The case for a Scope 3 carbon tax for financial institutions
In this guest commentary, Alejandra Padín-Dujon proposes a new kind of carbon tax, building upon recent EU legislation, that would penalise financial institutions’ ‘dirty’ investments.
The US Inflation Reduction Act of 2022 has provoked ire and accusations of sparking a ‘green subsidy war’ on this side of the Atlantic. While the US adopts policies intended to spur green investment, reduce emissions and safeguard energy security, Europe is considering its response.
Amid all the commotion, the EU recently marked its own pivotal climate moment: on 5 January 2023, it introduced the Corporate Sustainability Reporting Directive. This policy requires comprehensive reporting of emissions across company value chains. The Directive may appear minor, but it could form the basis for a novel kind of carbon tax: one that penalises financial institutions for carbon-intensive investments and produces new and additional international climate finance. The carbon tax would come at a critical time of economic and climate crisis, when financially constrained developing countries require funding for adaptation and compensation for loss and damage.
Global climate finance targets have lost much of their credibility in recent years. In 2009 in Copenhagen, ‘Annex I’ (developed) countries agreed on a target of $100 billion annually in international climate finance by 2020. Fourteen years on, this target has still not been met. Developing countries, whose climate finance needs are valued at over $1trillion annually, have suffered for it.
Conceptually, a carbon tax is simple: governments levy a fee on carbon emissions. Traditionally, this tax structure has been regressive, affecting low-income people in unequal societies the most. The idea behind a ‘carbon tax for banks’ is far better but more complex: it involves Scope 3 emissions, which are included in the EU’s Directive.
Scope 3 emissions, as defined by the Greenhouse Gas Protocol, are the ‘indirect’ emissions in a firm’s value chain, associated with the creation of inputs and expelled by outputs. These are distinct from Scope 1 emissions (those that firms release directly into the atmosphere) or Scope 2 emissions (which include emissions from electricity and heat). It is simple enough to comprehend the Scope 3 emissions of a car manufacturer – originating from its suppliers’ steel manufacturing processes, from the car emissions after purchase, and so on – but what about a bank?
Financial institutions have value chains too. Their Scope 3 emissions are their investees’ Scope 1 and 2 emissions. For a bank to report its emissions, it should multiply investee emissions by the percentage equity, financial control, or operational control it possesses, according to the Global GHG Accounting and Reporting Standard for the Financial Industry. If the bank invests in oil production, for example, then a carbon tax on Scope 3 emissions would hold it accountable for a percentage of the oil company’s Scope 1 and 2 emissions. This would create a disincentive to invest in ‘dirty’ industries – and, simultaneously, create a stream of finance to boost lagging international commitments on climate.
Past policy proposals have attempted to harness the resources of the financial sector to bankroll climate initiatives. In the UK, for instance, these have included a ‘Robin Hood’ financial transactions tax that would feed into a plethora of initiatives, from social welfare to climate. To date, the campaign has been largely unsuccessful, perhaps because the provenance and destination of the financing are not clearly linked. Yet a financial transaction tax would not be new: the UK’s financial sector has been subject to a stamp duty since 1694.
A Scope 3 emissions carbon tax on financial institutions would deliver novelty as well as a promising stream of international climate finance and a strong conceptual case – in essence, revising expectations around greening the financial sector. It would dramatically broaden the scope of accountability and discourage greenwashing. Offsetting carbon-intensive investments by buying carbon credits on the voluntary market, or touting ESG [environmental, social and governance] credentials through limited climate-friendly investments, would no longer serve to avoid culpability, either legally or in the court of popular (consumer) opinion.
By taking the leap to require corporations to report Scope 1, 2 and 3 emissions, the EU has (intentionally or not) laid the groundwork for a Scope 3 carbon tax on financial institutions. It remains to be seen whether policymakers will take what appears to be the natural – and necessary – next step.
Alejandra Padín-Dujon is Climate Policy Advisor at the Catholic Agency for Overseas Development (CAFOD). The views in the commentary are those of the author and do not necessarily represent those of the Grantham Research Institute or CAFOD.