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Essay About Carbon Tax Pros

In mid-June 2016, the U.S. House of Representatives voted overwhelmingly to stand against future proposals for a carbon tax, even though no current bill was anywhere near getting its serious attention.

Opponents, in that symbolism-rich congressional moment, saw the importance of laying down a political marker (were, say, a future Hillary Clinton administration look to push the idea). Carbon tax supporters saw pure political theater.

Why does the mere notion of a carbon tax matter enough for legislators to pass such a symbolic measure? Isn’t the United States already committed to addressing climate change through the Paris agreement?

The idea of a carbon tax is, as it turns out, a kind of freakish policy unicorn: It weirdly unites some people on political left and right.

For proponents, sending a price “signal” through the economy is the only way to get energy companies and startups to ramp up their low-carbon investments and search for conservation strategies. Currently, carbon pollution has no consequence; it is what economists consider an “externality.” A carbon tax could force businesses and citizens to cut back carbon-intensive services and goods. It could start a race for lower emissions technologies, which would give energy companies an edge on competitors.

Plus, some conservatives may be attracted to a carbon tax as an alternative to more EPA regulations.

For opponents – some of whom don’t believe that climate change is a serious problem and others who just think a carbon tax is bad strategy – regulatory alternatives may be seen as politically unpredictable and therefore dangerous enough to justify preemptive action. Hence, the House vote in June, which was designed to get legislators on record as opposing the bill, perhaps making it more difficult for them to change positions in a future House.

Politics aside, though, the bigger question is understanding a carbon tax on the merits.

Executing the policy

Proponents of a carbon tax often argue that assigning a fee to carbon dioxide pollution is relatively simple administratively.

They say that contrasts with addressing climate change by setting, monitoring, and enforcing caps on greenhouse gas emissions; and regulating emissions of the energy-generation sector, as the Obama administration is attempting to do through the Clean Power Plan. That’s an attraction for many right-leaning economists.

For progressives, a virtue is the comprehensive nature of a carbon tax, although many liberals would like to see both a carbon tax and emissions regulations.

The existing special taxes in place on the energy sector could mean the administrative groundwork for a carbon tax already exists. Proponents say it would not be hard to collect the money systematically and comprehensively. If the tax were levied at the “upstream” level of the energy system – across oil refineries and importers, natural gas terminals and pipelines, coal mines, and a few other sources – such a policy could cover perhaps 98 percent of the country’s carbon dioxide emissions.

Opponents don’t necessarily contest that a carbon tax could, in principle, be implemented from an administrative point of view, but they say there is no guarantee that a carbon tax bill passed by Congress would be simple. The non-partisan Congressional Research Service notes that legislators “could also choose to establish a carbon tax framework that rivals the complexity of a cap-and-trade program” such as that passed by the House in 2009 but never by the Senate. The horse-trading necessary to get a carbon tax passed might require all sorts of policy contortions.

Further, opponents point out that all taxes have “distortionary” effects, affecting free-market decisions and perhaps reducing gross domestic product growth. Making energy more expensive might do this, they caution. And there could be perverse and unintended effects, such as creating “leakage” whereby businesses, and energy production, move overseas.

Calculating the price

Were a carbon tax policy to begin to move through a future Congress, one giant headache would be getting enough legislators – and interest groups – to agree on how to accurately value and price carbon dioxide emissions, so that a fair tax rate could be assigned.

The U.S. government has proceeded in this area by developing a policy instrument and mathematical equation called the “social cost of carbon” – basically, the cost of the negative effects per year of a metric ton of carbon across a variety of environmental, health, and business dimensions.

To get this number, the tricky thing involves valuing a metric ton of carbon currently and far into the future. For those concerned a climatic tipping point soon could throw the world into chaos, each ton of carbon not emitted would have large and sustained future value.

For those anticipating no near-term crisis, the future value of that ton could be . . . not much. This future-value problem “discount rate” is massively consequential for how carbon prices would be set.

Currently, the price for one metric ton of carbon emissions is $37, a figure used in a variety of government decisions and influencing certain policies, such as vehicle and home appliance standards. But the $37 figure is highly contested, with academics and experts arriving at numbers ranging from between $10 to $220 or more. Many observers see little hope in the near future for reconciling the economic models.

Still, some proponents say that the social cost of carbon and its implementation is a strong enough framework for Congress to find common ground, even as other proponents contend that alternative calculations might be even better. British Columbia has experimented with a carbon tax of modest size (about $30 per ton), and researchers have noted its relative success in terms of emissions reductions and no measurable impact on economic growth. (There are many other instances of carbon taxes around the world that bear studying.)

Opponents, of course, say no tax should ever be implemented if it doesn’t have a sound basis. A unilateral new tax by the United States will just lead to the previously mentioned “leakage” problems. It is highly likely, they argue, that putting an economy-wide burden on the United States will do little to change the overall global trajectory of emissions – and larger countries with no such regulation (India and to some extent China) will just grow and pollute more, and industrial polluters will relocate there.

Distributing the revenue

For all its potential simplicity in administration and collection, the general concept of a carbon tax contains no natural solution for what to do with the money once government has it. On this issue, supporters begin fighting among themselves – including liberal groups who are all nominally on the same side of climate action. Many progressives want to use the revenues to address other societal problems, from the environment to health to inequality. Others want to invest the money back into low-carbon technological research and development, or favor some combination of spending priorities.

In this nitty-gritty of taxation and revenue allocation, opponents often pull out a strong talking point: Poorer people tend to spend a greater share of their family budget on energy-related services and goods. So the tax, according to many economists and non-partisan analysts, is considered to be “regressive” – it hits lower-income families harder than upper-income ones. (It’s an area of evolving research.) The Congressional Budget Office notes that a “policy that set a price of $28 per metric ton on CO2 emissions would increase costs for households by amounts that would equal about 2.5 percent of after-tax income for the average household in the lowest one-fifth (quintile) of the income distribution but less than 1 percent of after-tax income for the average household in the highest quintiles.” The burden might be unevenly distributed regionally, too, and workers in states with energy-intensive industries such as Ohio, Illinois, Michigan and West Virginia could be harder hit.

One reasonable solution to this inequity would be to refund more of the tax to poorer, harder-hit families. Yet that kind of wealth redistribution scheme is a non-starter for many of the very conservatives who might be inclined to support a carbon tax in the first place. What many conservative supporters want is a carbon tax that would be “revenue neutral.” Enacting a carbon tax only makes sense to many if it uniformly offsets the tax burden on individuals and corporations and is part of a broader set of reforms that simplify the tax code.

If there is a likely place where a proposed carbon tax bill could fall apart politically in any future Congressional battle, it is in this area. The projected revenues are gigantic, even if the price of carbon is set relatively low. Every imaginable interest group and constituency will be asking for consideration. That’s not to say a carbon tax bill will never be passed. But even for a policy touted for its elegant simplicity, nailing down the details may be anything but simple.

Filed under:carbon tax, GHG emissions, John Wihbey, pros and cons

A carbon tax aims to make individuals and firms pay the full social cost of carbon pollution. In theory, the tax will reduce pollution and encourage more environmentally friendly alternatives. However, critics argue a tax on carbon will increase costs for business and reduce levels of investment and economic growth.

The purpose of a carbon tax

The purpose of a carbon tax is to internalise this externality. What this means is that the final price of the good should include the external cost and not just the private cost. It is similar to the ‘polluter pays principle.‘ – which was incorporated into international law at the 1992 Rio Summit. It simply means those who cause environmental costs should be made to pay the full social cost of their actions.

Diagram to show welfare loss of a negative externality

This diagram shows that in a free market (without any tax), we get overconsumption (Q1) of carbon, leading to a welfare loss to society.

Social efficiency with Carbon Tax

The tax shifts the supply curve from S to S2. With the tax, consumers now face the full social cost (SMC). Quantity falls from Q1 to Q2. Q2 is socially efficient because social marginal cost = social marginal benefit.

Revenue neutral

In theory, a carbon tax should be revenue neutral. This means the tax raised from taxing carbon emissions can be used to reduce other taxes. There should be no overall increase in the tax burden. The aim is to increase social efficiency by making people aware of the full social cost.

Arguments for a Carbon Tax

1. Encourages alternatives. A higher price of carbon emissions will encourage firms and consumers to develop more efficient engines or alternatives to consuming carbon emissions. For example, with carbon taxes, it will be more efficient to develop hydrogen engines or solar power.

  • It might encourage more people to cycle or walk to work. This would have health benefits such as lower risk of heart attack.
  • This could make it more feasible to generate electricity from green sources (e.g. solar power). If we develop more green sources it will also make us less reliant on oil.
  • It will help make the transition to a post-oil economy easier.

2. Raises revenue. The revenue raised from a carbon tax could be used to subsidise alternatives such as green electricity or the revenue raised could be used to repair the damage caused by environmental pollution. Alternatively, a higher carbon tax could be used to reduce other taxes, such as VAT.

3. Leads to a socially efficient outcome. It makes people pay the social cost and overcomes the excess consumption we see in a free market.

4. Improves the environment. WIth higher taxes, firms will reduce pollution and look for alternatives which have a lower environmental impact. For example, it will make solar power even more competitive than traditional fossil fuels.

Problems of a Carbon Tax

  • Production may shift to countries with no or lower carbon taxes. (so-called ‘pollution havens’) This can give developing countries an incentive to encourage production processes which cause pollution, i.e. there is ‘outsourcing’ of pollution.
  • The cost of administrating the tax may be quite expensive reducing its efficiency.
  • It is difficult to evaluate the level of external cost and how much the tax should be.
  • Possibility of tax evasion. Higher taxes may encourage firms to hide carbon emissions.
  • If demand is price inelastic, the tax may have to be very high to reduce demand significantly. In the short term, firms may not feel they have many alternatives. Though, over time, demand will become more elastic as more alternatives are generated.
  • Consumers dislike new taxes and often don’t believe that they will be ‘revenue neutral’. This is not an economic argument, but it is a political reality and explains why it is often difficult to implement.
  • A global carbon tax may curtail economic activity in the poor developing world because they can’t afford the small increase in energy costs, but the developed world may simply be able to pay. There may be a need for a carbon tax to reflect different abilities to pay.

Carbon Tax vs Cap and Trade

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