The Power Of Taxing “Untaxed Externalities”

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If you are a regular CleanTechnica reader, you are familiar with the term “untaxed externalities,” which economists use to describe financial impacts of human behavior that are not figured into the costs of doing business. Here’s an example. Let’s say you are in the business of drilling holes in the Earth looking for oil or methane. All wells stop producing eventually and need to be capped. But decommissioning old wells costs money, so you set up a shell corporation to buy your old wells.

You go about your business of drilling more wells and a little while later, the shell company declares bankruptcy. Now the burden of capping those old wells falls on the taxpayers. Congratulations! You have successfully made the cost of cleaning up your mess an untaxed externality. Your balance sheet shows more profits from your operations than it should because you have found a way to cook the books by making someone else responsible for a portion of the costs associated with your business.

Capitalism is a concept that many people in business pay homage to for their success. But for capitalism to work as it should, all financial inputs must be included before arriving at the bottom line. By keeping all the profits for yourself but making others pay some of your costs, you are not a capitalist, you are fraud, a charlatan, and possibly a criminal. But you have a lot of zeroes in your bank balance, so many people will celebrate you as a hero. You will be hailed as a true American success story while all the while those uncapped wells you created continue to leak dangerous toxins into the water around them and the air above them.

Policy Initiatives Focus On Untaxed Externalities

Last year, the European Union adopted new rules that require companies that do business in the EU to disclose information on what they see as the risks and opportunities arising from social and environmental issues and on the impact of their activities on people and the environment. The new rules will ensure that investors and other stakeholders have access to the information they need to assess the impact of companies on people and the environment, and for investors to assess financial risks and opportunities arising from climate change and other sustainability issues.

In March of 2024, the US Securities and Exchange Commission, after years of effort, finalized new climate reporting rules that are similar to those created by the EU. The SEC said the new rules “are intended to enhance and standardize climate-related disclosures by public companies and in public offerings. The final rules reflect the Commission’s efforts to respond to investors’ demand for more consistent, comparable, and reliable information about the financial effects of climate-related risks on a registrant’s operations and how it manages those risks while balancing concerns about mitigating the associated costs of the rules.”

SEC chair Gary Gensler said, “These final rules build on past requirements by mandating material climate risk disclosures by public companies and in public offerings. The rules will provide investors with consistent, comparable, and decision-useful information, and issuers with clear reporting requirements. Further, they will provide specificity on what companies must disclose, which will produce more useful information than what investors see today. They will also require that climate risk disclosures be included in a company’s SEC filings, such as annual reports and registration statements rather than on company websites, which will help make them more reliable.”

Last year, a study by economists Michael Greenstone of the University of Chicago, Christian Leuz of Chicago Booth, and Patricia Breuer of Erasmus University Rotterdam found that paying for “untaxed externalities” would cost businesses about 44% of their profits. That number requires some explanation. It is a composite that analyzes over 15,000 businesses around the world.

There are enormous differences among them, both national and within industries. For instance, in Russia, paying the cost of climate harms would cost 129% of profits. In the US, that number is 25%. The researchers described their results as a “a first-cut preview” of what reliable emissions reporting might disclose. In their analysis, they used the Environmental Protection Agency’s standard measure of the cost to society of carbon emissions — $190 per ton of carbon dioxide. Researchers at the Potsdam Institute for Climate Impact Research place the cost of climate pollution at $38 trillion a year.

The findings highlight the potential importance of mandated carbon disclosure as a foundation not only for future policy or for pricing in markets, but also for peer benchmarking. The documented variation in carbon damages within peer groups will facilitate comparing companies in terms of their environmental impact. The researchers argue that transparency could prompt big polluters to reduce their emissions to match cleaner competitors, either voluntarily or because of pressure from shareholders or consumers.

National policies could also play a role. The EU is considering climate-based tariffs that would impose additional import duties on foreign made goods that have a higher climate impact. Using electricity from coal-fired generating plants in the manufacturing process would trigger a higher tariff than using electricity from renewable sources, for example.

Vermont Wants To Make Polluters Pay

Vermont lawmakers passed a bill this week that is designed to make big fossil fuel companies pay for damages from weather disasters fueled by climate change. Modeled on the EPA’s Superfund program, it would mandate that big oil companies and others with high emissions pay for damage caused by global warming. The money would go toward modernizing infrastructure, weatherproofing schools and public buildings, cleaning up from storms, and addressing the public health costs of climate change.

According to NBC News, the amount of money owed would be based on calculations of the degree to which climate change contributed to extreme weather in Vermont and how much money those weather disasters cost the state. A storm last year cost the state of Vermont $2.2 billion, mostly as a result of flooding. A company’s share of the total would depend on how many metric tons of carbon dioxide it released into the atmosphere from 2000 to 2019. State Senator Anne Watson, a co-sponsor of the bill, said it will push fossil fuel companies “to become purveyors of renewable energy sources and keep fossil fuels in the ground.” Massachusetts, Maryland, and New York are considering similar legislation.

The bill hinges on the ability to assess how much damage in Vermont has been caused by climate change — an accounting that would rely on a line of research known as attribution science. Over the last 20 years, researchers have honed their ability to confidently model the degree to which human influence has contributed to the severity and frequency of extreme weather. “We’re able to say very clearly, ‘We would not be experiencing these intense global temperatures without human-caused climate change and the history of carbon pollution,’” said Andrew Pershing, vice president for science at Climate Central, a nonprofit that conducts attribution science research.

Pershing pointed to extremely heavy rains as something scientists can attribute to a warmer atmosphere. “New England has had a 60% increase in the heaviest precipitation days,” he said, explaining that “for every 1 degree Fahrenheit increase in temperature, you get a 4 percent increase in the amount of water vapor that the atmosphere can hold.”

Superfund litigation at the federal level has been highly contentious and expensive. Some Vermont legislators voted against the bill because they think the money the state will spend on lawyers to defend lawsuits would be better invested in clean energy projects. The American Petroleum Institute, one of the major lobbyist organizations for fossil fuel companies, sent a letter to the state Senate opposing the bill, saying it “violates equal protection and due process rights by holding companies responsible for the actions of society at large.”

Vermont Attorney General Charity Clark told lawmakers that she is “ready and willing to defend this law. The science linking climate change to severe weather damage is robust enough to withstand scrutiny.” Other supporters of the bill similarly say that Vermonters should not be on the hook for the costs of responding to and preparing for climate change.

“You see towns across the state underwater, and communities and businesses financially devastated. The reality of the climate crisis just really comes crashing home,” said Ben Walsh, climate and energy program director for the Vermont Public Interest Research Group, which has been advocating for the bill’s passage. The bill will need to be signed by Vermont Governor Phil Scott, a Republican, before it goes into effect. Supporters are confident they have enough votes in the legislature to override a veto by the governor, if there is one.

The Takeaway

What we are seeing here is a painfully slow process of making fossil fuel companies pay for untaxed externalities. If the Chicago and Rotterdam researchers are correct, those costs could equal 25% or more of profits. That level of financial pain would cause wholesale changes in the fossil fuel industry and lead directly to lower carbon dioxide and methane emissions. It would also substantially disrupt the economy and could lead to higher prices for consumers.

It is too soon to say whether such policies will move the needle on global heating far enough and fast enough to keep the Earth from becoming too hot for humans to survive. The fossil fuel industry has been banking on its ability to put the burden of untaxed externalities on the shoulders of its customers for decades. The question now becomes whether it can continue doing so. In the final analysis, if there are no customers, every business model collapses.