A Simple, Effective, and Widely Unpopular Climate Policy
Is it finally time for a carbon tax?
With a new administration on the horizon, the hope of some long-awaited climate change action from our government is finally back. In his energy plan, Joe Biden pledges to make a lot of sensible moves, such as bolstering the solar and wind industry, incentivizing the use of clean energy, and investing in technologies like grid-level storage and small-scale nuclear reactors. Now these are all great, but they come with familiar criticisms about how the government is supposed to pay for it, how will they help transition workers, and how can we actually lower our energy dependence.
The current ways to deal with these concerns likely involve some complicated financial footwork with winners and losers, but what if there was a simple, minimal step solution? What if this fix also effectively disincentivized poor energy use? What if it was so unpopular that any politician would run at the very thought of it? Yes, I am talking about the so often misunderstood carbon tax.
Externalities
Before we get into the typical aversions to another tax and the political ramifications it would bring, let’s just take a moment to understand the nature of the problem. The idea to tax carbon emissions comes directly from the environmental economics concept of externalities. An externality is a consequence caused by an individual or organization’s action that affects other parties and is not included in the cost of the action. A simple example is waste pollution. A corporation that pollutes the ocean doesn’t necessarily feel and certainly doesn’t pay for the negative impacts on the people and wildlife that use it. Carbon emissions are another prime example. Currently, no person or organization fairly pays for the damages they cause to society by emitting CO2.
Externalities are perhaps the biggest threat to a totally free market economy. Without restrictions or deterrents from an outside source, there is no incentive for corporations to keep externalities in check. Because they do not pay for the true social cost, they will keep extracting pure profit until the damage is irreversible.
Luckily, there is a tried and true solution for dealing with externalities. By implementing a well-priced tax directly on the causes of an externality, you can incentivize against it and collect money to pay for the damages. Therefore, you are effectively attacking the problem from both sides.
The Social Cost of Carbon
The solution can be as simple as an all-encompassing price on each tonne of CO2 released into the air for any activity, however, the tricky part is determining that price. This is where the term “the social cost of carbon” comes into play. Determining this cost has been the goal of many scientific efforts and was popularized during the Obama administration. At the time, the President publicized a price of about $36 per tonne of carbon, which, in a likely attempt to keep political critics in check, probably underestimated the true price.
Three main factors go into determining the social cost of carbon that I will briefly explain. They are: 1) how much does each tonne of carbon affect the climate; 2) what will be the social damages of climate change and when will they occur; and 3) how should we discount future damages when paying for them today.
The first one is the only question with enough data and hard science to warrant consistent estimates. This results in a simple relationship between carbon ppm in the atmosphere and the Earth’s temperature; however, other climate aspects like storm and drought frequencies are a bit harder to project.
The second step is the most daunting. Determining every cost, and maybe even the few benefits, of rising temperatures is an arduous task. One of the most heavily researched models to do so is called DICE (Dynamic Integrated Climate and Economy), led by William D. Nordhaus. In the most recent version of the DICE model, the relationship between temperature change and damages is an exponential line that best fits 16 estimated data points collected from other independent studies. So in a sense, they outsourced this calculation by first collecting estimations from others, then evaluating their reliability, and finally fitting a line to the most credible data points. Rather than providing a single answer, this model is meant to be used as a tool so that researchers or the EPA can plug in different parameters and see the outcomes.
The third step is the most influential. Determining how much we should discount future damages when paying for them today has a huge impact on the eventual price. Using a discount rate of 5% vs 2% decreases the value of damages 50 years in the future by over 75%. So while we could endlessly debate the better option, let’s just meet somewhere in the middle at 3%.
Combining all of these steps and applying the average input parameters of most scientists leads to a social cost of carbon estimate of about $45 in 2020.
Tax Policy
So if this were a tax, what would it mean? Burning a full tank of gas releases about 10% of a tonne of CO2 into the air, which would mean you’d be taxed about $4.50 for each fill-up. And a 2-hour plane flight might incur a tax of $5-$10. According to a simple supply and demand exercise, consumers and corporations/suppliers will share the price increase of these goods and services, but since energy use is relatively inelastic, the consumer will likely bear most of the burden.
Therefore, these prices are definitely not negligible and might turn a lot of people off from the idea of a carbon tax. Furthermore, this tax may be considered regressive as it puts a heavier burden on the working class that can’t afford higher prices for essential energy use.
But not if we give most of it back. What if more than half of the money collected by the tax was split evenly and returned to each citizen? If the average American accounts for 16 tonnes of CO2 per year, as recent studies suggest, then that could result in a collection of about $720 per person. If the majority of that, let’s say $500, was given back to each citizen this would far outweigh the amount paid throughout the year by someone in the working class, which could be as small as $150.
We would essentially be instituting the exact opposite of an externality. Those causing the damages would pay, while society as a whole would benefit. The intent of this tax is not to increase income for the federal government, but to make every energy decision a personal one, where emitting has financial consequences. The nature of this system, where individuals feel responsible and have control over how much tax they pay, would greatly incentivize living a greener lifestyle, from buying cleaner consumer products to choosing renewable sources for your home electricity. And the corporations that take this seriously would finally gain a competitive edge over those that pollute more freely.
You might ask though if CO2 emissions harm those of future generations, then why would we give the money collected to people today? We should save some for those affected in the future, but it seems strange to create a sort of “Apologies for Polluting” savings account. A smarter way to achieve a similar effect would be to invest in technologies that reduce emissions or capture carbon. With an estimated yearly collection of $230B (using $720 per person), the remaining unreturned money ($70B) could have a pretty substantial impact on the acceleration of these technologies, thus minimizing the damages imparted on future generations.
With the growing concern and frightening outlooks regarding the future of our climate, it may seem like too daunting of a challenge to overcome. But I hope that through this exercise, we may realize that for the right price, no problem is unfixable.
