Carbon taxes are again being discussed in the United States as a means of reducing emissions of carbon dioxide and other greenhouse gases (GHGs). Three main arguments are proffered in support of carbon taxes, either alone or in combination:
- That by setting a price on greenhouse emissions equal to the “social cost of carbon,” a carbon tax would optimally reduce GHG emissions.
- That replacing existing regulations, subsidies, and tax expenditures with a carbon tax would more cost-effectively achieve emissions-reductions goals.
- That a revenue-neutral carbon tax would be economically beneficial.
These arguments are found to be wanting.
First, in theory, a carbon tax set at the “social cost of carbon” would lead to an optimal rate of greenhouse emissions. However, the “social cost of carbon” is highly uncertain. The current U.S. administration has chosen to use estimates of the “social cost of carbon” developed during the Obama administration, which would be in the region of $53 per metric ton of “carbon dioxide equivalent” emissions. This is likely significantly higher than the optimal rate.
A carbon tax applied with no offsetting reductions in other taxes or changes in regulations would increase the cost of goods and services. Energy and energy-related goods would be especially hard hit. A tax of around $50 per ton would raise natural gas prices by about 40% and gasoline prices by about 15% above recent levels. This would reduce economic growth by as much as 0.2% and also reduce employment. Even taking into account reductions in damage associated with GHG emissions, applying a carbon tax at a rate of $53 per ton would most likely cause net economic harm.
Second, numerous existing regulations, subsidies, and tax expenditures currently aim to reduce greenhouse gas emissions, including: the Renewable Fuel Standard, vehicle fuel economy and GHG emission standards, renewable portfolio standards, and tax credits for renewable energy and low-emission vehicles.
These regulations, subsidies, and tax expenditures cost hundreds of billions of dollars but do relatively little to reduce emissions. Replacing them all with a carbon tax applied at a uniform rate would in principle be both much less costly and more effective as a means of incentivizing reductions in emissions.
In practice, the likelihood of such a “grand bargain” being successfully implemented is extremely low because powerful, concentrated special interests who currently benefit from the regulations, subsidies, and tax expenditures would lobby heavily to maintain them.
Third, a revenue-neutral carbon tax, achieved by reducing either corporate income tax or the payroll tax or both, could have net benefits even if existing policies aimed at reducing carbon emissions were not repealed. However, it is unlikely that a carbon tax would be implemented in a truly revenue-neutral manner.
Many proposals from Congress and the Biden administration propose paying for new programs with carbon tax revenues, suggesting that there would be pressure to increase such revenue. This is precisely what happened in British Columbia, where an initially revenue-neutral carbon tax has gradually been increased. Elsewhere in the world, carbon taxes have almost ubiquitously been used for revenue-raising purposes.
Governments across the world, including the U.S. federal government and many state governments, have sought to regulate emissions of greenhouse gases (GHGs) through a vast array of regulations and subsidies. Several of these have been controversial. For example, federal mandates and subsidies to promote the production and use of ethanol as a fuel have been criticized by both economists and environmentalists.
Meanwhile, vehicle and appliance energy efficiency standards became a cause célèbre in the recent U.S. presidential election.
Governments across the world, including the U.S. federal government and many state governments, have sought to regulate emissions of greenhouse gases (GHGs) through a vast array of regulations and subsidies.
In the face of such controversies, many economists and policy advocates (on both the political left and right) have argued that a carbon tax would be a more efficient policy to reduce GHGs emissions than these regulations and subsidies. There are broadly three arguments made in favor of introducing a carbon tax.
First, from an economic perspective, it is viewed as an efficient way to reduce GHG emissions, thereby internalizing the “social cost” of those emissions.
Second, regardless of whether a carbon tax is desirable per se, it is widely viewed as being superior to existing regulations and subsidies.
Third, even if a carbon tax were introduced on top of existing regulations and subsidies, some argue that it would have net economic benefits if it were implemented revenue-neutrally.
This brief considers the arguments for and against such a tax. It is organized as follows:
• Part 2 describes and evaluates the merits and drawbacks of the social cost argument.
• Part 3 discusses the economic effects of introducing a carbon tax without any other changes in tax, subsidy, or regulatory policy. The aim is to describe the effects of introducing a carbon tax on top of existing policies.
• Part 4 describes and critically evaluates the “grand bargain” argument, whereby a carbon tax is introduced as a replacement for existing regulations, subsidies, and tax expenditures that are aimed at reducing GHG emissions.
• Part 5 assesses the possibility and consequences of introducing a revenue-neutral carbon tax, that is to say combining the introduction of a carbon tax with offsetting reductions in other taxes so that net revenue remains constant.
• Part 6 offers some concluding remarks.
This brief has explored the main arguments put forward in support of introducing a carbon tax.
Part 2 considered the argument that a carbon tax is justified on the grounds that carbon emissions impose a net external cost on society. While that may be true, the scale of those external costs remains uncertain. In determining an appropriate price for carbon emissions, the current U.S. administration uses “social cost of carbon” estimates developed during the Obama administration of approximately $53 per metric ton of CO2-e.
Part 3 explored the economic implications of applying a carbon tax at about that rate. Such a tax would significantly increase the cost of energy and energy-related goods. Studies show that, in the absence of any other changes to taxes, subsidies, or regulations, a carbon tax of around $50 per metric ton would cause U.S. GDP to fall by about 0.4%, lead to hundreds of thousands of lost jobs, and cause incomes to fall across the board, perhaps especially among those already on lower incomes.
While a carbon tax on its own would undoubtedly cause economic harm (notwithstanding any environmental benefits that might arise), it would likely be far less harmful than the many regulations and subsidies currently implemented to reduce carbon emissions. It would also likely be more effective than those policies in reducing emissions. So, in principle, a “grand bargain” in which a carbon tax was introduced in return for eliminating all those more harmful policies would have merit.
Unfortunately, as discussed in Part 4, the existing regulations and subsidies have created sets of concentrated beneficiaries, while the harms they cause are dispersed among the wider population. As such, any attempt to reform these policies is likely to be met with fierce and well-funded opposition.
Part 5 noted that a revenue-neutral carbon tax, achieved either by reducing (possibly even eliminating) corporate income tax or by reducing the payroll tax, could have net benefits even if existing policies aimed at reducing carbon emissions were not repealed. However, it seems unlikely that a carbon tax would be implemented in a truly revenue-neutral manner. Even if such a tax were initially close to revenue-neutral, numerous pressures would almost inevitably lead to it being increased at a rate such that it would generate additional net tax revenues.
Given the economic harm that would be caused by a carbon tax, and since most if not all the benefits from either a grand bargain or a revenue-neutral carbon tax would be generated by the reduction in other taxes, regulations, and subsidies, it would seem preferable for governments to reduce those taxes (or, at least not increase them), and remove those regulations and subsidies without imposing a carbon tax.