbon
emission (Frondel 2019, p. 153).

Since a CO2 tax gives incentives to reduce the consumption of CO2 intensive
products, it consequently increases the rentability of investments in technologies,
which reduce CO2 emissions like renewable energies and new mobility concepts.

The feasibility of a CO2 tax is questioned often, especially in regard to the societal
acceptance. An example to show the opposite is the CO2 tax of Switzerland, which
was introduced in 2008. This CO2 tax targets fossil fuels and was implemented
outside of the ETS (Thöne et al. 2019, p. 40). Through a partial redistribution among
the population and companies & the funding of an energy efficient building
modernization program, the tax gained public support and is widely accepted
among swiss citizens. Additional information campaigns helped to increase the
awareness for climate protection (Thöne et al. 2019, p. 41). The example of the
CO2 tax in Switzerland shows that the measure can have a desired steering effect
on the one hand and can also be explained to people on the other. This is particularly

5
true if the levying of the CO2 tax is not an individual measure but is embedded in
a catalog of measures that includes fair compensation.

Revenues are nationally collected with a tax (Pollitt 2019, p. 10). Which is an
advantage since it reduces the efforts to negotiate on an international level and it
lets countries adapt the tax to their local needs (Weitzman 2017, p. 566).
Furthermore, the transaction costs to negotiate are reduced as well as the time until
the tax can be implemented (Frondel 2019, p. 154). However, if the international
competition can operate without the similar tax burdens and no sufficient tariffs for
CO2 emissions are put in place, the competitiveness of the national companies can
be reduced to a certain degree.

A single price for multiple countries can be inefficient because of the different
structure of national economies. The price for emission to reach the desired steering
effect in one country can widely differ from the price in another country.
Compromising on carbon prices can lead to prices which are too low for wealthy
countries and too high for poorer countries. Therefore, the desired effect on carbon
emissions cannot be reached (Weitzman 2017, p. 567). Furthermore, the same
negotiation issues are relevant for an international coordination of price raising
(Pollitt 2019, p. 10). Through setting prices on a national level and incrementally
increasing them price volatility is reduced and this consequently reduces
uncertainty for consumers and companies.

3.1.2 Disadvantages

Independent of the kind of pricing mechanism for carbon, it will result in higher
prices for the consumer. Carbon pricing will not only lead to rising prices for fossil
fuels, but it will also increase the price of other products, whereby the extent of the
increased prices depends on the amount of carbon emissions, which is needed to
create the product and to deliver it to the customer (Frondel 2019, p. 152). This
price increase is intended and the reason this measure has a steering effect.
Nonetheless this development can lead to sinking acceptance for this measure if it
isn’t accompanied with fair compensation.

The price level of CO2 Tax is crucial for the effectiveness of this measure. Since
most politicians will favor starting with a small price and incrementally increasing
it, there is a constant need to evaluate and adapt the CO2 tax (Frondel 2019, p. 155).

6
In contrast to the cap & trade approach, the CO2 tax is not pro-cyclical, which
means that instead of an automatic adaptation to economic conditions through the
market, it needs to be adapted by legislators (Pollitt 2019, p. 11). Therefore, fixed
tax rates become more burdensome and hence difficult to defend in times of
recession, and more vulnerable to being reduced in a way that undermines the long-
term credibility of the carbon tax mechanism. In particular, it may be difficult to
raise taxes from their initial levels in order to strengthen the price signal (Frondel
2019, p. 155). Consequently, the vulnerability of the CO2 tax to subsequent
political interference can be very high, especially when public support is
decreasing. Differences in the political cycle mean that it would be difficult to
coordinate increases to tax rates across countries, in a way that agreements to
tighten the quantities within an emissions cap may not be. However, there is a
counterexample. The CO2 Tax in Switzerland was implemented with a mechanism
which adapts the price automatically and in a predictable manner, if the
intermediate objectives of the tax are not reached. This tax and its adaptation
mechanism are established and accepted among the swiss citizens (Thöne et al.
2019, p. 41). Nonetheless the collective coordinated international increase of the
tax will be very difficult, since it is not consistent with national sovereignty, and
there are no comparable examples globally of coordination upwards of
environmental or any other tax rates (Pollitt 2019, p. 11).

Furthermore, the theoretical effectiveness of the CO2 tax does not have to translate
into practical effectiveness. Especially in the case of the fossil fuel industry, it could
be problematic. If a relatively high CO2 tax is established in the most important
markets, this will lead to less demand, since the prices increase. Since the price
elasticity is -0.4 to -0.7 for fuel in Germany, a price increase of 10 percent only
would lead to a demand decrease of around 4 to 7 percent (Frondel 2019, p. 153).
Additionally, a high CO2 tax could lead the fuel industry into a so-called green
paradox. Fossil fuel producers, anticipating long run oversupply of fossil fuels, are
likely to increase extraction rates. The possible increased extraction of fossil fuels
in combination with a disproportionately price elasticity could severely limit the
effect of the CO2 tax in the short term. In this case quantity targets are likely to be
a more efficacious climate policy than carbon taxation (Pollitt 2019, p. 10).

7
3.2 Is the CO2 tax merely greenwashing?

Through the media and “Fridays for Future”-movement, the pressure on politics
regarding the climate issue increased drastically. The federal republic of germany
acted with the introduction of a CO2 tax starting from 01.01.2021 on the sectors
buildings and traffic. Companies that put fossil fuels, such as heating oil, gasoline
or natural gas, on the market must purchase emission certificates from the start of
the year. The price for one ton of CO2 is set at 25 € per ton initially (Bundeszentrale
für politische Bildung 2020). As already mentioned in chapter 2.1, however, a
minimum of 135 US-$, equivalent to approx. 111 €, per ton is necessary in order to
achieve the required savings of greenhouse gas emissions. Now the question arises
whether this low starting price leads to a "greenwashing" effect. Greenwashing
refers to the attempt by companies or institutions to be perceived as particularly
environmentally friendly through monetary donations, PR campaigns or similar
(Bibliographisches Institut GmbH 2020). Through the introduction of a CO2 tax
politicians try to indirectly suggest that they are taking all the necessary steps to
curb global warming. However, the very low starting price gives the impression
that this was done in favor of the companies. The fact that the amount of CO2
emissions is not capped could also lead to companies accepting the higher
"investment" on the production of their goods in the form of a CO2 tax. This price
increase will be passed on directly to the end customer, as already suspected, and
thus will not be such a great incentive to make production more climate friendly. A
CO2 tax also gives companies the opportunity to present themselves as greener and
to engage thereby into “greenwashing” themselves. Financially strong companies
can easily cover the higher financial tax burden and at the same time use this to
convey the feeling in their communication that they are contributing to the climate
crisis, even if they do not reduce their emissions at all. Politicians make it seem that
this is the right and necessary step to reduce emissions, but scientists believe that a
higher price is needed to bring about the necessary changes (Burger et al. 2019, p.
5). Capping the existing amount of CO2 would be a better alternative, as it happens
in an emission trading system, because the CO2 reduction can be better targeted
and controlled. It remains to be seen if the price of the CO2 tax will be increased
and thus the needed reductions will be achieved. Until then the CO2 tax seems to
be mostly a communicative tool of politics and can thus be called "greenwashing".

8
4. Conclusion
The introduction of a CO2 tax was a good first and correct step towards achieving
the climate targets. However, it is questionable at best whether the current strategy
of the German government will be sufficient to achieve the required reduction by
2030. To achieve the speed needed, an emissions trading system might also be
beneficial and should be taken into consideration regarding future measures. To
ensure that the current measures are no longer merely "greenwashing,"
policymakers must introduce more ambitious measures than they currently do.
Regarding the CO2 tax it is advisable to consider increasing the price per ton CO2
emission. This should be done through a system, which automatically evaluates and
adapts the price independent of political legislature. However, a certain degree of
price variation for a limited time within a predefined framework is advisable since
an important critique is that the CO2 tax is too rigid and can’t adapt to strong
economic fluctuations. The adaptation mechanism will lead to an increased
acceptance among the population, because it will take into account the current
economic situation. Only one-fifth of the economist panel respondents felt that a
carbon tax alone would be sufficient (Blum et al. 2019, p. 65). Thus, other measures
besides putting a price on emissions will be needed to keep global warming below
2 °C. It remains to be seen how the CO2 tax will affect the behavior of companies
and the population and to what extent the government will have to implement
further measures.

9
References

Bibliographisches Institut GmbH (Hrsg.) (2020). Green-wa-shing, das. Available

online at https://www.duden.de/rechtschreibung/Greenwashing (accessed
1/3/2021).
Blum, Johannes/Schiller, Raphael de Britto/Löschel, Andreas/Pfeiffer,
Johannes/Pittel, Karen/Potrafke, Niklas/Schmitt, Alex (2019). Zur
Bepreisung von CO2-Emissionen. Ergebnisse aus dem Ökonomenpanel. In:
Leibniz-Institut für Wirtschaftsforschung (Ed.). ifo Schnelldienst. München,
60–65.
Bundeszentrale für politische Bildung (Hrsg.) (2020). Ab 2021: CO2-Preis auf
Heiz- und Kraftstoffe. Available online at
https://www.bpb.de/politik/hintergrund-aktuell/324668/co2-preis-auf-heiz-
und-kraftstoffe (accessed 1/3/2021).
Burger, Andres/Lünenbürger, Benjamin/Kühleis, Christoph (2019). CO2-
Bepreisung in Deutschland. Ein Überblick über die Handlungsoptionen und
ihre Vor- und Nachteile. Umweltbundesamt. Available online at
https://www.umweltbundesamt.de/sites/default/files/medien/376/publikation
en/factsheet_co2-bepreisung_in_deutschland_2019_08_29.pdf (accessed
1/2/2021).
Deutsches Institut für Wirtschaftsforschung e.V. (2021). EEG-Umlage. Available
online at
https://www.diw.de/de/diw_01.c.411881.de/presse/glossar/eeg_umlage.html
.
European Commission (2021). Paris Agreement. Available online at
https://ec.europa.eu/clima/policies/international/negotiations/paris_en
(accessed 1/3/2021).
Frondel, Manuel (2019). Steuer versus Emissionshandel: Optionen für die
Ausgestaltung einer CO2-Bepreisung in den nicht in den Emissionshandel
integrierten Sektoren. Zeitschrift für Energiewirtschaft 43 (3), 151–157.
https://doi.org/10.1007/s12398-019-00260-x.
Nedumpara, James J./Pradeep, Shiny (2020). Implementing carbon tax: from
rhetoric to reality. Indian Journal of International Law.
https://doi.org/10.1007/s40901-020-00122-z.
10
Pollitt, Michael G. (2019). A global carbon market? Frontiers of Engineering
Management 6 (1), 5–18. https://doi.org/10.1007/s42524-019-0011-x.
Thöne, Michael/Gierkink, Max/Pickert, Lena/Kreuter, Decker, HannaHelena
(2019). CO₂-Bepreisung im Gebäudesektor und notwendige
Zusatzinstrumente. Energiewirtschaftliches Institut an der Universität zu
Köln gGmbH. Available online at https://www.ewi.uni-koeln.de/cms/wp-
content/uploads/2019/09/EWI_FiFo_Studie_CO2-Bepreisung-im-
Gebäudesektor_190918.pdf (accessed 1/3/2021).
Weitzman, Martin L. (2017). On a World Climate Assembly and the Social Cost
of Carbon. Economica 84 (336), 559–586.
https://doi.org/10.1111/ecca.12248.

11
Eidesstaatliche Erklärung
Wir versichern, dass wir die Hausarbeit „Evaluation of a CO2 Tax as a climate
policy instrument in Germany “ selbstständig und nur unter Verwendung der
angegebenen Quellen und Hilfsmittel angefertigt und die den benutzten Quellen
wörtlich oder inhaltlich entnommenen Stellen als solche kenntlich gemacht habe.
Die Arbeit hat in gleicher oder ähnlicher Form noch keiner anderen
Prüfungsbehörde vorgelegen.

Wir erklären uns damit einverstanden, dass die Arbeit mit Hilfe eines Plagi-
atserkennungsdienstes auf enthaltene Plagiate überprüft wird.

Datum, Unterschrift
_________________ __________________________
Sejla Idrizi

Datum, Unterschrift
_________________ __________________________
Nils Sitar

12