Seven Reasons Taxing Carbon Won’t Fly (and shouldn’t)
Pricing is considered the best policy for reducing carbon emissions, and carbon taxation monopolizes the conversation. To be sure, a carbon tax will reduce emissions; we get less of anything we tax. The tax, however, has serious drawbacks worth discussing since other carbon pricing options are available. Adopting a carbon tax will, I fear, damage public confidence in government, which cannot afford further setbacks. We will likely have just one bite at the carbon policy apple. Do-overs may not be an option. This article lists seven flaws of taxing carbon.
A goal of environmental policy is creating order from chaos. Today, carbon is emitted often unregulated. Taxing carbon after it has left the stack, the only way to do it, is a bit like closing the barn door after the horses are out; too little, too late leaving only herding as a remedy of last resort. Not an orderly process.
Taxing carbon addresses the problem indirectly, herding consumers and polluters in the general direction of emission reductions. Instead of pricing carbon, we should value pollution reduction or abatement, the real objective, and make it an asset worth creating and owning. A second article will describe a property-based carbon policy informed by EPA’s decades of experience with averaging, banking and trading programs. That article will outline a plan for addressing abatement directly. Abatement can be quantified, commoditized, valued and priced competitively through an economy-wide market accessible to all, especially polluters. Garret Hardin’s observation in his 1968 Science magazine article, “The Tragedy of the Commons,” is relevant here: “The tragedy of the commons . . . is averted by private property, or something formally like it.”
Understanding both the flaws of carbon taxation and an alternative property-based carbon policy requires no PhD in economics or mathematics. Common sense, recognizing what’s right in front of our noses, is enough.
First, a carbon tax is inequitable to consumers. The tax may be levied on polluters but is paid by consumers. This is deliberate. The tax is meant to increase prices and reduce demand for carbon intensive goods. The tax, however, is paid only when carbon is emitted and, therefore, only when policy has not eliminated emissions. No tax is paid when policy succeeds and carbon is abated. As if hostages, consumers will pay for industry’s failure to abate until polluters stop polluting.
A tax intended to change consumer behavior violates a most fundamental management principle taught every first year business student. When delegated responsibility or authority, subordinates must control the resources necessary to get the job done. Making consumers responsible for emissions they do not control violates this sound management principle.
This arrangement questions A.C. Pigou’s idea of a tax that reduces emissions by internalizing pollution’s external damages. In Paying for Pollution, Why a Carbon Tax is Good for America (Oxford University Press, 2019, p. 3), Gilbert Metcalf describes the theoretical basis of a tax.
Why is a carbon tax the right response? Markets work best when the price of a good reflects all its costs. If the price of the good doesn’t include all the costs — the damages from pollution, for example — then we are effectively subsizdizing that good and, as a result, will consume too much of it. Because we don’t include the costs of climate change in the price of fossil fuels, we consume more of them than is good for society. Taxing carbon aligns the price we consumers see with the true costs of using these fuels. It’s pretty simple. People respond to prices. If we raise the price of fossil fuels to reflect their true cost, consumption falls.
This approach just as easily explains why taxing carbon is the wrong response. A tax focusses on pricing carbon-intensive goods to include both internal production costs and external damages. Generally, when one pays for damage he or she causes, compensation goes to the damaged party. In this case, damaged individuals likely cannot be identified and the amount of damage, the social cost of carbon, is an estimate. Compensating unknown persons in indeterminate amounts will not be possible. Stopping the damage is a better remedy. Diverting private funds into the government treasury via carbon taxes is not the same thing.
When price is the object, how the money is used becomes secondary, and pollution abatement is demoted to collateral benefit status. It’s as if hounds hunting abatement have been thrown off the scent by the red herring of internalizing externalities.
I argue a tax compounds the problem. A tax on emissions raises prices, but emissions still exist. Eliminating pollution, on the other hand, is triggered, not by paying for the damage we cause, but only by paying the polluter’s abatement cost. Whether prices we pay internalize all, some or none of the damage is irrelevant; abatement will occur when the abatement cost is paid. Internalization is beside the point. External cost and abatement cost are not the same thing; paying one does not necessarily purchase the other.
Which begs the question, why bother with externalities when the key is abatement? Why base our policy on matching prices to external costs when we can focus directly on reducing or eliminating pollution? The theory of a carbon tax may itself be a Rube Goldberg device: taxing polluters to increase costs and prices to make consumers pay for pollution to, in circular fashion, cajole polluters into eliminating pollution. Why not cut to the chase? Government policy should tell polluters exactly what emissions are and are not allowed and strive to leave both consumers and intentional price increases out of it.
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[February 16, 2021. Upon further examination and reflection, I believe the following point, other than its first paragraph, is not correct. Market prices for goods will indeed rise to, or almost to, the level compensating the high-abatement-cost polluter and provide those with lower costs more revenue or a competitive advantage. This disproportionate advantage, however, is neither fair nor unfair. It is simply a reflection of an economic fact of life: lower production costs result in better market performance. The relative advantage of lower abatement costs for some polluters will exist under any carbon policy be it tax, auctioned or freely allocated cap and trade or intensity-based carbon reduction market such as Market Driven Compliance. The choice of carbon policy cannot change the unique abatement costs of individual polluters. On the other hand, if abatement costs are equal, a tax or auctioned cap and trade will favor firms with higher profit margins better able to absorb the tax and auction price. I stand by the six other points in this article.]
Second, it’s not fair to polluters either. The environmental damage of carbon pollution is not greater when a polluter’s profit margins are small. Yet, polluters with smaller profits have less ability to pay even though many low margin goods provide greater value in terms of sales to the economy. If we must favor one business over another, value to the economy is a better criterion than profit margin. Contrary to conventional wisdom, taxing every ton at the same rate does not distribute the abatement burden evenly throughout the economy. The threat to low margin industries is greater even if their production is more valuable.
Requiring pollution abatement is fair; making consumers pay random and unjust enrichment to some businesses while hamstringing others is not. Consider two competing widget makers. Due to factors important when factories were built and nobody thought about carbon, the abatement cost for one is $40 per ton and, for the other, $100 per ton. When the carbon tax is $41, the first widget maker will abate or offset its emissions and lock in future compliance costs at $40. Both will pass the $41 tax to consumers. When the carbon tax reaches $60, the second widget maker will pay the tax since it is less than the $100 abatement cost. Widgets will be priced accordingly. The first widget maker will raise its widget prices, too, not simply to cover its $40 abatement cost but as high as it can. The first widget maker can set prices to recoup $59 and still underprice the second firm paying $60.
So, the consumer pays the first firm an extra $59 — $40 for abatement plus $19 of unjust enrichment giving the first firm free abatement and a windfall. The second firm charges consumers $60 per ton of emissions and still pollutes albeit at a lower level due to reduced demand for its products. Rather than impose an equal burden on all polluters, a carbon tax metes out reward and punishment wholly disconnected from environmental damage, which for every emitted ton is the same.
Moving goal posts for all polluters is probably fair. Randomly moving the posts further away for some and bringing the posts closer for others is economically distorting and immoral. Decarbonizing our economy is like rowing a ship across the sea. It’s a gigantic boat on a very long voyage. Everyone needs to grab an oar. Randomly assigning the laboring oar to some while others are paid to be aboard is not fair and likely not efficient.
Third, a carbon tax is market-related but not really market-based. A tax merely hitches a ride on existing markets, increasing production costs and consumer prices, artificially, to manipulate price signals. Although credits from carbon sinks will certainly be traded, a tax cannot create a full scale carbon market in which polluters most efficient at reducing emissions sell credits to share their efficiency with others. A true carbon market will provide abatement incentives to the seller and reduce abatement costs for the purchaser. Both sides win, and the range of emission reduction costs across the entire economy will narrow. As explained in the second point of this article, a carbon tax will exacerbate abatement cost differences between polluters.
Fourth, a tax is a tax; a fee is a tax. The political lift is too heavy to enact any tax. Consumers will resent paying for industry’s emissions. Ultimately, “carbon taxes will have to confront the political optics of their blunt imposition of higher prices on familiar commodities.” (Rabe, Barry G., Can We Price Carbon? MIT Press (2018), p. 203.) Polluting businesses will resent random windfalls and costs unrelated to environmental harm. Adding insult to injury, consumers will pay not the cost of abatement but the tax and unjust enrichment.
Some argue our experience with tobacco should be replicated with carbon. In Can We Price Carbon?, Barry Rabe makes the following observation regarding our economic addiction to carbon vs the physical addiction to tobacco.
Even the hope of mounting an effective campaign to phase out fossil fuels that follows the playbook of the tobacco control case seems naïve on closer review. Decades of active promotion of tobacco use through aggressive advertising and subsidized production still failed to lure more than one-half of adult Americans to smoke. Its addictive qualities were potent and yet tens of millions of citizens found effective paths toward use reduction or elimination. Tobacco consumption was hardly necessary to meet fundamental daily needs or sustain the national economy. (pp. 13–14)
Today, our entire economy still depends on carbon but half of us never ever needed tobacco. Compare the clear link between tobacco and disease to the less obvious link between CO2 and climate change. Cigarettes cause cancer, COPD, heart disease and other fatal conditions while CO2 is neither acutely nor chronically toxic. Tobacco harms users and those close to them while CO2 acts globally, not locally. We all know someone damaged by tobacco use. My father, mother-in-law and father-in-law were victims. In contrast, few Americans gassing up their cars feel directly connected to wild fires, hurricanes or falling ocean pH. Major personal and immediate risks working against tobacco are not present with carbon. And, we depend on carbon far more than we ever did tobacco. Willingness to bear added consumer burden and economic distortion under a carbon tax does not rise to the level of tobacco.
Fifth, the hisorical experience with taxing tobacco does not augur well for abating carbon. The Federal Trade Commission reports cigarette sales declined from 458.6 billion cigarettes in 1998 to 216.9 billion in 2018, a 53% reduction. The Bureau of Labor Statistics reports cigarette prices increased 342% over roughly the same period, December 1998 through December 2018. This 53% volume reduction in exchange for a 342% price increase implies cigarette sales fell 1½% over the long term for every 10% increase in price.
This ratio may not translate well to carbon abatement considering the health, economic and political factors making cigarettes an easier target. In 2014, the Energy Information Administration reported “Gasoline prices tend to have little effect on demand for car travel.” The Bureau of Labor Statistics, in a March 2016 article “Using gasoline data to explain inelasticity“, stated,
Noting the continuous demand for gasoline and the relative stability of the estimated gallons of gasoline bought quarterly between 2004 and 2014, it is difficult to identify what will alter this trend. It seems that a doubling in price per gallon did not alter consumer’s consumption habits.
This comparison with tobacco suggests two conclusions. First, expecting carbon tax enactment to be just like the campaign against tobacco is wishful thinking. Second, should the wish be granted, replicating the tobacco experience — 342% price increase to achieve 53% in reductions — may be unlikely and insufficient.
Sixth, a carbon tax and dividend policy courts political disaster. I don’t mean bad news for Republicans or Democrats. I mean civic mayhem not solvable by the best bipartisan efforts of politicians and government. Climate Leadership Council modeling predicts a $43 (in 2017 dollars) carbon tax in 2021 and escalating at 4% per year can reduce carbon emissions in 2025 by about 24% from 2016 levels to 4,399 MMT. Increasing at 4% annually, the 2025 tax will be $49. Receipts in 2025, therefore, will be about $216 billion. Although we do not know what 2025 GDP will be, 2017 U.S. GDP was $19,543 billion. The tax, therefore, will be about 1.1% of 2017 GDP paid for emissions not abated. This amount does not include emission reduction or offset expenses paid in tax avoidance.
This is a huge amount of money. CLC proposes recycling the tax as dividends to individuals or families to offset regressive price increases in carbon intensive goods. One CLC example indicates the first year dividend will be $2,000 for a family of four. Other scholars have proposed using the tax to reduce distortionary taxes. Offsetting regressive impacts is an obviously great goal, but is tying anti-regressive measures to carbon tax revenues good policy? Assuming tax revenues are not intercepted or pork barrelled (a risky assumption), carbon dividends and tax relief will become entitlements. Government payouts and tax cuts are almost impossible to repeal or even reduce. All of which begs the question, how can entitlements be maintained as emissions fall or even disappear?
The task will not be easy. If the tax rate increases 4%, simple math tells us revenues decline if emissions fall by more than 3.85%. More rapid abatement will impair entitlement funding. Linking entitlements to carbon taxes pits an irresistible force against an immoveable object — one seeking maximum entitlements and the other maximum abatement. The two cannot coexist.
Government has an insatiable appetite for money and, caught between an immediate and tangible demand for entitlements and the future and indefinite benefits of carbon abatement, may choose emission maintenance. An entitlement debate could easily steal oxygen from the broader issue of global economic damage due to climate change. Can we trust our system to make the right choice? Politicians should not be in this crossfire and putting them there is not good policy. Regressive impacts deserve a solution not tied to a tax base we aim to destroy.
Seventh, leakage. No one has presented a fully credible plan for addressing emission leakage under a carbon tax. To cover carbon costs, domestic manufacturers must increase prices or lower margins placing them at a competitive disadvantage in international trade. Foreign manufacturers will increase market share, production and emissions; domestic manufacturers, faced with lower demand or margins, will shrink. The result? Emissions will “leak” from the United States to unregulated and lesser regulated countries and may even increase on a world-wide basis.
The Carbon Leadership Council tax plan “will apply its domestic carbon price to carbon intensive imports and will rebate fees paid on carbon-intensive exports.” Taxes on imports and rebates on exports “will cover energy and non-energy direct CO2 emissions and indirect CO2 emissions associated with energy production and carbon-intensive intermediate goods.” Since the proposal is based on emissions rather than carbon content, domestic goods such as cement, which is carbon intensive with negligible carbon content, should be on a level playing field with competing imports. In fact, as CLC points out, the U.S. is generally more energy efficient than other nations, and taxing goods on emissions will burden imported goods more than their domestically produced counterparts, thus benefitting domestic producers.
Exports, however, are not imports. Erasing carbon costs for exports is not the mirror image of equalizing costs for imports, and export competitiveness cannot be preserved with tax rebates. Under any carbon policy, some domestic emissions will be abated or offset by the manufacturer. Abated or offset emissions, however, will not be taxed. Tax rebates, therefore, cannot erase domestic manufacturers’ abatement and offset costs. An export policy based solely on tax rebates will hand foreign producers a competitive advantage. American exporters will be incented to forswear abatement entirely knowing only then will tax rebates fully cover their compliance costs.
Under a tax policy, a level playing field for exporters requires at least two steps: rebate the tax paid on what is emitted and, in addition, provide a refundable credit at taxpayer expense to offset the polluter’s cost of what is not emitted. Without an explanation of how abatement costs can be offset, we should not accept tax rebates alone will preserve competitiveness for American exports.
Tl;DR. This article lists seven objections to a carbon tax. Rather than prioritize emission abatement, a carbon tax treats consumers unfairly, intentionally imposing higher prices to reduce demand and coax emission reductions beyond those unilaterally undertaken by the polluter. A carbon tax is unfair to polluters favoring those most profitable rather than those producing greatest value. With consumer money, a tax awards arbitrary windfalls to polluters with low abatement costs even though their CO2 is just as harmful as any other. A tax does not create a true carbon market offering least cost options for abating pollution. A carbon tax deliberately raises prices on familiar goods, but consumers may feel no direct connection to the avoided harm making enactment unlikely. If enacted, a carbon tax is not likely to repeat our track record with tobacco, which itself may be insufficient. A carbon tax and dividend create an incentive to support government entitlements by maintaining emissions, a recipe for political crisis. Rebating a carbon tax for exports neutralizes the tax but does not offset abatement costs. Tax rebates, therefore, cannot create an equal footing for American exports in international markets and will provide domestic exporters an incentive to avoid abatement entirely.
A carbon tax increases prices to maneuver and manipulate individual and polluter behavior toward an undefined goal. A tax expresses what government does not want and fails to define what it does want. The unspoken message to polluters and individuals is, “As long as polluters pollute, your costs and prices will compound until I decide emission reductions are sufficient.” Government owes its economy and citizens more certainty. A less passive-aggressive approach would not tax emissions but demand and value emission reductions, define a downward trajectory of emission targets, reward polluters who do better and charge those who do worse. There is a tried and truly free market-based approach for doing that. Stay tuned.