Is a carbon tax more effective than EPA rules? You might be surprised.

June 25, 2013

As part of President Obama's new climate-change plan, the Environmental Protection Agency will design rules to limit carbon emissions from existing power plants. But is this really the most effective way to reduce greenhouse gases?


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Many economists will say no, it's not. EPA rules are a pretty blunt instrument: the Clean Air Act was originally designed for very different pollutants like sulfur and mercury, and the agency will need to get creative in applying the law to a more pervasive gas like carbon dioxide.

A better approach, they'll typically say, would be for Congress to set a price on carbon that required polluters to pay for the damage caused by their emissions. People would then decide how best to adjust to the new price of fossil fuels on their own. That would be cheaper and more efficient.

Again, that's the conventional wisdom. But in an interesting recent paper (pdf) for Resources for the Future, Nathan Richardson and Arthur G. Fraas look at this comparison in much greater detail. Their conclusion? It actually depends how each is designed. EPA regulations might even be more effective than a carbon tax in a few cases.

The authors first note that there are a bunch of ways to define "more effective" here. Is the aim of the climate policy to be as stringent as possible? To do the least harm to consumers as possible? To find a cost-effective balance between the two? To be flexible in the face of new information about climate change? To push along international climate talks?

And they point out that a great deal depends on how the EPA actually designs its carbon regulations and how Congress designs its carbon tax:

--There's a lot of uncertainty as to what the EPA rules will look like. For instance, EPA could bluntly require coal plants to adopt the most efficient new technologies available. Or the agency could let utilities trade credits among themselves to meet certain efficiency goals. Or the EPA could allow utilities to meet the standard by adding renewable power. Or the EPA could, in theory, set a cap-and-trade system for power plants.

The RFF paper argues that the latter, more flexible approaches on that list could be just as cost-effective at cutting emissions as a carbon tax. One possible option along these lines would be the proposal by the Natural Resources Defense Council to cut power plant emissions 26 percent by 2020 through a state by state approach. (That plan would cost utilities an estimated $4 billion per year.)

But the more flexible approaches are also riskier, legally speaking — the D.C. Circuit Court might strike down a cap-and-trade scheme. Richardson notes that a blunt technology standard is probably the safest approach for the EPA, legally, though it's also the least cost-effective.

--A lot also depends on what sort of carbon tax Congress might develop. There's also no guarantee that Congress would craft an ideal carbon tax of the sort that economists prefer. It's entirely possible for lawmakers to write quirks and loopholes into any tax bill that would make it less effective at cutting emissions than EPA rules.

In theory, the paper notes, a carbon tax would be superior to regulations at covering the entire economy rather than specific sectors and standing up to legal challenges. The revenue from a carbon tax could also be used to blunt the harm from higher electric bills and fuel bills. On the flip side, notes Richardson, a carbon tax set by Congress might not be as adaptable to new information about climate science in the years to come.

"Imagine that our estimates of the social cost of carbon rise in the future," Richardson says. "If you have a carbon tax set by Congress, it might be hard to change the tax in light of the new information. But if you're regulating through the Clean Air Act, then the EPA is required to continually reassess the threat and adjust regulations as needed."

Granted, this argument is all academic for now. Congress has shown no signs of enacting a price on carbon — EPA regulations are the only policy for cutting emissions currently on the table. But some lawmakers, like Sen. Sheldon Whitehouse (D-R.I.), think the threat of blunt regulations might ratchet up pressure on Congress to consider a carbon tax. This paper is a way to think through the pros and cons of each approach.

Further reading:

-- Here's the Resources for the Future paper on comparing a carbon price with EPA rules.

-- Here's a breakdown of Obama's new climate-change plan.

-- Could Republicans ever support a carbon tax? Bob Inglis thinks so. Meanwhile, here's a recent Congressional Budget Office analysis of various carbon tax proposals.

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Ezra Klein · June 25, 2013