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A Carbon Tax Beats Automatic Austerity

Austerity is dead — the victim of its 2010-2012 failure in the Eurozone. At last week’s G-8 summit at Camp David, leaders called for growth, not austerity. Even German Chancellor Angela Merkel, the iron lady of austerity, conceded that the crisis in Greece would require stimulus. A week earlier, IMF Director Christine Lagarde called for growth-oriented policies. And on May 6, the French elected socialist Francois Hollande, rejecting the austerity policies of his predecessor, Nicolas Sarkozy.

French Voters Gave Austerity the Boot on May 6

So what will austerity’s demise do to the case for a U.S. carbon tax, given that new taxes, or tax hikes in any form, are one of the two pillars of austerity? (The other, of course, is governmental spending cuts.) The answer to that question depends on the alternatives and the uses of the carbon tax revenues, but the key points are these: first, a carbon tax is almost certain to be better for economic growth than draconian spending cuts or higher taxes on incomes or wages; second, if its revenues are used to reduce other taxes or are spent in ways that spur employment, the net effect of a carbon tax can be stimulative.

Ironically, while there is now, finally, broad consensus that austerity in Europe has stunted its economic growth, the fragile U.S. recovery faces a ticking time bomb of automatic austerity, set to go off on January 1. Unless Congress acts, the deficit ceiling legislation enacted in 2011 will “sequester” $1.2 trillion of automatic across-the-board cuts on military and domestic spending. At exactly the same time, the Bush tax cuts are set to expire, which will raise the effective federal tax rate from about 16% of GDP to the Clinton-era 20% level. Last but not least, the payroll tax holiday is set to expire on Jan. 1 as well.

The alternatives to letting those time bombs explode are (i) repeal the “sequester” and extend the Bush tax cuts and the payroll tax holiday (leading to even larger deficits), or (ii) increase revenue by broadening the tax base. In 2010, two bipartisan deficit commissions, “Simpson-Bowles” (officially the National Commission on Fiscal Responsibility and Reform) and Rivlin-Domenici, recommended sweeping tax and entitlement reform. Rivlin-Domenici went further, urging broadening of the tax base by imposing a European style Value Added Tax. A VAT, of course, is a regressive sales tax (levied on virtually all consumer purchases) that can suck up revenue like almost nothing else. But it is so broadly based that it offers little environmental benefit. Other revenue options include worthy but politically-loaded proposals like repealing or limiting the home mortgage deduction.

Where does this leave a carbon tax? In our view, a tax on carbon emissions that starts low or even at zero, with a built-in ramp up over time (as recommended by former Fed Vice-Chair Alan Blinder), is an attractive alternative to pretty much everything on the standard menu — a VAT, higher income taxes or draconian spending cuts. A gradually-rising carbon tax would also yield gradually increasing revenues, helping to close the deficit while working better (at lower cost and more broadly) than any other policy to reduce global warming pollution. One particularly stimulative way to use carbon tax revenue would be to fund and expand the payroll tax holiday, a stimulus measure enacted in 2010 that increased employee paychecks by up to $2,000, but which is set to expire at the end of this year.

Economic analysts of virtually every stripe agree that unparalleled uncertainty about the strength of the recovery is helping to hold back investment and growth. Beyond the general lack of confidence, the energy sector faces additional regulatory and price uncertainty. A clear, upward price trajectory on carbon pollution would give entrepreneurs and investors in efficiency and renewables something to bank on. Without that predictable price signal, renewables will continue to face the prospect of “feast or famine” depending on Congressionally-enacted subsidies or the even more volatile price instability of cap-and-trade systems. And if a carbon tax helps avert an automatic “sequester” triggering draconian cuts in social programs, the result will be enormously better for low and moderate-income households that depend on the safety net.

The fact is that none of the options for avoiding a “fiscal cliff” on Jan. 1, 2013 are pretty. In that context, the dependably-growing revenue stream along with the vast climate benefits of a predictably-rising carbon tax make it a potential winner.

Photo: Flickr — Passarello Luna


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Game Over for Keystone XL? Backing Up Hansen’s Oil Savings from a Carbon Tax

“Game Over for the Climate,” Dr. James Hansen’s powerful op-ed in yesterday’s New York Times, adds a compelling new argument to the case for ditching the Keystone XL pipeline:

We should impose a gradually rising carbon fee, collected from fossil fuel companies … [T]he reduction in oil use resulting from the carbon price would be nearly six times as great as the oil supply from the proposed pipeline from Canada, rendering the pipeline superfluous, according to economic models driven by a slowly rising carbon price. (Emphasis added.)

Please be assured that Dr. Hansen’s “nearly six times” assertion is oil vs. oil, so that the substantial reductions in coal use are additional. His figure drew on modeling by the Carbon Tax Center, as I detail below.

The pipeline

The Keystone XL pipeline is primarily intended to carry crude oil refined from Alberta tar sands to various refineries in the U.S. Some crude would enter in Montana and Oklahoma as well, according to Wikipedia. Given the pipeline’s multiple entry and exit points, there may not be a definitive figure for the incremental tar sand crude it will deliver. Dr. Hansen’s figure is 830,000 barrels a day. Friends of the Earth, which is helping spearhead resistance to the pipeline, says “The Keystone XL pipeline would carry 900,000 barrels of dirty tar sands oil into the United States daily,” or 8-9% more than Hansen’s figure.

The carbon fee

As the graphic suggests, our modeling indicates that the oil savings in goods movement alone propelled by a carbon tax would be comparable to the oil delivered to this country by Keystone XL. And that’s just in the tax’s tenth year; the savings would grow further as the tax continued to ramp up, in contrast to Keystone’s maxed-out and eventually declining oil supply. Savings in each of the two top oil-consuming categories ― personal ground travel (mostly autos and light trucks, of course, but also recreational toys such as off-road vehicles and powerboats) ― and the catch-all “Other” (petroleum used in heating, construction, industry, agriculture, and oil refining itself) would be roughly double Keystone’s supply. All told, U.S. consumption of petroleum products in the tenth year of a carbon tax would be nearly 5 million barrels per day less than the business-as-usual projection, a reduction of 24%.

These savings assume the carbon tax devised by Rep. John B. Larson (D-CT) in 2009 and embodied in legislation he introduced in the House. That’s the carbon tax (or “fee,” to use the term Dr. Hansen prefers) that Jim assumed in his op-ed. It kicks off with a first-year level of $15/ton of carbon dioxide and rises at $10-$15/ton per year (we assume $12.50 in our modeling), reaching $127.50/ton of CO2 in its tenth year.

To be sure, Rep. Larson’s carbon tax proposal is an “aggressive” one. A carbon tax that gradually but steadily — unlike the violent gasoline price swings delivered by “the market” — raised prices of gasoline and other petroleum products by 10-12 cents a gallon each year would cut deeply into petroleum usage by driving consumers and businesses to make different (and more efficient) choices on both the demand and supply sides. And the tax would simultaneously reduce coal-burning for electricity generation — the source of one-third of all U.S. CO2 emissions from fossil fuel combustion until very recently — even more, because alternatives and low-cost opportunities for efficiency in that sector are even more abundant.

Here are some of the multitude of ways in which a predictably and steadily rising price for petroleum products would engender reductions in their provision and use:

  • Purchasing and preferential use of more-efficient vehicles by individuals, businesses, fleets
  • Spurring innovation to manufacture more-efficient cars, trucks, aircraft, etc., by optimizing vehicle shapes, materials, engine designs, controls, components, etc.
  • Substitution of proximity for distance in location decisions by families, businesses, institutions
  • Acceleration of recent trends away from suburbs and exurbs and toward urban centers
  • Prioritization of local sourcing over trans-national or global supply chains
  • Reductions in use of recreational motorized vehicles
  • Increased provision and use of “active transportation” (cycling and walking) and public transit, with corresponding decreases in driving
  • Logistical innovations in the trucking industry to increase load factors and miles per gallon
  • Greater car-sharing via price incentives and real-time apps that pair drivers and riders
  • Greater efficiencies in the food sector, including more-efficient irrigation and agricultural vehicles and/or their displacement by less energy-intensive farming methods
  • Upgrading and maintaining building envelopes and heating systems in oil-fired homes, offices and factories
  • Substitution of biofuels, electricity, natural gas, and/or hydrogen for petroleum products

While no econometric model can precisely predict the uptake of each of these measures, economists have combed empirical evidence for decades to infer sector-wide price-elasticities. (“Elasticity” is simply a measure of how much economic actors respond to price changes.) In our modeling of gasoline usage, we assume a 0.4 long-run price elasticity and a decarbonization rate of 1% for each $10/ton attached to CO2 emissions. For the various petroleum products that make up the “Other” category, we assume a slightly greater price-elasticity, 0.5, and the same decarbonization rate as for gasoline. (See further discussion on the Carbon Tax Center’s Web site, here.) The model also builds in lags to reflect lead times needed to adapt to the rising prices (note that legislating a steady ramp-up of the carbon tax would help compress the lags, since carbon-critical decisions could be made with an eye toward future prices rather than just last month’s).

Readers with an analytical bent may want to download the Carbon Tax Center’s carbon tax spreadsheet model. (Note that the link can also be found near the top of our home page, in the second-bulleted paragraph in the light yellow block of text.) With the model in hand, you may alter the carbon tax’s starting amount and the increase rate in the Summary page of the model, if you wish. On the Graph_CO2 page, the model plots emissions reductions compared to “business as usual,” giving an easily understood representation of the extent to which CO2 emissions would decline over time in response to the chosen carbon tax and rate of increase.

The section on “Annual Oil Requirements” begins at Row 173 of the Summary page. The tenth-year savings are shown in Column Y, corresponding to 2021, which would have been the tenth year of the Larson carbon tax, had it been enacted in 2010 or 2011 with startup in 2012.

The model, while skeletal in some ways, is intended to allow analysts and advocates to gauge the approximate impacts of different carbon-price designs on emissions, revenue, petroleum and other key parameters. We’re proud that Dr. Hansen relied on it in his Times op-ed, and we’re glad he continues to point to the enormous benefits of a steadily-rising carbon fee.


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