Real Clear Markets

The Tax Favored By Most Economists

Looking for a public policy that would improve the operation of the economy, lower our dependence on foreign oil, reduce pollution, slow global warming, allow cuts in government spending, and decrease the long-term deficit? Then a carbon tax is what you want. As one of the few taxes favored by economists, carbon taxes could help the nation address several issues simultaneously.

The basic rationale for a carbon tax is that it makes good economic sense: unlike most taxes, carbon taxation can correct a market failure and make the economy more efficient. Although there are substantial benefits of energy consumption, there are also substantial societal costs – including air and water pollution, road congestion, and climate change. Since many of these costs are not directly borne by those who use fossil fuels, they are ignored when energy production and consumption choices are made, resulting in too much consumption and production of fossil fuels. Economists have long recommended a tax on fossil-fuel energy sources as an efficient way to address this problem.

Not surprisingly, most analyses find that a carbon tax could significantly reduce emissions. Tufts University economist Gilbert Metcalf estimated that a $15 per ton tax on CO2 emissions that rises over time would reduce greenhouse gas emissions by 14 percent. Another study estimated that the European countries’ carbon taxes have had a significant effect on emissions reductions.

Although a carbon tax would be a new policy for the federal government, it has been implemented in several other countries (though not always in the manner advocated by economists), including the Scandinavian nations, the Netherlands, Germany, the United Kingdom, and Australia. The Canadian provinces of Alberta and Quebec adopted carbon taxes in 2007, followed by British Columbia in 2008. Meanwhile, California, the 9th largest economy in the world, has recently initiated a cap-and-trade system, which auctions carbon permits to companies.

Estimates suggest that a well-designed tax in the United States could raise amounts ranging up to 1 percent of GDP, revenue that could and should be used to reform other taxes or address the country’s substantial and unsustainable medium- and long-term budget deficits.

A carbon tax could have other benefits too, including reducing the American economy’s dependence on foreign sources of energy and creating better market incentives for energy conservation, the use of renewable energy sources, and the production of energy-efficient goods. The permanent change in price signals from enacting a carbon tax would stimulate new private sector research and innovation in developing energy-saving technologies and in harnessing renewable energy. The implementation of a carbon tax also offers opportunities to reduce and reform federal spending on other energy-related programs.

Two problems are sometimes raised in response to a federal carbon tax proposal. The first is its impact on low-income households, who use most of their income for consumption. However, this regressivity could be offset in any of a number of ways, including refundable income tax credits or payroll tax credits. Thus, while this is clearly a concern, it should not be prohibitive to implementing a carbon tax.

The second concern is whether the U.S. should act unilaterally. Without cooperation from the rest of the world, critics fear that a U.S. carbon tax would reduce economic activity here and make little difference to overall carbon emissions or levels. This view, however, understates the value of a permanent price signal for research and development and the social and environmental value of the reduction in carbon emissions that would come from U.S. action. It also discounts the experience of other countries that unilaterally created carbon taxes; there is no evidence that they paid a significant price, or any price at all, in terms of economic activity levels. If there is ever going to be multilateral action to limit carbon emissions, the US – as the largest per-capita emitter of carbon dioxide – needs to take a leading role.

No one is claiming the carbon tax is a perfect outcome. But relative to the alternatives, it has an enormous amount to offer.