Benefits

Estimated CO2 Reductions from the Larson Bill

The Carbon Tax Center regards the bill introduced in March 2009 by Rep. John B. Larson, chair of the House Democratic Caucus and fourth-ranking Democrat in the House of Representatives, as the optimal carbon-pricing bill introduced to Congress. Entitled “America’s Energy Security Trust Fund Act of 2009,” and summarized here, the Larson bill would establish a national carbon tax rate of $15 per ton of carbon dioxide in 2012, and would rise annually by $10/ton, with an alternate annual increment rate of $15/ton if required to meet emission reduction targets to be pre-established by U.S. EPA.

At this writing (Nov. 2011), we estimate that the carbon tax levels mandated under the Larson bill would lead to reductions in CO2 emissions such that, in 2020, emissions would be 29% less than actual 2005 emissions, and 30% less than emissions projected for 2020 in the absence of federal carbon-pricing legislation. (These figures assume that the initial tax installment is in place on Jan. 1, 2012; while this is obviously not possible, the figures indicate the power of the tax levels in the Larson bill to dis-incentivize high-carbon fuels and shrink CO2 emissions.) To view a graph showing the annual progression of emission reductions under the bill, click here. This will take you to CTC’s carbon-tax-model spreadsheet; once in the spreadsheet, please click on the eighth “tab,” entitled Graph_CO2. See below for more information on our spreadsheet model.

Discussion

The Carbon Tax Center believes that carbon taxes are justified on the principle that prices for fossil fuels should include the “externality costs” their use imposes on society, i.e., that polluters should pay for polluting. Nevertheless, the premise of our carbon tax advocacy is that a carbon tax will reduce the use of fossil fuels and their attendant emissions of carbon dioxide.

These emission reductions will come about in two ways: one, with carbon emissions now carrying a price, suppliers of electricity and fuel will be motivated by market-share considerations and other economic considerations to reduce the carbon content of their energy per btu or kilowatt-hour; two, end-use energy users will choose to substitute lower-carbon products and activities for higher-carbon ones in order to minimize their exposure to the carbon tax.

The first, “supply-side response” will materialize largely through investment — for example, in carbon-free wind power farms or relatively low-carbon gas-fired generating plants, or in lower-carbon biofuels. The second, “demand-side” response will arise in literally millions of decisions, ranging from the choice of car to drive (in multi-car households) to longer-term location decisions of families, businesses and institutions, all reflecting the fact that usage is at least somewhat sensitive to price, i.e., there is some “price-elasticity” (to use economic jargon) in energy usage.

To capture these responses quantitatively, CTC has developed a 5-sector National Carbon Tax Model. The model captures both demand- and supply-side responses to carbon taxes and incorporates time lags in end-users’ responses to the tax-induced higher prices. The model also allows estimation of the impacts of possible complementary taxes on gasoline and jet fuel — potential supplements to a “straight” carbon tax that would accelerate reductions in U.S. oil dependence. This “hybrid carbon tax” approach was floated in 2007 by Rep. John Dingell, who was then chair of the House Energy & Commerce Committee, and holds promise for joining the interests of climate activists and security advocates.

The CTC model has been updated in fall 2011 to reflect the deep and prolonged recession and other changed economic circumstances. It divides U.S. CO2 emissions into five sectors: electricity, which in 2009 accounted for 40.6% of nationwide CO2 emissions; personal ground travel, accounting for 22.9% (almost entirely from burning gasoline); freight (goods movement), 8.5%, largely in the form of diesel fuel for trucks; jet fuel for air travel (3.7%), and other (24.2%). We apply separate long-run demand price-elasticities — 70% for electricity, 40% for gasoline, 60% for jet fuel, and 50% for other — with further assumptions for supply-side substitution of carbon as well. (All assumptions are detailed in the spreadsheet; users may input their own. Readers interested in the carbon contents of electricity and various fuels may also wish to examine our Carbon Contents spreadsheet.)

As configured in the file version linked to in the paragraph before the previous one, the model assumes a carbon tax with an initial level of $15 per ton of carbon dioxide, ramped up each year with an increment of $12.50 per ton (so that the tax level in the tenth year is $127.50 per ton of CO2, for example). The annual increment rate of $12.50 is the arithmetic mean of the $10-$15 per ton range envisioned in Rep. Larson’s America’s Energy Security Trust Fund Act of 2009 discussed at the top of this page. The model, written in spreadsheet form, may be easily modified by changing a few settings in the Summary worksheet, to correspond to other initial tax levels and rates of increase. These may include either a straight carbon tax, a hybrid tax combining a carbon tax with an additional levy on gasoline and jet fuel, or, for that matter, a tax on gasoline alone.

The model indicates that such a carbon tax would, by 2020, result in U.S. CO2 emissions falling 29.5% below today’s baseline projections for 2020, and 28.9% below actual CO2 emissions in 2005. (By comparison, 2020 emissions under the Waxman-Markey bill passed by the House of Representatives in June 2009 but not enacted in the Senate would have been only 17% below 2005 levels — and the actual drop would have been less since, under that bill, U.S. companies would have been able to use “offsets” to avoid reducing emissions in their own domestic operations.) Also strikingly, the carbon tax provided in the Larson bill would cause U.S. petroleum consumption in 2020 to be 21% less than 2005 actual consumption and 2020 projected consumption (without a carbon tax).

Earlier, CTC developed a spreadsheet model of a statewide carbon tax for Colorado. Our Colorado model divided the state’s fossil-fuel burning into the electricity, gasoline, and other sectors. In that earlier model, the carbon tax, expressed per ton of carbon, not carbon dioxide), was set at $37 per ton of carbon, not CO2, and incremented linearly for thirteen years beginning in 2008, reaching $481 per ton of carbon (equivalent to roughly $1.30 per gallon of gasoline) before being maintained at that plateau.

With the above assumptions, CTC’s Colorado model yielded these results:

  • By 2020-2021, statewide CO2 emissions would have been 40% less than otherwise; the implied annual average emissions reduction rate (from the non-tax CO2 trajectory) was 3.7%.
  • A little over half of the reductions would have come about because demand (for electricity, gasoline, or “other” fuels) had shrunk; the remainder would have been realized through suppliers’ substitution of lower-carbon fuels and processes.
  • The lion’s share, around 60%, of the CO2 reductions were delivered in the electricity sector, with 30% in “other” and just 10% in gasoline.
  • Carbon tax revenues would have been enormous, permitting the Colorado Legislature to zero out the Sales Tax and the  Business Personal Property Tax by the fifth year, even while providing generous per-resident and per-employee rebates, a supplement to the federal Earned Income Tax Credit to assist low-income families, and a fund to finance targeted investment in energy efficiency and renewable energy.

Note that both the national and Colorado carbon taxes could be supplemented by other incentives and regulations that would drive emissions down even further.

Technical Notes on Price Elasticity

Price-elasticity denotes the extent to which a rise in price engenders a drop in demand. A price-elasticity of 50% means that the drop in demand is half as steep as the price rise. Thus, a 2% increase in price would engender a 1% decrease in demand. However, for large price increases such as we propose over time, the drops in demand would be proportionately less, reflecting the law of diminishing returns. And at the same time the phased-in tax is causing prices of fossil fuels to rise, incomes would be rising, offsetting some of the reductions.

Because many if not most determinants of energy use such as infrastructure, location and capital goods like houses and cars can’t be changed overnight, drops in demand due to higher prices usually take years. Our elasticity estimates are “long-run” figures, requiring around a decade to manifest fully, as opposed to “short-run” elasticities that apply to rapid but smaller changes, i.e., within a year. Short-run elasticities also exist, of course, as everybody who hesitates before paying an increased price for a product is aware, but they are less than the long-run values.

Below we give links to articles and papers on energy price-elasticity in the United States. Some are for a general audience, some are technical. Many focus on automobiles and gasoline, the area of energy use that has been studied the most.

  • Kenneth Small & Kurt Van Dender, Fuel Efficiency and Motor Vehicle Travel: The Declining Rebound Effect, 2006, revised 2007 (a shorter version was published in Energy Journal in 2007). Small, a Professor of Economics at U-C Irvine and a peerless transportation economist and thinker, has co-authored the most perceptive and persuasive analysis of U.S. gasoline demand we’ve seen. The paper analyzes 1966-2001 data for each of the 50 states and finds (i) a short-run price elasticity of gasoline of roughly 9% (comprised equally of changes in fuel efficiency and miles driven); and (ii) a long-run price elasticity of gasoline of around 40% (also arising equally from changes in fuel efficiency and miles driven). Note: Prof. Small has told us that adding more recent data through 2004 doesn’t alter these findings.
  • J.E. Hughes, C.R. Knittel, D. Sperling, Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand, 2006, National Bureau of Economic Research. The authors sift 2001-2006 gasoline use data and find the price-elasticity to be minuscule — just 4% in the short-run and, though they don’t quantify it, not much greater in the long-run.
  • C. Komanoff, Komanoff letter to Sperling. CTC’s Komanoff asks Prof. Sperling to reconcile his findings with the contrary findings of Small & Van Dender. The letter was sent Dec. 4, 2006; no reply has been received.
  • Nicholas Lutsey & Daniel Sperling, Energy Efficiency, Fuel Economy, and Policy Implications, Transportation Research Record, 2005. Though not strictly about price elasticity, this paper deconstructs technical changes in the U.S. auto fleet from 1975 to the early 1980s, a period in which most technical gains were devoted to improving fuel efficiency, and since then, when technical improvements have been used “to satisfy private desires (more power, size and amenities).” Anyone seeking to understand automobile fuel economy should read this paper.
  • Dermot Gately & Hillard G. Huntington, The Asymmetric Effects of Changes in Price and Income on Energy and Oil Demand, 2001, Economic Research Reports, RR# 2001-01, C.V. Starr Center for Applied Economics, NYU. Using 1971-1997 data, and lumping the U.S. with the other (OECD) industrial nations, the authors derive long-run price-elasticities of only 24% for all energy, but 64% for petroleum products alone. (Could fuel substitution be the reason for the disparity?) Encouragingly, they report a relatively low long-run income-elasticity, 55-60%, for both oil and energy in the OECD countries, indicating that, all things equal (i.e., with constant prices), each 3% growth of GDP gives rise to less than a 2% rise in energy use.
  • Douglas Bohi, Analyzing Demand Behavior, Johns Hopkins University Press. This 1981 book, written under the aegis of Resources for the Future, surveyed the extensive literature then available on price and income elasticities for all energy forms and use-sectors. The consensus reported included price-elasticities of 100% or larger for commercial and industrial uses of electricity — sectors often overseen by energy managers with the mandate and expertise to respond effectively to higher energy prices by revamping operations and ordering newer, more energy-efficient equipment.

We invite CTC friends and visitors to comment on these materials and to suggest further reading. One who has done so is environmental journalist-activist Gar Lipow, who has compiled a nifty bibliography of some of the best studies around on the price-elasticity of demand for energy. Gar’s summaries of nearly two dozen price-elasticity studies from the U.S. and around the world are an invaluable guide to this important subject.


Last updated: November 22, 2011