There are two primary regulatory systems for reducing carbon emissions – “cap-and-trade” and “carbon tax.” With cap-and-trade, a government entity (for example, the state of Washington) places a ceiling on the amount of carbon that can be emitted within the state in a given time period. It then provides allowances (or permits) to companies that enable them to emit a certain level of carbon. These companies can then sell their permits to emit carbon to other companies. Thus, there is a cap on carbon emissions, and companies can trade the right to emit to one another. The government entity reduces the cap each year, leading to a gradual decline in carbon emissions. In most cap-and-trade systems, companies can also procure “offsets,” whereby they invest in an environmental project that reduces the amount of carbon in the atmosphere (e.g., tree planting), and in return are granted the right to not reduce their own carbon emissions by a commensurate amount.
With a carbon tax, the government entity places a tax on the fuels that release carbon. Thus, when a consumer purchases gas at a station, there is a 10 cent (or some such amount) per gallon carbon tax applied to the price of the gasoline. This tax provides an incentive to reduce the use of carbon-based fuels. Carbon tax systems are generally revenue-neutral and self-extinguishing. Revenue-neutral means that 100% of the revenue generated from the carbon tax is returned to consumers via a reduction in their other taxes. Thus, the carbon tax revenue from the sale of gasoline is returned to consumers via a reduction in the property tax and the sales tax rates. For this reason, the revenue-neutral carbon tax is really not a tax at all, but rather a fee imposed on one set of transactions that is then returned via other another set of transactions. Self-extinguishing means that as consumers use less carbon-based fuels, and new technologies are introduced to replace carbon intensive fuels, the carbon tax can be slowly reduced. Thus, over time, the carbon tax extinguishes itself.
I propose the introduction of a revenue-neutral carbon tax into the state of Washington. This would be patterned off of the British Columbia provincial revenue-neutral carbon tax. This tax was introduced during the Great Recession – a difficult time to do so due to the fragile nature of the economy. It has been successful -- there has been negligible impact on economic growth, and carbon emissions are down significantly. Merran Smith, the head of Clean Energy Canada, states that: “What it has done is reduced our carbon emissions, reduced our fuel consumption, and in that period our GDP and our population has gone up.” Revenue-neutral carbon taxes have also been used in Scandanavia and elsewhere.
The carbon tax approach is superior to the cap and trade approach for a variety of reasons. First, the cap and trade approach allows companies to attempt to “game” the system in order to achieve larger initial allowances to emit carbon. This can allow companies in some cases to reap an economic windfall. For example, a manufacturing company that might be planning to stop using carbon-fuels in its production process might delay the change in order to obtain a carbon emission permit, and then proceed to sell that permit for a profit. This up-front carbon allowance allocation process makes corruption and bribery real concerns. Second, cap and trade systems can recognize offsets that are not really incremental. For example, a Washington State company might enter into a contract with a company in China to plant trees. This provides the Washington State company with the right to not make a commensurate amount of carbon emission reductions (i.e., it retains the right to pollute at a higher level). But it may that the Chinese company was going to eventually plant the trees anyway, and that the two companies conspired to argue that the tree planting would not have occurred without payment from the Washington State company. Third, in a cap-and-trade system, there are high administrative costs to set up the initial carbon-emission allowances, monitor compliance, monitor offsets, etc. Fourth, the price of carbon pollution permits can fluctuate wildly in cap-and-trade systems. For example, the snowpack level for a given season in Washington State will impact the abundance of hydropower, which will in turn have implications for carbon-based fuel demand and prices. Similarly, economic growth impacts the demand for carbon fuels. These (and other) factors can serve to create a highly volatile price for carbon-emission permits in the carbon market. Consequently, companies that are developing alternative energy technologies have a difficult time predicting the economic benefits of their technology. When the price of carbon permits is high, it appears that there will be a significant economic return to their technology; when the price of carbon permits is low, it appears that there will not be an adequate financial return. In short, volatile carbon permit prices under cap-and-trade schemes make it difficult for companies that are developing new technologies to make informed investment decisions. This volatility also makes it difficult to steadily and gradually lower the carbon cap every year. In each of these four areas, the carbon tax is far superior. There are no upfront carbon emission allowances, no carbon offsets, low administrative costs, and a constant carbon price for investors in new technologies to consider when making investment decisions. The carbon tax is a direct, relatively straightforward, easy-to-administer approach to reducing carbon emissions.
For these reasons (and others), policy analysts from all different disciplines and ideological orientations – economists and environmentalists, conservatives and liberals, etc., tend to agree that a carbon tax is far superior to a cap-and-trade approach. The June 7-13, 2014 issue of The Economist (a conservative periodical), for example, argues that a carbon tax is the best approach for addressing climate change. And in a June 24 editorial (printed in the Seattle Times), the liberal economist Paul Krugman claims that “…every economist I know would start cheering wildly if Congress voted in a clean, across-the-board carbon tax.” If the carbon tax is seen as superior by the vast majority of policy experts, then why is it not politically popular? The reason, of course, is that a number of businesses would oppose a carbon tax, and thus there has been insufficient political will to implement one. Unlike the cap-and-trade system, the carbon tax approach is essentially impossible to manipulate.
In light of the importance of effectively addressing the reality of climate change, and given that there is broad consensus amongst experts on the superiority of the carbon tax approach, and given that this approach has been implemented successfully elsewhere (e.g., British Columbia), it seems reasonable to propose that this is the best approach for Washington State. Some will argue that this is a federal issue rather than a state issue. While I agree with this observation in theory, I believe that the chance of the federal government implementing an effective carbon system anytime in the foreseeable future is essentially zero. Thus, as with so many other areas, it seems clear that the impetus for change will have to come from the states. Some will argue that because Washington State is a low carbon emission state (due the prevalence of hydropower) it shouldn’t need to be at the forefront of climate change response. I believe that this view is backwards – because Washington State enjoys a natural advantage in the carbon intensity of its energy production, it has an obligation to play a lead role in effectively addressing the challenge of climate change. In my view, now is the time and Washington State is the place for the implementation of a direct, revenue-neutral, self-extinguishing carbon tax.
- John Stafford
References: The Economist, June 7-13, 2014.2. Paul Krugman, The Big Green Test. Seattle Times, June 24, 2014.