Seven thrilling facts about carbon taxes from the CBO

May 23, 2013

Sure, Congress isn't exactly on the verge of passing a carbon tax. But the Congressional Budget Office (CBO) keeps releasing detailed analyses of the proposal anyway — just in case it comes up as, say, part of a broader budget deal.


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A carbon tax, you may recall, would impose a fee on oil, gas and coal. The idea is that this would help tackle global warming by raising the price of emitting carbon-dioxide. People and businesses would look for more efficient ways to use fossil fuels — or seek out clean alternatives.

But the details are always thorny: How big should the tax be? Should the revenue be rebated to the public? How do you avoid putting a heavy burden on the most vulnerable?

The newest analysis from the CBO delves into all of those questions and more. A few highlights:

1) A carbon tax that starts at $20 per ton would raise $1.2 trillion in the next decade. More precisely: "A price of $20 per metric ton on greenhouse gas emissions in the United States in 2012 and raising that price at a nominal rate of 5.6 percent per year would yield a total of $1.2 trillion in revenues over the 2012–2021 period."

2) That same carbon tax would hike gasoline prices by about 20 cents a gallon: Since the United States is so reliant on fossil fuels, any carbon tax would raise the price of stuff: "The burden imposed by a tax of $20 per ton on CO2 emissions would amount to 1.8 percent of before-tax income for households in the lowest quintile and about 0.7 percent of before-tax income for households in the highest quintile."

That carbon tax would also hike U.S. electricity bills by 16 percent on average, though coal-heavy states would see bigger hikes: "Households in Illinois, Indiana, Kentucky, Michigan, Missouri, Ohio, West Virginia and Wisconsin would see the biggest rise in electricity prices (27 percent), and households in California would see the smallest rise (7 percent)."

3) A carbon tax would have some ripple effects through the economy. This is laid out in Figure 1:

A carbon tax, the CBO notes, "would be likely to reduce both real wages and profits on investment to some extent, but the relative changes in wages and profits would be uncertain."

4) The biggest question, by far, is what to do with the revenue. Rebate it? Cut other taxes? If carbon-tax revenue is used to cut other taxes — say, payroll taxes or even corporate taxes — that could mitigate the economic impacts considerably, depending on how the tax was designed.

Policymakers could also rebate a portion of the revenues to soften the blow for the poor — just 30 percent of the revenue would suffice here. But the CBO seems to think this would be less economically efficient: "Lawmakers could face a trade-off between using carbon tax revenues to minimize the tax’s adverse effects on the economy as a whole and using them to minimize the tax’s impact on disproportionately affected groups."

Meanwhile, some energy experts have argued that some revenue should be used to fund new clean-energy infrastructure — so that people have alternatives to, say, gasoline. Either way, this is easily the most contentious carbon-tax question.

5) A carbon tax starting at $20 per ton would cut U.S. emissions an extra 8 percent by 2021. This would get the United States in range of its Copenhagen pledge to cut emissions 17 percent by 2020:

Note, however, that the CBO is modeling a $21 per ton carbon tax. Some economists have argued that the "social cost of carbon" — that is, the damage done by greenhouse gases — is much, much higher. They argue that a carbon tax should be anywhere from 2 to 12 times as big. That would, in theory, drive down emissions even further.

Also note that the carbon taxes being discussed here would only affect emissions from fossil fuels, which would leave out emissions from a host of other sources: agriculture, landfills, deforestation, land-use changes, etc.

6) The more value you place on future generations, the bigger the carbon tax should be. Let's check out Table 1:

The "discount rate" is a number that helps translate future values into present-day terms. It's a way to answer the question: "How much should we spend to cut emissions today to avoid climate-change damage in the future?" (See David Roberts for a longer, lucid discussion.)

We could spend all day arguing about what the discount rate should be. It's part ethics, part economics. But what the CBO is showing here is that the choice of discount rate has a big impact on how a carbon tax should be structured. A lower discount rate of, say, 2.5 percent — which puts a higher value on future generations — implies that the carbon tax should start off at a higher level.

Some economists, like Frank Ackerman of Tufts, have made the case for an even lower discount rate, like 1 percent, which would translate into an even higher initial carbon tax.

7) The CBO wants us to think of carbon tax as a hedge against the possibility of future catastrophe. The report notes that it's hard to say, precisely, how much damage global warming will cause in the future. If we knew that exact number, it'd be a lot easier to figure out how big a tax to place on fossil fuels in order to "pay for" all that damage.

So the CBO looks at things this way: "Given the inherent uncertainty of predicting the effects of climate change, and the possibility that it could trigger catastrophic effects, lawmakers might view a carbon tax as a reflection of society’s willingness to pay to reduce the risk of potentially very expensive damage in the future."

There's a whole lot more in the report — such as how the tax should be administered, or how to deal with industries that might move overseas. But those seven points are the big ones.

Further reading:

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

--The U.S. currently has some of the lowest energy taxes in the developed world.

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