A Carbon Tax is a Win-Win for the Economy and the Environment

By :: March 12th, 2013

Looking for a way to improve the operation of the economy, lower our dependence on foreign oil, reduce pollution, slow global warming, cut government spending, and decrease the long-term budget deficit? Then you should support a carbon tax, which could help the nation address all these issues simultaneously. A new paper I’ve written with Samuel Brown and Fernando Saltiel, Carbon Taxes as Part of the Fiscal Solution, argues the tax would even be a good idea if we didn’t have a budget problem.

Although a carbon tax would be new for the U.S. government, it already has been implemented in several European countries (though not always in the manner advocated by economists), Australia, and three Canadian provinces. California recently initiated a cap-and-trade system, which auctions carbon permits to companies and functions much like a tax.

A carbon tax makes good economic sense: Unlike most taxes, it can correct a market failure and make the economy more efficient. Although there are substantial benefits from energy consumption, there are also big societal costs that people don’t pay for when they produce and consume energy – including air and water pollution, road congestion, and climate change. Since buyers of fossil fuels don’t directly bear many of these costs, they ignore them when they decide how much and what kind of energy to buy. And that results in too much consumption and production of these fuels. Economists have long recommended a tax on fossil fuel energy sources as an efficient way to address this problem.

A carbon tax could significantly reduce emissions. Tufts University economist Gilbert Metcalf estimated that a $15 per ton tax on CO2 emissions that rises over time would reduce greenhouse gas emissions by 14 percent. Another study estimated that the European countries’ carbon taxes have reduced emissions significantly.

Estimates suggest that a well-designed tax in the United States could raise as much as 1 percent of Gross Domestic Product in new, revenue—money that could be used to reform other taxes, as discussed by Donald Marron and Eric Toder. Alternatively, those new revenues could help reduce the country’s substantial and unsustainable budget deficits.

A carbon tax would also reduce America’s dependence on foreign sources of energy and create better market incentives for conservation, the use of renewable energy sources, and the production of energy-efficient goods. The permanent change in price signals from enacting a carbon tax would stimulate new private sector research and innovation in developing energy-saving technologies and in harnessing renewable energy. The implementation of a carbon tax also offers opportunities to reduce and reform federal spending on other energy-related programs.

One downside: A carbon tax is regressive since low-income households use relatively more of their income to buy energy than those with higher incomes. However, this problem could be addressed by rebating some of the carbon tax revenues as refundable income tax credits or payroll tax credits.

Critics also fear that a unilateral U.S. carbon tax would hurt the domestic economy while doing little to reduce world-wide carbon emissions or levels. This view, however, understates the value of a permanent price signal for research and development and the social and environmental value of emissions reductions that would come from U.S. action. It also discounts the experience of other countries that have unilaterally created carbon taxes. There is no evidence that they paid a significant price, or any price at all, in terms of economic growth. Moreover, if there is ever going to be multilateral action to limit carbon emissions, the US – as the largest per-capita emitter of carbon dioxide – needs to take a leading role.

A carbon tax isn’t perfect. But relative to the alternatives, it has an enormous amount to offer.

13Comments

  1. Michael Bindner  ::  5:03 pm on March 12th, 2013:

    I am still more worried about the more visible filth being emitted on this planet than I am in carbon. In some parts of the world, the air cannot be breathed at all. Once we take care of that, we can move to carbon emissions. I suspect that a carbon tax is an alternative to a VAT or some other consumption tax. I would rather go for the real thing. If carbon emissions can be identified from particular sources, it would be better to regulate those sources than enact what amounts to a sin tax.

  2. Tax Roundup, 3/13/2013: Governor, legislators battle over who to give your money to. Plus: Education credit returns bog down. « Roth & Company, P.C  ::  9:04 am on March 13th, 2013:

    […] William Gale, A Carbon Tax is a Win-Win for the Economy and the Environment (TaxVox) […]

  3. Sidney F Gale  ::  9:51 am on March 13th, 2013:

    To the argument that such a unilateral tax would create a competitive disadvantage to US business, I would offer that 1) it will create an offsetting stimulative effect in the domestic economy if properly recycled, and 2) it will reduce the proforma price disparity between fossil fuels and renewables that results from fossil fuels not bearing their rightful share of environmental economic costs. This will result in a more reasonable economic cost/benefit comparison of alternatives than the current flawed ‘energy market’ provides. To those who would argue that a carbon tax is an artificial manipulation of the market, I would reply that it is no more artificial than failing to make fossil fuels bear their appropriate burden of climatic and economic damage, and failing to price them in a manner appropriate to their non-renewable, and therefore ‘scarce’ reality over time.

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  5. AMTbuff  ::  3:46 pm on March 13th, 2013:

    Given the dual premise that global warming is driven by human-caused CO2 emissions and that reduction in emissions is more cost-effective than accepting the warming and/or anticipating a technology breakthrough, a carbon tax is the most economically efficient solution.

    The logic is sound. The weakness of this argument is in the dual premise. Everyone focuses on the first half of the premise: “Is the globe warming and are humans responsible for it?” The second half is rarely questioned: “Given current technology is reducing CO2 emissions really our most cost-effective response?”

    In my experience, people who promote carbon taxes prefer larger government spending. That’s not a coincidence. To a committed proponent of large government, tax revenue is everything. The validity of the dual premise is irrelevant. Every problem has, or should have, a government-directed solution. The bigger the solution the better. Global warming is a perfect match to that mindset.

    The best argument for a carbon tax is that it could increase incentives for technology breakthroughs like fusion energy. Yet on balance government will probably still be a hindrance. Governments tend to fight breakthrough technologies because they disrupt entire economies. If anyone does come up with a technological solution, expect some of today’s proponents of carbon taxes to become opponents of technologies which make the carbon taxes unnecessary.

  6. IndependentJones  ::  5:58 pm on March 14th, 2013:

    My immediate reaction to this optimistic piece is that such a system would immediately be abused by the government. It would create a new revenue stream which would gradually grow as spending expands. In effect, regardless of the original idealism and intent, it would go into the general fund like so many targeted revenue sources have over the years (here in CT all of the lottery profits were supposed to go to education but now just go into the black hole of state spending). Lastly, I see it as regressive since companies would just pass it on to end users. It would most likely just grow government at the expense of the middle class taxpayer. I don’t trust it.

  7. Jack Gallagher  ::  7:39 pm on March 14th, 2013:

    Mr. Gale, it is fundamental that if you raise a carbon tax to suck 1% of GDP from the economy, in nominal terms, you will suffer 3% downdraft in GDP itself – not my theory, but Christina Roemer’s (the “multiplier” of taxes is 3x, while the multiplier of government spending is less than 1x). Where, pray tell, will at least 3x of GDP growth come from to offset the negative growth effect of the tax? Until you answer this question, your argument is weak.

    And, your assertion that there is no evidence that Europe has suffered economically from their carbon tax schemes? Really? Have you bothered to look across the pond the past five years. Why, if not for these drags on their economies, have they re-entered recession sooner than the U.S.? Lord knows, it can’t be because of “tighter” banking regulations. They continue to loan good money after bad, matching Mr. Bernanke step for step – which is why the relative value of the Euro versus the dollar hasn’t changed very much over the past five years.

    Also, we know where this nonsense leads. The fuel alternatives you seek to replace carbon fuels are exotic and expensive. In order to force producers to deploy their captial to these exotic energy sources, you will no doubt advocate simply raising the carbon tax until the carbon fuel cost equals or exceeds the exotics. Slippery slope, indeed.

    What amazes me is the number of commenters to this piece that are drinking the carbon tax kool-aid so willingly.

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