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.

Filed under Carbon Tax

11 Comments »

  1. well said!

    Comment by Emily — November 8, 2011 @ 2:59 pm

  2. [...] James Handley – Carbon Tax Center [...]

    Pingback by Daily Forecast: Today’s Online Buzz on Environmental Issues « Climate Task Force — November 9, 2011 @ 12:36 pm

  3. Bravo and Amen! If we can frame the climate change debate in terms of national security and/ or deficit reduction, I absolutely believe that we can “sway” those resistant to environmental arguments. For my money, a carbon tax is already vocally supported by a majority of leading economists, scientists and opinion leaders and, I believe, would be supported by a well-educated electorate as well. Moreover, the revenues from this approach can be recycled in tax relief for American families, making it politically attractive to members on both sides of the aisle. I certainly hope that Congress pays attention and at least includes a carbon tax in the discussion.

    Comment by climatetf — November 10, 2011 @ 3:43 pm

  4. Once again a very well thought out and sound path for carbon usage into the immediate future.

    Today’s reality being: The forces allied against any sane approach to an effective energy policy OPEC, Wall Street, The Coal Lobby, The Fracking fools, and the nuclear crowd, have all the $$$$$ and clout to stall and corrupt any meaningful change.

    The Solution is simple vote these known fossil/extractive influences out of Congress.

    Then extract a pledge from all political parties in the USA to:

    Campaign finance reform, strict penalties [ loss of office ] for accepting any perk from K Street. { Will never happen unless, We the People, come out in the streets as we are witnessing today by the Occupy Movements}

    Obama has no chance of stemming the forces arrayed against him. Dr. Chu et all are still convinced cap and trade is the only way to harness the beast. He and Obama are dead wrong on this approach. We must push for Cap, Tax, and NO Trade… M O B I L I Z E…

    Comment by jack bradin — November 19, 2011 @ 2:47 pm

  5. hi Jack,

    Thanks for your reply and passion. Yes, two pernicious dogmas: corporate “personhood” and the fiction that campaign money is protected “speech” top my list of targets for reform.

    But the forces arrayed against “truth in pricing” of fossil fuels don’t strike me as monolithic or even well-organized. Gimmicky cap/trade/offset isn’t dead, but seems seriously wounded. Last week, Entergy’s CEO endorsed a carbon tax while accepting an award from former(?) cap advocate National Wildlife Federation. Pew Climate Center (a USCAP founder) lost its Pew funding; director Elaine Claussen uttered “carbon tax” without her previous dismissive sneers.

    For better or worse, a carbon tax would help the gas and nuclear industries compete against coal, so I don’t count them as adversaries in the carbon tax fight. (And given the tremendous potential for gas to displace coal, substantially reducing the CO2 emissions of electricity generation, I’m not convinced that fracking is always an unalloyed evil: we haven’t even tried to regulate and clean it up.)

    The deficit reduction effort, while poorly-timed during “the great recession,” offers an opportunity for reform focusing on pollution taxes instead of taxes on work and other productive activity.

    In short, I sense an unsettled, even chaotic situation, potentially ripe for the climate movement to find common cause with tax reform advocates to enact a carbon tax. But as Adele Morris pointed out, the climate movement needs to shake off the hangover of cap/trade/offset and engage.

    Comment by James Handley — November 19, 2011 @ 4:34 pm

  6. Mr Handley:

    The present confusion and gridlock in government, particularly in the legislative branch of the Federal Government, might indeed augur for progress. Confusion, turbulence, no clear sense of purpose or direction might well provide an opening. In Spanish we have a saying, «Aguas revueltas, cosecha del pescador» which is similar to our Deep South proverb, «Troubled waters bring good fishing». Interestingly, there is a slight pejorative undertone in the latter, an implication that the fisherman is not pursuing noble objectives, so let’s go with the former.

    In the subject blog essay, Dr Morris gives a quick but pretty inclusive overview of why we should have a properly implemented Carbon Tax. (Nothing new to anybody who has been following this blog for very long, but it is great to hear another good voice.)

    But the Carbon Tax has support from folks on the political right as well as the political left, from supporters and opponents of nuclear power, from Peak Oilers and even a few Cornucopias, among others. There might be some well-reasoned arguments against the Carbon Tax, but at this time, after much reading, I am quite unaware of any whatsoever. So why is there resistance?

    I suspect the opposition comes from those with intelligence aplenty who have other interests than the general wellbeing, let alone the climate wellbeing: they recognize the Carbon Tax as a danger to their current accustomed wealth and comfort, to which they feel entitled. Along with their yakuzas. The very potential of the Carbon Tax is why they oppose it. They are the ones who have been stirring up and muddying the waters. Who else could it be? Trouble is, I have not the slightest idea as to prevail.

    Comment by David F Collins — November 20, 2011 @ 11:02 pm

  7. hi David,

    The opportunity: Deficit reduction and tax reform. The Joint Select Committee is only the beginning… lots more needed.

    Our response: Let Congress know you support a carbon tax because of its climate and fiscal benefits. Tell Republicans that you prefer a tax on CO2 pollution to taxes on desired activity, including work. Tell Democrats that a gradually-rising carbon tax can do more to slow global warming than regulations or subsidies.

    Comment by James Handley — November 21, 2011 @ 11:57 am

  8. This is a wonderful post. Thanks so much for putting up the text from Adele Morris’s speech. The material is useful not only for seeking to embed a carbon tax in broader tax reform, but also for crafting a stand-alone measure.

    Consider, for example a $12 carbon tax with 1/3 of the revenue used for dividends, to shield the poor and middle class, and 2/3 used to cut the corporate income tax to 25%. According to Ms. Morris, the dividends, though perhaps necessary politically, would be a slight net drag on the economy. But cutting highly-distortionary corporate income taxes should more than offset this drag.

    Greg Mankiw has recently written that reducing the corporate tax would be one of the most important steps we could take to boost the economy:

    “What can policy makers do to stoke animal spirits and encourage businesses to invest?

    “One obvious step would be a cut in the taxation of income from corporate capital. According to a 2008 study by the [OECD], ‘Corporate taxes are found to be most harmful for growth.’ Tax reform that reduced the burden on capital income and shifted it toward consumption would improve prospects for long-term growth and, in so doing, encourage greater investment today.” “How to Make Business Want to Invest Again”, NYT, Sep. 10, 2011.

    A carbon tax combined with a cut in the corporate tax would give both Democrats and Republicans something very significant.

    Comment by Huon — December 5, 2011 @ 6:36 pm

  9. Paul Krugman wrote an op-ed for the New York Times of November 27, 2011 entitled “Things to Tax”. He included several measures that would individually raise less than the $100 billion per year we could raise from a $20 per tonne carbon dioxide fee.

    Krugman didn’t have anything at all to say about pollution taxes in general, or carbon taxes in particular. The problem in getting a carbon tax approved may lie partially with lack of support from the environmental community; but there are still some influential economists to bring onboard.

    Comment by Daniel Jones — December 17, 2011 @ 10:57 pm

  10. hi Daniel,

    I share your frustration that more policymakers aren’t embracing the double advantages of pollution taxes in our current budget debate. (But as evidenced by our “scientists & economists” and “conservatives” pages, I’d say that economists of practically all stripes are very supportive.) Both the Simpson-Bowles and the Rivlin-Domenici commissions last year recommended a European-style “Value Added Tax,” apparently overlooking the environmental and efficiency benefits of a carbon tax.

    Last July, Krugman did make the case for carbon taxes. He wrote that, “given the right incentives — namely, putting a price on emissions, through either a tax or a tradable permit scheme — the economy will find lots of ways to emit less… [O]nce we get to the point where a carbon price makes [renewables] commercially viable, there’s every reason to expect huge improvement over time through, yes, the magic of the marketplace.”

    Comment by James Handley — December 18, 2011 @ 5:55 pm

  11. Making the carbon tax argument is easy intellectually and tricky politically. I know, I have been a long time advocate. It would have saved us billion’s of $ in our war efforts! And thousands of lives. Kevin Chisholm, candidate for U.S. Senate (I), Virginia

    Comment by Kevin Chisholm — February 14, 2012 @ 8:34 am

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