Carbon Tax
How It Works
The carbon tax works like any other tax, except for one thing: a carbon tax is used to reduce consumption and production of the product it taxes. Such taxes, called Pigouvian taxes or nicknamed "sin taxes," are employed to decrease the use of a product while creating additional revenue for the government (Baumol and Oats, 1988).
For example, cigarette and alcohol taxes are sin taxes that are essentially guilt free because society feels the consumption of those products should be limited anyway. For the carbon tax, in the case of industry, this tax can be levied directly on each ton of carbon emitted into the atmosphere.
It can also be levied indirectly on automobiles by taxing the gasoline that will eventually emit carbon gasses. The tax can be set and adjusted until a desired level of emissions is obtained.
Many economists argue that a Pigouvian tax is efficient in that it forces consumers and producers to pay for the cost of polluting. Without the tax, these goods may be overproduced and over consumed because society pays for the health and property damages of pollution, but the producers and consumers do not directly feel an increased cost burden.
Cost of Implementation 1
A carbon tax would result in a new source of revenue for the government and could be used to reduce the budget deficit.
Environmental Impact 3
Taxes can be adjusted to limit consumption of certain energy sources but there will not be a strong direct push toward new sources and technologies.
Foreign Energy Useage 4
Consumption of foreign energy sources can be limited but only to a certain degree.
Implementation 2
Systems like the proposed carbon taxes have existed for some time in the form of gasoline taxes or other "sin taxes." The US and other countries have much experience in working with these types of taxes.
Political Toxicity 10
Politicians seem to hate to use the T-word, but not as much as the public hates to hear it!
Barriers to Future Use
- The carbon tax may not be as politically popular as a cap and trade system (The Economist, 2007).
- The oil lobby may oppose implementation of a tax that would no doubt decrease their revenues (McFarland, 1984).
Pros of Use
- Costs are internalized: Industries and individuals directly pay for the increased risk of harm to society (Baumol and Oats, 1988).
- A carbon tax could make markets more efficient by incorporating a cost that has been previously excluded from production and consumption.
- Government gains a new revenue source that could be used to reduce other taxes, pay off government debt, research clean air technology, or for other uses.
- Carbon taxes are easy to apply to individuals as well as businesses.
Cons of Use
- Some economists argue that the use of any tax leads to inefficiencies in the market.
- The US has little experience taxing carbon as a pollutant.
- Industry would bear some of the burden and would resist implementation of the tax.
- The tax would be regressive in practice, for example adversely affecting those who have a hard time paying for gasoline as it is now.
Case Studies
New Zealand's Bold Attempt
In 2005 New Zealand planned to become the first country in the world to introduce a true carbon tax, imposing an almost three dollar ($3) a week charge upon citizens or an eleven dollar ($11) charge per ton of carbon emitted. While the tax was acknowledged to raise government revenues by almost $36 million a year, promoters cited tax breaks in other areas that would level the burden upon citizens. Unfortunately this tax, designed to reduce greenhouse gas emissions and set to come into effect in April 2007, was derailed in December 2005 due to rising oil prices which officials held had already partly achieved the intended effect of the tax in the transport. Worries that the depreciation in emissions would not justify the tax burden, New Zealand demonstrated the classic policy concerns entangled in a carbon tax. To read more on this story, click here.
Stories of Success and Failure from the North
Denmark, Finland, Norway and Sweden have had a form of carbon taxes in place since the 1990s, but the tax has not led to large declines in emissions in most of these countries - in the case of Norway, emissions have actually increased by 43 percent per capita. Juxtaposed against these negative results are Denmark's reduction in emissions of 15 percent. A combination of subsidized alternative energy and innovation plus a return of tax funds to industry to encourage environmental innovation spelled success for Denmark. To read more on this story, click here.
Most Important Fact
A carbon tax can be adjusted incrementally to bring carbon emissions down to a desired level. This is highly desirable when compared to other proposed controls that bear the possibility of missing a target level, for example with an initial issuance of permits in a cap and trade system.
Bottom Line
Economists like the idea because it internalizes a cost that the market does not and currently has no mechanism to account for. Incremental changes can be made and the government obtains a new revenue stream. On the other hand, elected officials may have difficulty getting their constituents to embrace a new tax. This makes another system, like a cap and trade system, more politically feasible.
