Behaviourally informed climate change policies

by Johannes Lohse

While greenhouse gas (GhG) emissions have been falling across many industrialised nations – for instance, GhG emissions in the UK are now 43.8% below their 1990 level – more substantive emission reductions are needed to stabilise the global climate at 1.5 or 2 degrees of warming. This reduction is becoming even more critical since falling emission in industrialised nations have been offset by rising emissions in quickly industrialising nations. By some estimates, global carbon emissions would need to fall by 7.6% each year for the next decade if the goal of restricting warming to 1.5 degrees is still to be met.

Decarbonising the economy requires changes in how we produce energy and food, how we travel and how we heat our homes and manage our cities. There are at least two fundamental reasons why relying on voluntary changes in consumer behaviour alone will not be enough to bring forth these radical changes.

The first reason is technology. Even with the restrictions on personal freedoms and economic activities put in place during Covid-19 lockdowns, global GhG emissions have “only” fallen by 6.4% in 2020 - with more considerable reductions seen in some countries like the US (12.9%) and EU (7.7%). The economic costs of lockdown measures have been in the trillions, and the support for them has been continuously weakening as a result. Further emission reductions will only find broad support in the population if they are economically less painful. We need more technologies that break the link between consumption and emissions. While there is more optimism now, with several industrialised countries recently displaying decoupling of GDP from both production- and to a lower degree from consumption-based CO2 emissions, it is still unclear whether decoupling can happen fast enough. A central question for climate policies for the coming decades is therefore how the development of such technologies and their diffusion can be sped up. Policies that directly support R&D for clean technologies could supplement other policies that support the diffusion of cleaner technologies through taxes and subsidies.              

The second reasons why voluntary changes in consumer behaviour will not be sufficient is engrained in the word “voluntary”. Climate change is a global problem that affects billions of people, most of whom are not even born yet. A single consumer completely changing their consumption habits today  would still have a minuscule impact on preventing future climate change if acting in isolation. The collective action of all consumers is required in this global cooperation problem. Our own research shows that the psychological mechanisms that typically support cooperation in small groups, such as punishing free-riders, are not well suited for a setting where groups are large and benefits mostly flow to those living in the future. It is therefore not surprising that the mean willingness to pay (WTP) for voluntary carbon reductions of 1 ton (which is about what the typical European emits in 6-8 weeks) found in incentivised settings is as low as $6. This WTP is far below even more conservative estimates of the social cost of carbon (SCC) which expect the economic cost of emitting an additional ton of CO2 now at around $30. Other estimates for the SCC come to  much higher values ranging from $55 to $90 today and $286-$1700 in 2100. In sum, voluntary climate actions are far from enough to reach an emissions trajectory that keeps global warming  within the limits set by the Paris Agreement.

Policymakers have long recognised the need for more stringent policies, and pricing carbon emissions through the tax system is becoming more common in many industrialised countries. The idea is simple – by attaching the same price to all emissions, carbon-intensive activities will become relatively more expensive. Increased costs provide an incentive to both firms and consumers to replace carbon-intensive, and therefore more costly, activities with alternatives that are cheaper and lead to lower emissions. A carbon price also helps consumers and firms quickly identify climate-friendly actions; complex information about the carbon content of single products or production process is boiled down to a simple price metric that decision-makers are typically familiar with.

It is not surprising that a panel of leading economists sees pricing emissions almost unanimously as the best and cheapest way of achieving additional emission reductions. However, this broad support for carbon taxes is not shared by the general population. For instance, while 65% of US citizens support more decisive efforts to combat climate change, only 35% support increasing the gasoline tax by 25ct per litre.

There are at least two reasons for the low support for carbon taxes.

First, some of those concerned about climate change are not convinced about the effectiveness of a carbon tax. At the heart of this concern is the misperception that taxes are merely a means of generating government revenue, ignoring the incentive effects that taxes typically have. This concern is not entirely unfounded. The price elasticity (i.e., the extent to which consumers react to a price change) can be indeed low for some relevant goods. For instance, some estimates suggest that a 10% increase in price only leads to a 1% reduction in demand for fuel. However, not all carbon-intensive goods are that price inelastic. For producers, there is even more compelling evidence that carbon taxes are not only effective but more effective than their alternatives. A comparison of clean energy subsidies in Germany and carbon pricing in the UK reveals that the latter approach has led to a 55% drop in emissions from energy production within five years. The former approach has led to much more modest emission reductions. However, one could still argue that subsidies in Germany have accelerated research into renewables considerably.

In sum, policymakers need to provide a more straightforward message about how effective environmental taxation can be. This message can be supported with several additional policies. Although irrelevant to the incentive argument, earmarking some of the tax revenue for environmental purposes has proven to be an effective strategy that convinces those who doubt the usefulness of environmental taxes. Those concerned about climate change may also worry that applying environmental taxes at the national level is ineffective as the resulting emissions reduction will be offset by higher emissions in other countries with lower taxes resulting from the relocation of polluting industries to less regulated countries. Besides the fact that these so-called “pollution haven” effects are weaker than one would expect in theory, introducing border tax adjustments – such as the one recently discussed by the EU – on carbon emissions may further calm such fears. Another strategy would be to stress the local co-benefits of reducing carbon emissions. Reducing carbon emissions by phasing out coal or reducing inner-city traffic often have local benefits such as improved air quality and shorter commute times. Stressing such co-benefits could be helpful in two respects. First, compared to the benefits of cutting carbon emissions, they are felt immediately. Second, they help local communities. Our own research shows that individuals care about the location where public goods are provided even when they do not personally benefit from them.

A second reason for citizens to be sceptical of carbon pricing is that they do not only overestimate their own burden of environmental taxes, but they also rightly anticipate that carbon taxes are often regressive. For instance, the Institute of Fiscal Studies finds that an increase in the UK fuel duty of 5% would impact the bottom 10% of income earners most. Behavioural economists have amassed a large body of evidence highlighting people’s aversion to inequalities such as this. Carbon pricing would therefore be best accompanied by redistributive measures to increase their acceptability. There are multiple policy proposals of how a more even distribution of the burden of climate policies can be achieved at the national level. Taxing carbon or auctioning off emission permits leads to additional government revenue. This revenue can be redistributed directly to lower-income households via a carbon dividend, or other distortionary taxes, such as income tax, can be lowered in a revenue-neutral way.

In addition to carbon pricing, several behavioural interventions could be used to “nudge” consumers towards more sustainable lifestyles. The first idea would be to recognise that we all suffer from status-quo bias. People tend to have an inherent preference for the current state of affairs, translating into opposition to any political reforms. Especially when thinking about local implementations of carbon pricing, such as clean air zones or congestion pricing, trial periods and low initial tax rates could overcome status-quo effects. Another area that appears promising is digging into the power of social norms. Our research shows that individuals are more willing to contribute to voluntary climate actions if they believe that others contribute as well. A typical application of these insights is in household energy use. Many power providers now inform their customers how their energy consumption compares to that of their neighbours. Such information is especially impactful on those households that consume far more energy than the average household. A final area where behavioural interventions may complement carbon pricing is information. Not only are consumers sometimes inattentive to price changes, poorly informed about energy efficiency standards or biased in their information uptake, but they may be also deterred from selecting into government subsidy programs if the application process is not streightforward. It is in this area where governments, from the local to the national level, can invest in simplifying online and offline processes using guidance from intelligent design principles.

In sum, more significant emission reduction efforts are needed if the 1.5- or 2-degree target is to be met. Carbon pricing is the key policy that can achieve this at the lowest cost. This is no secret and has been the consensus among environmental economists for the past thirty years. However, sufficiently high carbon taxes need broad acceptance by the public. In this paper, I have highlighted a few ways how increasing this public acceptance can be achieved. Smart climate policy should not stop there. Behavioural science and behavioural economics offer additional insights into how we can make carbon pricing more effective on the path to carbon neutrality.