The carbon pricing proposals of the "Fit for 55" package : an efficient and fair route to carbon neutrality?

In July 2021, the European Commission delivered the ‘Fit for 55’ package, which contains policy proposals for achieving the ambitious goals of the European Green Deal. This working paper discusses the carbon pricing component of the package, which comprises an extension of the Emissions Trading System, a revision of the Energy Taxation Directive, and a Carbon Border Adjustment Mechanism. While there is a broad consensus among economists about the merits of carbon pricing, implementation has not been widespread because of political-economic obstacles and a lack of international coordination. Despite that, ex-post evidence is fairly conclusive on the efficiency of carbon pricing in cutting CO2 emissions. Our discussion focuses on fairness and competitiveness. Distributional issues have to be considered more broadly than has previously been the case. The issue is not whether carbon pricing is regressive or not, but what the distributional consequences of carbon pricing are in comparison with other policy options. It appears that other options do not have better distributional consequences: failure to act will hit the poor more than the rich, environmental tax incentives benefit the rich more than low- and middle-income earners, and environmental standards may also be regressive, as the clean alternatives they impose are less affordable for low- and middle-income earners. But while carbon pricing procures revenue that can be used to compensate for regressivity, standards and norms do not procure any revenue that could be used for that purpose, and environmental tax incentives have to be funded. In addition, carbon pricing ensures cost-effectiveness in a better way than incentives and standards. Regarding competitiveness, it seems that the political dimension has dominated economic considerations. Economic evidence on carbon leakages is limited, but the fact that leakages seem to be limited results more from the political decisions made to date – free allowances under the Emissions Trading System and tax exemptions – than from economic mechanisms. The proposed Carbon Border Adjustment Mechanism would make it possible to achieve environmental objectives while limiting the adverse effects on competitiveness.