Air Pollution 5 page Paper

The Benefits and Difficulties Implementing a Carbon Tax in the United States of America, and a

Review of Global Carbon Taxes

STUDENT PAPER EXAMPLE

CEE 373: Fundamentals of Air Pollution

Professor John T. Fox

March 28th, 2014

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Table of Contents

Abstract .................................................................................................................................. iii

Introduction ........................................................................................................................... 1

The benefits of a carbon tax for the United States ................................................................. 1

Difficulties in implementation and inherent disadvantages ................................................... 3

A review of foreign carbon tax systems ................................................................................ 4

Global effects of a U.S. carbon tax ....................................................................................... 6

The potential for carbon taxes worldwide ............................................................................ 8

Conclusions ............................................................................................................................ 9

References .............................................................................................................................. 11

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Abstract

Economic incentives such as carbon taxes have been long-proposed as mitigation

strategies for global climate change. This report examines the potential environmental benefits

and economic disadvantages of a carbon tax for the United States of America, should one ever be

passed. Decreased carbon dioxide emissions and a net increase in US gross domestic product

could result from a carefully designed carbon tax, but the tax would be regressive in nature and

sensitive to its own price, possibly to the point of being economically unstable. Case studies

which support a carbon tax are examined for the European Union, as are a case study on

Australia which shows a carbon tax failure, and a study on British Columbia which is unclear.

Finally, the ways in which a US carbon tax would affect the global economy are considered, and

the potential for global carbon taxes are discussed. The idealist perspective of a unified global

carbon price is debunked, and an alternative which involves national carbon taxes and tariffs is

offered as a realistic alternative.

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Introduction

A carbon tax is most simply defined as a tax on emissions of carbon dioxide. The easiest

and most often-used way of collecting a carbon tax is by charging the initial sources of carbon-

based fuels. Oil, gas, coal, and other energy companies pay the tax on the amount of CO2

emissions their products will generate, and immediately pass the cost of the tax onto consumers.

The idealistic goals of a carbon tax are to quantify the external costs of the pollution created

when consuming energy, and to force consumers to pay those costs. Price signals created by the

tax encourage consumers to use less energy, thereby reducing carbon dioxide emissions.

In addition to these goals, a carbon tax must be economically justifiable. Economic

benefits of a carbon tax may include reductions of other types of taxes, and reductions in the

federal deficit. Problems with carbon taxes include their regressiveness, implementation

difficulty, and public opposition. The United States must balance these benefits and drawbacks

when considering a carbon tax. Luckily, there are many examples of carbon taxes around the

world, including a provincial tax passed in British Columbia, Canada; and national carbon taxes

passed in Australia and several European countries. These examples show carbon taxes with

widely varying degrees of success, and provide good case studies for the United States and any

other country considering a carbon tax.

The global effects of a U.S. carbon tax deserve the greatest amount of attention. The

ways in which a U.S. carbon tax would affect world markets, the competitiveness of U.S.

business in those global markets, world politics, and global climate change are examined. While

generalizations exist about a carbon tax hindering the United State’s economic strength, as well

as the limited effect the tax would have on global climate change, multiple factors support

scenarios in which a carbon tax in the United States could promote significant reductions in

greenhouse gas emissions worldwide, especially from developing countries. Politically scientific

themes predominate in this portion of the report, and allow for a thorough examination of the

relationship between carbon taxes and global climate change.

The benefits of a carbon tax for the United States

Many studies have estimated the positive environmental impacts of a U.S. carbon tax in

the form of CO2 emissions reduced from a projected baseline case in which current national

pollution standards and cap-and-trade legislation remain in effect. Several of these studies

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(NERA 2013, Rausch and Reilly 2012, Dinan 2012) propose taxes in the range of $20-$30

United States dollar (USD) per ton of CO2 emitted, A report prepared by NERA Economic

Consulting for the National Association of Manufactures estimated that a $20/ metric ton tax on

CO2, if implemented immediately and adjusted for inflation each year, would reduce U.S.

emissions from a baseline (untaxed) estimate of 5890 million metric tons to 4110 million metric

tons per year in the year 2053, about a 30% reduction (NERA, 2013). A separate report prepared

by the Massachusetts Institute of Technology Joint Program on the Science and Policy of

Climate Change projected a similar 29% reduction in U.S. CO2 emissions by 2053 by using an

inflation-adjusted $20/ metric ton tax. However, the MIT study projected the baseline and taxed

CO2 emission levels to be about 6800 and 4800 million metric tons, respectively, in 2045: both

higher than the NERA study (Rausch and Reilly 2012). The sensitivity of the emissions

modeling process is demonstrated by these two studies, but the potential reduction percentages

(30% and 29%, respectively) are in relative agreement for the $20/ton tax rate. Higher tonnage

rates were also investigated in both studies: the NERA (2013) study project that CO2 emissions

would be cut by 80% by 2053 with a tax starting at $20/ton and increasing in real value to

$1000/ton in 2053, while Carbone, et al (2013) estimated that a $50/ton tax would cut emissions

by 23% by the year 2025 (note the shorter time scale of this study when comparing percent

reduction values).

While carbon taxation should be designed for the primary purpose of reaping

environmental benefits, the reality is that the tax needs to have economic value in order to be

politically justifiable. This justification can be derived from two key ways in which carbon tax

revenues could be used: to lower other taxes in a revenue-neutral system and to reduce the

federal deficit (Hsu, 2011). In a revenue-neutral system, the revenue generated by the carbon tax

would be equaled by reductions in other taxes, most notably capital, labor, and/or consumption

taxes. Different effects are seen if the income from a carbon tax is applied to a reduction of the

federal deficit each year. In a deficit-reducing scenario, a portion of the revenue generated from

the carbon tax would be returned to consumers in the form of lower taxes elsewhere, but the

remainder would be used for other purposes such as payments on the national debt or for the

funding of subsidy programs.

The $20/ton, annually increasing carbon tax mentioned above would provide between

$1.25 billion (Rausch and Reilly, 2012) and $1.5 billion (Carbone, et al, 2013) in revenue each

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year, in 2012 dollars. The choice between using these funds in a revenue-neutral system, a deficit

reducing plan, or both, lies with the federal government. Carbone, et al (2013) project that a

revenue-neutral $30/ton CO2 tax, which offsets federal capital taxes, would actually contribute to

an increase in the United States’ GDP. Rausch and Reilly (2012) make a similar projection, but

also argue that economic gains will be greater in the long run if 50% of the carbon tax revenue is

used for deficit reduction. Shi-Ling Hsu (2011) notes the environmental double dividend which

is obtained when carbon tax revenue is used for subsidizing alternative energy: pollution is

reduced once during the generation of the revenue, and is reduced a second time when the

revenue is spent. These researchers show that a carbon tax can be economically efficient.

Difficulties in implementation and inherent disadvantages

Public opposition to a carbon tax in the United States is to be expected, even though there

is an ever-growing segment of the population willing to pay a reasonable amount to mitigate

global climate change. Most people hear the words “fuel, price, and increase” in the same

sentence and immediately proclaim their objection to the idea, without exhibiting any form of

rational thought. Energy companies easily promote this wave of public sentiment through

advertisements, lobbying, and campaign contributions. Even the introduction of carbon tax, let

alone its passage in the United States, will be nearly impossible without significant effort on the

part of citizen advocacy groups, environmentally-minded politicians and political advisors,

education groups, and economists. However, as the issue of global climate change grows ever

more salient, both Hsu (2011) and William Nordhaus (2007) both believe that political

conditions will soon become more favorable towards the “drastic” measure of a carbon tax.

In addition to the aforementioned difficulties with implementing a carbon tax in the U.S.,

there are several economic and social disadvantages of carbon taxes. The first argument against a

carbon tax is its regressive nature. Because individuals with lower incomes spend a higher

fraction of their income on home heating, gasoline, and other energy products, those same people

will end up spending a larger percentage of their income on the carbon tax. A $28/ton tax would

cost the average person in the lowest U.S. income bracket about 2.5% of their after-tax income

each year, while costing those in the highest income bracket only about 0.7% of their after-tax

income (Dinan, 2012). While Dinan (2012) recommends additional subsidies be awarded to

those in lower tax brackets to help offset the carbon tax, this represents the least economically

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efficient use of carbon tax revenue and undermines the efforts of revenue neutrality and deficit

reduction. The assurance of welfare is a necessary part of government, whether economically

efficient or not, and it appears that there is presently no solution to a carbon tax’s regressivity.

The strongest disadvantage of a carbon tax is its price sensitivity. If the price of carbon is

set too low, the tax will be ineffective in reducing demand and emissions, and public apathy may

take over. Additionally, a low carbon price can lull people into thinking that they have “done

their part” in mitigating global climate change, and demand for CO2-emitting fuels may actually

increase (Hsu, 2011). Alternatively, a tax rate set too high will cause U.S. industries to be

noncompetitive in both the domestic and world markets, and force companies to move out of the

U.S. and into other countries which have no carbon taxes. Apart from the loss of American

industries and jobs, this tax evasion tax will simply move CO2 emissions to different points on

the globe, and do nothing to mitigate global climate change. This issue is commonly referred to

as “carbon leakage” in the literature, and will be a central subject for the remainder of this report.

National tariffs have been proposed in order to raise the world carbon price, protect domestic

industries, and combat leakage (Anderson and Ekins, 2009). However, tariffs always induce

trade inefficiencies as they cause the burden to consumers to outweigh producers’ gains. Pricing

carbon is a delicate matter, and for the U.S., balancing the domestic carbon price with tariff rates

in order to maximize both emission reductions and economic efficiency will be a daunting task.

A review of foreign carbon tax systems

Despite barriers to carbon taxation, many nations have successfully passed carbon tax

legislation. Nowhere in the world are carbon taxes more prevalent and successful than in Europe,

in which Finland, the Netherlands, Norway, Sweden, Denmark, the United Kingdom, and

Germany have some form of carbon tax. Most of these country’s taxes are deficit-reducing taxes,

with the notable exception of Denmark’s mostly revenue-neutral tax (Sumner and Smith, 2009).

The findings of an extensive study performed by leading European economists and headed by

Mikael Andersen and Paul Ekins are presented in Andersen and Ekins’ book, Carbon Energy

Taxation (Oxford University Press, 2009). Dozens of economic models were used by the

researchers to track emission, pricing, and economic welfare trends in all of Europe, and were

analyzed and compared to determine if the noted countries were successful in reducing

emissions, while maintaining economic efficiency and preventing carbon leakage. The general

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results attributed to Andersen and Ekins are that all seven European countries which have carbon

taxes have benefited environmentally from them, and that evidence is insufficient to suggest that

competitiveness decreased or leakage took place over the term in which carbon taxes exist.

Andersen and Ekins analyzed CO2 emission reductions for the decade between 1994 and

2004, and most of the seven countries had emissions reductions between 4-6% in just a decade.

The UK and the Netherlands saw lower reductions of about 2%, but their carbon taxes did not

exist for the entire decade. Sweden led all countries with 7% CO2 reductions in that decade.

Economic competitiveness was examined for 56 industrial sectors spanning all countries by

modeling four variables: share of global production, profitability in percentage of sales, export

intensity, and import penetration. The models found that nine of those 56 sectors had increased

competitiveness under a carbon tax, 13 sectors had reduced competitiveness, and the remaining

34 sectors were not significantly more or less competitive than their baseline cases assuming no

carbon tax. While this looks like a net loss for the European Union, there is strong evidence that

industrial sectors are at first hurt competitively by carbon taxes, but in the medium- and long-

term become more competitive under a carbon tax. This time-dependency is evidenced by the

fact that eight of the 13 sectors displaying reduced competitiveness were in the UK and

Germany, both of which passed carbon taxes towards the end of the 1994-2004 decade, and

employed extensive exemptions for large emitters (see the Australian tax below). Finally, the

consensus of the models on carbon leakage was that leakage out of the EU summed to

approximately two percent of total EU carbon production. The authors expected that significant

leakage rates on the order of 25-40% would indicate true carbon leakage and loss of EU

industries to other continents. The low leakage rate, deemed statistically insignificant, is in

agreement with the competitiveness calculations described above: if industries are just as

competitive under the carbon tax as they would be without it, it makes sense that leakage would

be minimal.

The Canadian province of British Columbia passed a revenue-neutral carbon tax in 2008

which started at $8.95 USD and rose linearly each year to $26.84 USD per ton (Elgie and

McClay, 2013). A recently completed five-year review of the tax determined that per capita fuel

consumption fell by 17.4% in British Columbia, while rising a modest 1.5% in the rest of

Canada. Total greenhouse gas emissions fell by 10% per capita in British Columbia and only fell

by 1.1% in the rest of Canada, and GDP per capita saw a lower reduction in British Columbia (-

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0.15%) than in the rest of Canada, in which GDP fell -0.23% per capita (Elgie and McClay,

2013). While this study shows promising results for the tax, it is heavily criticized for its use of

per capita data to make reductions in fuel consumption and emissions to appear

disproportionately large in British Columbia and for its lack of a carbon leakage analysis.

Australia has what is the best example of a failed carbon tax. The Australian tax was

introduced on July 1st, 2012, and so far has had no impact on CO2 emissions in Australia and has

contributed to rising unemployment and budget shortfalls (Robson, 2013). Although the tax is

still relatively new, the public and political leaders are currently calling for its repeal. The

Australian tax is flawed in two major ways. In an effort to protect domestic industries, free

permits for the largest emitters are offset by more than one-third of the total tax revenue. About

one-sixth more of the tax revenue is used to fund command and control legislation (Robson,

2013). The tax was passed under the guise of a 50/50 scheme, where half the revenue is returned

to consumers and the other half is used for deficit reduction. The problems are, having taxpayers

pay for free permits is not deficit-reducing, and paying for command and control legislation

directly cancels out carbon tax revenue. The economic inefficiency (dead weight) of this tax is

nearly 50%, and Australia provides a lesson in what not to do with carbon tax revenues.

China is one of the more interesting countries to examine. Pollution in major Chinese

cities such as Beijing is so overwhelming that it is a tangible social issue, in addition to an

economic and environmental issue. Public support for pollution controls and a growing Chinese

middle class have led Chinese premier Li Keqiang to declare a “war on pollution,” according to

an article published in the Sydney Morning Herald on March 13th, 2014. Vice environment

minister Zhu Guangyao has identified that a carbon tax is being considered along with a broader

environment tax and cap-and-trade legislation.

Global effects of a U.S. carbon tax

The International Panel on Climate Change, in their fifth assessment report, warned that

an increase in global average temperatures above 2.5°C from pre-industrial levels, by the year

2100, is enough to cause “irreversible” and “drastic” changes in natural systems (Collins, et al,

2013). The report also projected that temperatures would rise anywhere between 2°C and 4.5°C

by the end of the 21st century, depending on many emission reduction scenarios, including the

“do nothing” scenario. The astute reader, after finishing the “Benefits of a carbon tax for the

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United States” section of this report, would have immediately wondered what effect the CO2

emissions savings discussed in that section would have on global climate change. Unfortunately,

an answer to that question is difficult to obtain. There is much speculation which attempts to

answer this question, but no real quantify the effect of CO2 reduction in the U.S. alone. As an

example of this speculation, a paper by Paul Knappenberger (2013), which does not appear to be

peer-reviewed, estimates that the U.S. could cause a “savings” of 0.2°C in global temperature

increase by the year 2100 if all CO2 emissions in the country ceased immediately. The author

uses this “insignificant” reduction as an argument against the carbon tax.

A calculation with a lower degree of difficulty is that which attempts to establish global

CO2 concentration goals for various climate change scenarios. The IPCC advocates an eventual

return to a CO2 concentration of about 350 ppm in order to eliminate the trend in increasing

global temperatures. Other researchers have estimated that the 2.5°C rise in global temperatures

will be achieved by a stabilization of CO2 concentration at 560 ppm, or twice pre-industrial

levels (Stern, 2006; and Nordhaus, 2007). The famous “Stern Review,” authored by Nicholas

Stern (2006) of the London School of Economics, recommends a worldwide carbon tax starting

at $85/ton and increasing thereafter, in order to achieve this CO2 and temperature stabilization.

Comparatively, a $20-$30/ton tax on carbon in the U.S. alone wouldn’t be expected to achieve

very much. However, the Stern study has one of the highest carbon tax estimates published, and

has been criticized for overestimating the price of carbon in order to achieve political

mobilization (Nordhaus, 2007).

William Nordhaus, a Yale professor of Economics, provided a thorough examination of

the Stern report and agreed in principle with the effectiveness of uniform global carbon taxation,

but arrived at very different conclusions about the carbon price. In Nordhaus’ (2007) model, the

optimum price for stabilizing emissions at 560 ppm, and so limiting global temperature increases

to 2.5°C by 2100, would be between $27 and $31 per ton of CO2 emitted. This price level is

much closer to the carbon tax levels which have been modeled by Carbone (2013), Dinan (2012)

and Rausch and Reilly (2012) for the U.S., and which have already been employed in other

countries. By this estimate, then, a carbon tax in the United States at about the $30/ton level

would be in line with estimates from economic and environmental models for global climate

change mitigation. The Knappenberger, Stern, and Nordhaus examples are cited not to

definitively evaluate whether a U.S. carbon tax would mitigate global climate change itself, but

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to illustrate the variety of estimates which have been made about the tax and the fact that from an

environmental standpoint, any scenario is better than the “do nothing” approach.

The political effects of a U.S. carbon tax are perhaps the most difficult to predict. By the

time a carbon tax is implemented, the U.S. could either be a leader or follower in climate change

legislation. Global climate change mitigation, how carbon taxes in the U.S. and other countries

can achieve mitigation, and the possibility of a unified global carbon tax, are all examined in the

next section.

The potential for carbon taxes worldwide

A global carbon tax in its idealized form has two characteristics: it is the same price

everywhere in the world, and is priced high enough to reduce energy demand to levels at which

CO2 concentrations are sustainable. This is an unrealistic scenario for many reasons, primarily

because the benefit of a country suddenly reducing its carbon tax to attract industry is large.

Most countries will not voluntarily hobble themselves with a carbon tax which could drive out

businesses and suppress economic growth, yet for a global carbon tax to become a reality, every

country must do precisely that at the same time (Nordhaus, 2007). Cultural views on

industrialization and global climate change will also prevent this idealized global carbon tax

from ever taking shape. Industrialized nations are quick to point out that they have already

decreased their emissions significantly, and the burden of mitigating global climate change now

falls largely on developing nations. Developing and underdeveloped nations respond with the

notion that industrialized nations have contributed all of the anthropogenic CO2 emissions up to

this point, and should be responsible for mitigating the effects of those emissions. Debates in

international circles about who is responsible for CO2 emissions, and how much they’re

responsible for, are unending.

However, countries have enacted carbon taxes for various reasons, as seen in previous

sections of this report: to raise revenue, to combat visible pollution problems in large cities, and

even primarily with environmental considerations in mind. The varied purposes of existing and

proposed carbon taxes show promise that a web of carbon taxes can be successful in countries

around the world. The most realistic scenario for effective global climate change mitigation is

not an all-encompassing global carbon tax as described in the previous paragraph, but separate,

self-administered taxes in countries which are the highest producers of carbon dioxide (Hsu,

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2011). The U.S., China, and India were responsible for 15%, 29%, and 6%, respectively, of the

world’s CO2 emissions in 2012 (Oliver, et al, 2013). These three countries alone generated about

half of the world’s CO2 emissions that year. Carbon taxes in those three countries, assuming the

approximate reduction rate of 30% predicted by NERA and Rausch and Reily, would decrease

global emissions by about 15% by mid-century with little economic sacrifice.

Because the largest producer and consumer economies would be covered if these three

nations enacted carbon taxes, the propensity for leakage could easily be minimized by an

international price agreement. With a unified carbon price, companies would have a hard time

relocating away from these three countries to avoid carbon taxes. There simply aren’t any other

countries which have the consumer power of the U.S. and China, or the labor supply of China

and India. These factors incentivize companies to remain invested in these countries despite the

tax cost, which is an example of consumer and producer power.

Even if no price agreements between the countries can be reached, tariffs can be used to

unify the prices of carbon between those three countries. The tariffs may only be needed

temporarily until prices can self-adjust on an international level, if the carbon taxes in Europe in

the late 20th century are any indication of how carbon taxes would behave in the global economy.

Furthermore, Anderson and Ekins (2009) report that the Chinese Council for International

Cooperation on Environment and Development (CCICED) suggested tariffs on carbon exports

from developing nations. While seemingly counter-intuitive for the competitiveness of producing

countries in global markets, Anderson and Ekins support these tariffs because they recycle tax

revenue in the producing country instead of awarding payouts to consuming countries. The

opportunity for a revenue surplus also exists when using an export tax as opposed to an import

tax. Export tariffs give nations greater control over the supply of goods and price that consumers

pay than steep import taxes do, and for those reasons warrant consideration as instruments to

unify global carbon prices.

Conclusions

Both environmental and economic sciences favor a carefully constructed carbon tax in

the United States. Despite the economic efficiencies and price sensitivities associated with a

carbon tax, the benefits to both the environment and the U.S. economy are projected to be small,

but most importantly, positive. These positive effects have been demonstrated most notably in

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the European Union, among other places, and prove the effectiveness of carbon taxes. The

debate on how global climate change is best mitigated will continue, but many economists and

climate scientists agree that a global carbon tax is the idealistic perfect scenario for reducing

emissions of CO2 and other greenhouse gases. While this ideal scenario cannot realistically be

achieved, it can at least be approached by a structure of national carbon taxes and tariffs. The

United States has the opportunity to join with developing and other developed and nations in

creating this global economic structure.

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