Posted by: bmeverett | February 14, 2013

Watch out for a carbon tax!

I was hoping that President Obama would reveal his climate change intentions during his State of the Union address, but all we really got was his standard political threat: “I urge this Congress to pursue a bipartisan, market-based solution to climate change, like the one John McCain and Joe Lieberman worked on together a few years ago. But if Congress won’t act soon to protect future generations, I will. I will direct my cabinet to come up with executive actions we can take, now and in the future, to reduce pollution, prepare our communities for the consequences of climate change, and speed the transition to more sustainable sources of energy.”

The President and Congressional Democrats will probably (for now) to demand more of the failed policies we have been pursuing for decades (R&D, mandates, renewable portfolio standards, manufacturing subsidies to well-connected renewable energy investors, subsidies, etc.) but the other shoe is bound to drop sooner or later. Personally, I’m expecting a push for a carbon tax, perhaps not now but certainly after the 2014 elections if the position of the Democrats improves.

Carbon taxes have a respectable intellectual pedigree. The British economist Arthur Cecil Pigou (1877-1959) suggested many years ago that government should impose taxes to counteract external costs in the economy. An external cost or “externality” is a cost imposed on people not party to the transaction and therefore not reflected in its price. In the early days of steam trains, for example, sparks from locomotives would set fire to farmers’ crops. Outlawing trains would have been stupid, but adding a tax to freight rates and passenger tickets would increase rail costs to discourage the agricultural damages and provide government with a source of revenue to compensate farmers. With this market distortion corrected through the price, consumers and investors could then set about determining the proper size of the railroad industry without further government interference.

As an approach to reducing carbon emissions, however, a “Pigovian” tax has a fatal flaw: we have no idea how to set a value on carbon, assuming it has any value at all. Many members of the Climate Community insist that human-induced climate change is sure to be so catastrophic that they are under no obligation to place a value on greenhouse gases. After all, you will pay whatever you have to save your life. As discussed in many previous posts, however, the science isn’t that clear.

In evaluating carbon taxes, we also need to bear in mind that the United States is no longer the prime mover of global carbon emissions. In 1990, the world emitted roughly 22 billion metric tonnes (mt) of CO2 from energy sources. The US accounted for 5 billion mt or just under one quarter. In 2013, the Energy Information Administration (EIA) estimates global carbon dioxide emissions of about 33 billion mt, with the USD accounting for just under 18%. By 2035, the EIA expects 43 billion mt of emissions with the US contributing less than 15%. In other words, if the US cuts its emissions by one-third by 2035, global emissions will decline by just 5%.

China, on the other hand, accounted for about 10% of global emissions in 1990, over 25% today (more than the US) and is expected to account for over 30% in 2035. In short, if the Chinese aren’t cutting emissions, then nothing that we do matters much.

We should also note that the EIA 2015 forecast assumes (1) a 51 miles per gallon new car fleet, (2) strong growth in solar energy and electric cars and (3) a continued contribution from wind energy and biofuels. Those programs will have cost a cumulative $1 trillion dollars, and their contribution will consist entirely of slowing the growth in US emissions, not bringing about a reduction in emissions.

Would a carbon tax help? Maybe, but how large should it be? The US currently emits about 5.7 billion mt of carbon dioxide from roughly 120 million households. The average American household therefore emits about 50 mt of carbon dioxide per year. A carbon tax of $10 per mt would initially cost each family $500 per year. OK, but how high would the tax have to be to effect serious carbon reductions? Let’s start with the easy stuff. If all existing federal and state subsidies were eliminated, onshore wind energy would require a carbon tax of about $170 per mt, costing the average family $8,500 per year. Offshore wind farms (such as the infamous Cape Wind Project off Cape Cod) would require a tax of $565/mt, costing each family $28,250. Solar energy? The tax would have to be about $800/mt or $40,000 per family. Light rail systems, those “efficient” people movers so beloved of city planners? You’d need a tax of about $10,000 per mt or $500,000 per family.

Herein lies the problem. Government planners can set a carbon tax either (a) high enough to encourage serious carbon reductions or (b) low enough to avoid severe hardship on average middle class Americans, but not both. All the early efforts at carbon taxes have opted for (b). The European Carbon Exchange is currently trading carbon emission rights at about 8 Euros per mt or $10. The Regional Greenhouse Gas Initiative of northeastern states in the US has a current price of $2. The “cap-and-trade” systems proposed but never adopted in the US Congress put limits on the carbon price of $25-50 per mt, a level equivalent to 20-40¢ per gallon of gasoline, hardly enough to encourage any change in either vehicle technology or consumer habits.

So why bother with carbon taxes at such low levels? The answer is that our elected officials are interested in revenue, not carbon reductions. Take cigarettes for example. American politicians rail at the disastrous effects of smoking on public health. They regard the tobacco companies as the worst kind of corporate criminals and berate them at every opportunity. If they really wanted to stop people from smoking, they could easily outlaw cigarettes and put the tobacco companies out of business. After all, Mayor Bloomberg has outlawed transfats and large soft drinks in New York City. Instead, officials at both the state and federal levels have been careful to set cigarette taxes at levels that maximize revenue, which in fact requires that people NOT stop smoking. If everyone in the US quit smoking tomorrow, most state budgets would collapse.

That’s exactly how Washington will see a carbon tax. Watch for the carbon tax to start at something like $20-25 per mt. That would provide the federal government with roughly $115-140 billion in annual revenue. So what if these taxes bring no carbon reduction? In fact, their very failure would provide a convenient pretext for continually raising the tax. President Obama and the Democrats have been promising for the last five years that they would not raise taxes on the middle class. The President could claim that carbon taxes are an environmental policy, not a tax policy and therefore not in violation of his promise.

It’s my guess that people won’t buy this when they see dollars flowing out of their pocketbooks in higher energy costs. That’s not to say, however, that President Obama won’t give it a try. Governments love to extract revenue from things they condemn, particularly cigarettes, alcohol and gambling. The Europeans long ago added gasoline to their list. Their population acquiesced. Let’s see what Americans do.


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