Who Pollutes Pays

The previous post “Accounting for Externalities” on December 4, 2020, shined a light on how the exportation of certain production costs to the public helps burnish profit margins and stock prices.  Smoke or toxic gases or waste water flow out to the air and to streams with a cost.   First identified in the 1920s by British economist Arthur Pigou as negative externalities, few companies are willing to own up to the practice.  Those with the courage to take up the reins of corporate responsibility have begun publishing Environmental Profit and Loss (EPL) statements, voluntarily exposing the costs to society of their production environmental consequences.  Such candid reports have not been forthcoming from heavy polluters such as oil and gas companies, chemical producers and power producers using fossil fuels. 

Some polluters need encouragement.

Pigou advocated a tax on activities associated with negative externalities (as well as subsidies for activities that create positive externalities).  The tax is assessed against businesses that create adverse side effects for society but do not include those costs in their pricing and production accounting.  This ‘Pigouvian tax’ on producers shifts cost back to the parties involved in production and consumption and away from the hapless public. 

Faced with such taxes, the producer can shift to a different product with lower environmental cost or it can pass the tax along to the consumers who actually use their product.  Those consumers in turn can then make a choice between paying the tax or moving along to a difference product that has more benign environmental consequences.  In the end, environmental costs reside where they belong with the producer and direct consumer. 

Carbon taxes are an example of such taxes.  The government sets a price that carbon emitters must pay for each ton of greenhouse gas emissions.   There are at least eleven countries in Europe that have imposed carbon taxes.  Sweden imposes the higher carbon tax rate of Euro 112.08 (US$132.17) per ton of carbon emissions. 

In the U.S. there is no national carbon tax, but several states have banded together in the Regional Greenhouse Gas Initiative (RGGI) to price carbon as part of a cap-and-trade program.  Such programs are the flip side of Pigouvian penalties like the carbon tax where governments set the price of carbon emissions and allow the market to determine the quantity of emissions.  By contrast, the cap-and-trade program sets the quantity of emissions and lets the market determine the price.

The Citizens’ Climate Lobby advocates an alternative carbon fee and dividend.  The fee would be imposed on the carbon equivalent emission of fossil fuels.  The fee would be collected and returned (net of administrative costs) back to households as a dividend.  It is expected that some consumers would pay more for energy when the carbon fee is imposed.  The dividend would help offset those higher costs. 

A bipartisan group in the U.S. House of Representatives has proposed such a carbon fee and dividend in the Energy Innovation and Carbon Dividend Act of 2019 or HR763.  The fee would be $15 to start and increase by $10 each year.  Passage of the legislation would give the U.S. its first carbon tax.  The bill rests with the House Subcommittee on Energy.  Unfortunately, no action has been taken since the week the bill was introduced in early January 2019. 

Carbon taxes or even the cap-and-trade approach at least theoretically put the matter of pollution in front and center in the market place where polluters and consumers can interact.  Polluting companies and their customers would have to pay for what they emit and consumer.  If they do not like the arrangement producers can meet their customers’ needs by shifting to more environmentally friendly products.

A hundred years on Pigou and his taxes have struggle to gain traction at least as far as carbon taxes are concerned. Likewise the more recently introduced cap-and-trade idea has barely got off the ground.  It is easy for polluters to hide behind politicians by using the carrot of campaign contributions.  Difficulty in defining emissions and measuring the costs provide handy material for obfuscation and diversion by those who prefer to keep the highly profitable status quo.

Carbon emitters in particular are in the proverbial ‘third quarter’.  It is no longer possible to wildly wave arms and complain it is all just too much fuss about nothing.  The consequences of greenhouse gas emissions are showing up in the costs of other companies and cutting into their profits.  The investment community is building up to the ultimate face off.  In one corner the shareholders of freeloading, heavy polluters like oil and gas companies and in the other corner owners of hospitals and insurance firms with shrinking profit margins.  As rising seas grab more land owners of crumbling ocean front properties are waiting to get in the ring too.  

The results of this wrangling is going to impact investors who may need to make sector shifts in their portfolios.  Many have already begun to divest of oil and gas companies and even those who are heavily reliant on fossil fuels such as utilities and airlines.  However, the issues may even extend to industrial agriculture where petroleum derived fertilizers are in widespread use.

    

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.