Carbon Pricing: The Best Policy that Nobody Wants
Although carbon pricing is lauded by economists as an efficient climate policy, impediments to its adoption at the federal level in the United States are fundamentally political in nature. The more likely driver of carbon pricing implementation in the United States is as a remedy to fiscal concerns, rather than as a result of successful environmental policy advocacy.
With Democrats’ victory in the Senate early 2021, there was resurgent hope among many carbon price (aka carbon tax) proponents, hoping that the policy would be an easy pass through budget reconciliation provisions and finally overcome Republican opposition to the policy. Surely, it was hoped, there would not be a repeat of Democrats’ failure to pass the Waxman-Markey climate bill, especially as carbon pricing has had surging popularity among business interests and even oil companies. Alas, again there has been no legislative momentum on carbon pricing.
This has been disheartening for carbon pricing proponents, especially economists who point out that the policy could abate billions of metric tons of carbon dioxide at a minimal cost. Carbon pricing has already been tried in many economies around the world and has not been met with the economic catastrophe that some carbon pricing opponents ascribe to the policy. But the failure of carbon pricing to garner political attention yet again should not be a surprise, and indeed it comes with many caveats. Carbon pricing is an important policy opportunity for climate change, but it is not easy to align the merits of good policy with political needs.
The Advantages and Disadvantages of Carbon Pricing
A common refrain from economists is that a price on carbon is among the most efficient ways of abating greenhouse gas emissions—but why is this? The answer requires some humility, especially among policymakers and climate conscious individuals. A carbon price works based on the fundamental economic principal that prices matter, and individuals respond to change in prices. We see this at work all the time. Cost plays a huge factor in people’s purchasing decisions from everything to a house, to a car, to a can of vegetables. Economists know a carbon price can reduce emissions because people respond to prices, and thus a higher cost associated with pollution is going to reduce the demand for the polluting product.
A carbon price as a policy is also particularly efficient because of consumer choice and the free market. If you had only one car manufacturer and then you impose a carbon price, the cost of cars may go up, but it wouldn’t result in much pollution reduction because consumers would have to either eat the cost of the carbon price or forgo the utility of owning a car. But, because we have competition among goods and services, the carbon price delivers an incentive for producers to cut pollution inputs in their products to lower their costs relative to their competition. This means the carbon price stimulates, rather than inhibits, innovation and cost reduction in the economy–making it less harmful to growth than government mandates.
A carbon price is also an effective climate policy because it allows for consumers to pay the carbon price in scenarios where avoiding the carbon emission is cost prohibitive. For example, low-carbon aviation fuels have an estimated emission abatement cost of $260 to $4,800 per ton of carbon dioxide avoided, but the estimated benefit per ton of avoided emission is about $51 per ton, so in such instances polluters can pay the tax rather than having to forgo the utility of air travel.
And last but not least, a carbon price has some potential for economic benefits that can mitigate the economic harm caused by what is essentially a tax on economic inputs. A carbon price is sometimes called a “Pigouvian Tax” because by including the externalized cost of pollution in the price of a product, it creates a natural incentive for a more efficient ordering of capital in the market. The revenues from a carbon price, which would be about $1 trillion over ten years, could also be used to cut taxes that have a greater economic harm than a carbon tax would, resulting in a net improvement to economic growth. The Tax Foundation estimates that an efficiently implemented “revenue neutral” carbon tax would improve economic growth in the United States by 0.8 percent (for comparison, long term projected growth is 1.6 percent).
With all that said, it seems like carbon pricing should be a no brainer policy but is not. One of the biggest problems with carbon pricing is that the efficient implementation outlined above is essentially never seriously considered. A poll on the preferred use of carbon price revenues found that the majority would want to see the revenues used for additional subsidies, and the least liked option for revenue use was corporate tax cuts—what economists would expect to be the most efficient implementation of a carbon price. Using revenues from a carbon price for subsidies undermines the virtue of a carbon price because it negates the competitive elements of the policy, resulting in higher costs, and the subsidies rather than the price being the driver of behavior change (and thus a less efficient allocation of capital).
When carbon pricing was effectively proposed as cap-and-trade in the Waxman-Markey legislation, only about 300 pages of the 1400-page bill were related to cap-and-trade, the rest of the bill being regulatory expansion. Similar to how using revenues for subsidies directly contradicts the advantages of a carbon price, regulations also target the same abatement opportunities as a carbon price and thus make less efficient regulatory policy the driver of behavior, rather than price signals, and exacerbates costs by having duplicative policies. The result of a regulatory centric approach to climate policy is that some consumers will incur more cost to change behavior than the environmental benefit gained, diminishing the overall efficiency of the policy. Furthermore, Waxman-Markey planned to give away emission permits rather than auctioning them, meaning it would have been a de facto subsidy to polluters and, as one of President Obama’s economists put it, giving away the permits would be “the largest corporate welfare program that has ever been enacted in the history of the United States.”
In short, a carbon price, if efficiently implemented, is an excellent policy for abating emissions. Unfortunately, such efficient implementation is not the default for carbon price proposals, and a cautious eye is needed when evaluating carbon pricing schemes.
What Makes a Price on Carbon Likely or Unlikely to be Implemented
The popularity of policy, though, is more based on perceptions than it is on reality. Many point to the successful implementation of carbon pricing in Europe as an example of success, but unfortunately the concerns of a typical European are often not the same as that of an American. The United States is characterized by a relatively rural population, energy intensive lifestyles often by necessity, and an abundance of fossil fuel resources that lower energy prices. Europeans, by contrast, typically live in areas of higher population density, and scarcity of fossil fuel resources creates an economic and energy security paradigm that favors alternative energy sources. A carbon price is not the natural policy preference for Americans.
Advocates of carbon pricing have leaned on the notion that it is fundamentally an informational deficiency problem. In other words, if people know how effective a carbon price is, then surely they will support it, so the answer is to get as many people to know how good carbon pricing is to naturally lead to policy adoption. This approach, though, fundamentally misunderstands the opposition to carbon pricing.
Political constituencies are not so much influenced by arguments of economic efficiency, but rather by the visibility of policy impact. Perceptions matter more than reality. As an example, there is widespread support for the National Environmental Policy Act (NEPA) and fierce opposition to any amendment of its requirements, but research consistently shows that it is clean energy technology—not fossil fuels—that are impeded by NEPA. However, perceptions that NEPA is a key component of environmental protection make it difficult to reform.
When it comes to carbon pricing, Americans have a high visibility of how changes in energy prices affect their daily lives. Gasoline prices are seen daily, electricity bills come monthly, and homeowners in cold climates that use oil to heat their homes are acutely aware of just how important energy prices are to their comfort. Additionally, American politics are characterized by sympathy and concern for low-income households, and as energy expenditures make up a greater share of these household’s costs, there is a difficult-to-refute argument that a carbon price is punitive to poor Americans.
The costs of a carbon price are known, but the benefits—which are manifested globally and are future rather than current benefits—are less visible. Consequently, it is hard to sell Americans on the virtue of a carbon price, or that the costs are worthwhile or can be negated somehow.
The Political Outlook of Carbon Pricing in the United States
When it comes to the political viability of a carbon price in the United States, it is important to understand that most of the opposition comes from Republicans, but Democrats have now had two opportunities to implement a carbon price with single party control and failed to do so both times. Even though Republicans are usually blamed for carbon pricing failure, Democrats have not been consistent supporters of it either. It is clearly politically unpopular, and both parties tend to prioritize other climate policies in lieu of carbon pricing (Democrats favoring regulation and subsidies, and Republicans favoring innovation and energy exports). As an approach to climate policy, the outlook of whether a carbon price will be implemented at the federal level is bleak.
What should not be ignored, though, is the rather poor fiscal condition of the United States. The March 2021 Long-Term Budget Outlook, which does not even account for recent spending packages that have been signed into law, estimated that the 2021 deficit would be 10.3 percent of GDP (second only to WWII spending), and a debt of 102 percent of GDP. The fiscal outlook is worsening, not improving, with both deficits and debt expected to grow in the long term.
The more likely scenario for the adoption of a carbon price is not as a climate policy, but as a fiscal policy. Compared to other opportunities to raise roughly $1 trillion of tax revenue, such as corporate taxes, payroll taxes, income taxes, etc., a price on carbon is likely to be among the least offensive. The bad news for carbon price advocates, though, is that both Republicans and Democrats have shown consistent disregard for fiscal constraint, and especially so during the pandemic. Exactly when the stars may align where politicians are finally forced to pay for their policies is unknown and will depend on the various economic circumstances that underpin growth and the near-term Congressional priorities.
In the end, despite carbon pricing’s merits as an economically efficient method of abating emissions, politics dictate that policy decisions are primarily based upon constituent demands rather than economic wisdom. Carbon pricing is inherently unpopular due to the high visibility of its cost impacts, while its potential benefits are harder to communicate and less understood, as are its comparative advantages to other climate policies. Given that yet again the opportunity to implement a federal carbon price as part of major legislative efforts has been passed over, proponents of carbon pricing would do well to recognize that it is much more likely to be adopted as a matter of fiscal prudence rather than environmental policy.