Carbon Tax Center

Majority in U.S. Support Revenue-Neutral Carbon Tax

12/2/2011 by James Handley

Sixty-five percent of Americans now support a modest revenue-neutral carbon tax to reduce pollution and create jobs, according to a survey of one thousand American adults conducted jointly last month by the Yale Project on Climate Communication and the George Mason University Center for Climate Change Communication. This is the first poll we have seen showing that a majority of Americans support a carbon tax.

Majority support for a carbon tax spanned the political spectrum in the Yale-George Mason poll, with 51% of self-identified Republicans, 69% of independents and 77% of Democrats supporting a carbon tax with revenue returned as lower taxes.

The survey found 60% support for a $10/ton CO2 tax if revenue is returned by reducing income taxes. (The pollsters helpfully noted that $10/ton CO2 equates to around 10 cents per gallon of gasoline.) That support slipped to 49% if revenue is returned via annual checks to families, with each family receiving the same amount. The apparent preference for an income tax shift over a “dividend” runs counter to the view that voters are more likely to embrace direct checks than tax shifts. The survey did not poll on monthly checks, nor on the payroll tax shift approach backed by many economists and embodied in Rep. John Larson’s carbon tax bill.

In the poll, 70% of respondents rated global warming as a high priority for the President and Congress, suggesting that reality in the form of this year’s record-breaking 14 weather-related disasters in the U.S. may be affecting public opinion more than the constant drumbeat of industry-funded climate science denial.

Greater funding for research on renewable energy was supported by an overwhelming 78% of respondents, with greenhouse gas regulation supported by 63%, slightly less than the 65% support for a carbon tax. The survey also found that 70% of respondents oppose fossil fuel subsidies, including a whopping 80% opposition among independent voters.

The Carbon Tax Center has long urged polling organizations to query voters on revenue-neutral carbon taxes, in order to test opinions on carbon taxes apart from anti-government sentiments. The strong public support for a revenue-neutral carbon tax evidenced by this groundbreaking survey suggests we are on the right track.

Why Isn’t The Environmental Community Using the Fiscal And Tax Reform “Window” to Push For A Carbon Tax?

11/8/2011 by James Handley

A carbon tax offers a unique and powerful combination of fiscal, economic-efficiency and environmental benefits, argued Adele Morris, the Brookings Institution’s Policy Director for Climate and Energy Economics, at an Oct. 18 forum convened by the Brookings Institution, the Urban Institute and the Tax Policy Center. Morris acknowledged the political obstacles. One of course is the failure of anti-tax politicians to distinguish beneficial “Pigouvian” taxes on pollution from conventional taxes that burden and discourage productive activity. But another has been “tepid” support for a carbon tax from the environmental community.

We heard that as a challenge: Why has the environmental community (with a few notable exceptions) parked itself on the sidelines of this crucial policy debate?

Adele shared her presentation text, which we reproduce below:

Time to ’86 the Tax Code? Prospects for Tax Reform After 25 Years

AN URBAN INSTITUTE – BROOKINGS INSTITUTION – TAX POLICY CENTER EVENT 10/18/11

The potential role for a carbon tax in a broader tax reform package is timely and economically important. This paper addresses two aspects of the issue: the economics and the politics. It makes good economic sense to embed a carbon tax in a broader tax reform package. If you’re going to “go big” on deficit reduction, it makes sense to include a carbon tax, and likewise if you’re going to do serious climate policy, it makes sense to raise revenue for deficit reduction or to offset other taxes. Despite the strong economic case, the political challenges to a carbon tax are many, and they aren’t just from anti-tax Republicans who don’t believe in the science of climate change. Some of the headwind to a carbon tax derives from tepid enthusiasm from Democrats and the environmental community.

Embedding a Carbon Tax in Broader Tax Reform

First and foremost, the reason to do a carbon tax is to reduce the risks posed by climate change. If you don’t believe the science that indicates that humans are responsible for rising temperatures then naturally there is nothing else compelling beyond this point. But if we stipulate the risks of climate change, then a policy that prices those damages (as best as we can estimate them) into fossil fuels is an economic no-brainer.

Adele Morris, Climate & Energy Policy Director, Brookings Institution

The kind of carbon tax policy I support is the canonical carbon tax recommended by many economists. It would fall on the carbon content of fossil fuels broadly across the economy. It would start modestly, at something like $15 to $25 per ton of CO₂, and ramp up at a modest real rate over inflation, something like 4 percent per year. It would allow tax credits for carbon in fuels that are not subsequently emitted, for example because it is sequestered underground or embodied in a product, such as plastics.

While it’s true that tax reform is hard enough without larding it up with a grab bag of other policy priorities, especially something as contentious as climate policy, there are several good economic reasons to combine these two efforts. First, a carbon tax can raise significant revenue. Depending on the tax rate, it can raise more or less revenue, but estimates suggest that a price on carbon about $33 per ton of CO₂ in 2020 would raise about $180 billion per year. A tax of about the size I described earlier would start out at revenue of about $100 billion per year, and it would rise from there. However, the revenue profile isn’t as steep as you might think because people respond exactly as you want them to — by emitting less carbon. That means that although the tax rate goes up, the revenue tapers off and eventually falls over the long run as the falling emissions dominate the higher tax rate. So a carbon tax is a medium- to long-run revenue instrument, but as emissions fall to low levels in the very long run the tax eventually raises little revenue, which is exactly what you want if the goal is to stabilize greenhouse gas concentrations in the atmosphere.

A second reason to embed a carbon tax in broader tax reform is that a carbon tax can be regressive. If you don’t make the carbon tax part of a progressive tax reform, then you have to fix the regressivity within the climate policy or not fix it at all. If you address the regressivity within the carbon tax system, you can end up with less efficient climate policy – for example with rebates to households to offset higher energy bills. This blunts the incentive to conserve energy, which means you have to have a higher carbon price to get the same environmental benefits, which is obviously more costly.

Third, a carbon tax used for deficit reduction could possibly avoid some of the protracted rent-seeking we saw over the cap-and-trade bill, where relatively little of the debate over cap-and-trade was over the cap — most of the squabble was over who got the free allowances. Everyone who thought they were about to lose their share of the pie had incentive to block the measure and get another bite at the pie. Maybe if all the carbon tax revenue goes to deficit reduction or to fund the reduction of other taxes, then there’d be less to squabble over and we could make some progress.

Fourth, a carbon tax policy that doesn’t apply the revenue for deficit reduction or to offset other distortionary taxes would be a lot more costly to the economy than one that does. The economic literature is clear on this. If you just give away allowances or carbon tax revenue, you’re not getting the economic benefit of reducing distortions from the existing tax system which in turn makes the climate policy a lot more costly than it could be.

A final reason to embed the carbon tax into other tax reform is that it might make it harder to unwind later. There’s always going to be a constituency to repeal the carbon tax, and it will get louder as the tax and retail energy prices go up. If there’s a countervailing constituency that is the clear beneficiary of the other taxes reduced, then we have a counterweight. That’s what they did in British Columbia, which is a model we should consider.

More on the Politics

AEI’s Kevin Hassett recently observed that one reason we not have discussed climate policy this long without actually putting a price on carbon is that economists haven’t done a good job convincing Republicans that Pigouvian taxes are okay, meaning that taxing something you want less of is good economic policy. I agree with his assessment.

I also think economists haven’t done a good job convincing the environmental community that Pigouvian taxes are good environmental policy. After decades of opposition, the good performance of the Acid Rain program led environmentalists to support the idea of cap-and-trade to control air pollutants. And we saw their strong support of the cap-and-trade legislation as it moved through the House but died in the Senate in 2010. However, even as the environmental community embraced cap-and-trade, which put a specific limit on emissions, they didn’t entirely trust it to do the job. Recall that only one title of the monster bill was cap-and-trade. The environmental community embraced, and still does, a wide variety of ancillary policies, some of which would have been redundant to the cap. These include appliance standards, fuel economy standards, renewable energy mandates and subsidies, and a host of other measures that would have shifted around where emissions reductions occurred and raised costs, but not necessarily decreased emissions below the cap.

So if there was lingering distrust of cap-and-trade, there’s probably even less confidence in a carbon tax to do the job. Very few NGOs supported a carbon tax over cap-and-trade, mostly because they viewed the cap-and-trade as more certain environmentally. Perhaps downward sloping demand is just not that convincing, and now, when we’re in the context of discussing a carbon tax instead of cap-and-trade, the unease over letting go of the ancillary policy apparatus is likely to be higher.

The political reality is that Democrats will likely have to give up something to get a carbon tax. It might include proposed or existing clean air act regulations that could become redundant with a carbon tax, spending on clean energy or green jobs initiatives, or transfers to what Republicans view as sketchy UN bureaucracies for climate finance in developing countries. (I would note that the politics of those ancillary policies aren’t just about concern about the environmental effectiveness of a carbon tax; there are important Democratic constituencies for these clean energy measures, such as renewable energy firms and labor unions.) But be that as it may, I think the way forward, if Democrats are serious about putting a price on carbon, is for leaders to put together a carbon tax proposal and to sell it in part by describing what they would be willing to give up to get it.

It might have to wait until we’ve tried everything else, and it hasn’t worked. We can pursue appliance standards and renewable subsidies and the like. Then when we’re not meeting our environmental goals, we’ll converge on the economic equivalent of concluding the earth revolves around the sun and put a price on carbon.

Carbon Tax: Win/Win for Climate and Fiscal Policy

10/20/2011 by James Handley

It’s not cap vs. tax anymore; it’s what kind of tax? That’s the take-home from a symposium, Fiscal Reform and Climate Protection: Considering a U.S. Carbon Tax, held earlier this week at Resources for the Future and co-sponsored by the Peterson Institute for International Economics.

American Enterprise Institute economist Kevin Hassett opened the day by pointing out that economists hadn’t convinced enough Republican lawmakers of the benefits of replacing taxes on productive activity with a tax on CO2 pollution. Hassett noted that damage from fossil fuels’ conventional pollution is large enough to justify a carbon tax even without considering global warming. But he hewed closer to Republican orthodoxy when he cautioned that it would be “folly” for environmentalists and Democrats to try to “prove their machismo” by “holding out for a $65/ton CO2 tax” to combat global warming. Hassett expressed relief that “corrupt” cap-and-trade “is finally behind us.”

RFF’s Ian Parry highlighted the intriguing potential for a CO2 tax to reduce emissions while increasing economic output — provided the revenue is used to cut distortionary taxes that otherwise drag down economic activity — a phenomenon that economists call a “double dividend.” As articulated in their paper, Moving U.S. Climate Policy Forward: Are Carbon Taxes the Only Good Alternative? Parry and his RFF colleague Roberton Williams advocate using carbon tax revenue to cut taxes on payroll and on savings or to lighten future tax burdens. Parry said he estimates that a $33/ton CO2 tax dedicated entirely to deficit reduction could close 25% of the U.S. budget gap.

Bob Simon, Staff Director of the Senate Energy and Natural Resources Committee (ENR), remarked that once one passes the “fork in the road” between “cap” and “tax,” the road signs look the same. Both policies must address revenue, regional disparities and impacts on energy-intensive trade-exposed industries. Simon suggested that broad multi-sector policies like caps and carbon taxes are more politically fraught than sector-specific policies like the Clean Electricity Standard for utilities that ENR voted up two years ago.

Joe Aldy, former White House special assistant on climate, pointed out that a $20/ton CO2 tax could raise $100 billion a year. Aldy, now teaching economics at Harvard, expressed hope that the advantages of a carbon tax will make it more attractive to deficit cutters than other options such as a value-added tax, a cut in mortgage deductions, or curtailing benefits.

Trevor Hauser, an energy specialist at the Peterson Institute, presented new modeling results indicating that regional variations in carbon tax incidence may be as little as 3%. Moreover, the emergence of shale gas as a resource option in coal-dependent states may soften opposition there, he suggested, improving legislative prospects for a carbon tax. Hauser stressed both the climate and fiscal benefits of a carbon tax; he showed a Chamber of Commerce memo rating a carbon tax as the most cost-effective climate policy, but he noted that their position may have changed.

Post Script: On the very next day, the Brookings Institution convened a complementary meeting, Time to ’86 the Tax Code? Prospects for Tax Reform After 25 Years. Brookings’ Director for Climate and Energy Economics Adele Morris urged those concerned about climate to push for inclusion of a carbon tax in fiscal and tax reform. In contrast to a value-added tax, Morris pointed out that carbon taxes offer unique additional advantages – they reduce CO2 emissions at the lowest cost and improve the efficiency of the economy.

Photo: Flickr — afagan

Farewell Sy Schwartz

10/5/2011 by Charles Komanoff

The Carbon Tax Center lost a dear friend and generous supporter last week, and the world lost a unique soul, with the passing of Seymour Schwartz — builder, environmentalist, philanthropist, and humanist.

Sy was 88, a World War II vet, father of three, with nine grandchildren. In an obit in last Sunday Times, Sy’s family described him as “visionary real estate developer, environmental champion, and, later, founder of the Common Sense Fund,” a non-profit that promotes practical, creative action on the environment and in the arts.

The Carbon Tax Center has been a fortunate beneficiary of Sy’s vision since our founding in 2007. The support of the Common Sense Fund was integral to the success of our three major public fora to date: the Congressional carbon-tax briefings we convened in 2008 (U.S. House) and 2009 (Senate) and our “Pricing Carbon” Wesleyan Conference last November. Sy’s mixture of optimistic idealism and hard-won realism was a mirror image to ours, and we hope CTC served his beliefs well.

The Common Sense Fund’s Web site says this about Sy:

Over a long career as a real estate developer in Connecticut, Sy was a visionary builder, using conservation zoning before it was popular, understanding how to work with challenging topography, and exploring and implementing alternative energy sources long before the mass realization of global warming.

It was Sy’s ardor for renewable energy that led to our meeting, in the winter of 2005, when Sy was 81. He had seen a video clip of me inveighing against the well-heeled opponents of the Cape Wind project in Nantucket Sound, and he rang me up, suspecting I might be a kindred soul. Little did he know! We quickly bonded over our disdain for self-professed environmentalists who support renewable energy so long as it’s not built nearby. Before long, we realized that our connection ran deeper and included devotion to nature, predilection for straight talk, and love of classical music.

Sy’s life story could fill a book. Yet somehow, his family captured his essence in these 40 words:

Sy had an independent and creative mind; he could make you rethink your position on settled questions. He was a lover of Bach, a walker, and an advocate for the common man. He understood that he was a fortunate man.

Sy relished the beauty in the world while retaining a wry appreciation of life’s absurdities and contradictions. He marveled at modern medical technology, but despaired over its costs and inequities. He was in awe of China’s progress in eradicating chronic poverty, but appalled at its ecological heedlessness. He feared that the world couldn’t stop climate change without building more reactors, but had no qualms in declaring that Fukushima would set back nuclear power for decades. He recognized the need for both congestion pricing and carbon taxes, but was keenly aware of the enormous political difficulty of enacting them.

Sy lived simply and considerately, and he wore old age with grace. He had a little bit of Gandhi in him, though none of the self-righteousness, and some of Mozart’s lightness too. He was sentimental but not soft, cantankerous yet sweet. He had a keen intelligence, a restless mind, and a great heart.

Carbon Tax Offers Super Powers to Super-Committee

09/11/2011 by James Handley

With a $1.5 trillion budget “canyon” to leap across, the new “super-committee” would be wise to summon the special elastic power of a gradually-rising carbon tax.

After prolonged high-wire suspense and partisan brinksmanship, President Obama and Congress agreed in early August to establish the twelve-member “Joint Select Committee on Deficit Reduction” to tackle the budget deficit and the national debt. The “super-committee,” as the JSC was instantly dubbed, comprises six Representatives and six Senators, three chosen by the leadership of each party in each chamber.

The JSC’s mission is to agree on $1.5 trillion in deficit reduction steps to be undertaken over the next decade. These spending cuts or revenue enhancements are to constitute a second installment beyond the $917 billion in cuts agreed to in the bargain to raise the debt ceiling. The JSC is to deliver its recommendations to Congress on Nov. 23, with the House and Senate required to vote the entire package “up or down” a month later. If the JSC cannot agree on deficit reduction steps of the required magnitude, or if Congress fails to adopt them, that will trigger $1.2 trillion of automatic cuts divided equally between domestic and military spending.

To be sure, Washington’s obsession with putting our faltering economy on an austerity diet is deeply troubling to Keynesians, including the Carbon Tax Center. Nevertheless, the fix is in, so let’s examine how a carbon tax could be made part of the debt and deficit solution.

The JSC’s options fall into three categories:

1) More budget cuts, which would contract the economy, compounding unemployment and speeding our descent into another recession,

2) Raising revenue by reforming the tax code, for instance by closing loopholes or reducing tax “expenditures” (i.e., tax exemptions that function as government grants), or

3) Finding new sources of tax revenue.

Given the Herculean dimensions of the super-committee’s task, the JSC may find itself pressing all three buttons. In the revenue category, there’s been some discussion of a “value added tax,” but less about a carbon tax or a Tobin (financial transactions) tax both of which have strong policy advantages.

Last year, William Galston of Brookings and Maya MacGuineas of the Committee for a Responsible Federal Budget included a carbon tax in their report, A Balanced Plan to Stabilize Public Debt and Promote Economic Growth. Also in 2010, Congressional Budget Office founder Alice Rivlin reportedly suggested a carbon tax to both the Simpson-Bowles commission, and the Rivlin-Domenici commission. Unfortunately, her recommendation didn’t make it into either final report, even though well-known economists Gilbert Metcalf and William Nordhaus conveyed the same recommendation to the Simpson-Bowles commission. Now the advent of the JSC with its $1.5 trillion mandate and short deadline has dialed up the pressure to look for revenue sources.

How much would a carbon tax reduce deficits? In May, the deficit-hawkish Peterson Institute hosted a fiscal summit in Washington, at which four out of six leading think tanks, including the conservative American Enterprise Institute, suggested pricing carbon as a way to raise government revenue. AEI recommended a carbon tax starting at $26 per ton and growing by 5.6 % per year after that. According Peterson, the proposal would raise $161 billion per year by 2020, enough to reduce the federal budget deficit by 22% that year. They point out that this is greater than the savings from raising the national retirement age to 70 and would reduce the deficit the same amount as eliminating all foreign aid and federal funding for education.

The Carbon Tax Center’s model shows that a more aggressive carbon tax proposed by Rep. John Larson, rising each year by an average of $12.50 per ton of CO2, would generate about $475 billion of new revenue by the tenth year. This would eliminate around 80% of that year’s CBO-projected deficit while reducing U.S. carbon emissions by 30%. Moreover, the mere expectation of a gradually-rising carbon price will reduce the risks and increase the returns to investors in low- and zero-carbon energy and energy efficiency, as former Federal Reserve economist Alan Blinder pointed out last winter in the Wall Street Journal. In other words, simply enacting a carbon tax – even one with a “grace period” prior to startup – would provide a stimulus to a key technology sector (not to mention one in which the U.S. is falling behind China and Germany).

Aside from the carbon tax rate, what other design criteria need to be weighed for a carbon tax to reduce both deficits and CO2 emissions? Economist Gilbert Metcalf recommends a tax covering not just CO2 but other greenhouse gases: methane, nitrous oxide, fluorinated gases and sulfur hexafluoride. Metcalf, a Tufts University economist now serving the Treasury Department, argues that this more broadly-based tax would achieve much greater emissions reduction, particularly in the early years, by inducing replacement of climate-damaging refrigerants and solvents with more benign substitutes – an easier task than rapidly phasing out fossil fuels.

What about the potentially regressive effects of carbon or GHG taxes on modest-income households? When Chad Stone, chief economist at the Center on Budget and Policy Priorities, analyzed the Waxman-Markey cap-and-trade bill in 2009, he concluded that only 15% of the permit revenues would be needed to compensate households in the bottom 20% of the income range for the price increases induced by carbon pricing. Presumably, this finding holds for a simple carbon tax as well. (The revenue could be distributed in a monthly or even weekly “lump sum” by electronic funds transfer). To build in this protection for the most vulnerable, we should reduce estimates of revenue available for deficit reduction by about 15% to provide funding for low income assistance.

If legislators choose to compensate a larger income range from the effects of a carbon tax, then of course, a greater share of revenue will be needed. But because of the strong upward skew in carbon use over the income range, the revenue needed to compensate lower and even modest income levels is substantially less than their proportion of the population, leaving a large portion available for deficit reduction.

Both the Domenici-Rivlin and the Simpson-Bowles deficit commissions considered a so-called “Value Added Tax.” A VAT is a sales tax applied at every level, which would particularly burden retailers and is likely to be even more regressive than a carbon tax. Europeans routinely refer to the EU’s VAT as a nuisance to business – it must be factored into virtually every business transaction – and punishment of the poor. Moreover, VAT’s have no climate or other social benefits, aside from being a source of revenue. When the energy and climate benefits of a carbon tax are compared to gumming up our economy with a VAT that “sticks” to everything, a carbon tax looks sleek, maybe even sexy.

A carbon tax should also be structured to protect energy-intensive industries in relation to overseas competitors. In their 2009 paper, “Design of a Carbon Tax,” Gilbert Metcalf and David Weisbach articulated a simple structure for harmonizing border tax adjustments that, consistent with the WTO’s prohibition on discriminatory taxes, would apply a carbon-equivalent import duty to energy-intensive commodities such as steel, aluminum, paper, chemicals and cement, along with finished products containing them. If a foreign manufacturer could show that its process is less carbon-intensive than production in the U.S., then its harmonizing carbon tax would be reduced.

Harmonizing taxes would incentivize our trading partners to enact their own carbon taxes – in effect, we would be taxing their carbon-intensive exports for them until they enacted their own carbon taxes. With a rising U.S. carbon price, the incentive for our trading partners to enact carbon taxes would rise as well.

In summary, a rising carbon tax offers the JSC an attractive revenue stream for deficit reduction, obviating the need for more onerous and regressive levies such as Value Added Taxes. Low income households could be protected from disproportionate regressive effects by setting aside 15% of carbon tax revenues. And with WTO-sanctioned border tax adjustments, a carbon tax will not disadvantage U.S. industry and will spur much-needed innovation, investment and job growth in low-carbon energy and efficiency in the U.S. It will also encourage establishment of a global carbon price with commensurate global emissions reductions.

The super-committee will need nothing short of super powers to leap across a $1.5 trillion chasm. A carbon tax can provide the extra “bounce” of a substantial and growing revenue stream along with the clear, predictable price incentives needed for sound climate policy and a healthy and growing clean energy sector.

Photo: Flickr — Chanchanchepon

Why Setting The Social Cost of Carbon Is Like Sound Parenting

08/4/2011 by James Handley

The U.S. may not yet have an actual carbon price, i.e., a carbon tax, but last year, a federal Interagency Working Group set a virtual “social cost of carbon” to be used in governmental cost-benefit analyses policies that affect energy and climate. This official estimate of the social cost of carbon — it was later formalized in a Department of Energy rule — is $21/ton of CO2, a figure that equates to around 20 cents per gallon of gasoline and 9/10 of a cent per kilowatt-hour sold.

You can view the social cost of carbon, or SCC, as an estimate of the “true” climate cost of fossil fuels — the cost of doing nothing about global warming. In economic theory it’s the “optimal” Pigovian carbon price or tax – the levy that would tell decision-makers across the economy how much effort to make to reduce CO2 emissions to minimize economic harm from global warming. If the SCC is set too low, economic actors won’t do enough to avert disaster; if it’s too high, we’ll overreact and suppress otherwise economical uses of fossil fuels.

Determining the appropriate or optimal SCC is a bit like deciding how much to spend on fire insurance — except that in this instance we know that if we do nothing, there’s a “fire” coming; we just don’t have a good handle on how bad it will be or when it will burn out of control. Now, a new, peer-reviewed report, “Revising the Social Cost of Carbon,” by economists Frank Ackerman and Elizabeth Stanton of the E3 Network, argues persuasively that DOE’s rule has set the social cost of carbon far too low.

Ackerman and Stanton identify assumptions about three crucial parameters that led the Working Group to substantially under-estimate the SCC:

1) Climate Sensitivity. This term carries a specific meaning in climate discourse: how much warmer Earth’s climate will get, on average, if CO2 concentrations in the atmosphere double from the historic 270 ppm to 540 ppm. Not long ago, the working consensus among climate scientists was that climate sensitivity (CS) was about 3 degrees Celsius (5 degrees Fahrenheit). But CS has always been expressed in ranges. For example, while the 2007 IPCC Fourth Assessment Report used the 3 degree C figure for CS, it also estimated that there is at least a 1-in-20 chance that doubling the CO2 concentration will cause 7 degrees C of warming, meaning that the Earth’s atmosphere may be more than twice as sensitive to CO2 as is generally assumed.

To get a feel for the magnitude of that much warming, consider that the difference between our climate today and that of the last ice age, when North America was covered by glaciers, is only about 8 degrees C. To the extent that scientists have overlooked important feedback mechanisms that will make the Earth get hotter as CO2 levels rise, CS will need to be revised upward.

2) Damage Severity. How much harm will any given amount of warming cause and how soon? Ackerman and Stanton critique the Working Group estimates which relied heavily on modeling by noted Yale economist William Nordhaus. They found that his damage function is set so low that it predicts half of world economic activity would continue even when Earth’s temperature had risen 19 degrees C!  In contrast, Harvard economist Martin Weitzman estimates that “just” 6 degrees C of warming would wipe out half of world economic activity. For support, Weitzman cites estimates published in the proceedings of the National Academy of Sciences that a global-average 12 degrees C rise would leave large parts of the world experiencing heat episodes at least once a year that no humans could survive. Needless to say, this suggests that Nordhaus is far too sanguine on damage severity, and that the Working Group’s estimate of the social cost of carbon is far too low.

3) Discount Rate. Discounting is the economist’s tool for quantifying the importance of future consequences in present-day decisions. The choice of a high discount rate makes the future seem farther off and represents an implicit assumption that future well-being is less important. A low discount rate weighs the future more heavily.  (To give high-discount rate economists their due, they argue that innovation will allow future society to cope and, indeed, prosper better than supposedly “static” models give credit for.)

If we assume that the future will be prosperous and that humans can adapt to a drastically-altered world, maybe it’s not so bad to lose half of whatever we now value in life to the ravages of global warming. But if the future looks like a long stretch of hard times, or if preserving some semblance of “traditional” nature and society is accorded some intrinsic value, then losing half might really be painful, especially if it means we lose half of our food production.

The Working Group used a relatively high discount rate of 3% in arriving at its SCC of $21/ton. Ackerman and Stanton point to the Stern Review of the Economics of Climate Change which used 1.5%. At bottom, the discount rate is a value judgment, akin to the question of how much to save for your 2-year-old’s education. But like the decision to start saving early, the discount rate affects results later very strongly.

Revised Estimates: Ackerman and Stanton argue that unrealistically low damage assumptions combined with over-discounting cause the official SCC of $21 to be many times too low. Using a range of assumptions from models and assessments that they consider more realistic, they calculate SCC values ranging from $56 to $893. While this range is obviously extremely broad and heavily dependent on assumptions, Ackerman and Stanton also point out that when the social cost of carbon — essentially the present value of the future damage if we do nothing about climate – passes a certain point, standard cost-benefit analysis stops making sense. In that situation, any action we can take to reduce carbon emissions is virtually guaranteed to cost less than the discounted present value of the damage.

Translated into pricing policy, this means that if a carbon tax is meant to internalize the social cost of carbon, it needs to aim high. While there are downsides to setting the carbon tax very high initially, it needs to rise (and be expected to rise) briskly enough to induce as much reduction in CO2 emissions as fast as our economy can deliver.

In short, the message of “Revising the Social Cost of Carbon” sounds like time-honored parental advice: Start modestly, don’t delay, and aim high. Ironically, it’s Generation Hot — to use journalist Mark Hertsgaard’s evocative phrase — who will need to deliver that message to their elders, rather than the reverse.

Photo: Flickr — Betty Bye

The Carbon Tax Revenue Menu

06/10/2011 by James Handley

Getting the politics to align for a carbon tax requires the right blend of honey and vinegar. For years, advocates’ and opponents’ attention alike has focused on the vinegar – the tax part. Lately, though, we’ve noticed growing interest about how to best spread the honey — the potentially huge revenues a carbon tax would generate. Here’s a primer on the options: what they are, how they would work, their merits and drawbacks, and who’s pushing them hardest.

Setting the initial tax rate at $15/T CO2 and increasing it by that amount each year (reflecting the maximum carbon tax rate and ramp-up of Rep. Larson’s bill) we estimate that the Treasury would take in approximately $80 billion in revenue in the first year. (This calculation uses the Carbon Tax Center’s spreadsheet model.) This amount would rise each year, though at slightly less than a linear rate as carbon reductions kicked in, reaching around $600 billion by the tenth year.

The allure of carbon tax revenue also offers a growing incentive for other nations to match a U.S. carbon tax in order to avoid WTO-sanctioned border tax adjustments, capturing the revenue themselves. Indeed, Brookings economist Adele Morris calls a carbon tax a “two-fer” because along with a growing revenue stream would come substantial CO2 emissions reductions. For the U.S., based on historic price-elasticities, CTC’s model projects a 30% reduction in climate-damaging CO2 emissions by the tenth year, compared to 2005 levels.

Six hundred billion (again, that’s the projected take in the tenth year from an ambitious carbon tax) is a lot of revenue, equivalent to around a quarter of federal tax receipts. As Ian Parry and Roberton Williams recently explained in “Moving U.S. Climate Policy Forward: Are Carbon Taxes the Only Good Alternative?” (Resources for the Future), the efficiency advantages of a carbon tax depend on using the revenue wisely. Not surprisingly, there are loads of claimants. Here’s a guide to the most prominent ones, sequenced more or less from the political left to right:

a) “Dividend.” Climate scientist James Hansen contends that to support a steadily-rising CO2 price, the public needs to see the money — every month. He calls his proposal “fee & dividend.” Senators Cantwell (D-WA) and Collins (R-ME) introduced the “CLEAR” bill which uses “price discovery” via a cap to set its carbon tax which would begin at a price between $7 and $21/T CO2, increasing 5.5% each year. CLEAR would return 75% of revenue via direct “dividends” and dedicate the remaining 25% to a fund for transition assistance and reduction of non-CO2 emissions. Rep. Chris Van Hollen (D-MD) also introduced a cap & dividend bill in the Ways & Means Committee. It relies on a cap to set the CO2 price indirectly, aiming for 85% reductions (over 2005 levels) by 2050.  Because of its similar emissions trajectory, we’d expect Van Hollen’s bill to generate similar revenue to Rep. Larson’s bill: roughly $80 billion in the first year, rising to about $600 billion within a decade. Both the CLEAR bill and the Van Hollen bill bear the intellectual and organizing stamp of social entrepreneur Peter Barnes, who founded “Cap & Dividend,” and Peter’s allies including the Chesapeake Climate Action Network.

b) Payroll tax rebate. Rep. John Larson’s “America’s Energy Security Trust Fund Act” pairs a carbon tax with rebates of payroll taxes on earnings. As articulated by Tufts University economist Gilbert Metcalf (now serving at the Treasury Department’s energy office), Larson’s proposal has the appeal of broad fairness. It would distribute revenue very evenly across both income and regions. Because Rep. Larson’s approach rebates payroll taxes via a credit on federal income taxes — it would rebate the payroll tax on the first $3600 of income in the first year, with that threshold and rising over time — it avoids tangling with the Social Security Trust fund.

Economist and former Undersecretary of Commerce Rob Shapiro supports the approach of a payroll tax rebate, arguing that cutting payroll taxes could spur job growth. Social entrepreneur Bill Drayton, founder of “Get America Working,” is also a strong advocate of using carbon revenue to cut payroll taxes in order to stimulate employment while reducing emissions. Al Gore captured the idea with the phrase, “tax what we burn, not what we earn.” Former Rep. Bob Inglis (R-SC) introduced the “raise wages, cut carbon” bill co-sponsored by Rep. Jeff Flake (R-Az). Conservative economists Greg Mankiw and Douglas Holtz-Eakin, both of whom have advised Republican presidents and candidates, have also supported shifting tax burdens from payrolls to carbon emitters. And the Progressive Democrats of America endorsed the Larson bill.

c) Deficit reduction. Brookings economists including Ted Gayer and Adele Morris have been pointing out the potential for climate policy to reduce deficits. While deficit reduction isn’t revenue return in the immediate sense that Dr. Hansen suggests, Morris points out that deficit reduction will benefit future taxpayers by paying down at least part of the nation’s debt, rather than letting it continue accumulating interest. In this way, she suggests, the impulse to help future generations via foresighted climate policy would have a natural fiscal correlative of reducing future tax burdens.

Supporters of applying carbon tax revenues to deficit reduction include MIT’s Michael Greenstone (chair of the Brookings Hamilton Project on climate and energy policy) and Alice Rivlin, founding director of the Congressional Budget Office, who co-chaired the Bipartisan Policy Institute’s alternative to the Obama deficit commission. Prof. Metcalf proposed a carbon tax to the commission, with revenue return as “transition assistance” in the early years, shifting to deficit reduction in later years. As Irwin Stelzer of the conservative Hudson Institute recently pointed out, when the options to close budget gaps sift down to unpopular alternatives such as a value added tax (regressive and annoying, as EU residents will attest) or curbing home mortgage deductions, a carbon tax may emerge with greater appeal. While Keynesians argue that the present weak economy militates against any net increase in taxes, a phased-in allocation of carbon tax revenues to deficit reduction such as Prof. Metcalf proposes may circumvent that objection.

d) Income tax cuts. Greg Mankiw has suggested cutting income taxes as an alternative to payroll tax cuts to return carbon tax revenues; those Form 1040’s could include a carbon rebate drawn from those revenues for every taxpayer. Revenue could be returned via a lump sum credit (which would be income-progressive) or by reducing income tax rates (arguably more stimulative of income-earning activity).

e) Corporate income tax (CIT) rate cut. At a recent AEI event “Whither the Carbon Tax,” AEI economist Kevin Hassett argued for a carbon tax paired with a reduction in the corporate income tax rate. The Wyden-Coates tax reform bill proposes to reduce top CIT rates and make up the revenue by closing numerous exemptions, indicating interest on the Hill. Adherents of CIT rate cuts point to IMF studies saying that U.S. CIT rates are among the world’s highest, asserting that these taxes are especially stifling of business activity and employment. Hassett and his AEI collegue Aparna Mathur argue that CIT’s are passed through as higher prices for consumers and passed back to the factors of production: labor (in the form of reduced wages) and capital (in the form of reduced corporate earnings). They estimate that using carbon tax revenue to cut the effective CIT rate would result in return of about 40% of revenue to wage-earners, which they assert would give the CIT to carbon tax shift a net progressive effect. Their conclusion may be a stretch, given that real wages have remained stagnant or fallen for decades while corporate profits are rising briskly, but a CIT cut has strong salience for conservatives and business leaders.

f) The sampler platter. The options listed above can be mixed and matched. In fact, British Columbia’s carbon tax (which started at $10/t CO2 in 2008 and rises $5/t each year — it notches up to $25 per metric ton on July 1) launched with a distribution of a $100 direct “dividend” to each taxpayer even before the carbon tax was levied, and is now returning revenue via cuts in payroll, income and corporate tax rates. Former BC Premier Gordon Campbell was re-elected to a third term in 2009 after enacting the carbon tax with this mix of revenue return measures, perhaps indicating that a diverse approach to revenue return can have broad and sustained appeal.

Each of the revenue options has important economic and political advantages as well as disadvantages. At the June 1 AEI event, Kevin Hassett decried Senator Cantwell’s direct “dividend” as “terrible policy” because it foregoes the efficiency advantage of using carbon tax revenue to reduce or possibly eliminate other taxes that dampen economic activity. In 2007 Hassett and his AEI colleague Ken Green published an essay aguing for a carbon tax shift as a “no regrets” policy for conservatives, because its tax reform benefits would make it worthwhile even without climate benefits. They pointed to the work of Stanford’s Lawrence Goulder who concludes that the benefit of reducing other distortionary taxes can be large enough to offset some or all of the dampening effect of adding a carbon tax, a phenomenon known as a “double dividend.”

Still, the potential political attractiveness of direct distribution of revenue can hardly be overstated. Dr. Hansen is no politician and doesn’t claim to be an economist, but he sticks to the “dividend” or “green check” while noting that because of its clear and briskly rising price, Rep. Larson’s approach is nevertheless the best climate option on the table. Rep. Van Hollen, outgoing chair of the Democratic Congressional Campaign Committee, certainly knows a thing or two about politics, and Senator Cantwell very effectively made the case for her “cap & dividend” approach last month at Brookings. But even she seems to be looking at other items on the revenue return menu. For the first time, she suggested appropriating some carbon revenue for deficit reduction, confirming that as high summer arrives in Washington, fiscal matters remain the topic for this Congress.

Photo: Flickr.

Brookings Panel Points To “Grand Bargain” – Carbon Tax to Reduce GHG Pollution and Deficit

05/21/2011 by James Handley

Last Wednesday, the Brookings Institution hosted “America’s Energy Future: New Solutions to Fuel Economic Growth and Prosperity.” The first panel, “New Policies for a Cleaner Economy,” featured heavy-hitters: John Deutch (MIT “Institute” professor, former CIA Director…), Joseph Aldy (former Obama assistant on climate & energy), as well as Brookings Senior Fellows Ted Gayer and Michael Greenstone, who moderated.

Greenstone opened by noting how closely-linked energy consumption is to our well-being, but strongly cautioned about very serious un-priced side effects, especially from fossil fuels. Gayer recommended reforming government cost-benefit analysis to focus more on those un-priced externalities, especially since consumer benefits, he noted, are already efficiently priced into markets. Deutch advocated creation of a national energy technology research corporation to harness private sector investment free of a Department of Energy that “is mostly about bombs.” Aldy proposed a technology-neutral “National Clean Electricity Standard” to tax carbon-intense electricity generation and credit low- and zero-carbon electricity,  while providing federal revenue.

Greenstone asked the panel if their proposals wouldn’t be better replaced by a “grand bargain” to provide more of what we like: income, and less of what we dislike: carbon pollution. “[T]he giant prize standing in front of us is the realization that one could raise revenue instead of raising income taxes… through a carbon tax or some kind of carbon charge.” Aldy enthusiastically agreed, claiming “evidence of bipartisan support” and pointing out that he and Brookings economist Adele Morris proposed a carbon tax to the Obama deficit commission.

Deutch chimed in, “I couldn’t agree more with a proposal to do a comprehensive greenhouse gas tax. It depends, of course, on how it’s designed… and how you allocate the revenue. So if you put onto a tax proposal like you say a revenue proposal, then you have at least some chance of selling it.” Deutch urged return of some revenue to taxpayers as “walking around money.” “We’ve got to get the legislation passed,” he concluded.

Would a Methane Tax Make Natural Gas a Green-Enough “Bridge” Fuel?

05/20/2011 by James Handley

(co-authored with Charles Komanoff)

From a climate standpoint, natural gas appears to have two huge advantages over coal. First, gas combustion releases 40% less carbon dioxide per Btu produced than does coal. Second, gas-fired power plants using “combined cycle technology” require 40% fewer Btu’s to produce each kilowatt-hour than coal-fired plants. Chain those advantages, and you find that new gas-fired power plants can produce 2.7 – 2.8 times as much electricity as a typical coal-fired generator while emitting the same CO2. No wonder gas is touted as a “bridge fuel” to renewables from coal, which accounts for 45% of U.S. electricity generation and a third of U.S. carbon dioxide emissions.

Of late, however, scrutiny of “fugitive” emissions from gas extraction and transmission is calling into question the assumption that gas is more benign for Earth’s climate than coal. The new wrinkle isn’t CO2 but methane itself, a potent greenhouse gas in its own right which can escape into the atmosphere at almost every step of the natural gas “fuel cycle.”

Natural gas (or simply “gas”) is 99% methane (CH4). Viewed over a 100-year time horizon (as the 2008 IPCC Fourth Assessment report did), methane’s greenhouse potency — its heat-trapping capacity, per pound of gas in the atmosphere — is roughly 25 times that of CO2. And if a 20-year timeframe is used, the greenhouse potency of a pound of methane becomes 72 times that of a pound of carbon dioxide. (The difference between the ratios arises because methane in the atmosphere breaks down about ten times as fast as CO2 — roughly a decade on average vs. a century for CO2.)

What’s bringing the issue of fugitive methane emissions to a boil is “hydrofracking” (or “fracking”). A highly invasive drilling process that releases gas by subjecting underground shale rock to hydraulic fracturing, fracking is being touted as a global-energy game changer. (“How Shale Gas Is Going To Rock The World” was the title of a May 2010 Wall Street Journal “special report.”)  But fracking is also an emerging source of massive air, soil and water pollution in states such as Pennsylvania that are the epicenter of the fracking boom.

In a recently-published peer-reviewed article, Prof. Robert Howarth and colleagues at Cornell University calculated methane releases from fracking and combined them with EPA data on gas pipeline leak rates to estimate methane losses across the gas fuel cycle. Their findings are sobering.  For every 100 cubic feet (the standard volume measurement) of natural gas “gathered” at the well and transferred to the transmission system:

• 0.6 – 3.2 cubic feet are released to the atmosphere in the frack drilling process, and
• 1.4 – 3.6 cubic feet of gas leaks into the atmosphere from the distribution system.

(EPA is expected to revise these estimates upward in view of more complete reporting showing greater leak rates, according to Howarth.)

Howarth et al. caution that their figures are based on very limited data, and are calling for further study. Nevertheless, their preliminary conclusion is that due to fugitive emissions in both the fracking process and gas pipelines, frack gas is causing as much global warming and climate change, per unit of energy output, as is coal. While that result is calculated for a 20-year timeframe, which understates the overall impact of carbon dioxide and, therefore, of coal, even over a 100-year timeframe fugitive emissions appear to take a huge bite out of any climate advantages that might otherwise be ascribed to natural gas.

It’s important to note that the Howarth analysis doesn’t take into account the second of the two “40% advantages” that we noted at the beginning of this post — the one reflecting the greater electric-generation efficiency of combined cycle gas turbines over conventional coal-fired steam turbines. This omission is significant in light of the fact that this efficiency edge has made combined cycle technology the overwhelming choice for recently-completed and proposed new gas-fired power plants. But regardless of the exact quantitative comparison between coal and frack gas, Howarth et al. are focusing much-needed attention on what now appears to have been the even starker omission (by most analysts) of substantial fugitive methane emissions in the natural gas fuel cycle.

Furthermore, as a frack gas drilling boom sweeps over the Marcellus Shale region of southwestern New York and huge swaths of Pennsylvania and West Virginia, residents are learning the hard way that fracking leaves vast amounts of dangerous chemicals in groundwater while also dumping polluted water, some of it radioactive, into rivers and streams. Congress is barely beginning to consider measures to close loopholes that exempt fracking from the Safe Drinking Water Act and the Clean Air Act, and these defensive initiatives are far behind the “NAT GAS” bill pushed by billionaire hydrocarbon mogul T. Boone Pickens to jumpstart a huge market for natural gas vehicles by subsidizing conversion of fleet vehicles and heavy trucks to gas.

Is there a way to legislate a clampdown on fugitive emissions of methane? Regulation requiring capture of gas, especially during the flow-back phase of gas drilling, should certainly be considered. But economic incentives are also worth a close look. Several carbon tax proposals would tax other greenhouse gases, including methane because, after CO2, it’s the top greenhouse gas driving Earth’s climate into instability. If, as Howarth and his colleagues have documented, fugitive methane emissions are a serious threat to Earth’s climate, could a tax on those methane emissions at their CO2-equivalent price correct the apparent market failure that leaves drillers willing to vent valuable and very climate-damaging methane?

We think so. Because methane is (at least) 25 times as potent a greenhouse gas as CO2, let’s consider a fugitive methane tax of 25 times the carbon tax rate, to reflect that potency. We calculate that a tax of $25 per ton of CO2 — to pick a modest, but not insignificant level — would imply a tax on fugitive gas of $13 per thousand cubic feet.* Since natural gas currently sells in wholesale markets for around $4 per thousand cubic feet (down from as much as $12 before the onset of the financial crisis), this tax would more than quadruple the incentive to capture methane provided by its current market price. That would appear to be a lot of leverage to capture fugitive methane, even from a fee pegged to a relatively modest carbon tax.

Howarth et al. report a huge range of fugitive methane emissions over the life of different frack wells — from a low of 140,000 cu ft to a high of 6,800,000.  At $13 / 1000 cu ft, the tax on those fugitive emissions would range from only around $60,000 per well to as much as several million dollars. (This enormous range is partly an artifact of the limited data available to Howarth.) While the low end is just peanuts to frack drillers, the high end is a significant fraction of the $2 to $10 million cost to drill a well.  It seems reasonable to expect that this tax, along with the market price of gas and the expectation of a rising CO2 (and equivalent fugitive gas) charge, would encourage deployment of equipment to capture, compress and store gas, at least at larger wells.

As both Howarth et al. and a recent report by the Post Carbon Institute point out, gas pipelines generally aren’t built and connected until wells are completed. Thus, well drillers who aren’t typically in the business of selling gas (and may not even own the rights to it) may not have ready access to gas pipelines and markets. This “split incentive,” along with the rush to establish and maintain drilling rights before leases expire, may help explain the reckless, wasteful discharge of climate-damaging methane into the atmosphere from frack wells. But gas can be compressed and transported by truck, so we’d expect that the price incentives of a rising greenhouse gas tax on fugitive methane would push well drillers to find ways to capture more of their emissions. Similarly, a substantial price signal should induce pipeline companies to repair and monitor leaking distribution systems. In this way, more of the lifecycle combustion advantages of natural gas as a true transition fuel could be realized.

As for fracking’s often-horrific “other” emissions: tough and comprehensive regulations are sorely needed. Congress should start with the “FRAC Act” H.R. 1084/S. 587 introduced by Rep. DeGette (D-CO) and Sen. Casey (D-PA), which would eliminate fracking’s exemption from the Safe Drinking Water Act; and the “BREATHE Act,” H.R. 1204 by Rep. Polis (D-CO.), which would bring fracking under the Clean Air Act.

* Authors’ calculation:

A $25/ton CO2 tax x 25x GHG potential  = $625/ton CH4.

$625/2000 lb x 44 lb/1000 cu ft  x  1000 cu ft/ 1.02 MM Btu = $13.5 /MM Btu

Flickr Photo:  Frack Well in Dimock, PA.  Brandi Lynn.

What’s the matter with elasticities? (Answer: maybe nothing)

05/1/2011 by Charles Komanoff

(This piece was originally posted to Grist on April 29, 2011.)

Price-elasticities — dimensionless parameters that express the extent to which a price increase triggers a usage decrease — are central to policies that aim to reduce a harmful activity by internalizing its damage into its price. The efficacy of carbon fees, congestion tolls, cigarette taxes, and the like turns on the proposition that the toll or tax will dampen consumption by more than a token amount.

If the price-elasticity is close to zero, then the fee devolves to a revenue-raiser that will never fulfill the purpose of reducing the harm. But if there’s at least a modicum of underlying price-responsiveness, then internalizing damage costs via a fee or tax can be a powerful and efficient way of combating pollution, while also raising revenue that can be invested and/or distributed to forestall regressive impacts on lower-income households.

As someone with a long-time orientation toward price incentives and cost internalization, particularly for major sources of environmental damage such as energy use and driving, I’ve made it my business to keep on top of the literature on price-elasticity. Several years ago, in the course of assembling a monster spreadsheet for modeling congestion pricing in New York City, I spent months combing empirical studies of driver responsiveness to changes in tolls, gas prices, and parking charges. Ditto to develop the Carbon Tax Center’s carbon-tax impact model, which subdivides energy use into four sectors — electricity, gasoline, aviation, and “other” — with different estimates of price-elasticity for each.

With this backdrop, consider the strange post this week by The Atlantic business and economics editor Megan McArdle.

McArdle’s piece, “Should We Re-Evaluate Carbon Taxes?,” began well enough:

I’ve long been an advocate of some form of carbon taxation — gas tax, source fuels tax, even cap-and-trade if nothing else is available. The tax seems like a three-fer: raise revenue, discourage use, and encourage innovation.

McArdle has indeed been a staunch carbon tax advocate. Back in 2007, in “The perils of buy local,” she noted the absurdity of making individuals track the carbon footprints of local vs. global food, and concluded:

[I]f we’re serious about cutting carbon dioxide emissions, we need a carbon tax, and not CAFE, or other sorts of piecemeal regulatory solutions.

While I wouldn’t have cast it as either/or, McArdle’s emphasis on a carbon tax is exactly right.

But McArdle’s new piece quickly leaves the rails:

Jim Manzi has been making a pretty compelling argument that [a carbon] tax will do much less than people like me have been anticipating. Even the long-term response to price increases is simply too low.

This is weird. For Manzi’s “compelling argument” turns out to be nothing of the sort. Rather than a considered examination of the vast body of studies of energy elasticities, Manzi’s “argument” is a lone table cherry-picked from the International Monetary Fund’s (IMF) new (April 2011) 242-page World Economic Outlook [PDF]. And lifted from the IMF not by Manzi himself but by Mother Jones political blogger Kevin Drum, in a post last Friday, “Everyone Loves Oil,” which in turn was built around a post the same day by peak-oil blogger Stuart Staniford.

OK, no crime in linking to someone else who linked to someone else who linked to someone else. For the goods, let’s go to the IMF table posted by Staniford, Drum, Manzi, and McArdle:

Hmm, looks like an elasticity-killer — on a quick glance. Over the period 1990-2009, the long-term price elasticity of oil demand shown for OECD countries — developed nations like the U.S., Western Europe, and Japan — is a meager 0.093. At that rate, a 40 percent rise in the price of oil would drop consumption by only 3 percent — a paltry impact, and far too small to justify putting a carbon tax at the center of climate policy.

But wait. The actual change in U.S. gasoline consumption over the past two decades tells quite a different story:

• From 1990 to 2010, the real pump price rose 40 percent (I’ve removed general inflation of 67 percent from the 133 percent nominal price rise from $1.22 to $2.84 per gallon; elasticities are calculated on real, not nominal, price changes).
• U.S. gasoline consumption grew by 25 percent over this period, from 7,235,000 to 9,034,000 million barrels a day.
• Real GDP grew by 65 percent.
• Let’s assume that, all things equal, each percent increase in economic activity is accompanied by a half-percent increase in gasoline use (i.e., an income-elasticity of 0.5). This mid-range assumption is more conservative than the 0.67 income-elasticity I’ve assumed for years.

With these inputs, the observed price-elasticity of U.S. gasoline demand over the past 20 years is around 0.20. The simplest way to see this is to observe that, absent price effects, the increase in gasoline usage would have been half of the GDP rise of 65 percent, or 32.5 percent. The actual increase, however, was 25 percent. Dividing the demand “shortfall” of 7.5 percent by the 40 percent real price increase yields an elasticity of around 0.20. (The true elasticity derived from these numbers is (negative) 0.23, since that’s the exponent to which 1.4, the price multiple, must be raised to yield 0.925, the quantity multiple (1 minus 7.5 percent).) That’s twice the long-term elasticity for OECD countries in the IMF table that McArdle et al. relied on.

But this correction to a 0.20 gasoline price-elasticity estimate is just for starters. As everyone knows, the long-term rise in gasoline prices has been more fluctuating than monotonic. Over the past eight years, the month-to-month price has fallen 43 percent of the time [see the "Volatility Graph" tab in this spreadsheet], obscuring the overall upward trend and giving drivers, car-makers and regulators alike a recurring “out” from the task of adapting to higher prices. Thus, the rough gasoline price-elasticity figure of 0.20 almost certainly understates the reductions in gasoline demand that a ramped-up, phased-in carbon tax, with its unambiguous price signal, could deliver.

To its credit, the IMF acknowledges this, in its Technical Appendix that McArdle et al. evidently overlooked:

To examine whether high oil prices are more conducive to substitution away from oil than low oil prices, we split the sample into periods of high and low oil prices … The results (Table 3.4) suggest that during periods of low oil prices, price elasticity is not statistically different from zero … In contrast, during periods of high oil prices, price elasticity is much higher, at 0.38. [p. 132/242. Note also that the figure of (negative) 0.038 in Table 3.4 is a typo; according to an IMF staffer I contacted, the intended figure, matching the text, is 0.38.]

As it happens, 0.38 roughly matches the 0.40 price-elasticity figure I inputted into my carbon-tax impact model. It’s also essentially the estimate of the long-run U.S. gasoline price-elasticity that the Congressional Budget Office proffered in its 2008 report, “Effects of Gasoline Prices on Driving Behavior and Vehicle Markets” [PDF]:

Estimates of the long-run elasticity of demand for gasoline indicate that a sustained increase of 10 percent in price eventually would reduce gasoline consumption by about 4 percent. That effect is as much as seven times larger than the estimated short-run response, but it would not be fully realized unless prices remained high long enough for the entire stock of passenger vehicles to be replaced by new vehicles purchased under the effect of higher gasoline prices-or about 15 years. Over that time, consumers also might adjust to higher gasoline prices by moving or by changing jobs to reduce their commutes-actions they might take if the savings in transportation costs were sufficiently compelling. Those long-term effects would be in addition to consumption savings from short-run behavioral adjustments attributable to higher fuel prices. (p. XI)

It’s also helpful to keep in mind that gasoline is both a minority factor in CO2 emissions (21-22 percent of the U.S. total) and the least-elastic large consuming sector. Gasoline demand is considered less price-sensitive than aviation, for which fuel accounts for a larger fraction of the overall cost than it does for driving; less price-sensitive than electricity, for which efficiency upgrades and behavioral changes provide rich opportunities for conservation; and probably less price-sensitive than home heating, manufacturing, trucking, etc., which my model subsumes under the rubric of “other.” The model assumes price-elasticities of (negative) 0.70 for electricity, 0.60 for aviation, and 0.50 for other, along with 0.40 for gasoline.

To see what these numbers mean, let’s select the (negative) 0.50 elasticity for “other”: A carbon tax that raised the price of heating oil, manufacturing fuels, etc. by 50 percent would be expected to reduce usage by 18-19 percent, since the assumed price multiple of 1.5 (that’s 1 + 50 percent) raised to the negative 0.50 power (that’s the elasticity) is 0.816, which is one minus 18.4 percent. As the carbon tax kept kicking in, a doubled price would reduce usage by nearly 30 percent, since 2 (reflecting the doubled price) to the negative 0.50 power is 0.707. Now we’re getting somewhere.

So McArdle, take heart. And Manzi, Drum, and Staniford, take note: There’s nothing wrong with price-elasticities, and little that a robust carbon tax couldn’t do, in conjunction with smart policies to remove institutional barriers to efficiency and renewable. Stop kvetching, and get on board.

Postscript: As I was posting this piece, my Carbon Tax Center colleague James Handley directed me to an April 27 post by Adam Ozimek, “Of carbon taxes and price elasticities“, that makes many of the points offered here … and more elegantly.