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How Would We Implement A Carbon Tax? (Almost) Everything You Need To Know

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"How Would We Implement A Carbon Tax? (Almost) Everything You Need To Know"

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by Richard W. Caperton

If you had told me on Tuesday morning that I was about to spend my day at a standing room only event that had nothing to do with the election, I would’ve said, “But, I’m not planning to go to a David Petraeus news conference!”  Ah, but it turns out that there are other topics that bring out the masses.  I did, in fact, spend the day at a standing room only event that had nothing to do with the election.

The topic?  Carbon taxes, of course.

Yesterday, the American Enterprise Institute hosted a conference to talk about anything and everything related to the economics of carbon taxes.  Normally, a full-day conference with more than a dozen speakers on a tax issue in DC will be lucky to get more than a few dozen attendees, even with a free lunch.  Carbon taxes, though, are different.  The enthusiasm for this issue is such that there were over 200 attendees, many of whom stood for half the day.

What makes carbon taxes different? Simply put, people across the political spectrum now know that putting a price on carbon is an indispensable tool for dealing with our climate and budget problems, and that a carbon tax is the most politically viable path forward.  This dynamic has created an exciting amount of momentum that now needs to be turned into policy.

Not only is the political situation ripe for a carbon tax, but yesterday’s AEI conference demonstrated that the thought leadership is ripe as well.  That’s not to say that there’s agreement on the best way to design a carbon tax; the ultimate design will likely be about political decisions as much as policy ones.  But, the implications of different policy choices are largely known, which was the focus of the conference.

The benefits of a carbon tax would be tremendous.  According to the Brookings Institution’s William Gale, the amount of money a carbon tax could raise is roughly comparable to the size of the Bush tax cuts, indexing the alternative minimum tax for inflation, or the budget sequester that’s part of the upcoming fiscal cliff.  Instituting a carbon tax would make it much easier to deal with our country’s budget crisis, because it would give us another tool for solving the problem.  And, a carbon tax can get significant reductions in greenhouse gas pollution.  Allen Fawcett presented findings from the Energy Modeling Forum that show a multitude of technology development scenarios that get to 50 percent reductions in greenhouse gases with a carbon tax.

Broadly speaking, there are two questions about designing a carbon tax: how to collect the money, and what to do with the money?  Neither of these is simple, and virtually every option involves tradeoffs.

First, let’s talk about collecting the revenue.  Do you want to cover the entire economy, just the energy sector, or even a smaller subset of industries?  As Rob Williams of Resources for the Future pointed out, most of the greenhouse gas reductions with a modest carbon tax will come from the electric power sector, which would seem to indicate that you could only deal with a small part of the economy and get almost all of the benefits at much lower political cost.  At the other extreme, you could cover things like agricultural-related methane emissions, although the mechanics of this are much more complicated.

After deciding how much of the economy to cover, you also need to decide where to assess the tax, which Jack Calder of the International Monetary Fund discussed.  You can assess the tax very far upstream, where fossil fuels enter the economy (at the mine mouth or wellhead, for instance).  This is relatively simple and gets at every use of fuels, but the problem is that it puts a tax on fuels that ultimately don’t get burned and contribute to climate change.  Oil used as a feedstock for plastics production, for instance, doesn’t add to greenhouse gas pollution, nor does coal burned in a hypothetical power plant with carbon capture and storage technology.  All things being equal, Calder’s ultimate recommendation is to make a carbon tax as similar as possible to our existing tax system, which should minimize administrative challenges and unintended consequences.

What about complementary policies?  That is, what should happen with the state renewable energy standards, federal incentives, and EPA regulations after a carbon tax is put in place.  While the conventional wisdom among economists is that these other policies simply make a carbon tax more expensive, Karen Palmer from Resources for the Future argued that these policies often deal with externalities – including positive externalities – that a carbon tax doesn’t fix.  And, the lesson from the acid rain program is that EPA needs to have the authority to go above and beyond a carbon tax based on up-to-date information about the costs and benefits of further pollution reductions.

Second, after you collect the revenue, you need to do something with it.  The biggest issue is that a carbon tax is most likely to be regressive; that is, it has a disproportionate impact on poor people.  Modeling by Aparna Mathur at AEI finds that a $15 carbon tax is effectively a tax of 3.54 percent of the income of the poorest decile of the population, but just .63 percent for the wealthiest.  Terry Dinan, a senior advisor at the Congressional Budget Office, has studied seven different ways to deal with this problem, and found that while there is no perfect solution, doing some sort of income tax or payroll tax rebate has a very positive effect.

Of course, once you have a pot of money (which will still be large even after fixing the regressivity problem), you want to spend the money wisely.  RFF’s Williams proposed three uses: cutting pre-existing taxes, reducing the deficit, and valuable public spending.  In the short term, it’s worth noting that simply reducing the deficit is probably not as valuable as spending on infrastructure, including clean energy infrastructure.

This is just a small sample of the issues that will come up in designing a carbon tax, and many of these choices don’t have options that are immediately obvious as being the “best” way to design the system.  But it’s clear that we know the implications of different policy choices.  After yesterday’s conference, no one should ever say that we don’t know how to design a carbon tax.  The bigger issue is that politicians need to decide what they want a carbon tax to achieve and then plug in the right policy tools.

And this is where the slowdown begins.  Of the standing room only crowd at AEI, there was almost certainly no consensus on any of the important questions.  Is the primary goal of a carbon tax to reduce the deficit?  Or to offset corporate income tax reductions?  Or to raise money for clean energy investments?  Or to simply cut pollution, with all of the money going back to consumers?

This issue will come to a head in 2013, and Climate Progress and CAP will have recommendations for building a progressive carbon tax.  Be on the lookout for new work on this issue in the coming weeks.

Richard W. Caperton is Director of Clean Energy Investment at the Center for American Progress.

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27 Responses to How Would We Implement A Carbon Tax? (Almost) Everything You Need To Know

  1. idunno says:

    “Modeling by Aparna Mathur at AEI finds that a $15 carbon tax is effectively a tax of 3.54 percent of the income of the poorest decile of the population, but just .63 percent for the wealthiest.”

    This is potentially very socially regressive already. The deal that Norquist, or somebody, was proposing was that, to agree to this massive 0.63 percent increase, the wealthiest decile should get an major income tax cut.

  2. Phil Blackwood says:

    It seems like a carbon tax could be used to fund disaster relief, linking cause and effect.

  3. Joan Savage says:

    An income tax rebate is a very hollow offer for the 47% who are already too poor to pay income tax.

    • Calamity Jean says:

      Not if it’s a refundable tax credit. If a low-income person’s income tax due was (for example) $162, and the amount withheld from his/her pay during the year was $153, normally that person would owe $9. If the carbon tax credit was $500, that same person would get a refund of $491.

      • dick smith says:

        A per capita check would hold 2/3 of Americans harmless. Go to the Carbon Tax Center to see the data. That’s actually far more progressive than is necessary.

  4. Mike Roddy says:

    It’s nice to see movement here, but $15 a ton is too low to cause a switch to clean energy.
    If we are serious, it needs to be higher.

    If the carbon tax is going to be collected at its end use, we need to look at two other key sources of CO2: logging and livestock production. Logging in the US accounts for around 400 Mt of CO2 annually, and some believe that the figure for meat production is even higher. Here is my own research on the emissions cost of industrial logging in the United States:

    http://www.inergyhomes.com/CO2emissions.pdf

    As with energy, there would be ancillary benefits. Houses would be built from durable, inert materials, and by eating less meat our diet would be healthier- and cheaper, too.

    • DRT says:

      I think all sources of GHGes should be included, cement production, methane leaks, everything. This is probably too simplistic but if the tax is high enough then issues like wood vs. steel for home building should work themselves out.

      • dick smith says:

        To give you a yardstick to compare different proposals.

        $10 per ton of CO2 emissions raises about $55 billion in annual revenues.

        If the tax were imposed at the first point of sale–the minehead, wellhead or border crossing–and passed on 100% to consumers–each $10 per ton of tax would add about 10 cents per gallon at the pump and about 1.2 cents per kWh at the meter.

  5. Kyle Sager says:

    It is great to see movement on this. Above all something needs to be done within a reasonable time frame.

    Taking Obamacare as an analogy: There were many nansayers who ceaselessly bandied excuses like “More study is needed.” Or “It should do this and not that.” to delay action. The result was the can was kicked down the road for nearly two full decades.

    We can not wait with climate. We need to take aggressive action now and we can make adjustments as we go. We’ll figure it out. Let’s take a leadership role with this in the world.

  6. Ronald Brak says:

    Australia introduced a $23 a tonne carbon price on the first of July. The revenue has allowed income taxes to be lowered and pensions and other government benefits to be raised so its overall effect is mildly progressive. There is no reason why a US carbon price couldn’t also be progressive overall.

  7. Jelly Jam says:

    I would like to see a portion of the carbon tax going to two things:

    1) Infrastructure – Developing an infrastructure bank that not only targets the clean energy sector but transportation/mass transit, waterways, wastewater, land reclamation, drinking water, retrofitting buildings, etc. It would also be great if States could receive a percentage of the carbon tax funds to start their own state-based infrastructure banks to bolster local, small businesses.

    2) Social Security – We “borrowed” $2.67 trillion from SS to “balance the budget” over the years. We need to put that money back and never touch it again.

  8. Senior Mentor says:

    “Oil used as a feedstock for plastics production, for instance, doesn’t add to greenhouse gas pollution, nor does coal burned in a hypothetical power plant with carbon capture and storage technology.”

    I strongly disagree with both points. Unless tax has been applied prior to making plastic a lot of energy is used to obtain & process it and then more energy to dispose of plastic after use. Mining, crushing & shipping coal produces large amounts of dust containing arsenic & heavy metals. Cleaning coal requires large amounts of water which becomes polluted with arsenic & heavy metals so it requires storage in ponds like tailings ponds in tar sands. They are, however, not built as well so they leak and often overflow.

    There is no such thing as clean coal!

    • BillD says:

      Presumably, the tax would be applied to the actual carbon emissions resulting from the manufacture of plastics. Oil that goes into the plastic does not generate CO2 and would not be charged. I agree that CO2 sequestering is not likely to be economical or effective. But if the CO2 is not released into the atmosphere, of course the CO2 tax would not be paid.

  9. tom farmer says:

    Useful follow-through blog and commentariat. I think TAX says it best. For what is needed. ‘Trading schemes’ etc appear to show how a market approach does not work. Without, I’d suppose, willing and able parties to them.

  10. paul magnus says:

    “What makes carbon taxes different? Simply put, people across the political spectrum now know that putting a price on carbon is an indispensable tool for dealing with our climate and budget problems,”

    What make a carbon taxes perfect is that it does a lot of things with one cast of the stone. .

    • paul magnus says:

      The main one I think is psychological. It tells people on a personal level… Hey this is serious we, each of us, has to do something about this problem.

      And that personal message say… Hey, its not going to be trivial. And hey there are going to have to be sacrifices.

    • paul magnus says:

      It also, on a practical level, gives us a mechanism to confront the emissions at the source and at the point of consumption.

      Its transparent, ist flexible, its nimble or it can be all these things and more.

      But mainly it is inevitable. And we need to get on with it.

      However, the tax wont be enough. At some point when the message gets through people will have to accept/should accept rationing and ww2 action in tackling this scourge we have released on ourselves and our future.

  11. Joan Savage says:

    Global warming talk heats up as think tanks revisit idea of a carbon tax

    http://www.syracuse.com/news/index.ssf/2012/11/global_warming_talk_heats_up_a.html

  12. Dan Miller says:

    It’s strange that there was no discussion of Fee and Dividend in the article (collect a fee on carbon from fossil fuel companies and distribute all revenues to every legal resident on a per-capita basis). It is revenue neutral and progressive (most lower income people would make far more in dividends than they pay in higher prices).

    It would stimulate investment and innovation and create millions of jobs. And, by the way, it would significantly lower CO2 emissions.

    Whatever policy is put in place, we need to also put a tariff on goods coming from countries without there own fee on carbon. This would protect american companies and, more importantly, get other countries to reduce their emissions. If we are the only ones to reduce emissions, it won’t really matter what we do.

  13. Jay Alt says:

    Is the proposal just a tax leveed at the mine or well-head and then handed back (at least some of the revenue) as income tax rebates?

    From where, then, do the needed incentives to change our behaviors come into play? We need those too!

    Officials can’t count on spending the revenue for anything to fight climate change, Grover didn’t bless that for the GoOPers. sheesh

    • Tom Pedersen says:

      Here in BC, the provincial government levied on July 1, 2008, North America’s first broad-spectrum revenue-neutral carbon tax: CAD$10/Tonne CO2 emitted, rising $5/Tonne/year. It’s now $30/Tonne CO2 emitted. The tax covers all combusted fossil fuels purchased at final point of sale in the province. It’s easy to administer and generates now about $1.2B annually in revenue. Every penny (by law) goes to reducing personal income tax and corporate tax, both of which are now low. BC has the lowest personal income tax in Canada (up to $119k declared income) and amongst the lowest corporate taxes in the G7 countries. The tax is having an impact (based on only four years of data): our per capita gasoline consumption for example has fallen 6% since July 1, 2008, relative to Ontario (the comparison factors out the impact of the recession on gas consumption). Our overall use of diesel, natural gas and light fuel oil is also falling. Meanwhile, our economy is growing at faster than the Canadian average and our clean tech sector is thriving, stimulated by the tax. Two points that made our approach politically acceptable: a) the revenue neutrality directed toward income/corporate tax reductions; b) the annual scheduled increases, which have been a key factor in encourage longer-term thinking and associated behavioural changes.
      -Tom Pedersen, Exec. Dir., Pacific INstitute for Climate Solutions, UVic

    • Calamity Jean says:

      The tax raises the price of energy, so it affects individuals in proportion to the amount of energy they use. But it’s refunded as a flat rate per person. People who use a lot of energy (generally higher income) end up with a net loss, people who use less energy (generally lower income) have a net gain. The net result is progressive.

      The rebate check can and should have enclosed a slip that says, “Did electricity cost you too much last year? If you use part of this refund to buy CFL or LED light bulbs you will lower next year’s electric bills.” Or, “Did gasoline cost you too much last year? If you use part of this refund as the down payment on a car with better gas mileage you will lower next year’s gas bills.”

  14. DRT says:

    Not a rhetorical question: What is the policy, tax or other, that actually gets us to do what is necessary? What policy will start a WWII like reindustrialization headed towards a GHG neutral and eventually GHG negative society? Is a GHG tax and tariff set high enough to make wind and solar cheaper than nat gas sufficient?

  15. dick smith says:

    A federal price on carbon is an essential first step. There is an emerging consensus among economists that the smartest way to do that is a carbon tax that embraces the following principles:

    •It reduces emissions by 80% by 2050. It’s based on our best science, and adequate to do the job.

    •It’s revenue neutral. All the taxes are recycled into the economy. Government keeps none of it.

    •It’s progressive. For lower-income Americans, the tax refunds match or exceed the taxes paid in.

    •It’s comprehensive. Markets sort the entire economy based on carbon use, which spurs innovation.

    •It protects business from unfair domestic and international competition with border taxes and credits.

    •It’s capital neutral. Government should not try to pick (and risk “locking in”) winning technologies.

    •It starts small. About 10-cents-a-gallon and a penny per kilowatt hour would be enough to start.

    •It increases predictably until we hit our emission goals. Businesses need predictable energy prices.

    •It’s easy to administer at home and to copy abroad. It’s one time—at the first point of sale—the mine head, wellhead or border crossing. We already collect sales taxes from these businesses. It doesn’t repeal, prevent or discourage any other private, state, regional, national or international strategies to reduce greenhouse gas emissions with other taxes, tradable permits, regulations or subsidies to alternative fuels. And, it works in countries with widely different economies.

    For the good of our nation, and to preserve a livable world for future generations, Congress needs to enact a revenue-neutral tax on carbon.