The Carbon Tax Prescription
Curtailing the detrimental effects human activity is having on the environment cannot continue to be delayed. Notwithstanding of the current administration’s stance, concerted efforts need to be made to reconcile humanity’s inevitable need for growth and consumption with an agenda that emphasizes the protection and preservation of our environment. A preliminary step towards developing this coexistence of warring ideals is the imposition of a carbon tax accompanied with a cap and trade system in the United States. Implementing such a system would be a long-term solution to curb pollution and emissions of greenhouse gases. Our current model allows for haphazard rates of emissions by business without much recourse against them as retribution. Looking to its success in other nations including Denmark, Norway, Canada, and Australia, a carbon tax model in the United States could be met with further support from the traditional opposition if framed as a nonpartisan issue by highlighting it as a financial incentive for future business growth unhindered by pollution.
As a long-term solution, a carbon tax entails corporations becoming committed to internalizing their externalities. The system incorporates the polluter pays principle (PPP), a framework outlined in the Rio Declaration of 1992 that compels the polluting entity to pay the total social cost, rather than just their own private cost they incur as the general populace pays the external cost of dealing with the damages of living with pollution (The United Nations Conference on Environment and Development, 1992). This system is outlined in the graphs below:
The first graph depicts our current situation, in which the polluter does not pay, where the social cost outweighs the social benefit at Q1, the free market equilibrium. This results in deadweight welfare loss as represented by the triangle formed by the vertical red lines. Looking at the second graph, in which the carbon tax, calculated as P2 – P0, is implemented, the negative externality of carbon emissions creates a social marginal cost that is greater than the private marginal cost. The tax then offsets this difference putting the total social cost, the sum of the private cost and the external cost, in the hands of the polluter, reducing production to Q2, reducing any deadweight welfare loss and increasing social efficiency.
This increased cost placed on the polluter will inevitably be met with contempt from transgressors, as the tax constructs a barrier to economic activity for these businesses. The argument against it does offer some valid points that suggest that such a tax could be restrictive on economic growth. Many of these arguments against the carbon tax are rooted in the precautionary rhetoric of Adam Smith in his The Wealth of Nations, while outlining his maxims on the general effects of taxes. He warns that taxes “may obstruct the industry the people, and discourage them from applying to certain branches of business which might give maintenance and unemployment to great multitudes”, (Smith, 1776). He continues to on to say “An injudicious tax offers a great temptation to smuggling. But the penalties of smuggling must rise in proportion to the temptation”.
An interpretation of this sentiment can provide guidance towards a solution that makes the carbon tax more appealing. While the carbon tax provides cost certainty of compliance for all the firms, it is decidedly austere and does not leave much room for flexibility. A common argument against the tax is that business will oft turn to tax evasion and pollute covertly to avoid paying these costs. Pairing a carbon tax with a cap and trade system will create a complementary tandem in which this subterfuge is discouraged, and the administration of both can be met with a rigid system of accountability while allowing flexibility and rewarding responsibility.
It is important to demarcate the similarities and differences between a carbon tax and a cap and trade system to understand the merits of both. Both approaches correct the market failure of holding polluters financially accountable, put a price on carbon, leverage market forces to attain efficiency, generate revenue, create a culture of compliance and accountability, and both require a robust system of monitoring and reporting (Center for Climate and Energy Solutions, 2009). The end goal for both approaches are one in the same; they both aspire to reduce the emissions of greenhouse gases without putting a damper on economic activity. The difference lies in the changes businesses must make in their behavior and the severity of these changes.
Such a dual framework is almost as if B.F. Skinner’s operant conditioning box was enlarged into an economic macrocosm. With these two systems implemented, the behavior of businesses would no longer go without consequence. The negative behavior of reckless greenhouse gas emissions would be reprimanded with fines, whereas responsible efforts to operate with reduced emissions would be positively reinforced with economic incentives. While this duality can serve as an interesting thought experiment in behavioral psychology, having both positive and negative reinforcements can provide firms with newfound flexibility, rather than coercing them to pay up when they infringe on their restrictions.
An interesting case study to look to when pondering the efficacy of such a two-pronged system is British Columbia in Canada (Porter, 2016). The province first established its carbon tax in July of 2008, pricing carbon dioxide at $10 Canadian dollars per tonne, increasing $5/tonne each year and plateauing at $30/tonne in 2012. Not only did this tax succeed in curtailing per capita emissions by 12.9% from 2008-2013, but the transparency of the tax implementation allowed businesses and consumers to operate with near perfect information with an ability to accurately price forecast. Over the 6 year period GDP growth in British Columbia increased by 1.55% while the rest of Canada’s GDP increased by 1.48%. The tax was not necessarily a catalyst for growth, but it is proof that the tax can be implemented without hindering economic activity (Carbon Tax Center, 2015).
In pairing the carbon tax with a cap and trade system, British Columbia aimed to avoid suffering the pitfalls of the former. Unlike the rigid strictures of a carbon tax, a cap and trade system provides businesses with the flexibility to tweak their own operations at their own behest to reduce carbon emissions in a cost-effective manner. Citing the approach’s success in the northeastern United States with acid rain reduction and carbon emission reduction in New Zealand, British Columbia views a cap and trade system as a reliable source of carbon price discovery, a potential gateway for a more integrated global carbon market, and a worthy incentive to reduce emissions (British Columbia Ministry of Environment).
A big benefit of a carbon tax is the expected encouragement of research and development in renewable alternatives and green technology. When emitting carbon becomes a crippling expenditure to corporations, they will become incentivized to look into more efficient technologies. It is important that this tax level is carefully set high enough so as to avoid businesses cunningly paying the fine rather than cutting back production, a loophole many automobile makers take advantage of when complying with CAFÉ standards. In theory, the revenue from a carbon tax will generate a communal fund to invest in new green technologies, and there is widespread public support for this fund to be reinvested. In a study from Yale University, in a survey of the public on their opinion on a carbon tax, over 70% of Americans support the use of the carbon tax revenue to compensate displaced workers in the coal industry, and almost 80% support the reinvestment of the earnings into clean energy and green infrastructure (Kotchen, Turk, & Leiserowitz, 2017).
The biggest roadblock in the United States will be uprooting the foothold the coal industry currently enjoys in our economy. Despite the efforts of Donald Trump to revive the coal industry with his initiative to reverse Obama-era acts including the Stream Protection Rule and the Clean Power Plan (Grunwald, 2017), his Secretary of State Rex Tillerson has expressed his understanding of and support for a carbon tax in the past during his tenure with Exxon and recognizes it as a veritable method towards combating climate change (Carroll, 2017).
With a pessimistic outlook, under this administration and with a Republican majority in the House and Senate, it is unlikely that a nationwide carbon tax will be implemented. It may perhaps be more feasible for state-level policymakers to introduce carbon taxes for their own constituencies, tailored to their state’s differing levels of economic activity and resources availability. A report by the Brookings Institution outlines the benefits of tax revenues and market price signaling as two incentives for state policymakers to take this initiative and notes that establishing state-level carbon taxes will be a mode for states to meet their previously set emission reduction goals as well as their expected standards under the Clean Power Plan (Morris, Bauman, & Bookbinder, 2016).
With an optimistic outlook, a framework with a carbon tax as the backbone with a cap and trade system as a deal sweetener can engender significant change in the nation’s economic climate and can alleviate the damage businesses are inflicting on the environment. Even if a national carbon tax is implausible at the moment, specialized state carbon taxes are sure to see success and provide incentive to test the system for the whole country despite the resistance. The strongest counterargument to a carbon tax would be proof that it has a detrimental effect on economic activity, but as we have seen in British Columbia, the reality is actually the opposite. If the United States wants to maintain its status as a global superpower and leader, it needs to lead an internal impetus to show a willingness to change the status quo and move towards more economically efficient and environmentally conscious business operations, and putting a price on carbon is the first step in that direction.
British Columbia Ministry of Environment. (n.d.). Consultation Backgrounder - Carbon Pricing. Ministry of Environment.
Carbon Tax Center. (2015). British Columbia's Carbon Tax: By The Numbers. New York: Carbon Tax Center. Retrieved from Carbon Tax Center.
Carroll, J. (2017, February 23). Exxon's New Chief Endorses Carbon Tax to Combat Climate Change. Retrieved from Bloomberg: https://www.bloomberg.com/news/articles/2017-02-23/exxon-s-new-chief-endorses-carbon-tax-to-combat-climate-change
Center for Climate and Energy Solutions. (2009). Cap and Trade v Taxes. Arlington: Pew Center on Global Climate Change.
Grunwald, M. (2017, October 15). Trump's Love Affair with Coal. Retrieved from Politico: https://www.politico.com/magazine/story/2017/10/15/trumps-love-affair-with-coal-215710
Kotchen, M. J., Turk, Z. M., & Leiserowitz, A. A. (2017). Public willingness to pay for a US carbon tax and preferences for spending the revenue. Environmental Research Letters.
Morris, A. C., Bauman, Y., & Bookbinder, D. (2016). State-Level Carbon Taxes: Options and Opportunities for Policymakers. The Brookings Institution.
Porter, E. (2016, March 1). Does a Carbon Tax Work? Ask British Columbia. Retrieved from The New York Times: https://www.nytimes.com/2016/03/02/business/does-a-carbon-tax-work-ask-british-columbia.html
Smith, A. (1776). Chapter II: On the Sources of the General or Public Revenue of the Society. In A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (p. Part II: On Taxes). Random House, Inc.
The United Nations Conference on Environment and Development. (1992). The Rio Declaration on Environment and Development. Rio de Janeiro: United Nations.