THE CARBON TAX ‘TIL NOW

Carbon Taxes: A Review of Experience and Policy Design Considerations
Jenny Sumner, Lori Bird, and Hillary Smith, December 2009 (National Renewable Energy Laboratory)

SUMMARY
Even such different proposals for systems to reduce greenhouse gas emissions (GhGs) as Cap&Trade or Cap&Dividend have something crucial in common: A cap on emissions. Without a cap, the effectiveness of any GhG-cutting plan has to be in question.

Not so, say advocates of the carbon tax, because it is a veritable law of economics that taxes change behavior. Therefore, it can be assumed within a reasonable certainty that a carbon tax will change emitters’ behaviors.

Advocates are so certain of a carbon tax's effectiveness that they believe it will eventually overcome politicians’ and voters’ repugnance to the T word (any new tax).

Carbon Taxes: A Review of Experience and Policy Design Considerations, from researchers at the U.S. Department of Energy (DOE) National Renewable Energy Laboratory (NREL), reviews the nearly 20-year history of carbon taxes in the U.S. and around the world and analyzes the design and effectiveness of these emissions reduction policies.

Their conclusion is that they are not sure.

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Some carbon taxes have been associated with reduced GhGs but the reductions came in a context of other policy efforts so it is not clear which policies accounted for what part of the reductions.

Other carbon taxes are too new to have definitive impacts.

What the researchers suggest, based on larger economic principles, is that higher taxes can change behaviors and lower taxes can generate revenues to fund New Energy and Energy Efficiency programs, so it depends on “the needs of the implementing jurisdiction.”

Questions any carbon tax design must consider:
(1) which sectors to tax,
(2) where to set the tax rate,
(3) how to use tax revenues,
(4) what the impact will be on consumers, and
(5) how to ensure emissions reduction goals are achieved

For a complete description of the strengths and weaknesses of the leading alternatives in the U.S. to a carbon tax, see CAP&DIVIDEND, CAP&TRADE OR CAP THE DEBATE?

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COMMENTARY
An ideal carbon tax can be more flexible than a Cap&Trade system without control provisions. The Congressional Budget Office (CBO) estimated net benefits of such a tax could be ~5 times those of an inflexible cap with no banking, borrowing, or other cost containment mechanisms. (This, however, is comparing unrealities.)

Advocates contend a carbon tax continuously encourages emissions reductions while a Cap&Trade system only encourages reductions up to the capped limit (although most Cap&Trade systems design in caps that ratchet down over time).

Advocates contend taxes are more straightforward to administer and less subject to gaming (although the IRS does not seem to suffer from a dearth of taxpayer gaming).

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Some business community advocates finds the stability of taxes more appealing than the emissions price volatility of a Cap&Trade system that has to deal with evolving supply, demand, and regulatory conditions (although market fluctuations also offer busines profit-making opportunities).

Taxes automatically generate revenues that can be used to make the rising energy costs that will come from putting a price on GhGs more equitable to low-income consumers (although Cap&Trade systems generates revenues for the same uses through the auction of allowances).

Taxes have most commonly been put on gasoline, coal, and natural gas but different localities have used significantly different tax rates.

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Carbon taxes may be most efficacious where Cap&Trade policies are ineffective because the point of regulation is uncertain or the tracking of the emissions is compromised. An example are the non-stationary sources like vehicle emissions. Some of the most appealing carbon taxes target identified gaps and areas Cap&Trade doesn’t reach.

The higher the tax, the more effectively it changes behavior; the lower the tax, the more revenues it generates to fund New Energy and Energy Efficiency programs. Rates also allow for provisions according to the needs of the locality, such as Sweden’s reduced rate to emissions-intensive industries.

Highest tax rate: Sweden, $105 per metric ton CO2; Lowest tax rate: California’s Bay Area Air Quality Management District (BAAQMD), $0.045 per metric ton CO2.

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Carbon taxes emerged in northern European countries in the early 1990s. Finland, in 1990, was first. The Netherlands (1990), Norway (1991), Sweden (1991), and Denmark (1992) followed. More than a decade later, the United Kingdom began its Climate Change Levy (2001). In the U.S., interest has waxed and waned. Recent federal policy has focused on Cap&Trade policies but localities have instituted taxes since 2007 and there were 3 carbon tax bills in 2009. They vary but all tax fossil fuel production and imports between $10 and $15 per short ton of carbon dioxide (CO2) in the first year, with tax increases over time.

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Design Considerations:
(1) The main consideration about the tax base is whether to tax upstream or downstream sources. Taxing upstream sources is simpler because there are fewer of them. Taxing downstream sources, like all electricity consumers, is a more direct signal.

(2) The rate of taxation determines whether it will cause behavior changes or generate revenue.

(3) Distribution of tax revenues, which could determine the political sustainability of the tax, can be (1) specifically to emissions mitigation (New Energy/Energy Efficiency) programs, (2) to individuals via income tax reductions and such measures, or (3) through government budgets to tax payers and tax-funded programs.

Boulder, Quebec and BAAQMD use the revenue for New Energy/Energy Efficiency programs. United Kingdom, British Columbia and France return the revenues to consumers. Sweden and Norway use revenues to fund general government budgets. Finland also directs revenue to the government budget but also cuts its income tax.

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(4) To prevent the carbon tax from disproportionately burdening low-income households, revenue distribution may include income tax reductions and credits to them. The French plan is to return all revenues to households and businesses through income tax reductions or a “green check.”

(5) Businesses may prefer carbon taxes, which give a predictable, long-term price signal that can be incorporated into plans, to Cap&Trade systems with fluctuating emissions prices. Energy-intensive industries may require special tax breaks to prevent a competitive disadvantage to comparable industries in places without emissions taxes.

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(6) Since emissions reductions will not come from a cap, a tax policy must be designed to produce them. Rates can be structured to automatically increase if emissions do not decrease but this has not been tried because the already politically challenging tax concept would only be further compromised. (There have been some rate increases imposed but none were automatic and in response to inadequate emissions reductions.) Many emissions taxes have been structured to make them more politically acceptable, with revenue-neutral provisions and refunds to low-income consumers.

(7) Metrics used to evaluate the effectiveness of tax policies vary but none have effectively distinguished between competing policies and alternative objectives

Effectiveness has been evaluated by (1) aggregate emissions reductions, (2) emissions reductions due only to the tax, and (3) emissions reductions from complimentary programs funded by tax revenues.

(8) Taxes can work successfully with other GhG-cutting policies like a Cap&Trade system or command and control regulations.

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Some European Union nations have a carbon tax and operate within the EU Emissions Trading Scheme (ETS). Norway’s tax on hydrofluorocarbons (HFCs) and perfluorocompounds (PFCs) addresses GhGs not included in the ETS.

Remaining questions:
(1) Will state and local governments overcome the popular and political objections to a new tax?
(2) How will current or proposed U.S. carbon taxes interact with established regional trading systems or the proposed federal Cap&Trade policies?
(3) If a carbon tax rate is high enough to change behavior, how will consumers tolerate it? If the tax is imposed on upstream sources and does not impact consumers directly, will they change their consumption behaviors?
(4) With the growth of carbon registries and more accurate and widespread carbon accounting, will the life-cycle emissions of sources be included into carbon taxes?

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QUOTES
- From the report: “Carbon taxes are often viewed as less politically acceptable than cap and trade systems. Despite the distinctions often made between the two policies, a pure carbon cap and trade system could be modified to address benefits that carbon taxes provide. A carbon cap and trade system could allow banking and borrowing of allowances or other cost containment mechanisms, thus decreasing price volatility. It could also raise revenue—by auctioning allowances—and distribute the revenue to low-income consumers. A review of the first compliance period of the European Union’s Emission Trading Scheme (ETS) found that the program evolved ‘surprisingly well’ and was able to establish a transparent price on tradable CO2 emission allowances…”

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- From the report: “Federal, state, and local governments are increasingly interested in instituting carbon taxes as a mechanism for addressing GHG emissions. While a handful of taxes were implemented in Europe in the early 1990s, few were adopted in the interim until a resurgence of interest on the part of local and state governments in recent years. Since 2007, new carbon taxes have been implemented in parts of Canada and the United States, while a number of others have been proposed.”

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- From the report: “In the most recent wave of carbon taxes, state and local governments have become more active in adopting taxes as either a complement to federal policies or a reaction to lack of federal leadership…There is also increasing interest in combining carbon taxes with other carbon mitigation policies. Carbon cap and trade systems may not cover all sectors or may be more difficult to implement in sectors without point sources (e.g., transportation); therefore, carbon taxes may be designed to work in conjunction with other carbon policies. For example, the recently proposed French carbon tax is designed to cover sectors not addressed by the European Union’s ETS.”