What’s A Carbon Tax?

A carbon tax is a tax on the carbon content of fuels — effectively a tax on the carbon dioxide emissions from burning fossil fuels. Thus, carbon tax is shorthand for carbon dioxide tax or CO2 tax.

Carbon and hydrogen atoms are the essence of every fossil fuel — coal, oil and gas.  The bond between carbon and hydrogen atoms is the primary source of the heat released in fuel combustion. In efficient combustion, all carbon atoms are converted to CO2. Carbon dioxide, an otherwise non-lethal and innocuous gas, rises in the atmosphere and remains resident there, trapping heat re-radiated from Earth’s surface and causing global warming and other harmful climate change. In contrast, non-combustion energy sources — wind, sunlight, falling water, atomic fission — do not convert carbon to carbon dioxide. Accordingly, a carbon tax (or CO2 tax) is effectively a tax on the use of fossil fuels, and only fossil fuels.

The carbon content of every form of fossil fuel, from anthracite to lignite coal, from residual oil to natural gas, is precisely known. So is the amount of CO2 released into the atmosphere when the fuel is burned. A carbon tax thus presents few if any problems of documentation or measurement. As discussed here, administering a carbon tax should be simple; utilizing existing tax collection mechanisms, the tax would be paid far “upstream,” i.e., at the point where fuels are extracted from the Earth and put into the stream of commerce, or imported into the U.S. Fuel suppliers and processors would pass along the cost of the tax to the extent that market conditions allow.

Per unit of energy (or Btu), natural gas emits the least CO2 of any fossil fuel when burned, and coal the most, with petroleum (oil) products such as gasoline occupying the middle range. Generally, a Btu from coal produces 30% more carbon dioxide than a Btu from oil, and 80% more than from natural gas (methane). A carbon tax would obey these proportions, taxing coal somewhat more heavily than petroleum products, and much more than natural gas.

To the extent carbon is included in a manufactured product such as plastic, but is not burned, that carbon will not be taxed. Similarly, to the extent the carbon used to produce energy is permanently sequestered rather than released into the atmosphere, that carbon will not be taxed or a tax credit will be provided.

Only a few jurisdictions in the world tax carbon. (See this page). Nevertheless, a large and growing number of economists, policy-makers and concerned citizens regard stiff carbon taxes as essential for creating the broad incentives needed to combat the climate crisis that gravely threatens civilization. See Supporters page.

Why A Carbon Tax?

The rationale for a carbon tax is simple: the levels of CO2 already in the Earth’s atmosphere and being added daily are destabilizing established climate patterns and threatening the ecosystems on which we and other living beings depend. Very large and rapid reductions in the United States’ and other nations’ carbon emissions are essential to avoid runaway climate destabilization and avert resulting severe weather events, inundation of coastal areas, spread of diseases, failure of agriculture and water supply, infrastructure destruction, forced migrations, political upheavals and international conflict.

A tax on carbon pollution will create the broad incentives to encourage decision-makers at all levels of society to reduce carbon emissions through conservation, substitution and innovation. Currently, the prices of gasoline, electricity and fuels in general include none of the long-term costs associated with devastating climate change or even the well-quantified near-term health costs of burning fossil fuels. This omission suppresses incentives to develop and deploy carbon-reducing measures such as energy efficiency (e.g., high-mileage cars and high-efficiency heaters and air conditioners), renewable energy (e.g., wind turbines, solar panels), low-carbon fuels (e.g., biofuels from high-cellulose plants), and conservation-based behavior such as bicycling, recycling and overall mindfulness toward energy consumption. Conversely, taxing fuels according to their carbon content will infuse these incentives at every link in the chain of decision and action — from individuals’ choices and uses of vehicles, appliances, and housing, to businesses’ choices of new product design, capital investment and facilities location, and governments’ choices in regulatory policy, land use and taxation.

A carbon tax won’t stop global climate disruption by itself — other, synergistic actions are required as well. But without a carbon tax, even the most aggressive regulatory regime (e.g., high-mileage cars) and “enlightened” subsidies (e.g., tax credits for efficiency and renewables) will fall woefully short of the necessary reductions in carbon burning and emissions.

No Tax Increase? How?

A carbon tax should be revenue-neutral in order to maximize the incentives to reduce emissions while avoiding “income” effects normally associated with taxes that would drag down economic activity. Revenue-neutral means that little if any of the tax revenues raised by taxing carbon emissions would be retained by government. The vast majority of the revenues would be returned to the public, with, perhaps, a very small amount utilized to mitigate the disproportionate impacts of carbon taxes on low-income energy users.

Two primary return approaches are being discussed. One would return revenues directly through regular (e.g., monthly) equal “dividends” to all U.S. residents. In effect, every resident would receive equal, identical slices of the total carbon revenue “pie.” The amount of every individual’s carbon tax would be proportional to their fossil fuel use, creating an incentive to reduce. But revenue return “dividends” would be equal and independent of individuals’ energy use, preserving the conservation incentive. Alaska has operated a “dividend” program for three decades, providing residents with annual allotments from the state’s North Slope oil revenues.

In the other revenue return method, each dollar of carbon tax revenue would trigger a dollar’s worth of reduction in existing taxes such as the federal payroll tax or state sales taxes. As carbon-tax revenues are phased in (with the tax rates rising gradually but steadily, to allow a smooth transition), existing taxes will be phased out and, in some cases, eliminated. This “tax-shift” approach, while less direct than the dividend method, would also ensure that the carbon tax is revenue-neutral and could offer other important benefits. For example, reducing payroll taxes could stimulate employment.

Each individual’s receipt of dividends or tax-shifts would be independent of the carbon taxes he or she pays. That is, no person’s benefits would be tied to his or her energy consumption and carbon tax “bill.” This separation of benefits from payments preserves the incentives created by a carbon tax to reduce use of fossil fuels and emit less CO2 into the atmosphere. Of course, it would be extraordinarily cumbersome to calculate an individual’s full carbon tax bill since to some extent the carbon tax would be passed through as part of the costs of various goods and services.

Revenue-neutrality not only protects the poor (see next section), it’s also politically savvy since it offers a way to blunt the “No New Taxes” demand that has held sway in American politics for over a generation. Returning the carbon tax revenues to the public would also make it easier to raise the tax level over time, a point made nicely by McGill University professor Christopher Ragan in a 2008 Montreal Gazette op-ed, and subsequently borne out by the experience in British Columbia where a revenue-neutral carbon tax has been gradually increased in four annual increments, remains politically popular and is driving down emissions.

Softening The Impact

A carbon tax, like any flat tax, is regressive — by itself. However, the regressivity of a carbon tax can be minimized, and perhaps eliminated altogether, by keeping the tax revenue-neutral in a way that protects the less affluent.

The operative fact is that wealthier households use far more energy. They generally drive and fly more, have bigger (and sometimes multiple) houses, and buy more stuff that requires energy to manufacture and use. As a result, most carbon tax revenues will come from families of above-average means, along with corporations and government.

That is why the two “return” approaches discussed above — carbon dividends or tax-shifting — can turn the carbon tax into a progressive tax. Because income and energy consumption are strongly correlated, most poor households will get more back in their equal carbon dividends or via tax progressive shifting than they will pay in the carbon tax. The overall effect of a carbon tax-shift could be equitable and perhaps even “progressive” (benefiting lower-earning households).

Cap-and-Trade Problems

A tax on carbon emissions isn’t the only way to “put a price on carbon” and thereby provide incentives to reduce use of high-carbon fuels. A carbon cap-and-trade system is an alternative approach supported by some prominent politicians, corporations and mainstream environmental groups. Cap-and-trade was the structure embodied in the Waxman-Markey climate bill that passed the House but failed in the Senate. And cap-and-trade is the cornerstone of the European Union’s “Emissions Trading Scheme” (ETS).

Under some conditions, cap-and-trade systems can be effective.  The U.S. sulfur dioxide cap-and-trade system instituted in the early 1990s, deserves credit for efficiently reducing acid rain emissions from power plants. However, the scale of a carbon trading system — it would be up to 100 times larger than that for sulfur — combined with the lack of readily available “technical fixes” for filtering or capturing CO2, appear to rule out the sulfur cap-and-trade system as a model for carbon. Recent evidence from the EU’s ETS suggests that price volatility and gaming by market participants has largely undermined the effectiveness of this complex, opaque  indirect cap-and-trade system for pricing carbon pollution.

We regard a carbon tax as superior to a carbon cap-and-trade system, for five fundamental reasons:

  • Carbon taxes will lend predictability to energy prices, whereas cap-and-trade systems exacerbate the price volatility that historically has discouraged investments in less carbon-intensive electricity generation, carbon-reducing energy efficiency and carbon-replacing renewable energy.
  • Carbon taxes can be implemented much sooner than complex cap-and-trade systems. Because of the urgency of the climate crisis, we do not have the luxury of waiting while the myriad details of a cap-and-trade system are resolved through lengthy negotiations.
  • Carbon taxes are transparent and easily understandable, making them more likely to elicit the necessary public support than an opaque and difficult to understand cap-and-trade system. The co-author of the U.S. Senate cap-and-trade bill, Sen. John Kerry, even told a reporter in September 2009, “I don’t know what ‘cap and trade’ means. I don’t think the average American does.”
  • Carbon taxes can be implemented with far less opportunity for manipulation by special interests, while a cap-and-trade system’s complexity opens it to exploitation by special interests and perverse incentives that can undermine public confidence and undercut its effectiveness.
  • Carbon tax revenues can be rebated to the public through dividends or tax-shifting, while the costs of cap-and-trade systems are likely to become a hidden tax as dollars flow to market participants, lawyers and consultants.

See our Tax vs. Cap-and-Trade page for more.

What About China?

China’s leap-frogging the U.S. as the World’s #1 annual carbon emitter is being cited to defend American inaction on carbon reductions. This stance ignores several central points.

For one thing, the U.S. will continue to be the world’s biggest contributor to global climate change long after China, or even India, surpasses us in annual emissions. That’s because carbon dioxide has an effective residence time in Earth’s atmosphere of approximately a century. Considering the many decades in which America’s carbon emissions dwarfed everyone else’s, of the CO2 now warming Earth, more than three times as much is the product of American emissions as Chinese emissions. Based on present trends, the earliest that China will surpass the United States as the leading source of CO2 is mid-century, i.e., around 2050. (See Slideshow, slide #8.)

Second, the United States will continue to dump the most CO2 into the atmosphere on a per capita basis for years to come. The average American is responsible for creating as much CO2 in a day as do people in developing countries in a week.

Third, just as corporations here use China’s inaction on carbon to justify U.S. inaction, so too are industry and government in China using our temporizing on carbon to rationalize theirs. The way out of this “alliance of denial,” as The New York Times terms it, is to stop delaying and start acting. Breaking this cycle should be easier for the United States, insofar as our per capita use of energy (and emissions of carbon) is many times greater than China’s, and given our well-developed political and administrative institutions.

While it is true that only concerted action by all the world’s nations and peoples can meet the climate crisis head-on, it is equally true that every action that reduces carbon emissions helps protect and stabilize climate. The injunction that the perfect must not become the enemy of the good has never been so apt as it is here and now, in Earth’s climate emergency. 

Moreover, a U.S. carbon tax could be designed to protect our domestic industry while encouraging other nations to enact their own carbon taxes through the use of WTO-sanctioned border tax adjustments that would impose harmonizing carbon taxes on imports from non-carbon taxing nations. 

See also –

Debunking The Myths (eight misconceptions about carbon taxes put to rest; an excellent primer)

FAQs (30 quick questions and answers about carbon taxes; another fine carbon tax primer)

What Is The Carbon Tax Center?

The Carbon Tax Center (CTC) is a non-profit, non-governmental organization formed in 2007 by economist Charles Komanoff and attorney Dan Rosenblum, in the belief that America needs a full and candid discussion of carbon taxing, particularly in the national arena. CTC provides intellectual and practical support, as well as a sense of community, to help carbon tax proponents in every region and across the political spectrum coalesce into a strong civic force.

Rosenblum stepped down in 2010. Komanoff oversees policy, conducts fundraising and maintains CTC’s carbon-tax spreadsheet model. Much of CTC’s organizing and networking, particularly among Washington advocates, think-tankers and Congressional staff, is carried out by chemical engineer and former US EPA attorney James Handley. Both Komanoff and Handley are fully engaged in CTC’s intellectual work, particularly propounding carbon taxing as a far more effective and encompassing policy than alternatives such as Clean Air Act regulation of greenhouse gases or energy subsidies.

Click here for more.

Last updated: September 17, 2013