It's Time for a Carbon Tax

A tax on the carbon content of fossil fuels has gained little traction so far. Few politicians have been courageous enough to propose or seriously work for implementing such a tax.  But support for a carbon tax is growing, and is coming from across the political spectrum. (1)(2)(3)  Why?  There are three obvious reasons:

First, it’s now incontrovertible that climate change is real, is driven by human emissions of greenhouse gases, primarily carbon dioxide, and is potentially disastrous for the environment and the future of civilization.

Second, none of the efforts so far to limit the buildup of carbon dioxide in the atmosphere have worked.  Yes, there have been gradual improvements in energy efficiency and carbon intensity of industry, and there has been a recent lowering of carbon emissions in the U.S. (4) But humanity continues to dump carbon dioxide freely into the atmosphere, and the levels are building (see chart).

Third, of the various methods under consideration to cut back these emissions, a carbon tax is the simplest, fairest, and most direct.   Some of the reasons why this is so are listed below:  (Much of this material has been adapted from essays available from the Carbon Tax Center (5) and from the book, The Case for a Carbon Tax, by Shi-Ling Hsu (6).)   

Some reasons why a carbon tax is the best approach

1)  A carbon tax is more economically efficient than other approaches.  Other approaches include cap-and-trade (establishing a carbon emissions cap and emissions allowances, portions of the total allowed emission, that can be traded), and command-and-control (limiting carbon emissions for specific emission sources).  Each of these two would target and control emissions from a subset of all emitting sources.  A third approach, subsidies, would target for encouragement specific technologies or industries.   Proponents of these other approaches often seem to believe that these approaches would not impose costs on anyone but the entities directly regulated.  But in the long run, it is inevitable that virtually all of the costs of other approaches to cut carbon emissions will be passed on to consumers.  However, because the imposition of costs would be selective, the course of the passing on of the costs could be torturous and rife with possibilities for poor investments and corruption.

But a carbon tax, levied on all fuels based on their carbon content, and ideally, including methane as well, (7) would affect all processes and products that are made with the combustion of fossil fuels. It would send a clear and uniform price signal to a vast variety of carbon dioxide-emitting sources.

An important aspect of economic efficiency is the avoidance of excessive formation of capital that can become “stranded.”  Excessive capital asset formation is a risk when the government picks winners by subsidizing certain industries.  For example, recently, before the poor net energy of ethanol produced from corn was widely understood, ethanol production enjoyed large subsidies.  A number of ethanol production plants were built that today appear likely to have a poor economic future.  If these plants become of little value, they will be stranded assets; capital that is lost to the economic system.   Because it would send a direct and immediate price signal to all users of fossil fuels, a carbon tax is less likely than other approaches to lead to stranded assets. 

2) A carbon tax would not interfere with other regulatory instruments or jurisdictions.  Besides the other major types of carbon control that have been tried, as discussed above, additional methods of cutting carbon emissions and developing renewable sources of energy are likely to be developed.  A carbon tax could co-exist with these other approaches without causing conflicts or confusions.

3) A carbon tax would be relatively easy to administer.  Levying a tax is something that governments have traditionally done.  Administrative agencies are already in place that collect taxes on fuels.  Fuel taxes could be adapted to a broader tax on the carbon content of fuels, and should include a tax, weighted by global warming potential, on direct releases of unburned fuel (e.g. methane leaks, oil spills) to the environment.  Implementing a carbon tax would essentially require only the setting of tax levels and establishment of a phase-in schedule. 

4) A carbon tax will encourage innovation across all sectors of the economy.  As discussed above, a carbon tax will send a steady and predictable price signal to all users of fossil fuels.  Every user will have an incentive to cut carbon emissions by becoming more efficient in use of these fuels.  The power of the market to stimulate innovation will apply not just to a few large regulated entities, such as would be the case with a cap-and-trade program and with a command-and-control system, but to all users of fossil fuels.

5) A carbon tax appears more amenable to international coordination than other pricing mechanisms.  So far, efforts at such coordination have been stymied by opposing positions of important nations.  For example, China and India have balked at the idea of establishing a cap on carbon emissions that would apply to them.  But, there seems no reason why they might not impose carbon taxes of their own.  Another aspect of international coordination that could be problematic is the incentive to nations without carbon pricing to become “free riders.”   If, for example, goods manufactured in the U.S. rise in cost because fuel costs increase due to a carbon tax (or other carbon pricing mechanism), goods produced in countries that do not have such a tax could enjoy a competitive advantage.  However, such inequalities could be adjusted with border tax adjustments.  Although legal thinking is still evolving on the issue, it appears that such adjustments, e.g., fees levied on imports from nations without a carbon tax, would be legal under the rules of the General Agreement on Trade and Tariffs. Also, adjustments based on a carbon tax appear much more likely to be acceptable under World Trade Organization than adjustments based on a cap-and-trade program.(8)

6) A carbon tax will raise revenue.  (This is also true with a cap-and-trade program that auctions its allowances, with the important difference that fluctuations in the prices of cap-and-trade allowances make it impossible to predict, and count on, those revenues.)  This revenue could be used to offset other taxes, such as payroll taxes, and thus could make a carbon tax system revenue-neutral.  Much of the recent support of a carbon tax has focused on a revenue-neutral approach.  Given the palpable need for reform of the current tax code, a carbon tax could be the centerpiece of a new approach to taxation that would have many advantages over the current system.  If revenue neutrality was not insisted upon, some of the revenues of a carbon tax could be used for other purposes, such as reducing budget deficits, subsidizing research and development of low-carbon and renewable energy sources, and developing capabilities to adapt to climate change.

What about the cost of a carbon tax?

Despite the arguments of proponents of cap-and-trade, command-and control, and subsidy programs that these approaches would affect only the regulated, or supported, entities, it is certain that virtually all of the costs would eventually be passed on to consumers in some form, such as in higher electricity rates.  Subsidy programs are not immune; the money spent has to come from somewhere.   But, especially at the outset, costs of these other approaches are not as apparent, and can be hidden or disguised enough to make them seem innocuous.  A carbon tax, however, is up front and unmistakable.  Yes, it is a cost.  Yes, it will raise the price of gas, of heating oil, of food, of products and processes that are made with or otherwise involved with the combustion of fossil fuels, which includes just about everything in the 21^st century industrialized world.

Yet this apparent weakness of a carbon tax is its fundamental strength. A carbon tax will put a price on carbon that is readily apparent and will propagate to every corner of the fossil fuel-using system. Unfortunately, the directness of a carbon tax plays into the naiveté and reactive aspects of human nature, and often stimulates knee-jerk negative reactions.  For example, carbon taxes are typically and summarily branded as “regressive.”  In fact any tax on consumption of essentials is capable of being regressive, because people with lesser incomes usually spend comparatively more of their money on essentials than the wealthy.  Payroll taxes, for example, are regressive.  Property taxes and sales taxes are regressive.  The regressive aspect of sales taxes is ameliorated to a degree by the exemptions of food and clothing.  It is by no means clear that a carbon tax would be more regressive than other ways of controlling carbon emissions.  And, there are many ways of minimizing the effects of a carbon tax on those least able to pay for it, for example, by a flat distribution of pro-rata shares of the revenue to every taxpayer (9). 

It must be stressed that the cost of a carbon tax is a cost on a pollutant that is already on its way to imposing a huge cost on all of humanity: the cost of potentially catastrophic climate change that cannot be remediated.   The costs of a carbon tax can be avoided by conserving fuel use and by developing ways to produce energy without using fossil fuels.  A carbon tax, more so than other approaches of controlling carbon emissions because of its directness and broadness, can unleash the innovative forces of the market.  And, to the extent that the costs of a carbon tax are avoided, the threat of irreversible climate change will be pushed back and possibly eliminated.  

When enough of us awaken to the real and present danger of climate change, and to the need to put a price on carbon emissions, we will realize that a carbon tax is the answer. There are signs that this is starting to happen. Some countries and jurisdictions already have a carbon tax, including Sweden, Australia, and British Columbia.  Several carbon tax bills have recently been introduced in the U.S. Congress. (10)

References

1) See http://energyandenterprise.com/ 

2) Shultz, George, and Gary Becker, 2013, Why We Support a Revenue-Neutral Carbon Tax, Wall Street Journal, April 7, 2013 (on line), April 8, p. A19 (print); http://online.wsj.com/article/SB10001424127887323611604578396401965799658.html  

3) Gore, Al, 2013, The Future: Six Drivers of Global Change, Random House, New York

4) Some of this is because many coal-burning power plants have shifted to natural gas, which releases less carbon to produce a given amount of energy.  The sluggish economy and higher prices for gasoline, which have limited driving somewhat, have also played a role. 

5) See http://www.carbontax.org/

6) Hsu, Shi-Ling, 2011, The Case for a Carbon Tax, Island Press, Washington, DC

7) Methane, the main ingredient of natural gas, is a potent greenhouse gas, with a global warming potential (GWP) 25 times greater than carbon dioxide when looked at over a 100-year time frame, and a higher GWP on shorter time scales.  Estimates of the percentage of natural gas that leaks during extraction and distribution activities vary widely.  If leaks are sufficiently high, natural gas has no advantage over coal in terms of greenhouse gas emissions, and could even be worse.  See http://www.climatecentral.org/news/limiting-methane-leaks-critical-to-gas-climate-benefits-16020  
8) Hsu, Shi-Ling, 2011, The Case for a Carbon Tax, Island Press, Washington, DC

9) Hansen, James, 2012, Storms of My Grandchildren’s Opa, http://www.columbia.edu/~jeh1/mailings/2012/20121213_StormsOfOpa.pdf

10) See http://www.carbontax.org/progress/carbon-tax-bills/

 

Thanks to Charles Komanoff of the Carbon Tax Center for helpful comments