The Case for a Carbon Tax

Summary.  Increased burning of fossil fuels, producing higher rates of emission of greenhouse gases, generates worsening patterns of extreme weather events that affect human wellbeing.  In response to this trend, policies are being proposed to abate emissions.  This post summarizes two recent newspaper articles proposing use of a carbon tax, or a more limited gasoline tax, for lowering emissions.  It is judged that a carbon tax is simpler and more effective than establishing a cap-and-trade regime for limiting emissions.

 

Introduction.  Humanity’s rate of use of fossil fuels for energy has grown to high levels in recent decades, and is projected to continue increasing for the indefinite future.  As a result, the annual rate of emission of carbon dioxide (CO₂), the main greenhouse gas, as well as other greenhouse gases such as methane, has likewise been increasing.  Most CO₂, once it enters the atmosphere, remains there indefinitely for a century or longer, for there is no naturally occurring mechanism that removes it. 

Climate scientists hold greenhouse gases responsible for the recent long-term increase in the world-wide average temperature.  In turn, the warmer planet harbors an increased potential for more, and more intense, extreme weather and climate events such as rainfall and resulting floods, heat waves and resulting droughts, and wildfires.  These events have catastrophic effects on human populations, and inflict serious economic harms.

These considerations lead climate scientists and economists to develop mitigating policies intended to slow the growth in the rate of emissions.  This would have the effect of lowering the rate of increase in the CO₂ content of the atmosphere.  It must be noted that, because CO₂remains resident in the atmosphere for a century or longer, its atmospheric concentration cannot be reduced within reasonable time frames; even if emissions ceased entirely, the result would be merely to stabilize the CO₂concentration at the new, higher level.  One policy intended to abate the rate of emission of CO₂ is to impose an economic hurdle to use of fossil fuels.  This post describes recent opinion articles proposing use of a carbon tax or a gas tax to accomplish this.

Two Economics Commentators have recently come out in support of a carbon tax.  Robert Frank, professor of economics at Cornell, commenting in the New York Times, advocates a carbon tax for the following reasons.  First, he summarized some of the adverse weather events in the U. S. mentioned above in the Introduction, emphasizing that climate scientists today believe that man-made greenhouse gases building up in the atmosphere contribute to the causes of these events.  Dr. Frank cites a global climate model study by Sokolov and coworkers that concludes that the global average temperature in 2045 has a median probability of increasing by 1.85ºC (3.3ºF), and by 5.1ºC (9.2ºF) by 2095, beyond the present level, which has itself already increased about 0.7ºC (1.3ºF) above the temperature that prevailed before humans began burning fossil fuels.  These predictions, based on Sokolov’s current more comprehensive model, are higher than earlier ones by his group and by others.

Dr. Frank then suggests gradually imposing a carbon tax in the U. S., citing an earlier recommendation by the U. N. Intergovernmental Panel on Climate Change for a tax of US$80/metric ton (1.1 U. S. tons) of emitted carbon, which works out to about 70 US cents per U. S. gallon of gasoline.  However, in view of the more dire temperature rise situation currently foreseen he also suggests a tax that could be as high as US$300/metric ton, translating to a rise in the price of gasoline of about US$3.00/U. S. gallon.  Many countries around the world already have taxes on fuel about this high, and, he notes, nations have adapted by developing more efficient cars.

Dr. Frank cites two beneficial economic effects of a carbon tax.  First, it would contribute to reducing the U. S. fiscal deficit, which is highly desirable.  In addition, phasing in the tax gradually only after the present economic distress in the U. S. had passed would provide a timed incentive to make energy use in all its aspects more efficient even before the tax took effect, thus contributing overall to a reduced rate of emitting greenhouse gases.  The U. S. could contribute to a worldwide increase in energy efficiency by imposing carbon-based tariffs on imports.  This, for example, would provide incentives for foreign emitters of large amounts of greenhouse gases to develop efficiencies in their own lands.

Dr. Frank concludes “If the recent meteorological chaos drives home the threat of climate change and prompts action, it may ultimately be a blessing in disguise.”

Eduardo Porter, an economics columnist with the New York Times supports a more limited carbon tax in the form of a gas tax.  Mr. Porter noted that President Obama’s administration has ruled that motor vehicle fleet average gas efficiency has to reach 54.5 miles per U. S. gallon by 2025, almost doubling the present efficiency.  (In a previous action his administration had set a standard of 36.6 miles per U. S. gallon by 2017.)  The administration foresees that by 2025 these standards should result in a reduction of fuel use by 12 billion gallons, with a concomitant lowering of greenhouse gas emissions when burned.

But Mr. Porter has several concerns with the use of vehicle efficiency standards to lower use of fossil fuels for transportation.  First, he states that the engineering, production and societal costs to attain such efficiency may be excessive, representing an ineffective use of productive resources.  This is so even accounting for the reduction in harms inflicted by lowered incidence of weather extremes, and better health such as lower incidence of asthma, according to economists.  Second, he warns that more efficient vehicles may have the “perverse incentive” of inducing drivers to travel more, not less, because the expense per distance traveled will be lower.  In other words, vehicle efficiency standards do not change behavior toward reducing use of fossil fuels.  Further, they only take effect as people move from older, less efficient cars to newer, efficient ones, a process that stretches out over the decade or more needed for the fleet standard to be put in place.

Instead, Mr. Porter favors a gas tax.  First, a gas tax directly affects drivers’ behavior right away, even with their existing vehicles.  They would travel less, and when they decide to buy new cars, they would opt for more efficient ones which in turn provides the incentive to manufacturers to optimize efficiency.  This effect has already been observed when gas prices rose in the past for brief episodes.  Second, any inequity in imposing a gas tax can be reversed by offering tax credits at income tax time, say, to people with lower incomes; behavior at the pump is affected by the price tag staring drivers in the face rather than by the distant, subconscious, expectation of a return of the tax at a later time.  Third, the gas tax spurs car makers to make the most efficient vehicles they think drivers would buy in response to the newly imposed gas tax.  Mr. Porter cites a currently circulating analysis by Prof. Christopher Knittel, an energy economist at the Massachusetts Institute of Technology, that found that if a gas tax had been imposed in the 1980’s, after the Arab oil embargo, gas mileage could have improved by 60% by now.  Instead, car makers have emphasized increasing size, weight and power. 

Tom Friedman, a foreign affairs columnist for the New York Times, has repeatedly called for a tax on carbon as the most direct way to lower consumption of fossil fuels, in order to minimize the growth of greenhouse gases in the atmosphere and to reduce U. S.importation of petroleum from abroad.  Others at the New York Times espousing a carbon tax, both conservatives and liberals, are David Brooks, Nicholas Kristof and Bob Herbert.

In 2011, Profs. Daniel Esty (Commissioner of Energy and Environmental Protection for the state of Connecticut) and Michael Porter published an op-ed article in the New York Times espousing a carbon tax.

Analysis

Cap-and-Trade Mechanisms to Lower CO₂Emissions. Two principal economic mechanisms have been devised to lower the rate of emissions of greenhouse gases, including CO₂.  One is the cap-and-trade mechanism.  In this regime the government jurisdiction (region, nation or state) administratively establishes how many emission allowances, usually worth the right to emit 1 ton of CO₂, for example, that each fixed point source of emissions (e.g., a power plant) is allowed.  These are granted or sold to the source.  Accordingly, cap-and-trade requires initially establishing the emissions rate for each source, which relies on reporting from the sources without bias.  The total of all allowances constitutes the “cap”.  Allowances have value, because a source that succeeds in reducing its emission rate can “trade” them on an open market to other sources whose emission rate exceeds their allowances.  Cap-and-trade is intended to lower overall emission rates with time, as the administering government lowers the cap each year; this would result in increasing the price  of each allowance.  The result is to lower emissions, while reflecting the price of the allowances by an increased cost for generating power or using energy, which is passed on to consumers.

Thus cap-and-trade uses market forces to, on the one hand, induce conservation behavior by consumers, and on the other hand, to induce efficiencies in generation of energy.  A further complication, though, is the right usually built in to cap-and-trade regimes to “offset” excess demand for allowances by “importing” allowances from outside the territory of the regime; these also must be monitored effectively by those administering the regime.

Cap-and-trade, it can be seen carries several difficulties and inefficiencies.  Its administration is very complex: there is the need to allot allowances and lower them each year; market mechanisms must be established; and offsets must be monitored.  Additionally, the market for allowances establishes third-party traders having no interest in global warming, but only in trading an object (allowances) for profit among themselves, potentially leading to market abuses and speculation. 

The European Union established a cap-and-trade in the last decade, but it was initially judged a failure because it wound up issuing more allowances than necessary, leading to a collapse of the market.  On the other hand, the American regimes in California, and in the Northeast Regional Greenhouse Gas Initiative, are operating cap-and-trade regimes at various stages of progress.

A Carbon Tax or a Gas Tax.  The second principal mechanism for lowering emission rates is imposition of a tax on all forms CO₂ emissions, frequently including other greenhouse gases, or a more limited tax on gasoline only.  A carbon tax impacts all sources of energy and economic activity that depend on fossil fuels.  A gasoline tax is more restricted to limiting use of fossil fuels for personal and commercial transportation.

Administratively a carbon tax is far simpler than setting up a cap-and-trade regime.  It too is based on economic behavior, affecting the demand side of the market, as opposed to the supply side impacted by cap-and-trade.  Typically a carbon tax is imposed gradually, beginning at a low level and increasing annually to an economically meaningful level.  A political “sweetener” for a carbon tax could be a rebate to needy taxpayers to compensate for the increased year-long expense arising from the tax, as noted above. 

This writer believes that a carbon tax is preferable over a cap-and-trade regime for its simplicity, efficiency and effectiveness. 

Mr. Porter’s article above cites U. S. government studies on the overall “social cost of carbon”, per ton of CO₂ emitted.  This arises from harms due to extreme weather and climate events, and adverse effects on health and nutrition from global warming.  These calculations are subject to great uncertainties, but economists place the cost at between US$5 to 68, and increasing even more as time passes.  It thus behooves all societies, including our own, to take active measures to lower emissions, striving to attain zero emissions as soon as possible in order to minimize the harms from extreme events.

Gas taxes are very effective in affecting drivers’ travel habits.  The graphic below

Sources: New York Times presenting data from the U. S. Department of Energy and the World Bank; http://www.nytimes.com/interactive/2012/09/11/business/Fuel-Taxes-and-Consumption.html?ref=business

 

shows per capita use of fuel for driving in developed countries decreases as the size of the gas tax increases.  The U. S. has the lowest gas tax correlated with the highest amount of fuel used per capita. It is seen that most of the benefit appears to be attained at a tax level of about US$2.20 per gallon (although other factors not apparent from the graphic may also be in play.)  As an example, in Great Britain, according to Mr. Porter, the gas tax is about US$3.95 per U. S. gallon.  Ford, the American car maker, sells a model of its+ compact Focus there whose efficiency is 72 miles per U. S. gallon.  A Focus model sold in the U. S. gets only 33 miles per U. S. gallon.  Clearly, automakers currently have the technology and capability to mass produce fuel efficient cars.  While further research can be devoted to enhancing efficiency, this shows that the state of technology today is sufficient to garner significant improvements today.
 

Conclusion.  Frank and Porter have proposed imposing a carbon tax or a gasoline tax to abate further increases in the rate of emission of greenhouse gases.  A carbon tax is judged to be more straightforward, efficient and effective than implementing a cap-and-trade regime for reducing emissions.  No government bureaucracies need to be created, and the simplest of motives driving economic activity by individuals have an immediate effect on behavior.  Where deemed necessary, tax rebates could be devised to ease the tax burden on people with low incomes.  A carbon tax additionally would have positive effects on American society, for it would contribute to resolving our severe fiscal problems.  Policymakers should give serious consideration to this mechanism for abating greenhouse gas emissions.

© 2012 Henry Auer