Common Tragedies

Thoughts on Environmental Economics

Carbon tax proposals

Posted by Daniel Hall on September 19, 2007

Carbon taxes are an economically efficient way to address the externalities from greenhouse gases. The conventional political thinking, however, is that a cap-and-trade approach is more likely what with “tax” being a four-letter word in DC.*

So the carbon tax proposals that are out there are probably facing an uphill battle. But boy, would they help themselves out if their sponsors thought them through a bit.

There are two major proposals that have been introduced so far: Stark-McDermott (HR 2069) and Larson (HR 3416). The Larson proposal calls for an initial tax on the carbon content of fossil fuels that equates to about $16.5 per metric ton of CO2 emissions in 2008, and for this tax to be raised by 10% annually in real terms (i.e., on top of inflation). This means that prices get relatively high by 2030 (up over $130/metric ton CO2). This would almost certainly get us below 1990 level emissions by 2030, and probably much sooner. (For a comparison look at the price trajectory from the recent EIA analysis of the Lieberman-McCain bill, which achieves 1990 level emissions at lower carbon prices.)

Where it gets weird is what happens after that: prices just keep rocketing up without stopping, to $1,000/metric ton CO2 after mid-century and beyond. I can’t imagine the U.S. maintaining the political will to pay those kind of prices much beyond 2030 (if it could do so until then).

The Stark proposal, on the other hand, errs in the other direction: it initially imposes the equivalent of a $3/metric ton ton CO2 charge on the carbon content of fuels, and then raises this by $3 every year. As written the amount would increase every year until U.S. CO2 emissions were 80% below their 1990 levels. I can nearly guarantee you, however, they would never get there — at least not due to the carbon price alone — because the bill doesn’t bother to account for inflation. This mean that the tax grows very slowly: even assuming a relatively low average annual inflation rate of 2%, the tax tops out at less than $60/metric ton CO2 in real terms just after mid-century.

I tend to think carbon taxes have an “institutional design” characteristic that favors them over many other types of policies: once set up they are more likely to be a stable and robust policy instrument through which to deal with carbon externalities. Neither of these proposals, however, seems written for the long haul.

*And cap-and-trade is economically efficient too, when designed correctly.

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