Effective Climate Policy: The Case for a Carbon Tax

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A carbon tax is the most effective and least costly climate policy.

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Economists on both the left and the right advocate for a carbon tax. To be sure, they often have differing motivations for a carbon tax. Some want to address climate change while others want to swap a carbon tax for more distortionary taxes such as payroll taxes or income taxes. But why, despite bipartisan agreement among economists, is a carbon tax seemingly off the policy table, even in the midst of fiscal negotiations in which new revenue sources are in such great need?

Hsu The Case for a Carbon Tax.jpgIn my recent book, The Case for a Carbon Tax: Getting Past Our Hang-ups to Effective Climate Policy, I take a stab at answering this question. Opposition to carbon taxes is a mile wide but an inch deep: it likely stems from certain inherent framing problems when one speaks of a “tax.” But the problem is deeper than mere labeling, as relabeling it as a carbon “fee” would not solve the political problem.

The heuristics of either climate policy or fiscal policy are such that the idea of a carbon tax systemically draws attention to its most unattractive aspects. For those concerned with climate policy, a carbon tax seems so much less attractive than alternatives—such as regulating under the Clean Air Act or subsidizing putative emissions reductions technologies—because it most obviously costs consumers. For those concerned with fiscal policy, leading with the word “carbon” inevitably raises the question of why the government should peg a tax to carbon in the first place.

Opposition to carbon taxes is based upon superficial misperceptions that can be best addressed through persistent, simple, and plainspoken messaging. This message should be that climate change is a risk that calls for the expenditure of some money insuring against some effects of climate change. The most effective and least costly means is a carbon tax. Even if alternative policies for reducing emissions through regulation do not obviously cost money, ultimately people still pay, whether as taxpayers, automobile owners, electricity users, or just consumers of goods in a fossil-fuel-powered economy. A “tax” only sounds worse than regulation.

Ten simple arguments support a carbon tax. Any policymakers interested in turning rhetoric into action would undoubtedly benefit from drawing upon any combination of the following arguments:

1. “Government is bad at picking winners, and emissions.jpglosers are good at picking governments.” Rather than government driving how companies should control their greenhouse gas emissions, innovation in emissions reduction technology is going to have to come from the private sector. As opposed to other climate policies, a carbon tax is the only truly technology-neutral policy.

2. Economic efficiency.  Climate policy must sort industries not only by their value, but also by their embedded carbon emissions. A carbon tax accounts for carbon emissions in every stage of production. This kind of sorting cannot be done efficiently by the Clean Air Act, which, by commanding and controlling carbon emissions, essentially asks each industry to just try its best.

3. Broader incentives to innovate. Creating the right incentives for innovation will require a broad price signal that ripples throughout an economy in order to take advantage of as many greenhouse gas reduction opportunities as possible. These opportunities are diverse and disparate, and the way to tap into all of them is to have a broad price signal. Of all climate policies, a carbon tax provides the broadest price signal of carbon damages.

4. Deeper and steadier incentives to innovate. A carbon tax provides, over time, the most stable price signal to stimulate innovation in emissions reduction. For example, in 2009, in the midst of the great financial recession, U.S. carbon dioxide emissions fell 6% from 2008 levels. If the U.S. were under a cap-and-trade regime and not a carbon tax, 2009 would have been a year in which everybody took the year off in terms of emissions reductions, which could have dulled ongoing incentives to innovate.

5. Carbon taxes do not subsidize the formation of capital. People seem to think that capital in the form of buildings, facilities, and structures is unambiguously good. But when we discover that there is something harmful or inefficient about expensive capital we have acquired, it can be very difficult to get rid of that capital. A carbon tax is the only capital-neutral way of reducing emissions.

6. Respect federalism. A carbon tax is the one climate instrument that allows states to pursue climate policy without interference from the federal government. Alternatives to a carbon tax usually raise tricky questions of federalism, inviting litigation and imposing coordination costs.

7. Carbon taxes are administratively simpler. A carbon tax readily builds upon an existing tax collection and energy record-keeping infrastructure, such that the administrative costs are minimal when compared to other emissions regulations, especially if taxes are collected upstream in the energy distribution chain.

8. Revenue raising. Only a small fraction of carbon tax revenues are needed to fully address the regressive nature of a carbon tax, something that can readily be achieved by rebating money to the poorest households. What can be done with the remainder? One could return all of the money to taxpayers, for instance by reducing payroll or income taxes. The U.S. could alternatively reduce corporate income taxes, which are the highest among the G8 countries. One can debate what to do with revenues, but it should be recognized that a carbon tax represents an opportunity to reduce distortions in our economy.

9. International coordination. An international cap-and-trade program, as contemplated by the Kyoto Protocol, is clearly a failure. However, holdouts like China, India, and other countries are more likely to be open to a global carbon tax, which allows them to keep the proceeds for whatever use they deem fit. A carbon tax does not smack of an externally imposed mandate that intrudes onto sovereignty.

10. Carbon dioxide is a stock pollutant and needs a stock reduction policy. The amount of reduction in any given year is unimportant, as would be the focus of something like a cap-and-trade program or regulation under the Clean Air Act. Instead, what is important is that the world begin operating under a price signal immediately, so that the stock of atmospheric carbon dioxide can be drawn down. A carbon tax achieves this goal.

A carbon tax is the simplest, most straightforward way of reducing emissions, while providing fiscal flexibility that is much-needed at this juncture.  It promises an opportunity to reform tax policy while maintaining revenue streams. Compared to the panoply of other emissions reduction and climate policies, a carbon tax simply works best.

Shi-Ling Hsu

Shi-Ling Hsu is a professor of law at the Florida State University College of Law. He is the author of The Case for a Carbon Tax: Getting Past Our Hang-ups to Effective Climate Policy (Island Press, 2012).