Editor’s Note: On May 22, Adele Morris participated in a Capitol Hill briefing hosted by the Center for Climate and Energy Solutions. At the briefing, Morris and her co-author Aparna Mathur discussed carbon pricing options. Watch her full presentation.
A full assessment of climate policy options requires understanding the policies’ potential benefits and costs. Such an assessment necessarily draws from the different technical disciplines that study trends in global temperatures; model the potential impacts of increasing greenhouse gas (GHG) concentrations in the atmosphere, and assess the likely economic impacts of policies designed to abate GHG emissions—including macroeconomic outcomes and distributional impacts.1 This paper examines the issues and options for designing an economically efficient policy for reducing GHG emissions and leaves the scientific case for such a policy to others.
We start with the premise that policies that charge emitters of GHGs in proportion to the damage caused by their emissions would create widespread market signals that efficiently lower emissions across the economy over time. The price signals would shift consumer demand, drive new investment, and encourage technology development toward less emissions-intensive goods and services. While other environmental policies, such as investments in basic research on low-emissions technologies, might be justified, economists widely agree that a price on GHGs, and carbon dioxide (CO2) in particular, would be an important element in an economically efficient environmental policy portfolio.2 There are multiple ways to put a price on carbon, but the two most comprehensive are an emissions tax and a cap-and-trade system. Given the recent focus on tax reform and deficit reduction in the United States, this paper explores the design options and implications of a carbon tax embedded in broader fiscal reform.
When economists talk about a GHG or carbon tax, they generally have several key features in mind. First, the tax would be an excise tax on the carbon content of fossil fuels. It would apply to other sources of CO2 and non-CO2 greenhouse gas emissions (with the tax scaled to those gases’ heat-trapping properties relative to CO2) to the extent emitters and emissions are readily identifiable and taxing them would be administratively feasible. Second, the tax would be applied to fossil fuels as they enter the economy, at the choke points in their distribution system so that a large share of emissions could be taxed via a minimum number of firms. Next, the price signal would start modestly (although views differ in what that means) and ramp up gradually in real terms. Finally, the policy would allow tax credits for carbon in fuels that is not subsequently emitted, for example because it is sequestered underground or embodied in a long-lived product, such as plastics. All in all, economists generally recommend that the excise tax be simple and comprehensive, with few exemptions, complications, and ancillary policies. Of course, in practice it may not be that simple. Legislation may diverge substantially from the economists’ ideal, and some tax design details raise important challenges for which there is not a single obvious resolution, such as whether and how to address the burdens of the carbon tax on the poor.
This paper reviews options for the design of a GHG tax in the United States. It first surveys the possible justifications for establishing a carbon tax and discusses its potential role in a broader fiscal reform package.3 We review evidence on how much revenue a carbon tax could raise, and by how much it could reduce emissions. We consider issues such as how to set the carbon price trajectory, options for using the revenue, and the likely distributional effects of different approaches. We also discuss how the tax could allow changes in command-and-control regulation of greenhouse gases and other energy policies, and how to prevent a U.S. carbon price from disadvantaging U.S. firms relative to their competitors in countries that do not equivalently control emissions.