The trouble with carbon pricing

By Matto Mildenberger & Leah C. Stokes, Boston Review

1. Carbon pricing isn’t working in California.

Over a decade ago, California put a price on carbon pollution. At first glance the policy appears to be a success: since it began in 2013, emissions have declined by more than 8 percent. Today the program manages 85 percent of the state’s carbon pollution: the widest coverage of any policy in the world…

But while the policy looks good on paper, in practice it has proven weak. Since 2013 the annual supply of pollution permits has been consistently higher than overall pollution. As a result, the price to pollute is low, and likely to remain that way for another decade…

This is not a surprise. Though legislators aimed to tighten the law in 2017, oil and gas lobbyists thwarted their efforts. One powerful labor union initially supported ending free permits for big polluters, but reversed its position after Chevron  offered it a union contract to retrofit refineries. The final legislation prohibited enacting new regulations on California’s fossil fuel industry — regulations that could have done more than the state’s weak carbon price.

CTC director Charles Komanoff was lead author of this report lauded by M+S.

Rather than carbon pricing, other regulations — clean electricity standards, clean car programs, and aggressive energy efficiency — deserve much of the credit for the state’s progress.

Why carbon taxes still matter

By Charles Komanoff, Carbon Tax Center

1. California carbon pricing is off to a fine start.

While CTC would have preferred California price its carbon pollution directly with a carbon tax, we’re glad to see Mildenberger & Stokes report that the state’s carbon emissions have fallen more than 8 percent since cap-and-trade started up. That decline exceeds by at least half the 5.4 percent drop for the U.S. as a whole in 2013-2019 (calculated from national emissions data in the BP Statistical Review of World Energy, 2020), even as California’s economy was booming relative to the rest of the country.

It’s regrettable that industry hardball watered down the program. But the authors present no evidence that emission reductions from unspecified “new regulations on California’s fossil fuels industry” would have surpassed those from carbon pricing. (The ProPublica story they linked to is silent on that score.)

We’ve studied and applauded the state’s clean electricity standards and aggressive energy efficiency for more than four decades. M+S even cited our 2019 report documenting and quantifying these policies’ accomplishments, California Stars: Lighting the Way to a Clean Energy Future, shown at left. (They linked to it at “regulations,” in the last paragraph.) But much of energy demand and the resultant use of fossil fuels falls into huge pockets that even the best-crafted standards can’t touch, as we’ve discussed many times, at length (e.g., here and here).

Unlike M+S, we don’t shy from touting the synergies between carbon pricing and energy standards. And there’s this benefit, too: Carbon pricing has already narrowed California’s “environmental justice gap,” as we documented in a new post earlier this week.

California is one of only twelve U.S. states to have adopted any carbon price — the idea has simply proven difficult to enact. When Oregon attempted to vote on a carbon pricing bill in 2019, Republican legislators fled the state and hid in Idaho to prevent the quorum necessary to pass the law. And this isn’t just happening in the United States — the policy is politically unpopular around the world.

When Australia passed a modest carbon tax in 2011, things got ugly quickly: right-wing radio hosts hurled misogynistic invectives against Prime Minister Julia Gillard; angry protesters descended on the parliament building in Canberra; and climate-denying opposition leader Tony Abbott crisscrossed the country, accusing the government of “economic vandalism.” When he took office three years later, Abbott quickly repealed the policy.

In France a proposed carbon tax fueled the country’s yellow vest movement, triggering the worst domestic riots since 1968. The proposal was soon abandoned.

As M+S surely know, the U.S. right is in open revolt against all climate action (even light-bulb efficiency standards!), not just carbon pricing. Ditto Australia.

Journalist Chris Ketcham on the Champs Elysee. March 2019 photo by Agnes Dherbeys.

France’s “yellow vesters” weren’t protesting climate action, they were rising up against the yawning gap separating them from the super-rich, a gap that President Macron cruelly widened when he dialed back wealth taxes just before he pushed through a modest carbon levy that exempted aviation fuel. (See Christopher Ketcham’s vivid, on-the-ground reporting for Harper’s on the gilet jaunes, which we summarized last year.)

The climate movement can harness the growing fury at the ever-expanding wealth gap with a program to tax both extreme wealth *and* carbon emissions and invest the proceeds into the Green New Deal, as we’ve written here.

Part of [carbon pricing’s] enduring appeal is that it provides an elegant response to a complex problem. Carbon pollution is everywhere. So, economists argue, increase the cost of releasing it into the atmosphere, and let markets take care of the rest. [emphasis added]

Taxing carbon emissions has nothing to do with “markets” and everything to do with fixing the enormous market failure that allows fossil fuel companies and monster-truck drivers and frequent flyers pay zero for climate pollution. Please, can we all retire the “lets markets do the job” nonsense?

As climate change research grew more prominent in the 1980s, economists described pollution as a “negative externality” — polluters kept the profits from selling fossil fuels while society at large picked up the tab for the harm they caused. (emphasis added) If problems such as acid rain were “market failures,” then pricing forced polluters to “internalize” the costs. Anyone who released carbon pollution into the atmosphere would have to pay for the harm they caused. Policymakers have consistently pushed this idea at every level since the 1990s. And many economists remain attached to it: over 3,500 U.S. economists, including twenty-seven Nobel laureates, have signed a letter supporting carbon pricing…

The idea developed into two main forms: a carbon tax and cap and trade. Carbon taxes impose a price on every unit of carbon pollution released. Cap and trade — also called emissions trading — limits the quantity of carbon pollution that can be released, with polluters trading permits to cover their emissions. Both methods promise the same theoretical result: a reduction in pollution.

Like the roots of a tree branching out in search of water, a carbon price would find carbon wherever it was released. Goods made with fossil fuels would rise in cost. In response, people would make a million tiny decisions to get off carbon: buying the electric-powered lawn mower rather than the gas guzzler, jumping on a bicycle for the last mile rather than calling an Uber, switching to an induction stovetop and ditching the fossil gas. And it wouldn’t just be the public changing its ways; industries would also find places to cut back on carbon as their cost of doing business rose. Policymakers dreamed of sending these signals out across the economy to coordinate distant actors wherever the messages found them. The government could not possibly regulate all the myriad ways that carbon was emitted, but the power of the market could solve the problem — at least in theory.

The problem with carbon pricing is not the idea on paper—it is its application in practice. According to economists, an effective carbon price must be high enough to make polluters pay for the externalities they generate. It must also cover all economy-wide sources of carbon pollution.

First, a shoutout to Mildenberger & Stokes for elegantly articulating the rationale for carbon pricing in their third paragraph at left (“Like the roots of a tree branching out in search of water …”). Bravo!

Nevertheless, their formulation betrays a significant fallacy: The vast externalities from burning fossil fuels aren’t pocketed by the companies that extract and sell them, despite what M+S imply (“polluters kept the profits from selling fossil fuels”). Rather, so long as there’s a modicum of competition — as there is in the oil business — the monetary difference between the market price and the true social cost accrues to consumers. Absent carbon pricing, everyone who flips a switch, operates a vehicle or buys a manufactured product pays less than full price for the fossil fuels that enable the activity.

Worldwide, the richest 1% of consumers cause double the carbon emissions of the poorest 50%, notes Oxfam in new research reported by The Guardian. In other words, the lion’s share of the multi-trillion dollar fossil fuels externality is pocketed by the global rich. The class disparity in U.S. emissions, though rising, is less stark, but here too, an outsize share of the carbon subsidy accrues to those who drive the oversized vehicles, jet around the globe, heat and cool their multiple dwellings, and so forth.

If any fact deserves to be “centered” in progressive discourse about climate change and carbon pricing, it’s this one. Lately, though, the idea of human participation in fossil fuel use has been discarded. Current dogma pins all climate responsibility on the fossil fuel industry, even though the industry’s lifeblood is the gas pump and the light switch.

The fossil fuel purveyors have plenty to account for. But centering them in policy seems to have lulled Mildenberger & Stokes into a binary view of carbon pricing, e.g., “an effective carbon price must be high enough to make polluters pay for the externalities they generate.” Actually, no. Any carbon price will set off a cascade of actions (as captured in that marvelous M+S third paragraph) causing cuts in carbon emissions. The higher the price, the greater the cascade. There is no single carbon price threshold or tipping point. The task before us is to win the highest carbon prices possible.

Carbon prices now exist in 46 countries, covering about 22 percent of the carbon pollution that humans release each year. But these policies are riddled with loopholes… Big carbon polluters — fossil fuel companies, electric utilities, automakers, petrochemical companies, and other heavy industries — have used their structural power to receive policy exemptions, handcuffing the invisible hand of carbon pricing. The result is that carbon pricing passes in the places that already have little pollution. For example, all U.S. states with [some] carbon pricing already had below average per capita energy-related carbon pollution in 2006, before these policies came into effect…

Even when prices do exist, they are quite low. According to the World Bank, countries need policies between $40 to $80 per tonne to meet the Paris Agreement targets. Yet half of the world’s carbon prices are less than $10 per tonne, while only five countries — Sweden, Norway, Liechtenstein, Switzerland and France — are in the target range. Even the prices in these countries are probably too low. Estimates for the social cost of carbon — a measure of the societal harm carbon pollution causes—range from a couple dozen to several hundred dollars per tonne of CO₂. University of California San Diego climate scientist Kate Ricke and colleagues estimate this social cost could be a staggering $417 per tonne. No carbon price in the world comes close to that number.

It’s true that carbon pricing has stalled throughout the world. Too few countries have it, too few sectors are covered, and prices are far too low.

This wasn’t pre-ordained. A promising moment for carbon pricing in 2008, sparked by British Columbia’s successful carbon tax launch, was snuffed out when the Great Recession unleashed a storm of right-wing nationalism. A second window — the 2014 U.S.-China bilateral agreement and the ensuing 2015 Paris climate accord — slammed shut a year later when Trump took power in Washington.

We don’t wave away these facts, and we acknowledge how easily carbon pricing becomes kindling for climate resistance. This knowledge informed our decision to refrain from protesting the downplaying of carbon pricing in the Democratic Party’s 2020 platform. Likewise our decision in late 2019 to expand CTC’s mission to include taxing extreme wealth along with carbon emissions (see Point 2).

Nevertheless, the fact that CO2 taxes of four hundred dollars a ton aren’t on the horizon doesn’t invalidate the ability of robust carbon taxes to propel large-scale reductions in emissions (see Point 6). We don’t have to “center” carbon taxing in climate policy, it just needs to be in the mix. And by making the carbon tax income-progressive, we can ensure that the mix is progressive as well.

In Norway, which has one of the highest carbon prices in the world, emissions in the oil sector rose by 78 percent between 1990 and 2017. One reason emissions didn’t fall is because of a problem economists call “demand inelasticity”: if an economic activity is extremely profitable, or if there are no easy alternatives, people and companies may not demand less even as prices increase…

The evidence is mixed, however, on whether carbon prices can drive innovation and provide more of these cheaper substitutes we need. In her study of the national U.S. cap-and-trade program for sulfur dioxide, Margaret Taylor found that innovation actually declined after the system went into effect. As Tobias Schmidt has shown, cap-and-trade systems tend to produce incremental improvements in polluting technologies rather than driving new, clean alternatives.

Other research suggests limited innovation. In their study of the EU’s carbon market, economists Raphael Calel and Antoine Dechezleprêtre estimate that patenting increased by 9 percent for regulated firms. However, given how few companies fell under the carbon price, overall low carbon technology patenting increased by less than 1 percent. Carbon price-induced patenting in the UK may have been considerably higher. Still, we lack strong evidence that carbon pricing has rapidly induced the innovation we need in new, cleaner technologies. By focusing on the low-hanging fruit—the “cheapest” ways to cut carbon pollution —we fail to build the ladder necessary to curb the more difficult emissions to reduce.

And that shouldn’t surprise us. Consider this scenario: if the United States managed to implement a $50 per tonne carbon price, gasoline prices would increase by $0.44 per gallon. That means Americans’ monthly driving costs would increase by about $25, enough to put a dent in many families’ budgets. Some people might drive a bit less; a few might set up a carpool. But corporations will not innovate new technology because of minor tweaks in the price of energy. The prices of oil already fluctuate greatly year to year, and that hasn’t exactly produced the climate technology we need.

Norway’s oil and gas extraction sector makes for a strange anti-pricing example, insofar as the sector’s carbon emissions have risen no faster than its growth in output (see calculations at end of section). Moreover, because Norway’s carbon tax hasn’t changed since the early 1990’s, it wouldn’t be expected to be driving cuts in emissions today. What the tax may have done is contribute to Norway’s oil and gas sector’s superior emissions intensity, nearly 60 percent less than the world average, according to research by Denis Hoffman, a chemical engineer working in Canada’s petrochemical industry, resulting partly from removing CO2 from natural gas and injecting it into undersea caverns — precisely the kind of innovation that M+S insist isn’t driven by carbon prices.

The deeper truth is that while alternatives to buying and burning fuels may be easy or hard, depending on circumstance, they are almost always more available than most folks imagine or than M+S imply. Our own statistical analysis of U.S. gasoline usage since 1960 points to a price-elasticity of around (minus) 0.35, which translates to at least a 20 percent reduction in use from doubling the price. How would the reduction happen? Through daily behavior changes (trip-chaining, choosing closer destinations, more walk-bike-bus-train, less lead-footed driving) and, over time, changes in capital stocks (fewer guzzlers, more investment in and purchase of EV’s, greater infill development, and so forth).

If we don’t see much give in gas use due to price swings, it’s because of the swings themselves. A carbon tax with a highly transparent annual ramp-up in the tax level would have less noise and more signal, spurring greater reductions.

Our Norway calculations, unpacked: Per BP, Norway extracted 0.91 exajoules of fossil gas in 1990 along with 1,716,000 bbl/day of crude oil in 1990, and 4.12 EJ of gas in 2019 and 1,731,000 bbl/day of oil in 2019. Using 1 Btu = 1055 J and ascribing 5.8 million Btu to each barrel of crude oil, we have 1990 extraction of 0.863 quadrillion Btu’s (“Q”) of gas and 3.633 Q of oil totaling 4.496 Q, and, for 2019, 3.905 Q of gas and 3.665 Q of oil totaling 7.570 Q. The 1990-2019 increase in quads is 68.4 percent. We thank Prof. Mildenberger for updating his emissions figure to a 70 percent rise to 2019 and for clarifying that the figure covers oil and gas extraction.

If it hasn’t driven the necessary innovation, perhaps carbon pricing has delivered emission cuts? One model suggests Norway’s carbon tax reduced carbon pollution by about 2 percent in its first decade. Similarly the EU cap-and-trade system likely reduced emissions by about 4 percent between 2008 and 2016. In British Columbia, Canada, the carbon tax may have been more successful, reducing emissions by 5–15 percent between 2008 and 2015. But these reductions, while laudable, are nothing compared to what needs to be done — we need annual cuts of almost 8 percent a year until 2030 to limit warming to 1.5 degrees Celsius.

Evidence suggests carbon pricing won’t drive emissions reductions quickly enough. It is like bringing a stick to a knife fight. The policy might help for a little while, but it’s unlikely to secure a victory without other weapons to attack the problem. Economists have tried to sharpen the stick, pushing for better policy design, higher prices, and broader coverage. But their efforts have largely failed.

The percentage figures from M+S at left seem right to us, especially for British Columbia, which we examined in depth in 2015, finding that per-capita emissions there fell 3-4 times faster than in non-taxing Canadian provinces during the first five years of BC’s carbon tax.

That tax started in 2008 at $10 per ton of CO2 and topped out in 2012 at $30 — close to the limit of what a lone province or state can bear without huge gaming or leakage. If a $30 tax can cut emissions by 5-15 percent, imagine what triple-digit carbon taxes could accomplish. Rather than demonstrating that carbon pricing can’t drive emissions reductions quickly, BC’s success points to robustly rising carbon taxes’ vast potential.

Mildenberger & Stokes are absolutely right that carbon pricing needs complementary policies. Few proponents of carbon pricing disagree. Economists haven’t failed, it’s the political system that hasn’t delivered. Criticism by climate hawks like M+S isn’t helping.

Carbon pricing … makes it easy for fossil fuel companies to rally opposition. Presenting themselves as champions of the little guy, these companies highlight how the policy would increase gasoline and electricity costs for the public. Polluters have even helped school boards and local governments estimate impacts from a carbon tax on their budgets. It’s not difficult to draw attention to these costs when everywhere we drive, giant signs declare the price of gasoline. If that number rises, people notice. There are no roadside signs displaying the devastating costs of climate change: wildfires, stronger hurricanes, rising sea levels, and new infectious diseases like COVID-19.

What if we could make the benefits of carbon pricing more visible? This is the logic behind the price-and-dividend approach. Canada and Switzerland are the only two countries that have adopted this policy, though it is also part of proposed legislation in Congress. Like traditional cap and trade, this policy would cap emissions and require that companies buy pollution permits. Then U.S. residents with Social Security numbers would receive money back from the program, gathered from polluting firms. According to political scientist Theda Skocpol, a dividend would give the public a tangible benefit to organize around, thus contesting the power that entrenched polluters have over U.S. policymaking. Give the public a green check every month, the thinking goes, and it might just embrace climate policies.

This is especially true for low-income households. Recent models by economists Anders Fremstad and Mark Paul show that a U.S. carbon tax, without compensation, would impose the greatest burdens on low-income households. A dividend could be designed to disproportionately return revenues to poor households.

Carbon price and dividend gives greater attention to the politics of climate policy than earlier approaches, but it still struggles to make the benefits more salient than the costs. In the two countries with a price and dividend, the benefits are buried in income tax or health insurance forms. In our own research, we find these policies do not substantively increase public support for climate policy. This shouldn’t surprise us. Dividends are, at best, a band-aid solution to carbon pricing’s political woes. They create a debate over whether people want a check to cover their increased energy costs. Yes, some would rather have the check, but most would still prefer cheap energy.

We’ve already noted (in Point 5) how easily carbon pricing is made a flash point. And we appreciate the authors’ relative openness to the “dividend” approach for distributing the revenues from carbon pricing. Alas, their treatment is muddled.

We’ve rarely if ever seen reference to “price-and-dividend.” Rather, the guiding idea, popularized since 2009 by Citizens Climate Lobby as “fee and dividend,” is a straight-up levy (which CCL labels a fee) on the carbon content of fossil fuels, with the proceeds distributed to U.S. households in equal amounts (“dividends” or “green checks”).

M+S aptly write, “Give the public a green check every month, the thinking goes, and it might just embrace climate policies.” Not just that, increase the size of the green check each year, and the public will buy in further. The expanding check could give lawmakers cover to ramp up the carbon tax rate, allowing it to start gradually at just $15 or $20 per ton but reach triple digits — a level that every economic model predicts will set off big (30-40 percent) emission reductions within a half-dozen years. And the promise of the ramp-up will spur households, planners and entrepreneurs to raise their decarbonization sights, unleashing waves of products and actions — infill development, higher product efficiencies, zero-energy buildings — locking in even larger cuts in fossil fuel use.

Contrary to M+S, there’s no need to tailor carbon dividends to benefit poorer households; the policy’s very design does that automatically, by virtue of the pronounced tendency of poorer families to spend less on energy and fuels and richer families to spend more. We’ve lost track of the number of studies documenting that fee-and-dividend would be income-progressive in the aggregate, with few actual households losing ground.

Again contrary to the authors, neither Canada nor Switzerland nor any other country has a carbon price with dividend. And why the straw man of burying the green check in other pots of money, when electronic benefit transfers could keep the dividend separate and make it manifest?

Last, why the defeatism that most Americans would take cheap energy over the dividend check especially when most households’ green checks would outpace their higher energy expenses? (More on that score here.) And we ask Mildenberger and Stokes to bear in mind: the longer we keep energy cheap, the more time it will take to phase out fossil fuels and the greater the climate damage while we’re doing it.