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The Problems and Politics of Carbon Tax Pricing

Even though it has been around since the 1970s, carbon tax has gained popularity as a policy measure only in recent times. While the fundamentals of a carbon tax are already known, several questions relating to its design and implementation remain. None, however, is more important than the one about its price.   

Put an unrealistically  high tax cost and a country runs the risk of depressing productivity figures as consumers and industry pull back and GDP suffers. But a low carbon tax tantamounts to a token gesture that does not achieve much by way of a cut in carbon emissions. 

Carbon tax proposals in recent years span an array of figures. For example, the Obama administration estimated carbon tax prices in the region between $15 to $50 while the Trump administration has a much lower estimate of between $1 to $7 for the tax price. Other peer-reviewed price estimates for carbon tax span the gamut from $0 to $1,000. 

Congressman Ted Deutch (R-FL)  suggested taxing carbon at $15 per ton on a yearly basis, with an increase of $10 per ton every year, in January. His estimate is less than the $24 per ton proposal put forward by Carlos Curbelo, who was also a Republican Congressman from Florida, last year. (Curbelo lost his reelection bid to a Democrat last year and received the honor of being mocked by President Trump). Curbelo’s proposal planned for a 2% increase in line with increases in the Consumer Price Index (CPI). 

The wide range of these estimates is primarily due to the conceptual peculiarities of such a tax. A carbon tax is essentially a social cost on using carbon. But it is difficult to estimate these costs in an increasingly complex and interdependent global order and energy system. 

Alternate design approaches, that do not attempt to estimate a social cost in advance, come with their own set of problems. For example, one can begin with the end tax rate as goal and calculate the required emissions that will enable reaching that goal. The problem with this approach is that it may be the wrong idea to use tax amounts as tools for targeting carbon emission goals. Another method is to set tax rates for given revenue targets year-over-year. But setting revenue goals might distract from the ultimate emissions goal.     

At a recent event, Dr. Noah Kaufman, research scholar at Columbia University’s Center for Global Energy Policy, said one of the best ways to approach planning for a carbon tax is to work backwards from a planned date for net zero emissions. 

The United Kingdom, which has set a date of 2050 for net zero emissions, is following this approach. The country is the second-biggest polluter of carbon in the EU and has set a charge of 16 pounds (approx. $20) per ton of carbon, starting November 4 and subject to a no-deal Brexit. The carbon tax would replace levies under the European Emission Trading System (ETS). 

But these estimates are predicated on sensitivity to several inputs, each of which has an important bearing on the overall result and could derail efforts to maintain an optimal carbon tax price. 

For example, development of new renewable energy technologies could accelerate the move towards a carbon-free economy. Economic growth figures also play an important part in determining carbon taxes, primarily because the tax has a direct relationship with productivity. Government policies to tackle other environmental problems, such as air pollution and energy efficiency targets, can also be used in concert with carbon tax policy for maximum impact. In such cases, their figures could have a direct bearing on the amount for carbon tax. 

The Politics of Carbon Tax Pricing 

An optimal carbon tax price is also about Washington politics. The carbon tax proposal is among the few proposals to curb climate change that enjoys support from both sides of the aisle. It’s market-based incentive structure appeals to Republicans while Democrats are enticed to it because it allows for progressive tax increases and makes a place for environmental concerns at the table. But both parties disagree on the exact price at which carbon emissions should be taxed in society. (The difference in carbon tax price estimates between Obama and Trump administrations is an example of the disparities in their thinking).   

According to Susanne Brooks, Director of U.S. Climate Policy and Analysis at the Environmental Defense Fund (EDF),  hybrid programs are the best way forward because they combine concerns for the environment (carbon emissions) and industry (price). 

Such programs are a combination of cap-and-trade systems and carbon taxes. A cap is set on the maximum amount for carbon emissions and carbon tax prices are adjusted to suit the emissions target. The carbon tax amount is allowed to vary only within a certain range to ensure that carbon emissions trading is not affected. 

But linking prices for both emissions and taxes comes with its own set of disadvantages. For example, it would mean that regulators would have greater control over the market. It could also mean increased volatility in emissions trading markets. Brooks says that all Congressional bills for carbon taxes have, so far, included tax adjustment provisions. Again, the extent of those adjustments is still a moot point in negotiations between Democrats and Republicans. 

 

“No one really knows,” said Susanne Brooks, when asked about the political constraints on fixing a carbon tax price, at the same event. She said it both parties (and other stakeholders in the process) have “very different levels of ambition.” The difference in ambitions is not only with regards to pricing but also about the factors incorporated into the design process for carbon tax prices. For example, the Green New Deal has made people consider the social ramifications of such taxes and whether they affect all constituents equitably.

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Discussions

Matt Chester's picture
Matt Chester on Sep 20, 2019 1:11 pm GMT

Great insights on an important topic, Rakesh. Thanks for sharing. 

But a low carbon tax tantamounts to a token gesture that does not achieve much by way of a cut in carbon emissions. 

I'd also note that not only would a too low carbon tax be ineffective, but it would actually be harmful towards the end goals of emissions reductions in the long run. The reason for that is the difficulty in passing a carbon tax cannot be overstated, and if all the political capital is spent getting an insufficient price then it'll be that march harder to tackle other areas where work is need.

I'll post here a quote from David Roberts aka Dr. Vox since I think he lays it out quite well:

To me, all of the above suggests a simple conclusion: Carbon taxes are good policy, an important part of the portfolio, but unlikely ever to be sufficient on their own. It’s worth getting a price on carbon anywhere it can be gotten, but climate hawks should not believe, and definitely shouldn’t be saying in public, that a carbon price is enough, that it’s worth trading anything and everything for, that when we implement it, we are done.

For one thing, it’s unlikely to be high enough. For another, it strikes me as unwise to leave other sectors unreformed for a decade or two while we clean up electricity. If that happens, we could reach 2030 or 2040, run out of coal to retire, and find ourselves needing very rapid, very large reductions from those other sectors, for which we will be ill-prepared.

I asked Kaufman, the director of Columbia’s School of International and Public Affairs, about this as well. He noted that “it’s a feature rather than a bug of a carbon tax policy that its near-term effects are concentrated in one industry.” That should serve to reduce political opposition from oil and gas.

But he also added, “if I were developing an optimal climate policy portfolio, I’d absolutely include a host of other policies, like funding clean transportation infrastructure, efficiency standards, and a boatload of support for innovation.”

John Larsen, director of the Rhodium research, told me that the sectoral analysis of carbon tax effects can show policymakers “where to focus additional policy action.”

“A very reasonable case can be made from our results,” he said, “that more action across the economy is required if the US is going to do its fair share in tackling climate change.”

Carbon pricing, whatever form it comes in, will almost certainly need to be supplemented with technology research, development, and demonstration policies; pollution regulations; and spending on infrastructure, adaptation, and transition assistance. A carbon price supports, funds, and accelerates the effects of those other policies (which is great!), but it is not a substitute.

The proper target for advocacy is action sufficient to reduce emissions to net-zero carbon as fast as practicably possible. What limits that effort is not ultimately the choice of policy instruments, but the constraints of political attention, organization, funding, and intensity. Loosen those constraints and everything, including a carbon tax, gets easier.

Bob Wallace's picture
Bob Wallace on Sep 20, 2019 8:51 pm GMT

Put an unrealistically  high tax cost and a country runs the risk of depressing productivity figures as consumers and industry pull back and GDP suffers. But a low carbon tax tantamounts to a token gesture that does not achieve much by way of a cut in carbon emissions.

There's a rather simple solution.

1) Institute a carbon tax. 

2) Take the revenue from the carbon tax and use it to subsidize/lower end user costs.  Keep the consumer (industrial, commercial, retail) electricity rate stable.

If necessary use some of the hundreds of billions we spend on health problems resulting from fossil fuel use to offset any shortfall between tax revenue and end-user rates.  

Since wind and solar are now less expensive than fueling many fossil fuel plants it's likely that it wouldn't take much of a carbon tax to push utiltiies away from fossil fuels.

Cost of energy remains staple.  Consumers/industry does not suff.  GDP does not suffer.

Bob Wallace's picture
Bob Wallace on Sep 20, 2019 9:05 pm GMT

That is only electricity.  Transportation is likely a solved problem.

Batteries are now cheap enough that we are almost able to offer sub-$30k long range EVs.  VW may, in fact, be producing them in 2020.  The monthly out of pocket costs for a $30k EV and a $25k ICEV are about the same.  The higher monthly EV car payment would be offset for most by the fuel/electricity savings and maintenance savings.  A $30k EV is basically a "Camry killer".

And battery prices are continuing to fall.  Within the next five years we will almost certainly reach manufacturing cost parity between EVs and ICEVs.(1)  If we have adequate competition we should see EV prices starting to drop below that of same-featured ICEVs by 2025.  When that happens new ICEV sales will collapse.

It's not clear how a carbon tax on petroleum would speed the move to EVs at this point in time.  Time to EV/ICEV price parity is largely an issue of battery manufacturing scaling up.  People are buying all the EVs that are being produced now and the market will expand as more are produced and prices drop.

Adding a carbon tax on fuel would impact consumers and the GDP.  With little to no impact on accelerating our move to electric transportation.  If you've got a different take I'd love to hear it.

(1) Tesla may already be at price parity with its direct competition.  The Tesla 3SR sells for slightly less than the BMW Series 3 and the Mercedes C Class.  The $35k Tesla 3 sells for only  $550 more than the Camry XLE V6 and offers more for the money.

 

 

Bob Wallace's picture
Bob Wallace on Sep 20, 2019 9:22 pm GMT

And there's heat.  Building heat may be a place where a carbon tax could help a move off fossil fuels.  But it's a tax that could really hurt those with the tightest budgets.

If we taxed heating fuel and created a subsidy for those with limited incomes that might push others to switch to heat pumps.  At least they would be less likely to replace a furnace with another furnace.

Probably the best near term solution for cutting carbon emissions from heating would be to expand our weatherization programs.  A relatively small expendature on better windows, doors, and insulation should greatly cut the amount of fuel used.

Then change our building codes so that heat pumps are required in new construction.  Do that and the market for fueled furnaces will drop to the point at which manufacturing will cease and people replacing furnaces 10-15 years later will only find heat pumps on the market.

---

A possible least cost solution for low income households.

Create one 'comfortable' room rather than trying to heat/cool all of a poorly built house.  Provide good dual pane windows or (much cheaper) thermal shutters.  Insulate the exterior walls, ceiling and floor of that room.  Install a mini-split heat pump (<$700) that could make that room comfortable year round.

If people wanted to heat/cool other rooms they could leave connecting doors open but they are the ones who would have to pay for the electricity.  

I grew up with only a oil fired floor furnace in one room.  On cold days/nights the family stayed in that room.  It wasn't a bad life.

 

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