Would a carbon tax cut emissions drastically? Not on its own.

November 20, 2012

Lately, the White House and Congress have been talking up tax reform. And that's given policy wonks an excuse to revisit one of their favorite environmental proposals — the carbon tax. The government would slap a fee on greenhouse-gas emissions to offset tax cuts elsewhere. It would boost the economy and address global warming. What's not to love?


Nothing to see here, just a good old-fashioned all-American carbon tax. (Ben Margot/Associated Press)

Well, set aside the fact that there aren't yet any prominent politicians touting the idea. It's still worth discussing on its merits. And one of the biggest questions here is whether a carbon tax would actually reduce U.S. greenhouse-gas emissions significantly. Is it a comprehensive solution to climate change? Or just a small first step?

Many economists would argue that it could indeed be a comprehensive solution on its own. If you tax oil, coal, and natural gas and make them all more expensive, then people and companies will either use fewer fossil fuels or they'll seek out alternatives. Markets will adjust to the change in price. That's the standard theory: If you price the carbon externalities correctly, markets will adjust.

But not everyone's convinced. Over at the Brookings Institution, Mark Muro recently argued that a carbon tax, by itself, might not be enough to make a significant dent in U.S. global-warming emissions. Sure, in the near term people would cut back on fossil fuel use and companies would find innovative ways to reduce emissions. This is what appears to be happening in British Columbia, which levied a carbon fee in 2008. That's a start. But modern economies are so heavily dependent on fossil fuels that there's only so much we can reasonably cut back. Alternatives aren't readily available yet.

One way to see this, Muro says, is to ask carbon tax advocates what they think will happen. Sebastian Rausch and John M. Reilly of the MIT Global Change Institute recently put forward a proposal for a $20/ton carbon tax that would rise 4 percent each year, starting in 2013. (The funds would be used to offset taxes elsewhere.) Here's what their economic model predicts would happen to U.S. greenhouse-gas emissions:


Blue line: MIT reference case with no carbon tax. Black line: EIA reference. Green line: Scenario with MIT carbon tax in place.

With a carbon tax in place, U.S. greenhouse gas emissions do start declining quite a bit (this is the green line). But by 2030, emission levels stall, even though the carbon tax keeps rising and rising each year. The United States wouldn't get anywhere near the 80 percent cut by 2050 that the White House has envisioned.

One explanation here is that MIT's proposed carbon tax just isn't high enough. But Muro favors another possibility--that a carbon tax alone isn't enough to drive deep reductions. The private sector tends to under-invest in energy R&D and key bits of infrastructure such as transmission lines. Without further policies, it's unlikely that we'll see a sweeping transformation of our energy system to give people alternatives to coal plants and gasoline-powered cars.

That's why Muro argues that a portion of the revenue raised by a carbon tax should be used to fund public clean-energy R&D. The country won't wean itself off oil solely because carbon gets taxed. We'll also need public-transit alternatives, or electric-vehicle infrastructure, or futuristic new hydrogen cars. And in many cases, he notes, the government may have to help bankroll this infrastructure.

Indeed, Muro writes, there's a growing body of economic research suggesting that a price on carbon can only be fully effective at tackling global warming if it's paired with increased public funding for energy research and technology: 

[Frank] Ackerman argued a few years ago that getting the price right is necessary but far from sufficient to mitigate climate change and that direct public sector initiatives are required to disrupt path-dependencies and accelerate learning. ....

Turning to empirical evidence, Calel and Dechezleprêtre looked at company patenting patterns under the EU emissions trading system (a cap-and-trade pricing scheme) and concluded that the system has had very little impact on low-carbon technology change.  And then, earlier this year, a Swiss-German team found that the EU system has stimulated only limited adoption of low-emissions technology and that research, development, and deployment (RD&D) technology “push” measures induced more action.

This seems to be a slowly congealing conventional wisdom among those urging forceful action on climate change. Here's how Grist's David Roberts puts it: "In short, the tax side is not enough. Effective climate policy also requires spending."

Of course, there's a downside to this strategy too, too. Making a carbon-tax proposal more complicated could also make it more politically contentious. Right now, the few conservatives who actually support a carbon tax, such as former Rep. Bob Inglis or economist Greg Mankiw, are mainly in favor of a carbon fee that's used to help cut other taxes in a revenue-neutral manner. And even that isn't a terribly popular view among Republicans in Congress. It could prove an even tougher slog to get them on board with diverting a portion of carbon-tax revenue for R&D and infrastructure spending.

Further reading:

--How would a carbon tax work in practice? Let's ask British Columbia.

--How to engineer a carbon tax so that it doesn't hit the poor the hardest.

--Dave Roberts offers up ten reasons why a carbon tax would be trickier than many environmentalists think.

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