Carbon Tax

i-d220dbf7d77be2a6fe2c6a8a52dca256-p8121867.jpgThe Wall Street Journal polled 60 economists, and a big majority backed a carbon tax:

Forty of 47 economists who answered the question said the government should help champion alternative fuels. "Economists generally are in favor of free-market solutions, but there are times when you need to intervene," said David Wyss at Standard & Poor's Corp. "We're already in the danger zone" because of the outlook for oil supplies and concerns about climate change, he said.

A majority of the economists said a tax on fossil fuels would be the most economically sound way to encourage alternatives. A tax would raise the price of fossil fuels and make alternatives, which today often are more costly to produce, more competitive in the consumer market. "A tax puts pressure on the market, rather than forcing an artificial solution on it," said Mr. Wyss.

A tax like this would give positive incentives for alternative energy without specifying precisely which forms are best. Firms could cut carbon emissions by increasing efficiency, shifting to clean power sources, or any combination of factors. Farmers who shift to practices which build up soil carbon could even get a credit against energy consumption.

The Carbon Tax Center is a handy source of information about how such a tax could be implemented in a politically progressive manner. They argue that the tax is inherently progressive, since wealthier people consume more energy as it is, and the benefits go to everyone equally. If the revenue from carbon taxes is used to cut other taxes (ideally through a larger Earned Income Tax Credit and reduced rates across the board), the tax would not be any more costly to the average consumer, and ought to do no net harm to the economy. Individual businesses would have to adapt, and undoubtedly would.

The benefit of a carbon tax is that it discourages exactly what we think is bad – excess carbon emissions. Those emissions place costs on society at large which no one feels responsible for. Those costs are then external to the market place, which is why economists call them externalities. Externalities distort markets and make them inefficient.

By my thinking, the fundamental role of government is to address those sorts of market inefficiencies, and one way to do that is by using tax policy to bring externalities back into the costs that markets set. Raising taxes by the right amount can do exactly that.

This calculus becomes very real when we ask, as the Wichita Eagle does whether three more coal-fired plants would matter. The answer is yes, but only incrementally. The utility has a choice. It can build those plants, paying whatever coal costs down the line, plus the current cost of the plant, plus maintenance and taxes for the next 20 years. It can also build a natural gas plant, with the attendant costs. It could build wind turbines, which would have yet another set of costs.

The marginal cost to the environment of 3 large coal plants is, of course, modest. The same is true of each vote cast in an election, or every dollar gathered from taxes. It all adds up, though. Adding a tax on carbon emissions would change that cost analysis. Maybe it would still be worth building all three plants, but maybe it would be more economical to build two big coal plants and a large wind farm. Maybe two of the plants could be replaced by renewable energy sources.

A carbon tax decreases the margin of the coal plant over other fuels. That difference in cost could be spent building a different kind of plant, but could also be spent to fund research into cleaner, more efficient technologies. A utility that produces less energy from coal, and uses the a portion of the tax saving to invest in research could still come out ahead financially while encouraging innovation.

The decision that the utility makes today will have serious impacts on the cost of electricity down the line. Undoubtedly they will have to pass the costs of a carbon tax on to their consumers, who would surely prefer the power coming from renewable sources when it becomes cheaper. Choosing to build these plants today will lock consumers into higher energy prices down the line, since some form of regulation of coal power seems increasingly inevitable.

To my mind, some sort of carbon tax makes more sense than an "upstream" cap-and-trade system. Both wind up making things more expensive for consumers, but capping upstream basically means rationing fuel production, which seems foolish. The problem, after all, is mostly from consumption – the demand side, not the supply side. The European cap-and-trade system caps emissions makes much more sense, because it is levied on a gradually increasing range of carbon emitters, beginning with industry, and gradually moving to transportation and individuals. Combine a carbon tax levied at the scale of refineries with an expanding cap-and-trade system like we see in Europe, and you incorporate costs and incentives on all the scales. Balance increased carbon taxes with decreases in overall taxation, and the system remains fair and effective.

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Cap and trade is vulnerable to political shenanigans. Say industry X has traditionally emmitted Y amount of carbon therefore we
give it Z amount of emmission credits. Of course fixing those numbers selects winners and losers and powerful economic players will try to game the system. There also is an incentive to increase emmisions prior to the start of the system, as past emmisions are likely to determine future allowances. I've seen similar bad incentives in consumer areas. I know people who make sure to waste water during good times, because during the droughts they will only be allowed x% of wet year consumption.

This is all true. Setting up cap-and-trade is the hardest part, but once allocations are established, it does good work.

So you want to penalize the old coal plants by imposing a cap and forcing they to buy pollution credits. What does that do for the old coal plants? Force them to install emission controls? force them to shut down? So we charge consumers more for energy from old coal and subsidize wind farms by penalizing old coal. Why not just put a cap in place and give old coal x years to come into compliance and prevent ENRONesque trading scams of credits? We should totally oppose the building of inefficient wind by subsidizing wind with tax cuts, electricity rates and green credit scams. Every 10 MWs wind you install will have be backed up by 9 Fossil WMs. The preference is gas because gas can built fast and cheap. What's the cost in terms of $s and
GHGs and pollution from the gas/wind mix when compared to clean coal keeping in mind you have to almost double installed MW capacity for the wind-gas mix. How sustainable is burning all that gas as if we have some right to burn it up in this generation. The wind-gas mix puts out 0.4 tonnes CO2 eq per MW-hr. How does that compare with the high efficient coal plants the Europeans are building? The Germans now get 6% of their energy from wind. They are building clean coal because its too costly to achieve higher penetration by wind. Why waste money on inefficient wind when the money can be better spent on conservation and high efficiency new coal. Britain's gas and electricity regulator now wants the Renewables Obligation scheme scrapped because it has cost consumers $billions and "Worse still, the emissions savings delivered are small and almost unbelievably expensive."…

By Balck Sheep (not verified) on 09 Feb 2007 #permalink

The details of how a carbon cap could be implemented are important. Many proposals currently place caps at current levels, and do gradually reduce them exactly as you describe.

As for gas/wind generation, I am aware that wind currently needs excess generating capacity. What I think we ought to be doing is creating the capacity to store excess wind generated electricity. The technology exists and could be implemented to use any of various storage methods to even out energy produced by solar, wind, or other "bursty" generating methods.

There's all sorts of storage ideas. But there's a difference between what we are actually doing vs some ideal. The gas plants are being slapped up as we build wind. Otherwise the lights would go out when there isn't enough wind blowing. So we are now committed to burning gas for 25 years. Why can't the environmentalists see this?

Some say wind can be backed up by stored water behind dams. That's true if you don't need the stored water for peak demand. Otherwise you use up stored hydro on wind during base load and have to meet peak demand with gas. That amounts to a shell game.

Has anybody taken a big picture look at fossil fuel consumption for electricity, transportation, industry, residential heating combined to say that wind is the best way to achieve the needed GHG cuts in the long term considering the environment, costs and energy security?

By Black Sheep (not verified) on 09 Feb 2007 #permalink

There is hydraulic storage, but everything from compressed air to hydrogen, batteries or flywheels would also work.

For the cost of building gas plants, we could be improving grid storage to back up renewable sources.

Kansas has the capacity to produce 30 times its electrical consumption from wind alone. I'm not saying it should go that far, but putting excess production capacity in place would eliminate the problems you are describing, especially combined with grid storage.

The choice to build gas furnaces is perfectly valid, but will bring costs in the future, whether those costs are incorporated through taxes or through environmental change.

Is the choice to build gas burners valid when we would get 3 times the kick if the dollars were being spent on conservation and improved efficiency? Or have we achieved all we can in these areas? Are gas burners preferred over nuclear? It looks like big oil&gas are pushing wind because wind commits us to burning up the gas. The greens have been taken in by by big oil and gas. Are they planning any LPG ports on both coasts?

By Black Sheep (not verified) on 10 Feb 2007 #permalink

I agree that we should be spending money on energy efficiency and conservation. We also need to add generating capacity, both to replace old plants and to shift towards an electric (rather than petroleum) economy.

My understanding is that gas and nuclear are not competing technologies. Gas has the benefit of being able to ramp up or down quickly, covering up spikes or dips in demand or generating capacity. Nuclear and coal both provide a consistent baseline of generation.

As for the costs of these things, my original point in the post above was that costs are not adequately integrated into the marketplace. Gas and coal have costs to society which aren't incorporated into the pricing process. Gas plants may be cheaper than mass storage, but that balance could shift if the costs to society were incorporated.

So while it may be cheaper today to build a gas plant and a wind farm, a carbon tax that integrates the externalities might well mean that it's cheaper to build a wind farm and a storage system. Fixing the market inefficiencies would get us around the problems you are accurately describing.

You could always apply demand-side economics to the problem and just quit using carbon based fuels, if you think the science is conclusive that they are causing a problem.
Just think of the wake-up call it would send to industry if global warming believers quit using fossil fuels. Sure would work a lot faster than a carbon tax.

What you are suggesting is the equivalent of asking people who don't like smog to voluntarily switch to unleaded gas, while allowing cars without catalytic converters to be produced. Upgrades would be prohibitively expensive, so that act would be an expensive example of altruism. Fine for individual consumers, but impractical for anyone who is living paycheck to paycheck or anyone who makes a living by driving.

Even assuming I am willing to pay a little more for cleaner energy, I can't build my own windfarm around my apartment. I can't even choose to buy only electricity generated cleanly. Internalizing the costs of carbon fuels is the fairest and least disruptive way to push utilities and other big consumers into shifting their business decisions.

Conservation is important, but no one should have to give up driving or abandon hot water or electricity. The only way to change the electrical marketplace is through regulation, and making them pay the true costs of their practices.

Wind runs 24-7, when she blows that is. So you are displacing base load nuclear with wind. And since wind needs to be backed up by gas for most of its rated energy (preferred option because plants are cheap)we are displacing nuclear with the wind-gas mix. Many greens dream that they can replace nuclear with wind. NOT. By wind-and mostly gas yes and that is what is happening NOW and people should wake up and realize what they are doing when they support wind farms that achieve only 25% efficiency. Blame the subsidized rates and tax breaks for them being built in the first place and as you point out they can build a gazzilion MWs of gas with no penalty. OK I concede on the carbon tax. BUT FORGET THE CAP and TRADE on CO2 eq because it is totally bogus. The Europeans cheated assigning themselves credits from day 1. I object to seeing my $s given to some African dictator because some utility is polluting the air I breath.

By Black Sheep (not verified) on 10 Feb 2007 #permalink

Black Sheep, you keep insisting that wind must be backed up by gas. I keep arguing that it doesn't, and your response seems just to be to repeat yourself.

Yes, gas is cheap. It is cheap because of externalities. A carbon tax (see the title of this post) would change that cost structure. It would make storage more economical.

European cap and trade doesn't involve Africa, it is an EU program. Each country has a certain allocation, and each industry gets a fraction of the national allocation. A company (not a nation, so no tax $s) that exceeds its limits will have to buy credits from another company that has a surplus of carbon credits. That gives each company an incentive to beat its cap, since exceeding the cap is expensive and efficiency produces something of value a carbon credit that can be sold on an open market. The economic arguments behind these sorts of tradable quotas are well-developed. They worked well and with no obvious economic harm in reducing sulfur dioxide emissions, which cause acid rain.

I'm all for conservation. It's stupid to run things inefficiently. But here's the thing, putting a carbon tax in place is an explicit way to penalize fossil fuels as an energy source. It is portrayed as a Pigovian tax without merit and would be almost hopeless to implement fairly. In reality its just another tax on energy that only really hurts those "living paycheck to paycheck or anyone who makes a living by driving."
If you really buy into the idea that fossil fuels are the bogeyman then live your life that way. Thats what people do when it comes to food. Why not energy? Heat your water with solar.

You'll note that the carbon tax I described above is revenue neutral, so it would be coupled with tax cuts. On average, no one pays more than they did before.

I don't know why you say it is "without merit," nor why it would be hard to implement fairly. The tax could be levied on refineries, or at ports, mines and wells, with the costs incorporated at the source. Easy to implement.

I rent, so I can't add solar water heaters. I keep the temperature low, I keep my thermostat low, and I bike to work. I can't do anything about the electricity for my computer or the lights and appliances.

That is a market failure. There is no market in electricity at my level, and at the level that there is a market, it is distorted by externalities.

The IPCC gives it better than 90% chance that human activities, especially carbon dioxide emissions from burning fossil fuels, have increased temperatures already and will continue to do so. If we wanted, we could implement a carbon tax at 90% of the projected cost of climate change per unit emissions, incorporating any uncertainty in the estimates right into the carbon tax.

The precautionary principle would probably argue for a higher rate, but that's an issue that would be subject to all sorts of negotiations, which would include arguments about uncertainty regarding the effects of carbon emissions.

The analogy to groceries is nonsense, though. Someone else's decision to eat conventionally grown fruits doesn't affect my life. Someone else's decision to emit greenhouse gases does affect my life. When someone else's actions cause another person harm, it is very appropriate for government to get involved. It is absolutely necessary when that person's actions affect society as a whole.

Josh, I am stating what is reality vs. some Utopian dream. Gas plants are being built and they are displacing base load nuclear and the greens think that's OK because wind is a small component of the mix. How many MWs gas capacity has been built in the last 5 yrs vs. storage? Yes the Euro program is for Euro. The Euros handed out lots of extra credits esp. to the former soviet block countries and now industry and untilites that can't meet the caps have to buy them.
Did those utilties that paid $100 for a CO2 credit made a good investment on behalf of their consumers when the credits are now worth $10. Shades of ENRON. The money leaves the country. Consumers pay more. And the pollutants get spewed at home. Per KYoto they can also build wind farms in Mongolia and take credit at home, not that does anyting to clean up the pollution at home either.

You are right about the on average no one pays more part.
i expect more wealth will be created just from shuffling papers in office towers. But some will win and some will loose. Which camp will US consumers find themselves in?

DAprez. The carbon tax is a compromise vs. an outright fraud like credit trading. People won't reduce dependence on fossil fuels unless they get some "motivation". You hit on the question of social justice. Who pays? The tax will hit the average working JOe the worst because the elites can afford it. This is important. The IPCC says global change is investitable. It's just a matter of hot fast and severve. If that's the case put the cap on everything. Here's your 3 ton allotment buddy. Or should the elites even be allowed to pay their way out and continue their eccessive consumtion. A lot of elites talk green. Are Al Gore & family selling any of the mansions? Is he parking any of the fleet? Does he fly economy? To close attention to what they are dreaming up. "On average no one will be paying more." Reality doesn't match their words.

By Black Sheep (not verified) on 11 Feb 2007 #permalink

Black Sheep, you are right to be skeptical about the details of carbon tax implementation. If it is done wrong, it could well be regressive. It could also be done in a way that makes the tax code more progressive. The entire tax could be used to fund a massive EITC, or to establish a negative income tax for the lowest earners. It could also be implemented as a uniform cut in marginal tax rates. Or a combination of a larger EITC (which benefits the poorest workers), cuts in the middle tax brackets, and tax credits to make it easier for middle and lower class workers to increase the energy efficiency of their home and car.

I am not saying it will be work out perfectly by magic. It will take serious work and serious negotiations through a public process. If you agree that a carbon tax is part of the solution, write your congresscritter and make it clear that it has to be revenue neutral, and has to give those benefits to middle class workers. Check out the link to the Carbon Tax Center above for more details.

Capping carbon without attaching a trading scheme will work less well than cap and trade. If you support a cap, you should support emissions trading. It worked well for SO2. It encourages a sense of ownership and uses market dynamics to our collective advantage.

I agree with your description of the current reality. I disagree about the claim that it is utopian to argue for a different system. Gas plants are cheaper today because of market failures. Fix the market failures and grid storage or other options will be more feasible.

The IPCC report is summary for policymakers and not science.
The 90% number is put in there by heavily biased editors from the green camp to generate media hype in support of a theory that is not scientifically proven. The problem is that it leads people to believe that emissions of greenhouse gases are on par with causing health problems but that fact is that science is so very far from establishing this a valid conclusion.
"Global Warming" is billion dollar business with a limited revenue stream because all of the funds that support it come from governments. A carbon tax is great way to increase the revenue stream. The more hype and fear you can inject into the public mind, the faster you can start seeing the increase in revenue.
What precisely is the effect of adding CO2 to the atmosphere? You state the doubling CO2 doubles the heat trapped but there are doubts about that among many climatologists. Yet when they speak out they are bashed outright as loonies and oil-industry shills. They are demoted and have their careers threatened.

Daprez, the IPCC report is a summary of an assessment of the science. To the extent that any scientific theory can be proven, global warming is. Disagreement with the TAR's conclusions is almost nonexistent in the peer reviewed literature.

You can invoke elaborate conspiracy theories, but that doesn't cut much weight with me. I know how science works, and I know that if there were contrary evidence, the incentives to publicize it would be enormous. No one makes money off of climate change except the gas and oil industries.

There is no doubt that, all things being equal, doubling CO2 would double the warming effects. All things aren't equal, and there was dispute about balancing forces a decade ago. That debate is resolved at this point.

The IPCC report is summary assessment of some of the science. Cherry picked to bias the argument in favor of global warming.
There is a conspiracy to paint any information contrary to the view that the science is complete agreement with anthropogenic C02 as the cause for the end of the world as we know it. I know how science works too as well as politics.
You say, "There is no doubt that, all things being equal, doubling CO2 would double the warming effects. All things aren't equal, and there was dispute about balancing forces a decade ago. That debate is resolved at this point."
You say that but where is the empirical basis for that conclusion? I have looked along with many other scientist with significant accreditations and respectable reputations. The evidence to finger C02 as the root of all evil is not scientifically conclusive. You, and the IPCC, are rushing to judgment. What is conclusive is that C02 has gone from being a trace gas, to well, being a little bit more of a trace gas. What isn't conclusive is how much of the greenhouse effect is due to C02. Yet scientists that point out this lack of evidence get pilloried to get them to shut up because they are spoiling the party.

Can you provide any evidence of "cherry picking"? Can you provide any evidence of a "conspiracy"?

If you read the IPCC report, you'll see a figure that lists the various radiative forcings, and which shows their magnitude, an error bar, and an assessment of scientific understanding. The magnitude of change from carbon dioxide is the highest, with a tiny error bar and high scientific understanding. A doubling of a warming gas will double its effects. If you disagree, you have to show why.

There is no doubt that human activities are well on the way to doubling carbon dioxide concentrations, and that we've seen a 30% increase in CO2 already due to human activities. If that increase in CO2 didn't increase temperature, you would have to offer some force that would act in opposition to CO2's forcing, some negative feedback or a contrary forcing.

Those forcings do exist. Aerosols have reduced the warming we've seen, but those will decline as smog controls get better. There are negative feedbacks (and positive feedbacks) and there are no models showing those negative forcings and negative feedbacks outweighing the positive forcings and feedbacks.

This is how science works. You present data and test hypotheses. The hypothesis of anthropogenic climate change has gotten stronger and stronger because it keeps passing tests, and alternatives keep failing. If you don't think anthropogenic CO2 is driving the climate change we have already seen, what is the forcing?