Carbon Tax
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House GOP leaders recently confirmed again what I wrote last week: There isn’t going to be a carbon tax in the next two years or, probably, for as long as the GOP controls the House. I’ve been asked by a few climate types, “Why not spend your time pushing for it rather than poo-pooing its chances?” It’s a reasonable question. The answer, I suppose, is that I do not regard it with the same reverence as many economists and climate hawks.

That’s not to say I wouldn’t welcome a substantial, well-designed carbon tax. But is it the sine qua non of climate policy, the standard against which all climate solutions are measured and for which any sacrifice is justified? No. Those who support a carbon tax over cap-and-trade often tout its simplicity, but the fact is, there are plenty of ways to screw up a climate tax too. Not everything that goes under the name is worthy of support, especially if it’s achieved at the expense of other liberal or green priorities. And given the current political milieu, it’s likely that any carbon tax that did manage to pass would be a bum deal for America’s poor and middle class. (Actually, that’s probably true for anything that passes, period.)

Here are 10 reasons for a more tempered and realistic attitude toward a carbon tax.

1. It’s conservative.

There’s a reason so many conservative (and neoliberal) economists support carbon taxes: They fit comfortably in a worldview that says problems are most effectively solved by markets, with minimal government intervention.

Current markets have a flaw: They do not reflect the external costs associated with carbon dioxide emissions (namely, the impacts of a heating planet). The answer, economists argue, is to determine the “social cost of carbon” and to integrate that cost into markets via a carbon price, tax, or fee. With an economy-wide, technology-agnostic carbon tax in place, the market will eliminate carbon wherever it is cheapest to do so, insuring that we don’t “overpay” for carbon reductions.

Implicit (and often explicit) in this view is the notion that other attempts to tackle carbon — say, EPA power plant rules, or fuel-economy standards, or clean-energy tax credits — are merely backdoor, inefficient ways of pricing carbon. If you get the social cost of carbon right and levy an economy-wide tax that prices all tons of carbon equally, then you have optimized the market, carbon-wise. All other regulations and subsidies will only serve to disrupt market efficiency. They are sand in the gears, as it were.

The problems with this worldview are too many to list here, much less to litigate. Economists James Galbraith and Dean Baker argue that free markets are a myth; all markets everywhere are already designed, shaped, and regulated, usually to the benefit of the wealthy. Economist Dani Rodrick argues that industrial policy — “picking winners and losers” — is ubiquitous, a feature of all advanced economies, whether acknowledged or not. Sociologist Fred Block argues that virtually every industrial success story (e.g., fracking) can be traced to government-supported innovation.

Anyone familiar with the U.S. electricity sector knows that there is little resembling a market in that Rube Goldberg hodgepodge of overlapping jurisdictions and quasi-monopolies. The entire U.S. coal sector depends on supply from the Powder River basin, which is public land administered by the government. Internal-combustion vehicles are heavily favored by a century of road-building and sprawling land use.

And so on. There is no pristine “free market” for regulations and subsidies to besmirch. The game is always rigged, and right now it’s rigged in favor of the fossil-fueled status quo. The notion that a problem like climate change, with its century-spanning effects and potentially existential risks, will be solved exclusively or even primarily with “market mechanisms” is a religious doctrine, not a realistic appraisal.

What government proactively plans, encourages, and accomplishes is just as important to the climate struggle as what the market penalizes. Put more bluntly: the spending matters as much as the taxing. Which implies that …

2. It’s the revenue, stupid.

Brookings notes that …

… a carbon tax starting at $20 per ton and rising at 4 percent annually per year in real terms would raise on average $150 billion a year over a 10-year period while reducing carbon dioxide emissions 14 percent below 2006 levels by 2020 and 20 percent below 2006 levels by 2050.

$150 billion a year — pretty soon you’re talking about real money! That could be used to support cleantech R&D or deploy renewable energy or build green infrastructure … or it could be used for none of those. Point is, what happens to the revenue should be at the center of climate hawks’ negotiating strategy; it’s not some peripheral bargaining chip.

3. “Revenue-neutral” means foregoing any money for climate solutions.

A “revenue neutral” carbon tax is one in which all of the revenue raised is returned automatically to taxpayers. Most of the carbon tax proposals floating around today are revenue neutral, mainly, as far as I can tell, because conservatives demand it. (Conservatives don’t trust government with revenue.) There are three ways to achieve revenue neutrality, which I will list from most to least desirable:

  • A dividend system (supported by James Hansen, Bill McKibben, and lots of other greenies) would distribute the carbon revenue to citizens on a flat per-capita basis, the same way Alaska distributes its permanent fund money.
  • A similarly progressive option is to use carbon revenue to reduce payroll taxes, which are paid by around 80 to 90 percent of Americans.
  • A regressive option is to use carbon revenue to reduce income taxes, which are paid by between 50 and 60 percent of Americans and are the main source of progressivity in the U.S. tax system (wealthier people pay a higher rate). Replacing a progressive tax with a regressive tax would redistribute wealth upward. Unsurprisingly, that’s the policy supported by Republicans like economist Art Laffer, who have long loathed the income tax.

Note what all these uses of carbon revenue have in common: They do nothing to reduce carbon emissions or encourage clean energy. And to boot, they wouldn’t even reduce taxes much.

4. Carbon money should fund clean energy.

There are two distinct tasks for climate policy. One is to reduce carbon emissions at lowest cost. The other is to develop and deploy a new energy system. The evidence shows that a carbon tax is good at the first, but not great at the second. That’s where the revenue comes in.

I was going to gather together the research on this, but then I discovered that Mark Muro of Brookings has done it for me. Bless you, Mark Muro of Brookings. (Pardon the long excerpt — all the emphases are mine.)

The sticking point here is that while the conventional wisdom among carbon pricers holds that higher dirty energy prices will provide the right market signals to entrepreneurs, who will then develop and deploy clean new technologies, a ton of evidence suggests that pricing alone won’t generate enough deployment to get us where we need to go. Instead, it is becoming increasingly obvious that along with pricing we need a direct technology deployment push.

One hint of this comes from the modelers. Under neither of their respective carbon tax proposals do the Brookings or MIT groups forecast that emissions will drop enough to even come close to the 80 percent cut in emissions below 1990 levels that is the nation’s long-term carbon emissions goal. Yes, fossil fuel use would go down, oil imports would shrink slightly, and emissions would decline, but much more work would need to be done to tackle global warming. Similarly, an interesting analysis by the Breakthrough Institute concluded that a $20 per ton carbon tax would offer just one-half to one-fifth the incentive of today’s subsidies for the deployment of solar, wind, and other zero-carbon technologies.

These results reflect the growing body of literature that has begun to suggest—and document—that broad economy-wide pricing strategies alone induce only modest technology change and deployment. Last year, Matt Hourihan and Rob Atkinson of the Information Technology and Innovation Foundation ran through some of the literature pertaining to a wide range of industries, while at the same time, scholarship specifically on energy has been accumulating.

Ackerman argued a few years ago that getting the price right is necessary but far from sufficient to mitigate climate change and that direct public sector initiatives are required to disrupt path-dependencies and accelerate learning. Acemoglu and others more recently demonstrated that the optimal carbon policy is not one-sided but involves both carbon taxes and direct research subsidies. They urge immediate action.

Turning to empirical evidence, Calel and Dechezleprêtre looked at company patenting patterns under the EU emissions trading system (a cap-and-trade pricing scheme) and concluded that the system has had very little impact on low-carbon technology change. And then, earlier this year, a Swiss-German team found that the EU system has stimulated only limited adoption of low-emissions technology and that research, development, and deployment (RD&D) technology “push” measures induced more action. This group concluded that none of the first three phases of the trading system were “capable of triggering increased non-emitting technology adoption” and that “only renewable-technology pull policies had this effect.”

And so we arrive back at the revenue: The accumulating evidence and the appropriate fit of the tax to its use argue heavily for at least a portion of the revenue of any carbon pollution fee to be applied to direct investment in energy system clean-up, whether through R&D or later-stage deployment supports.

In short, the tax side is not enough. Effective climate policy also requires spending.

This is commensurate with some of the revenue being rebated to low-income taxpayers, or used to reduce taxes, or wasted on the fake long-term deficit problems. Public investment in clean energy is not the only legitimate use of the revenue. But it is the use for which climate hawks should be advocating most strongly.

5. Carbon taxes are regressive.

I mentioned this is passing already, but it’s worth emphasizing. On their own, carbon taxes hit the poor harder because the poor spend a larger proportion of their income on energy. It isn’t difficult to solve that problem. Using the revenue to reduce payroll taxes would do it. Setting aside some revenue for direct rebates to low-income taxpayers would do it. (By the way, the Waxman-Markey bill did exactly that.)

But swapping a carbon tax for the income tax wouldn’t. Using carbon tax revenue to reduce the deficit wouldn’t. If climate hawks want progressivity — and they should, if they hope for broad grassroots support — they’ll have to fight for it.

6. Carbon tax revenue is supposed to decline.

Remember, the goal of a carbon tax is to decarbonize the economy. As carbon declines, carbon tax revenues will decline, unless the tax is almost continuously ramped up. This wouldn’t matter so much for revenue earmarked for clean energy or direct rebates. There will be less need for that revenue as the economy decarbonizes.

But what if carbon taxes have replaced payroll taxes, which fund Social Security? As revenue declines, so will funding for Social Security. Not good. Or what if carbon taxes have replaced income taxes? As revenue declines, individual tax burdens will decline, which will delight conservatives, but should be a source of concern for liberals in favor of active government. The fact that a carbon tax is intended to phase itself out over time cannot have escaped the attention of its conservative supporters.

7. The carbon lobby will want to axe EPA regulations in exchange.

Exxon has been supporting a carbon tax (notionally) for several years, but it’s made clear that it sees such a tax as “an alternative to costly regulation.” This is what everyone’s favorite dirty-energy lobbyist Frank Maisano recently wrote (behind a paywall):

No carbon tax should be considered before serious regulatory reform is undertaken. The U.S. EPA is moving forward on an approach that regulates carbon, which is akin to fitting a square peg in a round hole. Not only is it legally dubious, but it is not likely not work in practice, either.

Suffice to say, the fossil fuel lobby would never give a carbon tax their OK unless EPA regulations on carbon (and possibly other pollution regs) were scrapped. We saw this fight play out once already, around the cap-and-trade bill.

Unless it was for a high-and-rising tax (which is unlikely), that would be a terrible trade for greens. The implicit carbon price in EPA regs is higher than an explicit tax would likely be. In developing regulations, EPA uses the government’s official “social cost of carbon,” which is around $26/ton. There’s good reason to think that figure is dramatically too low. But it is already higher than a politically realistic carbon tax.

8. The carbon lobby will want to axe clean-energy support programs in exchange.

The same argument goes for clean-energy subsidies: the implicit cost of carbon in those subsidies is far higher — two to five times higher — than a $20/ton carbon price. Trading subsidies for a tax would, especially in early years, represent far less direct support for clean energy.

9. The environmental benefits are uncertain.

The great benefit of a carbon cap over a carbon tax is that a cap ensures a particular level of emissions reductions (yes, yes, depending on how carbon offsets are used). The thing with a tax is, no one can be sure in advance how much it will reduce emissions. The history of environmental policy is one of overestimating costs, so chances are good that the initial tax level will be set conservatively.

That’s what typically happens with cap-and-trade systems — compliance costs are overestimated, there are too many emission permits issued, permit prices plunge, and there’s little financial incentive to reduce emissions. But a cap-and-trade program has a built-in protective measure: the cap. Emissions are either falling or they aren’t, and if they aren’t, the cap provides a statutory basis for further action. It’s not perfect, but it’s something.

What happens if a tax isn’t reducing emissions enough? It means Congress has to raise it. How much does Congress like raising taxes? How much do American voters like it when Congress raises taxes? Now imagine raising a tax repeatedly, on an ad hoc basis. Unless taxes take on a very different political valence in U.S. politics, that looks like a nightmare. The carbon tax could end up limping along at hopelessly low levels for ages, like the U.S. gasoline tax.

Now, theoretically, the tax could be programmed to rise a certain percentage each year, like the one Brookings modeled. Or there could be a “look back” provision that periodically assesses the tax’s performance and adjusts it accordingly. But …

10. All political incentives push toward a poorly designed tax.

It’s true that a carbon tax can be well-designed. For economists, that means using the revenue to reduce distortionary taxes. For clean-energy hawks, it means using the revenue to spark cleantech growth. For both, it means provisions that automatically boost the tax if emission reductions are not on track. (And there are other considerations too: how far upstream to levy the tax, how to deal with cross-border “leakage,” etc. This post could have been even longer, trust me.)

The worst possible thing to do from both perspectives would be to set the tax at a static, low level and use a bunch of the revenue to carve out special deals for various industries. Then you’d get the economic hit from the tax and malign distributional issues.

And yet … that is exactly where all the incentives point. There are many financial interests involved. Every one of them will be leaning on legislators to a) keep the tax as low as possible and b) secure them favorable treatment.

This same rent-seeking spectacle took place around the climate bill. But another benefit of a cap-and-trade system is that no matter how distributional issues are settled (i.e., no matter how the permits are allocated), the cap remains the same and the environmental benefits are guaranteed. When it comes to a tax, however, loopholes and kickbacks reduce environmental benefits. Securing those benefits will be a constant, running battle. Environmentalists will be “those people who are constantly fighting to raise taxes.” That is unlikely to endear them to the public or generate support for other green initiatives.

To sum up

A well-designed carbon tax would be a fantastic thing. In my dream world, it would start at $50/ton and rise 5 percent a year. Twenty-five percent of the revenue would go to rebates for low-income taxpayers; 25 percent would go to reducing payroll taxes; the rest would go to public investments in clean energy RD&D and infrastructure. Whee!

Even a tax considerably smaller than that, done right, could enable Obama to meet the emission reduction goals he pledged in Copenhagen. It might also inspire other countries to follow suit, or at least convince other countries that the U.S. is finally in the climate game. It would be a big deal.

But a carbon tax is not magic. If climate hawks go into negotiations accepting that carbon pricing must be revenue neutral, that market incentives can solve climate change on their own, that government spending and regulatory actions merely inhibit proper market functioning, that the overall tax burden needs to be reduced, that deficit reduction is an overriding short-term priority … well, even if they come out of that negotiation with a carbon tax (which, as noted earlier, they won’t), it will be low, regressive, and ineffective. And they will have worked themselves into an ideological corner that will be difficult to escape.

Worse yet, what if they make all those concessions and come out of it with nothing? The concessions will remain on the record forever, serving as the baseline to future negotiations. (That’s pretty much how the cap-and-trade battle worked out.)

What’s needed on climate change, ultimately, is a wholesale, society-wide commitment to remaking energy, agricultural, and land-use systems along low-carbon lines. “Market mechanisms” like a carbon tax are a crucial part of that effort, especially as a source of funding, but they are in no way a substitute for that effort. We won’t get out of this that easily.