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Estimated CO2 Reductions from a Briskly Rising Carbon Tax

The Carbon Tax Center long considered Rep. James McDermott’s “Managed Carbon Price Act,” one of the two most effective climate measures ever introduced in Congress. (The other, the “America’s Energy Security Trust Fund Act” introduced in 2009 and re-introduced in 2015 by Rep. John B. Larson, chair of the House Democratic Caucus and fourth-ranking Democrat in the House of Representatives, had a similar price and ramp-up and therefore a similar emissions reduction profile.) The bill by McDermott, a staunch Democrat who represented Washington’s 7th congressional district from 1989 to 2017, would have established a national carbon tax starting at a rate of $12.50 per metric ton of carbon dioxide, rising annually by the same $12.50/metric ton.

We estimated that the carbon tax levels mandated under the McDermott bill would have reduced U.S. CO2 emissions from fossil fuel combustion by 1/3 within a decade. Using our 8-sector carbon-tax-model spreadsheet, we projected that the bill would have led to the progression of emission reductions shown in the graph below:

Discussion

Carbon taxes embody the principle that truthful prices for fossil fuels must include the “externality costs” that their burning imposes on society, i.e., that polluters should pay for the damage caused by polluting. Briskly increasing carbon taxes will instill in energy consumers and producers strong incentives to efficiently reduce their use of fossil fuels and the attendant emissions of carbon dioxide while increasing efficiency and shifting to renewable energy.

The “supply-side response” will materialize largely through investment — for example, in carbon-free wind or solar power farms or lower-carbon gas-fired generating plants, or possibly in low-carbon biofuels. The  “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 an 8-sector National Carbon Tax Model, which we update every year or two. 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. It divides U.S. CO2 emissions into seven sectors: electricity, which in 2015 accounted for 37% of nationwide CO2 emissions; personal ground travel, accounting for 22% (almost entirely from burning gasoline); freight (goods movement), 9%, largely diesel fuel for trucks; jet fuel for air travel (4%), oil refining (6%), other petroleum (also 6%), natural gas other than for electricity (11%), and, an eighth “sector,” miscellany (5%).

We apply separate long-run demand price-elasticities — 70% for electricity, 35% for gasoline, 60% for jet fuel, and 40-50% for the other sectors — 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, the model assumes an initial (year-2016) carbon tax of $12.50 per metric ton of carbon dioxide, ramped up each year by the same $12.50 per metric ton (so that the tax level in the tenth year is $125 per metric ton of CO2, which equates to $113.40 per short ton, for example). The model indicates that such a carbon tax would, by 2026, result in U.S. CO2 emissions falling 31-32% below today’s baseline projections for 2026, and 41% below actual CO2 emissions in 2005. Also strikingly, the carbon tax provided in the McDermott bill would cause U.S. petroleum consumption in 2026 to be 26% less than 2005 actual consumption and 19% below 2026 projected consumption (without a carbon tax).

Notes on Price Elasticity

Demand price-elasticity denotes the extent to which rises in price engender 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 be required to engender a 1% decrease in demand. Importantly, 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 can take years to materialize fully. 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.

In a 2015 blog post, What an Energy-Efficiency Hero Gets Wrong about Carbon Taxes, we explored (and dispelled) some myths about price-elasticity and carbon taxes that are surprisingly widespread, even among veteran environmental advocates and analysts. It remains one of our most widely read posts, and we commend it to anyone seeking to understand how, why and how fast a carbon tax can be expected to cut carbon emissions.

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.

• Resources for the Future working paper 23-11, Prest, Fell, Gordon & Conway, Estimating the Emissions Reductions from Supply-side Fossil Fuel Interventions, 2023. Belying the title’s supply-side emphasis, this paper contains an excellent compendium of recent research estimating demand elasticities in the U.S. and some other countries for gasoline and/or crude oil. It finds an average of (negative) 0.35 for crude oil’s elasticity. Though the authors’ assertion that gasoline’s demand elasticity should be double that for crude oil would imply 0.70 for gasoline, we believe that this assertion is somewhat simplistic, especially for the United States, where infrastructure, culture and policy inhibit demand adaptation. All things considered, we believe the paper’s conclusion supports a U.S. gasoline demand price-elasticity greater than 0.35 but not twice as great.
• 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 sifted 2001-2006 gasoline use data and found price-elasticity to be minuscule — just 4% in the short-run and, though they didn’t quantify it, not much greater in the long-run.
• 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, co-authored the most perceptive and persuasive analysis of U.S. gasoline demand we’ve seen. The paper analyzed 1966-2001 data for each of the 50 states and found (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 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 sifted 2001-2006 gasoline use data and found price-elasticity to be minuscule — just 4% in the short-run and, though they didn’t quantify it, not much greater in the long-run.
• C. Komanoff, Komanoff letter to Sperling. In a letter sent in December 2006, CTC’s Komanoff asked Prof. Sperling to reconcile his findings above with the contrary findings of Small & Van Dender.
• Nicholas Lutsey & Daniel Sperling, Energy Efficiency, Fuel Economy, and Policy Implications, Transportation Research Record, 2005. Though not strictly about price elasticity, this paper deconstructed 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 were 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 derived 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 reported 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.

We invite CTC friends and visitors to comment on these materials and to suggest further reading. In 2007 environmental journalist-activist Gar Lipow compiled a handy bibliography of some of the best studies 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.

We also recommend the overview of seven sets of integrated assessment model results presented in “Carbon Taxes to Achieve Emissions Targets, Insights From EMF-24” (Stanford Energy Modeling Forum, 2012) which concluded that a carbon price would need to rise briskly, to roughly $440/ton CO2 by 2050 to reduce U.S. emissions in that year by 80%. That’s a serious price trajectory, in line with CTC’s modeling results.

With U.S. carbon dioxide emissions from fossil fuel combustion currently (2022) hovering above 5 billion metric tons a year, even a midrange carbon tax of $50 per metric ton would generate on the order of $250 billion in annual revenue. The magnitude of this figure underscores the importance of designing and implementing a carbon tax carefully and skillfully.

Unsurprisingly, this subject has spawned a robust literature. Below, we summarize two excellent resources, from 2009 and 2015, written by pre-eminent experts in carbon tax policy and economics.

An even better starting point is the Jan. 2017) report by the U.S. Treasury’s Office of Tax Analysis, Methodology for Analyzing a Carbon Tax. It’s a superb and mercifully brief (28 pages) guide to the nuts and bolts of administering a carbon tax. The table at left is indicative of its detail. Download here (pdf).

The Design of a Carbon Tax (Gilbert Metcalf & David Weisbach, Harvard Environmental Law Review, 2009; 58 pp.). Here’s the article’s abstract:

We consider the design of a tax on greenhouse gas emissions for the United States. We consider three major issues: the tax rate (including the use of the revenues and rate changes over time), the optimal tax base, and international trade concerns.

We show that a well-designed carbon tax can capture about 80% of U.S. emissions by taxing only a few thousand taxpayers, and almost 90% with a modest additional cost. We recommend full or partial delegation of rate setting authority to an agency to ensure that rates reflect current information about the costs of carbon emissions and abatement. Adjustments should be made to the income tax to ensure that a carbon tax is revenue neutral and distributionally neutral.

Finally, we propose an origin-basis system for trade with countries that have an adequate carbon tax, and a system of border taxes for imports from countries without a carbon tax. We suggest a system that imposes presumptive border tax adjustments, but allows an individual firm to prove that a different rate should apply. The presumptive tax could be based on average emissions for production of the item by either the exporting country or the importing country.

Implementing a US Carbon Tax: Challenges and Debates, a 2015 book compiling articles from the economics literature covering a range of design and implementation issues, edited by Ian Parry, Adele Morris and Roberton C Williams III.  Chapters cover these topics:

1. Carbon Taxes as Part of the Fiscal Solution

2. Choosing among Mitigation Instruments: How strong is the case for a US carbon tax?

3. Administration of a US Carbon Tax

4. Carbon Taxes to Achieve Emissions Targets: Insights from EMF 24

5. Macroeconomic Effects of Carbon Taxes

6. The Distributional Burden of a Carbon Tax: Evidence and implications for policy

7. Offsetting a Carbon Tax’s Burden on Low-Income Households

8. Carbon Taxes and Corporate Tax Reform

9. Carbon Taxes and Energy-Intensive Trade-Exposed Industries: Impacts and options

10. The Role of Energy Technology Policy alongside Carbon Pricing

11. Mixing It Up: Power sector energy and regional and regulatory climate policies in the presence of a carbon tax

12. Implications of Carbon Taxes for Transportation Policies

See also:

• What’s the best way to design a carbon tax? Brad Plumer (Washington Post, 3/13/12).
• Putting a Price on Carbon, A Handbook for U.S. Policymakers (World Resources Institute, 2015).
• Taxing Carbon: What, Why, and How (Tax Policy Center, Urban Institute & Brookings Institution, 2015).

Finally, the excerpts below from a 2007 memo from CTC to a House Ways & Means Committee member setting parameters for administering a federal carbon tax may be helpful.

Tax Upstream

We propose to tax fuels as far upstream as practicable, i.e., at the point where possession of the carbon-bearing fuel passes from the “producer” (e.g., coal mine; oil wellhead or tanker; gas wellhead) to the immediate next entity in the supply chain (e.g., coal shipper or utility; oil refiner or importer; natural gas pipeline). Presumably, each such transfer will be codified in a contract, or at least a bill of lading, specifying the attributes of the fuel.

This will minimize the number of points in the economy at which the tax would be levied. It will also simplify tax treatment of potential downstream carbon control technologies such as CCS (coal capture and sequestration), as discussed below.

Carbon Variability Requires Taxing by Btu, not by Fuel Weight or Volume

The tax rates will be stated in dollars per million Btu of heat content for each fuel. A more familiar approach based on physical quantities of fuel isn’t tenable, due to wide natural variations in carbon content within each fuel type. These variations are most stark for coal. A ton of lignite typically contains around 40% less carbon than a typical ton of bituminous coal, for example. To tax the two respective tons at the same dollar rate would be grossly unfair since combustion of the lignite ton releases 40% less carbon into the atmosphere than for the bituminous ton. Actual disparities would be even more pervasive and pronounced on account of variations in carbon content per ton within each major coal category (bituminous, subbituminous and lignite).

Fortunately, variations in carbon content of coals correspond fairly closely to variations in Btu content. This isn’t surprising, since it is the combustion of carbon into carbon dioxide that produces almost all of the heat energy released by burning any type of coal. Thus, lignite and bituminous coal differ by only 5% on average in carbon content per million Btu; differences in carbon per Btu among different batches of coals within the same category are probably less still.

Our approach, therefore, is to specify standard (and slightly different) tax rates for the three categories — bituminous, subbituminous and lignite — and to offer coal purchasers the option of applying for a lower tax rate than given in the standard schedule, on the basis of a coal assay performed and substantiated by a licensed, bonded entity, subject to random spot checks for accuracy.

Petroleum (Oil)

Taxing the carbon content of petroleum presents a different set of issues because of the dozen or more different petroleum products, each of which has its own carbon profile. For example, a barrel of residual fuel oil contains roughly 15% more carbon than a barrel of gasoline. This variability can be circumvented by (i) expressing the carbon tax for  petroleum in the same terms as the tax for coal, i.e., in dollars per million Btu of heat content, and (ii) levying the carbon tax on crude oil as possession passes from the producer to the refiner or pipeline. (Where one company owns both entities in the transaction, the tax can be charged at the point of transfer from the producing “business unit” tothe refining or pipeline “arm.”) This approach has the added virtue of maximizing incentives to refrain from flaring and venting of carbon-bearing gases and liquids and thus to maximize energy outputs per unit of carbon emitted.

At the same time, however, the United States imports significant quantities — several million barrels per day, overall — of refined petroleum products such as gasoline, heating oil, residual fuel oil and jet fuel. Because each has a distinct carbon profile, it is advisable to establish individual product tax rates, also in dollars per million Btu of heat content, to apply to imports of petroleum products. (Crude oil imports would be taxed at the standard “domestic” crude tax rate.)

The assay option noted above for coal, whereby coal purchasers could apply for a lower tax rate on the basis of a certified assay, and again subject to random spot checks for accuracy, would also be available to oil pipelines and refiners.

(Note: the final memo will contain rates for another 8-10 petroleum products; each will be in the vicinity of the range shown here for gasoline, resid and crude.)

Natural Gas

Natural gas exhibits little variability in carbon content per million Btu of heat content, and thus one figure should suffice, with the assay option still available to cover special cases. [We will check to ensure that LNG arriving by tanker has the same carbon-to-energy ratio.] The tax would be charged at the wellhead in order to maximize incentives to refrain from flaring.

Rebates for CO2 Control

The bill should provide the opportunity for partial or total rebate of the tax payments if the paying entity can prove that some or all of the carbon dioxide emissions will be kept from entering Earth’s atmosphere for millenia. This rebate approach has several virtues:

* It provides fair and workable treatment of “partial combustion” which will vary by user and use (e.g., unburned coal in ash that is returned to the mine for underground disposal; possibly also cement manufacturing, and plastics manufacture).

* It creates positive incentives to minimize emissions.

* It puts the burden on the fuel producer to demonstrate emissions avoidance (as opposed to a partial tax which allows the producer to reduce taxes unilaterally and burdens the government with substantiating a rebuttal case).

Procedures for producer documentation of CO2 avoidance and/or sequestration will be spelled out in the next iteration of this memo.

Tax Rates

Following are tax rates consistent with charging $50.00 per ton of carbon (not carbon dioxide) emitted. Consistent with the intent of phasing this level in over a five-year period, the rates for years 1 through 4 would be calculated by multiplying the rates in the table by 20%, 40%, 60% and 80%, respectively.

These amounts are derived in a spreadsheet developed by Charles Komanoff.

All rates are expressed in dollars per million Btu of fuel.

Bituminous coal	$1.40
Subbituminous coal	$1.45
Lignite	$1.47
Crude Oil	$1.12
Gasoline	$1.07
Residual Fuel Oil	$1.18
Natural Gas	$0.80

18. How will carbon taxes handle carbon sequestration? Plastics? Petrochemicals?

Offsetting credit will be provided to the extent the carbon dioxide is actually sequestered, in order to eliminate any disincentive to sequestration. Releases of CO2 from converting fossil fuels to plastics or petrochemicals in non-combustion processes will be taxed at the same level as CO2 emitted in the production of energy or for transportation purposes.

19. Will a carbon tax apply to nuclear power?

A carbon tax will only be imposed on the use or combustion of carbon and the resulting emission of carbon dioxide. A carbon tax would not be imposed directly on the generation of nuclear power, though of course it would apply to any CO2 released in mining, enriching and transporting uranium, in other uses ancillary to the generation of nuclear power (such as fuel used for back-up generation), and in storing radioactive wastes.

20. How high should carbon taxes go? How fast should they climb?

While carbon taxes will need to be rise briskly to create the required price incentives, they will need to be phased in to give individuals and businesses the opportunity to adjust. There’s no magic formula or perfect number, but a tax that grows fast enough to reduce CO2 emissions by 1/3 within a decade probably offers a viable combination of meaningful incentive and opportunity for adaptation. The $15 per ton of CO2 “starter tax” mentioned earlier, equating to around 14 cents a gallon of gasoline, fits the lower end of that range. At least as important as the tax level is the commitment to keep raising the tax, preferably annually, so that energy-critical decisions, from car-buying (Hummer vs. Prius) to home-buying (exurb vs. transit-oriented community) to factory locating (highway interchange vs. rail line), are made with carbon-appropriate price signals.

21. Must carbon taxes be global to work?

Though carbon taxes can be applied locally, nationally or globally, the eventual goal is a global tax. Not only is the climate crisis global in both scope and solution, but a global carbon tax will avert potential leakage by carbon emitters attempting to move their combustion of carbon from countries that tax carbon to those that don’t. U.S. carbon tax legislation should include border tax adjustments to help protect domestic industry from unfair competition and to tax imports of other nations until they enact their own taxes on carbon pollution. Still, let’s not make perfection the enemy of the good; carbon pollution should be taxed wherever possible.

22. Why a carbon tax instead of a cap-and-trade system?

Carbon taxes are superior to cap-and-trade programs for seven fundamental reasons:

• Carbon taxes will lend predictability to energy prices, whereas cap-and-trade systems will only exacerbate price volatility that discourages investments in carbon-reducing energy efficiency and carbon-replacing renewable energy.
• Carbon taxes can be implemented more quickly than complex permit-based cap-and-trade systems.
• Carbon taxes are transparent and easily understandable, making them more likely to elicit public support than opaque and complex cap-and-trade.
• Carbon taxes aren’t easily manipulable by special interests, whereas the complexity of cap-and-trade leaves it rife for exploitation by the financial industry.
• Carbon tax revenues can be more or less guaranteed and integrated into state or federal fiscal policy, owing to their predictability, whereas the price-volatility of cap-and-trade precludes its being counted on as a revenue source.
• Carbon taxes are replicable across borders, since the price “metric” embodied in a carbon tax is far more universal than the quantity-reduction metric underlying cap-and-trade.
• Perversely, cap-and-trade discourages voluntary/individual carbon reductions, since those cause a lowering of prices of emission permits which undercuts low-carbon investments; carbon taxes are free of this unintended negative consequence.

23. How responsive is energy demand to the price of fuels?

That varies with the type of fuel, the expected persistence of the price change, and the availability of substitutes. The two forms of energy that economists have studied most intensively are gasoline (which in 2014 accounted for 20% of U.S. emissions of carbon dioxide) and electricity (39%).  From our own micro-economic analyses as well as a literature review, CTC believes a “price-elasticity” of 35% (or negative 0.35, in the jargon) is an appropriate assumption for gasoline demand, and 70% for electricity. These assumptions mean that drops in demand are less steep than rises in the fuel price but are still substantial. For all other fuel uses, ranging from diesel fuel for trucks and jet fuel for planes to home heating and industrial fuels — the overall price-responsiveness is probably greater than for gasoline but less than for electricity. (See more detailed discussion on our “Effectiveness” page.)

These estimates are “long-run” elasticities, meaning that price rises take years to fully affect demand. Households and businesses can’t overnight adjust their stocks of energy-using equipment (cars, major appliances, office layouts, etc.), nor can they instantly adapt location decisions that determine distances that people and goods travel. On the other hand, carbon taxes and the resulting relative rises in fossil fuel prices will induce reductions in carbon emission rates on the supply side. For example, higher coal prices due to carbon taxing will lead cost-minimizing power grids to more heavily dispatch lower-emitting natural gas power plants in the short run, and to switch increasingly to zero-carbon wind and solar generation over time.

24. What are the non-climate costs of using fossil fuels?

Fossil fuels burden human beings, communities and nature with enormous environmental and social damages apart from destabilizing climate. Chief among them are “traditional” air pollution such as car and truck exhaust and smokestack emissions; destruction of land and water from extracting and transporting fuels; and the militarism, economic inequality and political authoritarianism that is endemic to extractive economies (e.g., Saudi Arabia, Nigeria, Indonesia). Many researchers believe the magnitude of these and other “indirect” costs exceeds the “market” prices paid for coal, oil and gas.

25. What are the ancillary benefits of taxing carbon?

As the previous Q&A suggests, U.S. carbon taxes will deliver vast non-climate benefits by discouraging use of fossil fuels. These will range from better air quality and less strip-mining to reduced entanglement in the unstable and dangerous Middle East and a less powerful fossil fuel industry. Americans can also look forward to a slew of indirect benefits – for example, lighter road traffic arising from a decrease in vehicle-miles traveled, as families and businesses adapt to higher gasoline and diesel fuel prices by trimming their least essential trips and consolidating others.

26. Who favors carbon taxes?

Carbon taxes are supported by a diverse group of opinion leaders, pundits, scientists and economists. The task now is to broaden and deepen support for taxing carbon among both the political elites and the grassroots – and to do so in the face of concerted opposition from fossil fuel interests determined to preserve (and increase!) their sales rather than watch their sector, and profits, shrink as the carbon tax steadily diminishes sales and use of coal, oil and gas.

27. How have past fuel tax efforts fared in the U.S.?

Poorly. The idea of taxing energy to better reflect its full costs collides with Americans’ historical entitlement to cheap energy and the anti-tax ideology of the past 35 years, not to mention the political muscle of the fossil fuel industry. This triad helped kill the last big effort to tax energy — President Clinton’s Btu tax in 1993. Nevertheless, we’re optimistic that making the carbon tax revenue-neutral, with all revenue recycled via tax-shifting or returned via carbon tax dividends, can soften resistance. Indeed, as described in the next Q&A, polls now point to strong support for a revenue-neutral tax designed to combat climate change.

28. What does polling indicate about carbon taxes?

Opinion polls increasingly find Americans grasping the need to address climate change and warming (oops) to a revenue-neutral carbon tax. A January 2015 poll by political scientists at Stanford University and Resources for the Future found that two-thirds of Americans support making corporations pay a price for carbon pollution, provided the revenues are redistributed, i.e., made revenue-neutral. (See graphic at left.)

More recently, in March 2016, nearly two-thirds (64%) of Americans polled told Gallup’s annual environmental poll that they are worried a “great deal” or a “fair amount” about global warming. That figure is up from 55% in March 2015 and is the highest reading since 2008, according to Gallup. (See graphic below.)

Other results from the 2016 Gallup poll are equally striking. They show a record-high share of Americans stating that climate change poses a threat to them and their way of life; a record number agreeing that climate change is caused primarily by human activity; and climate concern climbing across the political spectrum.

There’s more about these two polls as well as earlier ones on our page on opinion polling.

29. What will a carbon tax look like to me?

On the one hand, just about everything requiring fossil fuels, from a drive in the country to imported produce, will cost more, with prices rising the most for activities or goods that use the most fossil fuels. But the upside is three-fold: (i) your tax reduction or dividend check will offset much, perhaps more than 100%, of those price increases; (ii) you’ll be able to minimize your tax bite by cutting down on fuel usage (e.g., shortening those country drives, buying locally-grown produce, purchasing “green power” from wind and solar cells); and (iii) Americans’ combined behavior changes in response to the carbon tax will go a long way toward protecting the climate and averting the cataclysmic consequences of unchecked global warming.

30. Who’s taxing carbon now?

See our Where Carbon Is Taxed page. Or, download Sightline Institute’s excellent 2014 report, All the World’s Carbon Pricing Systems in One Animated Map, with maps tracing the institution (and, in at least one instance, Australia, the rescission) of carbon taxing worldwide, as well as carbon pricing administered via cap-and-trade programs. The Sightline report includes helpful tables, too.

The most notable carbon tax in the Western Hemisphere remains that in British Columbia. Carbon dioxide emissions from that province, Canada’s third most populous, began to be taxed on July 1, 2008 at a rate of $10 (Canadian) per metric ton and were raised annually to reach the current rate of $30 per metric ton (which equates to just over 20 U.S. dollars per U.S. ton). (We assessed BC’s carbon tax in a December 2015 report.) Voters in Boulder (Colorado) passed a carbon tax referendum in 2006; while Boulder’s tax equates to just $7/ton and applies only to electricity, it nonetheless establishes an important precedent: the first climate-protecting tax ever levied in the United States. Citizens in Washington State and five other states are campaigning to enact statewide carbon taxes.

31. What’s the political strategy for winning carbon taxes?

An effective campaign for carbon taxes must be both intellectually sound and politically palatable. The key point: Taxing climate pollution is economically and morally preferable to taxing productive activity such as work, savings or investment. Instead of discouraging productive effort, initiative and investment as other tax burdens do, a tax on carbon pollution raises the cost of harmful activity and thereby encourages efficiency and renewable energy. Revenues from carbon taxes can fund “dividends” to all U.S. residents or be used to reduce existing taxes, shifting tax burdens onto pollution and pollution-generating activities. Framing taxes on carbon pollution as an embodiment of the “polluter pays” principle unites interests as diverse as environmental-justice advocates, free-market conservatives and classical economists. Sound design of the revenue side of carbon tax legislation will also ensure that people of limited means, who use less energy than average, are made better off, not worse.

32. What can I do to advance carbon taxes?

The big need now is to develop grassroots support for a carbon tax. Start talking about a tax on climate pollution at your local environmental, religious or civic group meetings. Subscribe to CTC’s occasional but timely emails by filling in the sign-up pop-up box on our home page. Join Citizens Climate Lobby, the vital and committed nationwide network of activists that is putting the revenue-neutral carbon tax known as “fee-and-dividend” (delightfully explained in CCL’s 2-minute video) on the policy map. And please donate to the Carbon Tax Center, via our on-line Donate page. It’s contributions from people like you that enable us to conduct research, work on advocacy, and share knowledge and hope on carbon taxing. Thank you.

A “robust” carbon tax — one high enough to significantly change fuel incentives, drive innovation and transform our energy system and culture — is going to generate large amounts of revenue.

Fossil-fuel burning in the U.S. now (pre-pandemic, 2019) emits around 5 billion metric tons of carbon dioxide a year. A carbon tax set at the threshold of robustness — $50 per metric ton — would generate roughly $250 billion a year in new tax proceeds. That’s a significant figure by any measure. It equates to 6-7 percent of total U.S. tax proceeds (currently $3.86 trillion). Spread among the country’s 128.5 million households (as of 2017), it’s $1,950 a year.

Not surprisingly, “what to do with the carbon tax revenue” is the most contentious issue surrounding carbon tax proposals, especially for possible carbon taxes at the federal level where the tax rate could be higher and political divisions are starker.

Revenue-Neutral Carbon-Taxing

Revenue-neutral means that government retains little if any of the tax revenues raised by taxing carbon emissions. Instead, the revenues are returned to the public; with, perhaps, small amounts utilized to assist communities dependent on fossil-fuel extraction and processing to adapt and convert to low- or non-carbon economies.

There are two overlapping but nonetheless disparate reasons for structuring a carbon tax to be revenue-neutral.

One is to appeal to (or appease) voters and elected officials who claim to abhor government and thus don’t want to swell its coffers.

The other is to counter or at least minimize the natural regressivity of carbon taxes by returning revenue in a way that protects the less affluent, while preserving the tax’s price-incentive to reduce emissions. (Keep in mind that wealthier households use more energy, since they generally drive and fly more, have bigger (and sometimes multiple) houses, and buy more stuff that requires energy to manufacture and use.)

There are two primary approaches to returning or recycling the tax revenues.

One approach, discussed below in detail, returns revenues directly through regular (e.g., monthly) “dividends” to all U.S. households or residents. Every resident or household receives an equal, identical slice of the total carbon revenue “pie.” In this approach, which adherents at Citizens Climate Lobby call fee-and-dividend, each individual’s carbon tax is proportional to his or her fossil fuel use, creating an incentive to reduce; but everyone’s dividend is equal and independent of his or her usage, preserving the conservation incentive. Alaska’s dividend program has provided residents with annual allotments from the state’s North Slope oil royalties for three-and-a-half decades.

In the other revenue-return method, each dollar of carbon tax revenue triggers a dollar’s worth of reduction in existing taxes such as the federal payroll tax or corporate income tax — or, on the state level, sales taxes. As carbon-tax revenues are phased in (with the tax rates rising steadily but not too steeply, to allow a smooth transition), existing taxes are phased out. While this “tax-shift” is less direct than the dividend method, it too ensures that the carbon tax is revenue-neutral. It offers other important benefits, as well; for example, reducing payroll taxes could stimulate employment.

To repeat: each individual’s receipt of dividends or tax-shifts is independent of the carbon taxes he or she pays. That is, no person’s benefits are tied to his or her energy consumption and carbon tax “bill.” This separation of benefits from payments preserves the carbon tax’s incentive 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, 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 decades. 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 was ramped up in four annual increments; that tax remains politically popular and is driving down emissions.

In any event, either of the two “revenue return” approaches — carbon dividends and tax-shifting — can make carbon taxes income-progressive. Because income and energy consumption are strongly correlated, most poor households will get more back in their carbon dividends or via tax-shifting than they will pay in the carbon tax. The overall effect of a carbon tax could thus be equitable and even “progressive” (benefiting lower-earning households).

Revenue-Positive Carbon-Taxing (Investing in Alternatives)

It may seem axiomatic that carbon-tax revenues should fund renewable energy or efficiency upgrades. And that approach always polls well, making it politically attractive.

Nevertheless, climate and energy realities indicate that only a robustly-rising carbon tax can deliver the deep and broad CO2 emission reductions needed to avert climate disaster. Building public support and maintaining the fairness needed for such a substantial carbon tax can most easily be done if all or nearly all of the carbon-tax revenue is returned to taxpayers. See “Making a carbon tax income-progressive” and our blog post: “Which Carbon Tax: Robust or Miniature? (July 7, 2013)”

Dividends

(a/k/a Carbon Dividends or “Green Checks”)

One revenue treatment that is both income-progressive and appealingly straightforward is to return the revenues equally to all U.S. residents. This  so-called “dividend” would be a national version of the Alaska Permanent Fund, which since the 1970s has annually sent all state residents identical checks drawn from earnings on investments made with the state’s North Slope oil royalties. (For a federal carbon tax, the “dividend” checks should be provided quarterly or monthly to keep households ahead of the budget treadmill.)

The dividend approach was so attractive and elegant that the nation’s most energetic and active advocacy organization for carbon taxes has organized around it. That’s the Citizens’ Climate Lobby, which calls its approach carbon fee-and-dividend.

Nevertheless, it seems fair to say (and important to acknowledge) that by 2018, the second year of the Trump administration, fee-and-dividend has run out of political room. Not a single “sitting” (i.e., still in office) Republican member of Congress has publicly endorsed fee-and-dividend, even as a concept, let alone an actual bill. Yet the premise of fee-and-dividend has always been bipartisanship, since Democrats, with their preference for activist government, would accept a revenue-neutral carbon tax such as fee-and-dividend only if it delivered Republican votes.

For a decade, we wrote glowingly about fee and dividend — most recently in 2017 articles in The Nation and the Washington Spectator. We also praised the Climate Leadership Council’s “carbon dividend” proposal and advocacy in those two pieces and in numerous blogs (here, here, and here, inter alia). But as we wrote in June 2018, we believe that the time for carbon dividend proposals has probably passed. We wrote:

The [political] center to which Baker-Shultz (CLC) and fee-and-dividend (CCL) were designed to appeal barely exists. It’s not just that no sitting Republican has endorsed Baker-Shultz or indeed fee-and-dividend in any form. It’s also that the Democratic majority that will be needed to pass a carbon tax bill appears unlikely to rally around a revenue-neutral carbon tax, whether it’s organized as fee-and-dividend or some form of tax swap.

Economic Progressivity of Fee-and-Dividend

In 2016 CCL released a detailed paper examining how a carbon fee-and-dividend would impact U.S. households. The study took into account geographic variations in electricity sources and gasoline use and drew on a database of carbon intensity of expenditures for 5.8 million households to analyze the net effect of returning revenue to households on a modified per capita basis. Here are the major results:

• 53% of households (and 58% of individuals) would receive more in dividend payments than they would spend due to higher fossil fuel prices.
• Another 19% of households would incur only a slight loss, defined as a net loss no larger than one-fifth of one percent of pre-tax income.
• Nearly 90% of households below the poverty line would benefit an average of $311, an increase of roughly 2.8% of pre-tax income.
• In contrast, the net loss for the top quintile of households would average $-322 or only -0.18% of pre-tax income.

Notably, these findings support a dividend plan’s ability to transform a carbon tax into a progressive policy that neutralizes the burden that lower-income households would otherwise face, directly and indirectly, due to higher fuel prices. CTC advocates a progressive distributional outcome for both pragmatic and ethical reasons: pragmatically, because a carbon tax will require broad, sustained, public and political support; and ethically, because it’s not tenable to solve the climate crisis on the backs of those who can least afford it.

A Caveat — CBO’s “haircut”

The non-partisan Congressional Budget Office routinely “scores” members’ bills for their prospective impact on tax revenues. To streamline its analyses, CBO long ago settled the so-called “CBO haircut” by which it assumes that one-quarter of indirectly raised revenues would need to be allocated from the tax proceeds in question in order to make up for reduced tax revenues collected from conventional sources such as personal or corporate income taxes. But modeling of carbon tax proposals consistently finds that when revenue is strategically returned by reducing other taxes that tend to slow down economic activity, the net negative impacts are much lower than CBO’s 25% assumption and in some cases may be eliminated altogether. While returning revenue as “dividends” (which economists call “lump-sum rebates”) offers less potential to reduce economic drag than tax shifts, CBO’s assumption still seems like an over-estimate.

In any event, rigid application of the 25% CBO haircut could, on paper at least — and, likely, in Congressional deliberations — limit the carbon tax revenue perceived to be available for “dividends” to 75%. Yet even with this reduced fraction of revenue, returning carbon tax revenue via a direct dividend represents a simple and income-progressive means to make carbon taxes distributionally fair; though with the haircut, the share of households reaping a net benefit via an equal 75% dividend would be lower than the 58% of individuals mentioned above.

Related CTC blog posts

• The Carbon Tax Revenue Menu (6/10/2011)
• Should Carbon Pricing Advocates Support the Cap-and-Dividend Bill? (12/2/2010)
• Scientist James Hansen Proposes “People’s Climate Stewardship Act”: A Simple Carbon Fee with Revenue Returned to Americans (4/25/2010)
• Progressive Democrats Say: “Cut Out Wall Street — Price Carbon Directly and Recycle Revenue to Households.” (10/20/2009)
• Back to Plan A: The Revenue-Neutral Carbon Tax (7/6/2009)

Related news reports and opinion pieces

• Alaska’s Permanent Dividend Fund — A policy ripe for export (Bangor Daily News, 6/20/2011)
• James Hansen Rails Against Cap-and-Trade in Open Letter, Advocates Fee-and-Dividend to Reduce Carbon Emissions (The Guardian, 1/12/2010)
• Cap and Fade (James Hansen, NYT op-ed, 12/6/2009)
• How CBO budget scoring devalues efficiency (Dave Roberts, Grist 10/15/2009)

Cogent opinion pieces by dividend proponent James K. Boyce (U-Mass, Amherst)

• Does Biden’s insurance policy for the climate go far enough? (The Hill, 2/26/2021)
• Carbon Dividends: The Bipartisan Key to Climate Policy? (Institute for New Economic Thinking, 2/17/2017)
• The Carbon Dividend (New York Times, July 29, 2014)

Tax-Shifting

The distribution of carbon tax burdens creates an opportunity for “progressive tax-shifting,” in which a portion of carbon tax revenue is dedicated to reducing regressive taxes such as the payroll tax (at the federal level) or sales taxes (at the state level). An early proponent of such a carbon tax shift was Al Gore, with his exhortation to “Tax what we burn, not what we earn.” Shifting taxes away from payroll and/or sales taxes and onto carbon pollution could raise, not lower, the after-tax incomes of a majority of below-median-income households, giving this approach a net progressive effect.

In addition to this potential progressive effect of tax shifting, a wide range of economists, [including Lawrence Goulder, Roberton Williams & Ian Parry, Gilbert Metcalf & David Weisbach, Alan Viard, Robert Shapiro, Donald Marron & Eric Toder] have concluded that use of revenue to reduce other taxes would improve the overall efficiency of the economy, for example, by removing burdens on work.

In October 2007, the Brookings Institution published a A Proposal for a U.S. Carbon Tax Swap — An Equitable Tax Reform to Address Global Climate Change by Tufts University economics professor Gilbert E. Metcalf, describing a national carbon tax paired with an income tax credit for payroll taxes paid. Metcalf assessed the impact of a tax of $15 per metric ton of carbon dioxide and five major greenhouse gases. Revenues would be used to credit payroll tax paid on the first $3,660 of earnings per worker. Metcalf showed that such a tax swap would be both revenue-neutral and distributionally-neutral. (Harvard professor and former Bush Administration economist Gregory Mankiw mentioned the Metcalf paper in a Sept. 2007 New York Times op-ed, discussed on our blog.) Rep. John Larson (D-CT) adopted Metcalf’s framework for his “America’s Energy Security Trust Fund Act,” discussed on our Bills page.

More recent analysis has confirmed the importance of carbon tax revenue wisely; using it to reduce other “distortionary” taxes can offer large enough efficiency benefits to reduce or even possibly eliminate the economic drag that a carbon tax would otherwise create. In Deficit Reduction and Carbon Taxes: Budgetary, Economic, and Distributional Impacts (2013) researchers from Resources for the Future found that using carbon tax revenue to reduce corporate income tax rates offers large enough efficiency benefits to more than overcome the efficiency loss of a carbon tax. The next best option is using revenue to cut wage taxes, while using revenue to cutting other consumption taxes is somewhat less efficient. Finally, refunding carbon tax revenue in a “lump sum rebate” (dividend) offers the least economic efficiency benefit.

Reducing the top marginal corporate income tax rate has been articulated as a goal by leaders of both major political parties. In an effort to attract Republican interest, Rep. John Delaney (D-MD) has introduced a carbon tax measure that would devote half its revenue to corporate income tax reduction.

Nevertheless, the growing economics literature on carbon taxes suggests a strong a tradeoff between the efficiency benefits of using carbon tax revenue to cut taxes on capital (as the Delaney proposal would do) and the distributional benefits of cutting taxes on labor (as Rep. Larson’s proposal would).

Related CTC blog posts and articles

• British Columbia’s Carbon Tax Architects Speak (2015).
• The Carbon Tax Revenue Menu, outlining the benefits of various revenue options (2011).
• Carbon Tax Offers Super Powers to Super-Committee, discussing potential for a carbon tax to reduce the deficit (2011).
• Midterm Advice for Congress: Tax Carbon Instead of Jobs (Robert Shapiro, Huffington Post, 2010).
• Capitol Hill Briefing on Carbon Taxes Draws Overflow Crowd, Rep. John Larson (D-CT) led off CTC’s event, articulating the benefits of a taxing carbon pollution while cutting wage taxes (12/9/08).

Related journal articles and papers

• Taxing Carbon and Recycling the Revenue: Who Wins and Loses? (Donald Marron, Eric Toder, and Lydia Austin, Urban-Brookings Tax Policy Center, Nov. 2015).
• Tax Policy Issues in Designing a Carbon Tax (Donald B. Marron and Eric J. Toder, Urban-Brookings Tax Policy Center, 2014).
• Getting to an Efficient Carbon Tax: How the Revenue is Used Matters (Jared Carbone, Richard D. Morgenstern, Roberton C. Williams III, and Dallas Burtraw, Resources for the Future, 2014).
• A Carbon Tax in Broader U.S. Fiscal Reform: Design and Distributional Issues, Adele Morris (Brookings) and Aparna Mathur (American Enterprise Institute), C2ES, 2014).
• Carbon Tax Revenue and the Budget Deficit: A Win-Win-Win Solution? (MIT, 2012).
• The Potential Role of a Carbon Tax in U.S. Fiscal Reform (Brookings, 2012).
• Fiscal Policy to Mitigate Climate Change (IMF, 2012).
• How Climate Policy Could Address Fiscal Shortfalls (Adele Morris & Ted Gayer, Brookings, 2010).
• Addressing Climate Change Without Impairing the US Economy (Robert Shapiro, U.S. Climate Task Force, 2009).
• A Proposal for a U.S. Carbon Tax Swap (Gilbert Metcalf, Brookings, 2007).