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A coal fired power plant in Luchegorsk, Russia.
A carbon tax would tax electricity production using coal.
A carbon tax is an environmental tax on emissions of carbon dioxide. Carbon dioxide is a heat-trapping "greenhouse" gas. The purpose of a carbon tax is to protect the environment by reducing emissions of carbon dioxide, helping to mitigate climate change. Some environmental taxes include other greenhouse gases; the global warming potential is an internationally accepted scale of equivalence for other greenhouse gases in units of tonnes of carbon dioxide equivalent.

Carbon atoms are present in every fossil fuel (coal, petroleum, and natural gas) and are released as CO2 when they are burnt. In contrast, non-combustion energy sources—wind, sunlight, hydropower, and nuclear—do not convert hydrocarbons to carbon dioxide. A carbon tax can be implemented by taxing the burning of fossil fuels—coal, petroleum products such as gasoline and aviation fuel, and natural gas—in proportion to their carbon content. If carbon dioxide emissions are not released into the atmosphere on combustion of fossil fuels, e.g., carbon capture and storage, then a carbon tax will not apply. Accordingly, a carbon tax increases the competitiveness of low-carbon technologies, such as renewables, compared to the traditional burning of fossil fuels.

Background

Carbon dioxide: global warming contributor

Scientific consensus holds that anthropogenic greenhouse gase emissions are the primary cause of global warming. Carbon dioxide is a major greenhouse gas and as such it is considered an air pollutant. Worldwide, 27 billion tonnes of carbon dioxide are produced by human activity annually. Two governmental mechanisms are being considered or implemented to reduce this amount: environmental taxes (of which the carbon tax is one) and capping emissions.

Economic theory

A carbon tax is an indirect tax—a tax on a transaction—as opposed to a direct tax, which taxes income. A carbon tax is also called a price instrument, since it sets a price for carbon dioxide emissions. In economic theory, pollution is considered a negative externality, a negative effect on a party not directly involved in a transaction, which results in a market failure. To confront parties with the issue, the economist Arthur Pigou proposed taxing the goods (in this case fossil fuels) which were the source of the negative externality (carbon dioxide) so as to accurately reflect the cost of the goods' production to society, thereby internalizing the costs associated with the goods' production. A tax on a negative externality is called a Pigovian tax, and should equal the marginal damage costs.

Within Pigou's framework, the changes involved are marginal, and the size of the externality is assumed to be small enough not to distort the rest of the economy. Some argue that impact of climate change could result in catastrophe and non-marginal changes."Non-marginal" means that the impact could, at some time future date, significantly reduce the growth rate in income and welfare. The amount of resources that should be devoted to avoiding low-probability, high cost climate change impacts is controversial. Policies designed to reduce carbon emissions could also have a non-marginal impact.

Prices of carbon (fossil) fuels are expected to continue increasing as more countries industrialize and add to the demand on fuel supplies. In addition to creating incentives for energy conservation, a carbon tax would put renewable energy sources such as wind, solar and geothermal on a more competitive footing, stimulating their growth. Former Federal Reserve chairman Paul Volcker suggested (February 6, 2007) that "it would be wiser to impose a tax on oil, for example, than to wait for the market to drive up oil prices."

Social cost of carbon

The social cost of carbon (SCC) is the marginal cost of emitting one extra tonne of carbon (as carbon dioxide) at any point in time. To calculate the SCC, the atmospheric residence time of carbon dioxide must be estimated, along with an estimate of the impacts of climate change. The impact of the extra tonne of carbon dioxide in the atmosphere must then be converted to the equivalent impacts when the tonne of carbon dioxide was emitted. In economics, comparing impacts over time requires a discount rate. This rate determines the weight placed on impacts occurring at different times.

According to economic theory, if SCC estimates were complete and markets perfect, a carbon tax should be set equal to the SCC. Emission permits would also have a value equal to the SCC. In reality, however, markets are not perfect, and SCC estimates are not complete.

An amount of CO2 pollution is measured by the weight (mass) of the pollution. Sometimes this is measured directly as the weight of the carbon dioxide molecules. This is called a tonne of carbon dioxide and is abbreviated "tCO2". Alternatively, the pollution's weight can measured by adding up only the weight of the carbon atoms in the pollution, ignoring the oxygen atoms. This is called a tonne of carbon and is abbreviated "tC". Estimates of the dollar cost of carbon dioxide pollution is given per tonne, either carbon, $X/tC, or carbon dioxide, $X/tCO2. One tC is roughly equivalent to 4 tCO2.

The 2007 IPCC report contains an assessment of the literature on the SCC: Peer-reviewed estimates of the SCC for 2005 have an average value of $43/tC with a standard deviation of $83/tC. The wide range of estimates is explained mostly by underlying uncertainties in the science of climate change (e.g., the climate sensitivity), different choices of discount rate, different valuations of economic and non-economic impacts, treatment of equity, and how potential catastrophic impacts are estimated. Other estimates of the SCC span at least three orders of magnitude, from less than $1/tC to over $1,500/tC. The true SCC is expected to increase over time, probably at a rate of 2 to 4% per year.

Border Issues

Concerns have been raised about carbon leakage, the tendency for energy-intensive industries to avoid a carbon tax by migrating from nations with a carbon tax to nations without a carbon tax because the cost of energy is cheaper there. One solution to this problem is for carbon-taxing countries to levy carbon-equivalent tariffs on imports from non-taxing nations. A paper by Neuhoff (2008) considers the impact of carbon pricing on the economy and carbon leakage:

[...] for 98%-99% of economic activities the cost increase from carbon pricing is trivial relative to other cost components.
Only in 24 sub-sectors the cost increases from carbon emissions are significant.
Because of factors like transport costs, product differentiation, and sunk investment costs there is no concern about leakage in several of these sub-sectors.
Thus only a few sub-sectors, like basic steel and cement production, are likely to require targeted measures to address leakage concerns.


Petroleum (motor gasoline, diesel, jet fuel)

Many OECD countries have taxed fuel directly for many years for some applications; for example, the UK imposes duty directly on vehicle hydrocarbon oils, including petrol and diesel fuel. The duty is adjusted to ensure that the carbon content of different fuels is handled with equivalence.

While a direct tax should send a clear signal to the consumer, its use as an efficient mechanism to influence consumers' fuel use has been challenged in some areas:
  • There may be delays of a decade or more as inefficient vehicles are replaced by newer models and the older models filter through the 'fleet'.
  • There may be practical political reasons that deter policy makers from imposing a new range of charges on their electorate.
  • There is some evidence that consumers' decisions on fuel economy are not entirely aligned to the price of fuel. In turn, this can deter manufacturers from producing vehicles that they judge have lower sales potential. Other efforts, such as imposing efficiency standards on manufacturers, or changing the income tax rules on taxable benefits, may be at least as significant.
  • In many countries fuel is already taxed to influence transport behavior and to raise other public revenues. Historically, they have used these fuel taxes as a source of general revenue, as their experience has been that the price elasticity of fuel is low, thus increasing fuel taxation has only slightly impacted on their economies. However, in these circumstances the policy behind a carbon tax may be unclear.


Some also note that a suitably priced tax on vehicle fuel may also counterbalance the "rebound effect" that has been observed when vehicle fuel consumption has improved through the imposition of efficiency standards. Rather than reduce their overall consumption of fuel, consumers have been seen to make additional journeys or purchase heavier and more powerful vehicles.

Calculation

A carbon tax that compensates for the SCC varies by fuel source. The carbon dioxide production of the fuel source per unit mass or volume is multiplied by the SCC to obtain the tax. Based on the mean peer reviewed value ($43/tC or $158/tCO2), the table below estimates the tax:

Fuel CO2 Emissions
(lbs CO2per fuel volume or mass)
Tax
(per fuel volume or mass)
CO2 Emissions
per BTU of electricity
(lbs./million BTU)

Tax per KWHThe calculation is: A lbs CO2/million BTU x (1 million BTU/ 1000000 BTU) x (1 BTU/.00029 KWH) x (1 tonne/2205 lbs) x ($158/tonne CO2) = B $/KWH
gasoline 19.6 lbs CO2/gallon $1.41/gallon n/a n/a
deisel fuel 22.4 lbs CO2/gallon $1.59/gallon n/a n/a
jet fuel 22.1 lbs CO2/gallon $1.58/gallon n/a n/a
natural gas 120.6 lbs CO2/cu. ft. $8.63/cu. ft. 117 $0.029
coal(lignite) 2791 lbs. CO2/ton n/a 215 $0.054
coal(subbutuminous) 3715 lbs. CO2/ton n/a 213 $0.053
coal(butuminous) 4931 lbs. CO2/ton n/a 205 $0.050
coal(anthracite) 5685 lbs. CO2/ton n/a 227 $0.055


Implementation

Australia

A cap-and-trade scheme or a carbon tax are options which are being considered in Australia. In 2007, the Productivity Commission suggested that a carbon tax should implemented. Currently, the government seems to be leaning towards establishing a cap-and-trade.

European Union

During the 1990s, a carbon/energy tax was proposed at the EU level but failed due to industrial lobbying. On January 1, 1991, Swedenmarker enacted a carbon tax, placing a tax of 0.25 SEK/kg ($100 per ton) on the use of oil, coal, natural gas, liquefied petroleum gas, petrol, and aviation fuel used in domestic travel. Industrial users paid half the rate (between 1993 and 1997, 25% of the rate), and certain high-energy industries such as commercial horticulture, mining, manufacturing and the pulp and paper industry were fully exempted from these new taxes. In 1997 the rate was raised to 0.365 SEK/kg ($150 per ton) of CO2 released. In 2007, Sweden will raise taxes on carbon emissions.

On September 10, 2009 Francemarker detailed a new carbon tax with a new levy on oil, gas and coal consumption by households and businesses coming into effect during 2010. The new carbon tax is 17 euros (25 US dollars) per tonne of carbon dioxide (CO2), which will raise the cost of a litre of unleaded fuel by about four cents (25 US cents per gallon). The tax will not apply to electricity as mostly produced by France's network of nuclear reactors.

Finlandmarker, the Netherlandsmarker, and Norwaymarker also introduced carbon taxes in the 1990s. Finland was the first to introduce the tax. In Italymarker, carbon tax was introduced or modified with the article 8 of the law December 23, 1998, n. 448, according to the conclusions of the Kyoto Conference of 1–11 December 1997.

In 1993, the UKmarker government introduced the fuel duty escalator (FDE), an environmental tax on retail petroleum products. The tax was explicitly designed to reduce carbon dioxide emissions in the transport sector. Since carbon is in fixed ratio to the quantity of fuel, the FDE roughly approximated a carbon tax. The transport lobby in the UK was extremely critical of the FDE. The FDE, which was the UK's only 'real' carbon tax, failed because of the political criticism it provoked, and the automatic increase of the FDE was cancelled in 1999. Increases in fuel tax have since been discretionary. The politically-damaging fuel protests in 2000 contributed to the government decision to reduce the real rates of fuel tax. At the time, tax and duty represented more than 75% of the total pump price. In money terms, the past increments of the FDE remain in force, but in real terms, increments have been reduced by the rate of inflation. In 2006, tax represented about ⅔ of the pump price.

In Irelandmarker it is speculated that carbon taxes will be introduced in the 2010 budget (which will be delivered at the end of 2009). No carbon tax was introduced in the emergency April 2009 budget.

United States

In 1993, then President Bill Clinton proposed a BTU tax. It would have taxed all fuel sources based on their heat content except for wind, solar, and geothermal. It was never adopted. His Vice President, Al Gore, had strongly backed a carbon tax in his book, Earth in the Balance, but this became a political liability after the Republicans attacked him as a "dangerous fanatic". In 2000, when Gore ran for President, one commentator labeled Gore's carbon tax proposal a "central planning solution" harking back to "the New Deal politics of his father." In April 2005, Paul Anderson, CEO and Chairman of Duke Energy, called for the introduction of a carbon tax. In January 2007, economist Charles Komanoff and attorney Dan Rosenblum launched a Carbon Tax Center to give voice to Americans who believe that taxing carbon emissions is imperative to reduce global warming.

In November 2006, voters in Boulder, Coloradomarker passed the first municipal 'carbon tax', a tax on electricity consumption (utility bills) with deductions for using electricity from renewable sources (primarily Xcel's WindSource program). Revenues go to fund programs by the city to reduce greenhouse gas emissions.

In May 2008, the Bay Area Air Quality Management District, which covers nine counties in the San Francisco Bay Areamarker, passed a carbon tax on businesses of 4.4 cents per ton of CO2.

Some states are considering the imposition of carbon taxes. For example in 2006, the state of Californiamarker, passed AB-32 which requires California to reduce greenhouse gas emissions. In a effort to execute AB-32, the California Air Resources Board put forth the idea to implement a carbon tax but has yet to reach agreement with the Western States Petroleum Association who represent the refineries in the state. The WSPA holds that AB-32 only allows a carbon tax to cover administrative costs.

Canada

On February 19, 2008, the Canadianmarker province of British Columbiamarker announced its intention to implement a carbon tax of $10 per tonne of carbondioxide equivalent (CO2e) emissions (2.41 cents per litre on gasoline) beginning July 1, 2008, making BC the first North American jurisdiction to implement such a tax. The tax will increase each year after until 2012, reaching a final price of $30 per tonne (7.2 cents per litre at the pumps).Unlike previous proposals, legislation will keep the pending carbon tax revenue neutral by reducing corporate and income taxes at an equivalent rate. Also, the government will also reduce taxes above and beyond the carbon tax offset by $481 million over three years.

In the 2008 Canadian federal election a carbon tax proposed by Liberal Party leader Stéphane Dion, known as the Green Shift, became a central issue in the campaign. It would have been revenue-neutral, with increased taxation on carbon being balanced by tax cuts for individual citizens. However, it proved to be unpopular and led the Liberal Party to its worst share of the popular vote since Confederation.

New Zealand

In 2005, the Fifth Labour Government proposed a carbon tax for New Zealandmarker in order to meet obligations under the Kyoto Protocol. The proposal would have set an emissions price of NZ$15 per tonne of CO2-equivalent. The planned tax was scheduled to take effect from April 2007, and applied across most economic sectors though with an exemption for methane emissions from farming and provisions for special exemptions from carbon intensive businesses if they adopted world's-best-practice standards of emissions.

After the 2005 election, the minor parties supporting the Fifth Labour Government opposed the proposed tax, and it was abandoned in December 2005. In 2008, the New Zealand Emissions Trading Scheme was passed into law.

Carbon taxes compared to cap-and-trade

An alternative government policy to a carbon tax is a cap on greenhouse gas (GHG) emissions. Emission levels of GHGs are capped and permits to pollute are freely allocated (called "grandfathering") or auctioned to polluters. Auctioning permits has significant economic advantages over grandfathering. In particular, auctioning raises revenues that can be used to reduce distortionary taxes and improve overall efficiency. A market may be allowed for these emission permits so that polluters can trade some or all of their permits with others (cap-and-trade). A hybrid instrument of a cap and carbon tax can be made by creating a price-floor and price-ceiling for emission permits. A carbon tax can also be implemented concurrently with cap.

Both cap-and-trade and carbon taxes give polluters a financial incentive to reduce their GHG emissions. The main difference between them is that carbon taxes provide price certainty on emissions, while a cap provides quantity certainty on emissions. According to Weitzman (1974), uncertainty over the impacts of climate change and the future costs of reducing carbon intensity (i.e., the carbon output per unit of energy), are reasons to support price stability.

It has been argued that compared with carbon markets, carbon taxes have several problems. One problem is that a tax suffers from combining a set price for carbon along with a transfer of revenue from industry to government. According to the Carbon Trust, this guarantees that the price will not be set at the appropriate level, but will instead be determined by the politics of large-scale revenue transfers.

Unlike a cap system with grandfathered permits, a carbon tax raise revenues. If the revenues are used to reduce other distortionary taxes, this can improve the efficiency of the tax. On the other hand, a cap with grandfathered permits can have an efficiency advantage of being applied to all industries. This provides an equal incentive at the margin for all polluters to reduce their emissions. This is an advantage over a tax that exempts or has reduced rates for certain sectors.

Support

A number of leading scientists, economists, environmentalists, opinion leaders, and business leaders from across the political spectrum support a carbon tax. Some American conservative have supported such a carbon tax because it taxes at a fixed rate, independent of income, which complements their support of a flat tax.Carl Pope, executive director of the Sierra Club, supports a carbon tax over cap-and-trade because employers will know exactly what they paid for the carbon dioxide they produced, and because a cap-and-trade system (with grandfathered permits) rewards those who have the highest emissions now and have done the least to reduce them previously.The American Enterprise Institute, Environmental economist Jack Pezzey, economist Jeffrey Sachs (director of the Earth Institute of Columbia University), Yale economist William Nordhaus, The Earth Policy Institute, The Australia Institute, the Centre for Independent Studies, James Hansen, NASA scientist, and Harvard professor, Gregory Mankiw also prefer carbon taxes to cap-and-trade.Gary Becker, a conservative economist, expressed his support for carbon taxes over cap-and-trade. Becker won the Nobel Prize in economics in 1992.

Former Vice-president of the U.S. Al Gore said:

"We should start using the tax code to reduce taxes on employment and production, and make up the difference with pollution taxes, principally [on] CO2. Now I fully understand that this is considered politically impossible. But part of our challenge is to expand the limits of what's possible. Right now we are discouraging work and encouraging the destruction of the planet's habitability."


A number of businesses and business leaders also support a carbon tax. FedEx CEO Fred Smith has publicly endorsed a carbon tax, as has James Owens, CEO of Caterpillar. Owens called for a “definitive price on carbon that will help drive the choice of individuals to reduce the amount of carbon consumed in this country.”

On December 11, 2008, Rex Tillerson, the CEO of Exxonmobil, said a carbon tax is "a more direct, more transparent and more effective approach" than a cap and trade program, which he said, "inevitably introduces unnecessary cost and complexity." He also said that he hoped that the revenues from a carbon tax would be used to lower other taxes so as to be revenue neutral.

Criticism

Carbon taxes have been criticised for being unduly harsh on certain social groups, particularly those who live in rural areas (as they are required to travel more by car and are confined to a limited home fuel mix) and the elderly (who are most at risk of fuel poverty).

Irish criticism

In Irelandmarker it was speculated that a carbon tax would be introduced in the Government's supplementary April 2009 budget. This is a matter of concern for rural dwellers, who make up about one third of the Irish population. The NGO Irish Rural Link [12637] has noted that according to the Irish Economic and Social Research Institute (ESRI) “a carbon tax would weigh more heavily on rural households”. Irish Rural Link claim that experience from other countries has shown that carbon taxation will only succeed if it is part of a comprehensive package of measures, which includes reducing some other taxes which does not appear to be the Government's approach. IRL claim that in the rush to introduce revenue raising measures the regressive effects of a carbon tax will not be adequately offset.

Distributional impacts

In most instances, firms pass the costs of a carbon price onto consumers. Studies typically find that poor consumers spend a greater proportion of their income on energy-intensive goods and fuel. Therefore cost increases in energy tend to impact the poor worse than the rich.

Studies by Metcalf et al. (2008) and Metcalf (2009) consider the possible distributional impacts of carbon taxes in the USmarker. The 2008 study considers three recent tax bills introduced to the US Congress. The taxes themselves are highly regressive, but when revenues from the tax are returned lump-sum, the taxes become progressive. The 2009 study looks at a carbon tax combined with a reduction in payroll taxes. It is found that this combination can be distributionally neutral. With an adjustment in Social Security payment for the lowest-income households, the carbon tax policy can be made progressive.

A study by Ekins and Dresner (2004) considers the distributional impact in the UK of introducing a carbon tax and increasing fuel duty. It is found that a carbon tax can be made progressive, but that the tax would make those currently worst affected by fuel poverty more badly off. Of the policy options looked at for transport, the most effective in compensating low-income motorists is found to be an increase in fuel duties and the abolishment of vehicle excise duty.

See also



Notes and references

  1. Letter to U.S. Senators from 18 scientific organizations, by Alan I. Leshner (Executive Director, American Association for the Advancement of Science), Keith Sietter (Executive Director, American Meteorological Society), Douglas N. Arnold (President, Society for Industrial and Applied Mathematics), et al., October 21, 2009
  2. "Volcanic Gases and Their Effects", United States Geological Survey, retrieved 10-8-2009
  3. The correct conversion factor is the molar mass of carbon dioxide divided by the molar mass of carbon (approx. 44 g per mol divided by 12 g per mol)
  4. "Opposition puts carbon tax on the table", ABC news, Feb 19 2009
  5. "Carbon tax 'has merit'" The Age, April 4 2007
  6. http://www.colby.edu/personal/t/thtieten/eco-taxation.htm , http://www.thelocal.se/8522/20070917/
  7. http://news.smh.com.au/breaking-news-world/sarkozy-unveils-new-french-carbon-tax-20090910-fjhw.html
  8. Mayo, Ed. "The Potential of eco-taxes." The Ecologist 26 (1996): 204-06.
  9. Italian carbon tax law 23 december 1998 - http://www.camera.it/parlam/leggi/98448l.htm
  10. BBC 2 February 2006, Why UK petrol prices remain high.
  11. City Approves 'Carbon Tax' in Effort to Reduce Gas Emissions
  12. Bay area passes carbon tax Los Angeles Times, May 21, 2008
  13. WSPA memo, re: AB 32 Implementation- Scoping Plan Scenarios, Catherine H. Reheis-Boyd, COO of the Western State Petroleum Association, May 30, 2008
  14. B.C introduces carbon tax
  15. http://www.rev.gov.bc.ca/documents_library/notices/British_Columbia_Carbon_Tax.pdf
  16. Government of British Columbia, B.C.'s Revenue-neutral Carbon Tax
  17. Bryden, Joan. Liberals cast themselves in leader's light. Toronto Star. October 20, 2008.
  18. Bilton, Chris. Green shifting right? Eye Weekly. January 7, 2009
  19. Reid, Scott. The good, the (mostly) bad, and the faint signs of hope. The Globe and Mail. December 26, 2009.
  20. Findlay, Martha Hall. After the Green Shift. Globe and Mail. January 19, 2009.
  21. Speech announcing carbon tax detail, Pete Hodgson, Minister of Climate Change Issues, The Beehive, NZ Parliament, 2005-05-04, retrieved 2009-09-18.
  22. NZPA, Carbon tax ditched, NZ Herald, 2005-12-05, retrieved 2009-09-24. Archived at WebCite.
  23. Noah, Timothy (Nov. 9, 2006). The GOP Triangulates. Slate.
  24. "Tax on Carbon Emissions Gains Support", Juliet Eilperin and Steven Mufson, The Washington Post, April 1, 2007, Page A05
  25. "Exploring a Carbon Tax for Australia", John Humphreys, The Centre for Independent Studies
  26. "Experts divided on carbon tax", Matthew Warren, The Australian, July 17 2008
  27. "Replace Kyoto protocol with global carbon tax, says Yale economist", The Guardian, March 12 2009
  28. "We need to start emissions debate", John Humphreys, The Australian, Feb 18, 2009
  29. "Carbon tax only way to keep planet cool: Hansen", AFP, March 12 2009
  30. "The Power in the Carbon Tax", John D. Dingell, Washington Post, page A21, August 2, 2007
  31. http://mediacenter.fedex.designcdt.com/node/347
  32. http://www.bloomberg.com/apps/news?pid=20601103&sid=af7xdAInGuOQ
  33. Exxon supports carbon tax, Herald News Services, January 09, 2009
  34. [1] ESRI Working Paper 'A Carbon Tax for Ireland'
  35. [2] IRL Carbon Tax Briefing Note


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