GETTING OUT OF THE RED Less red with more green

Carbon tax is a sensible, money-saving option

Earlier this year, the Inter-Agency Working Group on the Social Cost of Carbon, a panel assembled for the purpose of estimating the harm that a ton of CO2 emissions causes to the world, concluded its efforts to put a price tag on greenhouse gas emissions. Using up-to-date scientific assessments and an appropriate time discounting of future harms, the working group concluded that the Environmental Protection Agency and other federal bodies should use $21 as the baseline estimate of the damage caused by releasing a ton of CO2 into the atmosphere.

Conveniently, the Congressional Budget Office made an estimate of its own shortly after: how much extra revenue would the U.S. government collect if it were to levy a carbon tax of $20/ton CO2 and increase that tax by 5.6 percent each year?

The answer, as it turns out, is quite a lot. Over a ten-year window, the CBO expects such a carbon tax would collect $1.18 trillion.

There are many legitimate arguments against the introduction of a carbon tax. For one, carbon taxes are regressive, falling disproportionately on the poor. For another, they require the introduction of a wholly new tax administration system. But the most important of the criticisms boils down to this: of that $21 in harm that a ton of CO2 causes, only $1 of it is inflicted on American citizens.

So, why should the U.S. adopt carbon taxes, when such a large fraction of the benefits from reducing global warming accrue to other nations?

There are three reasons why carbon taxes are a sensible solution:

Firstly, U.S. policy should make some allowance for the welfare of non-citizens. The U.S. spends billions of dollars in aid, either directly, through its own programs, or indirectly, through support for international efforts — why should it balk at providing aid through another channel?

Secondly, the U.S., if it plays its diplomatic cards right, should be able to leverage an offer of reducing emissions into wealth transfers to the U.S. from benefiting countries, or corresponding cuts to those countries’ emissions. Just because past efforts to reach a collective agreement on carbon abatement have failed doesn’t mean that they are forever doomed, and even a partial agreement would mean recouping a sizeable fraction of the $21 benefit.

Finally, and most importantly, excise taxes have a very low bar to clear to make them superior to regular income taxes. So long as the choice is between carbon taxes and income taxes, the question is not how much deadweight loss a carbon tax produces in absolute terms, but rather how much it produces relative to the income tax. If, for example, carbon taxes produce twenty cents of loss to society per dollar of revenue, while income taxes destroy fifteen cents of value, then the $1 of benefits that accrues to American citizens could justify a carbon tax of $20.

Taken together, it may well be that the optimal carbon tax is even higher than the textbook optimal Pigouvian tax rate of $21/ton. It is important to remember that a dollar of revenue collected through carbon taxes is a dollar less needed in spending cuts and tax hikes — even the most efficiency-minded conservative, so long as they recognize the harms posed by global warming, should be willing to offset income taxes with carbon taxes.

Action: Institute a $20/ton tax on Carbon dioxide. 10-year savings: $1.18 trillion