California: Carbon Tax Hurts Just like Cap-and-Trade

A recent article in the LA Times by Jon Healey discusses the proposal by California State Senate President Darrell Steinberg (D-Sacramento) to exempt fossil fuel producers from California’s cap-and-trade system, and instead impose a carbon tax on fuels. Even though this move (in theory) might make energy prices less volatile, it would still raise them, and thereby hurt California residents. Moreover, any carbon scheme (whether cap-and-trade or a straight tax) would do little to curb global carbon dioxide emissions.

AB 32 Review

In 2006, the California legislature passed and Governor Arnold Schwarzenegger signed AB 32, the Global Warming Solutions Act, which set a goal of reducing California’s greenhouse gas emissions to 1990 levels by 2020. In 2011 California enacted a cap-and-trade program to help achieve this ambitious goal.

The actual regulations are outlining the program are hundreds of pages, but the gist is simple: Starting in 2013, specified companies (about 350 businesses) in California must pay the state government for “allowances” (permits) that entitle them to emit carbon dioxide within the state. By reducing the quantity of allowances over time (about 3 percent per year, from 2015 through 2020), California’s government can increase their price, and force emissions to match the desired targets (assuming the authorities enforce the regulations strictly enough to achieve compliance).

Cap-and-Trade versus Carbon Tax?

In the academic literature, a cap-and-trade program and a carbon tax have largely the same effects, so long as they are calibrated properly. If the legislature sets the quantity of allowances so that the resulting market price of a ton of emissions is $10, then this system will have (to a first approximation) the same impact on the economy as a carbon tax set at $10 per ton. Now it’s true, there are subtle arguments by which professional economists favor one approach versus the other, having to do with our uncertainty about the size of the (alleged) “negative externality” and consequently whether it’s better to get the “carbon price” a little bit wrong, versus getting the “emissions quantity” a little bit wrong.

Steinberg himself hits upon a related justification for his proposal, when he argues that a carbon price (which would start at 15 cents per gallon) would provide more predictability in gasoline prices for consumers, rather than bringing oil companies into the cap-and-trade program next year (as will happen under the status quo). Opponents of his proposal argue that foisting such a hodgepodge (with the cap-and-trade applying elsewhere and the new carbon tax applying just to fossil fuels) on the state would actually make prices more volatile.

Without knowing the exact details of how these programs will play out—especially considering that once the genie is out of the bottle, future legislatures can always tinker—it’s hard to see which approach will make prices fluctuate the most. But what is certain is that both approaches—cap-and-trade versus carbon tax—will make gasoline and other fossil-based energy more expensive.

Moreover, because the program only applies to the state of California, it will largely by a symbolic gesture. Even stopping all United States emissions immediately would have a negligible impact on global temperatures in 2100 relative to the “business as usual” baseline, because the vast majority of growth in emissions is expected to come from China, India, and other emerging economies. Consequently, imposing a plan that would merely cut California’s emissions won’t register at all.

Tax Reform Hopeless

Another lesson from the Steinberg proposal is that it is quite naïve for “conservative” proponents of a carbon tax to keep telling us how much economic growth we’ll get from using its receipts to offset other taxes. This is because in practice, the revenues from a carbon tax (or cap-and-trade) will be used to fund “green” projects. For example, the LA Times articles explains:

The plan Steinberg outlined would take oil companies out of the cap-and-trade system, requiring them instead to pay a carbon tax of 15 cents a gallon next year. Two-thirds of the money raised by the tax, which would increase to roughly 24 cents in 2020, would be doled out to California families earning less than $75,000. The rest would be used to support mass transit.

Thus, right off the bat we see that one-third of the revenues from the tax would go to increased spending, and even the two-thirds earmarked for return to taxpayers would be distributed in a lump-sum transfer to low-income families. This might be fair on ethical grounds, since such families will be hit hardest by a hike in energy prices, but it is not at all what the “supply-side” proponents of a carbon tax need—they tell Americans how great it would be if carbon tax receipts were used to lower the top marginal income tax rates.

Conclusion

The fact that a leading member of the California legislature wants to tinker with AB32 so soon into its operation just shows that we will never get the “policy certainty” that advocates of a carbon pricing scheme promise. The only thing consumers can really count on, is that they will be paying more at the pump and to their electrical utilities if AB32 stays in place.

IER Senior Economist Robert P. Murphy authored this post.