What’s the best way to design a carbon tax? Lawmakers ask for suggestions.

March 13, 2013

On Tuesday, four Democrats in Congress unveiled a brand-new proposal for a carbon tax. The set-up is simple: The U.S. government would slap a fee on fossil-fuel emissions and refund the revenue back to the public.

Choose your own adventure. (Michael Williamson/Washington Post)

But there's a twist: The precise details of the carbon tax have yet to be thrashed out. The four lawmakers are soliciting public comments for how big the tax should be and how best to rebate the money.

The proposal is being put forward by Reps. Henry Waxman and Earl Blumenauer, as well as Sens. Sheldon Whitehouse and Brian Schatz.

Here are the key questions they're wrestling with:

1. What is the appropriate price per ton for polluters to pay? The draft contains alternative prices of $15, $25 and $35 per ton for discussion purposes.

2. How much should the price per ton increase on an annual basis? The draft contains a range of increases from 2 percent to 8 percent per year for discussion purposes.

3. What are the best ways to return the revenue to the American people? The discussion draft proposes putting the revenue toward the following goals, and solicits comments on how to best accomplish each: (1) mitigating energy costs for consumers, especially low-income consumers; (2) reducing the Federal deficit; (3) protecting jobs of workers at trade-vulnerable, energy intensive industries; (4) reducing the tax liability for individuals and businesses; and (5) investing in other activities to reduce carbon pollution and its effects.

4. How should the carbon fee program interact with state programs that address carbon pollution?

Those are, indeed, difficult questions. So let's take a look at each of them in turn:

1) How big should the carbon tax be? Economists have long argued that a carbon tax can be an elegant way to tackle climate change. If you tax oil, coal, and natural gas and make them more expensive, then people and companies will either use fewer fossil fuels or seek alternatives. Markets will adjust to the new price.

But there's plenty of dispute over what the appropriate price on carbon emissions should be. For that, you need to figure out how much damage heat-trapping greenhouse gases are actually causing — and figure out how highly to value future generations. The federal government currently pegs the "social cost of carbon" at $21 per ton. Other economists have concluded that the price should be up to 12 times as much.

2) How quickly does the tax need to rise to curtail emissions? A tax that rises each year should, in theory, drive down emissions. But a lot could depend on how quickly the tax actually rises.

Here's one example: Sebastian Rausch and John M. Reilly of the MIT Global Change Institute recently put forward a proposal for a $20-per-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 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.

Under this proposal, U.S. greenhouse gas emissions do start declining quite a bit (this is the green line), with a relatively small impact on the U.S. economy. But by 2030, emission levels stall, even though the carbon tax keeps rising by 4 percent each year. The United States wouldn’t get anywhere near the 80 percent cut by 2050 that the White House has envisioned.

It's possible the MIT model is too pessimistic or wrong. It's also possible that deeper emissions cuts might require a carbon tax that rises even more sharply. But a higher tax could also prove more costly to the economy unless it's offset properly. So there's a delicate trade-off here.

3) What's the best way to use the carbon tax revenue? A carbon fee usually gets criticized for hurting poorer Americans the most—they spend the biggest slice of their income on gasoline and other energy-intensive products, after all. But Rausch and Reilly found that a lot of the distributional effects depend on how Congress rebates the revenue, as shown in the chart below:

The green line shows how different income groups would be affected in 2015 if the carbon tax was used to fend off cuts to social welfare programs like Medicaid. Lower-income Americans would benefit significantly, while wealthier Americans would take a small hit.

By contrast, the red and blue lines show the effects if revenue from the carbon tax was used to cut the corporate tax or personal income tax—in those cases, higher-income Americans would come out ahead.

If, however, carbon tax revenue was used to cut payroll taxes—that’s the black line—then the welfare effects in 2015 are more or less neutral.

On the flip side, some experts like Mark Muro of Brookings have argued 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, Muro argues, the government may have to help bankroll this infrastructure.

4) How does the carbon tax interact with the states? California is currently operating its own comprehensive program to cut greenhouse-gas emissions 80 percent by 2050. And 10 states in the Northeast have a small cap-and-trade program for electric utilities. Should these states somehow get "credit" for moving early on global warming? And what's the best way to do that under a carbon-tax system?

In any case, these are all difficult questions. Those who want to join in on this debate can submit comments to the lawmakers at cutcarbon@mail.house.gov. The comment period ends April 21.

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