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

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.