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Carbon Tax Center

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A Carbon Tax Beats Automatic Austerity

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

French Voters Gave Austerity the Boot on May 6

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

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

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

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

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

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

Photo: Flickr — Passarello Luna

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

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

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

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

The pipeline

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

The carbon fee

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

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

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

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

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

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

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

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

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

Are EPA Hammers The Best Tools to Ratchet Down Global Warming Pollution?

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Massachusetts v. EPA (2007), the Supreme Court’s 5-4 decision upholding EPA’s authority to regulate greenhouse gases, is rightly considered a legal milestone in the fight against global warming. But it’s nearly impossible to find an economist, business person, or even an environmental advocate who thinks that EPA regulation of the numerous and diverse activities causing global warming can ever be more productive, fair and cost-effective than policies using price incentives. Even Environmental Protection Administrator Lisa Jackson testified to the House Energy & Commerce Committee that regulation by her agency under the Clean Air Act isn’t the best response to global warming.

Where does EPA regulation of greenhouse gases stand today, after the failure two years ago of carbon cap-and-trade legislation? Recall that in 2009, a huge campaign by environmental groups, along with a well-coordinated effort by the House Democratic leadership, led to House passage of the Waxman-Markey climate bill. That bill would have largely supplanted EPA greenhouse gas regulation with a cap-and-trade-offset system, an indirect way to put a hidden and fluctuating price on CO2 pollution. But in the Senate, John Kerry’s frenzied effort to build a coalition around cap-and-trade with offsets came to naught in 2010. The failure of climate legislation, along with the GOP takeover of the House later that year, leaves climate policy exactly where the Supreme Court left it: at EPA’s doorstep.

The Environmental Protection Agency has issued rules mandating aggressive improvement in efficiency of new autos and trucks, and rules mandating “Best Available Control Technology” for new and expanded coal-fired power plants and other stationary sources. For CO2 emissions, BACT is essentially a combustion efficiency standard. But EPA has yet to propose rules for a far larger category of GHG’s: CO2 emissions from existing stationary sources such as power plants and oil refineries. And indeed, fears of economic dislocation and job loss ― which are always concerns when existing facilities come under stringent regulation ― will make it hard for the agency to clamp down hard on these sources, particularly in today’s heavily politicized climate.

Nevertheless, it’s important to ask what a maximal strategy of EPA GHG regulation might accomplish, and how that approach stacks up against indirect pricing proposals like Waxman-Markey and simpler, more direct carbon pollution taxes such as Reps. Larson and Stark have proposed. Economists Dallas Burtraw, Arthur Fraas and attorney Nathan Richardson of Resources for the Future recently examined EPA’s regulatory options. Looking at a decidedly optimistic scenario, they concluded that EPA regulations would reduce domestic greenhouse gas emissions by 12.9% by 2020 (from a 2005 baseline). That estimate assumes that EPA adopts a flexible approach involving tradeable performance standards, which they concede may be less legally defensible than more prescriptive and costly facility-specific regulatory approaches. Their figure also includes non-CO2 GHG emissions reductions counted in CO2-equivalent terms. By comparison, they estimate that the Waxman-Markey bill would have achieved nearly identical reductions in domestic emissions, 12.7%, in the same eight-year time frame.

What carbon tax level and ramp-up would yield the same 12.9% reduction that Burtraw et al. project for EPA regulations? To see, I ran the Carbon Tax Center model developed by director Charles Komanoff. The model uses historic price elasticities in five sectors to estimate emissions reductions for a given CO2 price trajectory. Thus, the model relies on history to predict future behavior — it assumes we will find ways to use less fossil fuel to the same degree as we’ve responded to price changes in the past; the model also accounts for the increasing difficulty (“diminishing returns”) of reducing emissions.

In the table below, I’ve summarized and ranked in order of effectiveness (which corresponds well with revenue), three legislative and two economists’ carbon tax proposals as well as two carbon tax scenarios that the CTC model indicates would mimic the expected emissions reductions of EPA GHG regulations by 2020:

Proposal Initial Rate ($/T CO2) Increase / yr CO2 Tax Rate in 2020 ($/T CO2) Emission change by 2020 Cumulative Gross Revenue 2012-2020 ($B)
Cantwell-Collins $14 (+/-7) 6% $22.31 – 9.1% 866
Krupnick: Waxman-Markey equiv. $18 8% $33 – 12.3% 1,181
CTC: EPA equiv. (% increase) *
 $21.50 6% $34.27 – 12.9% 1,289
CTC: EPA equiv. (step increase) $10 $3.50 $38 – 12.9% 1,136
AEI / Peterson $26 6% $41.44 – 15.1% 1,532
Stark $10 $10 $90 – 24.0% 2,166
Larson $15 $12.50 $115 – 28.9% 2,694
The Cantwell-Collins “CLEAR Act,” a cap with a “price collar” sets a CO2 price between $7 and $21, rising 6% annually. Krupnick et al. (RFF) used the US DOE’s NEMS model to estimate that an $18T/CO2 carbon tax rising 8%/yr to $33/T CO2 by 2020 would achieve equivalent domestic emissions reductions to Waxman-Markey, very similar to the emissions reductions which Burtraw et al. expect from EPA regulations. (Reassuringly, CTC’s model applied to Krupnick’s price trajectory predicts similar results.) For the third scenario, I chose a 6% annual increment in the CO2 price and used the model to estimate the starting price needed to achieve the same reductions as EPA regulations. For the fourth scenario, I took the opposite tack, specifying a $10 starting price and letting the model determine the annual increment rate that would achieve the same reductions as EPA regulation. The fifth estimate uses the carbon price proposed in Fiscal Solutions: A Balanced Plan for Fiscal Stability and Economic Growth, (Peterson Foundation & American Enterprise Institute, 2011). Finally, I ran the price levels and increments in the carbon tax bills introduced by Rep’s Pete Stark D-CA and John Larson D-CT respectively, to estimate the emissions reductions that their climate bills would achieve by 2020.

The results suggest that, holding other things equal, until 2020 climate advocates should be indifferent between EPA GHG regulations and either (i) a carbon tax starting at $21.50 per ton of carbon dioxide and rising at 6% a year, or (ii) a carbon tax of $10/ton rising by $3.50/yr. But of course, other things aren’t equal: a carbon pollution tax would generate billions in revenue, as shown in the far right column in the table. Indeed, economists Ian Parry and Roberton Williams of RFF estimate that the Krupnick proposal would close 1/3 of the U.S. budget gap by 2030. Moreover, as Burtraw et al. point out, it’s not clear how much further EPA regulation could reduce emissions after 2020. That’s because regulations are essentially static and do little to induce innovation or to reduce fossil fuel demand via conservation.

Burtraw et al. conclude:

EPA action under the Clean Air Act is inferior to new [carbon pricing] legislation from Congress, especially over the long term. Although it is possible to identify some readily available opportunities for emissions reductions and push them via regulation (with market tools to keep costs down), it quickly becomes difficult to identify what steps should be taken next. A carbon price (either cap-and-trade or a carbon tax) created by legislation would allow the market to make these decisions.

The numbers tell a sobering story: EPA regulations might, optimistically, achieve significant near-term reductions, albeit at a higher cost than a CO2 pollution pricing system. But more importantly, those regulations can’t be expected to induce further innovation and reduce demand (for example by encouraging improved efficiency) and EPA has explicitly stated that it is not mandating replacement of high carbon energy sources (coal and oil) with lower or zero carbon sources (gas or renewables).

Where does this leave us? Consider the interesting situation that could arise by year’s end. Congress faces both mandatory “sequestration” of the military and domestic budgets (imposed by the debt ceiling legislation) and expiration of the Bush/Obama tax cuts. The House and Senate may therefore be forced to consider ways to raise revenue, perhaps as early as in the “lame-duck” session after the Nov. 6 elections, when the pending retirement of some members and the passing of the election season might allow political “grand bargains” to be struck.

In that eventuality, it will be important to hammer home the point that a rising carbon pollution tax offers not only the potential to achieve greater and far more sustained emissions reductions than EPA regulations, but also a growing stream of revenue from taxing pollution. That is especially salient now, when every tool available is needed to encourage job growth and productive economic activity including reducing or at least avoiding new taxes on work and investment.

Photo by “thefixer” (Flickr).

* Postscript: In A Balanced Plan to Stabilize Public Debt and Promote Economic Growth (2010), William Galston (Brookings) and Maya MacGuineas (Committee for a Responsible Federal Budget) recommended a carbon pollution tax similar to my third scenario: starting at $23/T CO2, rising 5.8% yearly, with proceeds to reduce payroll taxes and deficits.