The Never Ending Threat of the Carbon Tax

Despite the brutal bipartisan legislative defeat in 2009 of the Waxman-Markey cap-and-trade bill, there continue to be policymakers who want to impose a carbon tax. This time, the failures of current tax incentives and proposed regulations that attempt to lower our carbon dioxide emissions and encourage renewable energy are the impetus for the imposition of a carbon tax.  But as we have explained many times, carbon taxes are economically harmful, not matter how they are dressed up.

Dissatisfaction with the Tax Credit Incentive Structure

Everyone acknowledges that the tax code is too complex. This provides an opportunity for those interested in pushing a carbon tax to present it as the solution to everyone’s problems. A recent Senate Finance Committee hearing about the energy tax extenders gave some clues that carbon tax advocates are laying the groundwork for another carbon tax push.

In his opening speech, Senator Hatch bashed the Obama administration’s energy policy and immediately brought up the threat of a carbon tax. He stated, “Proponents of a cap-and-trade approach have, for the most part, acknowledged that this proposal is dead. However, instead of admitting failure and moving on, they are repackaging cap-and-trade by calling it a carbon tax.”[1]

Pro-Carbon Tax Testimony

Gilbert Metcalf, a witness at the hearing, testified in favor of a carbon tax. Metcalf was the Deputy Assistant Secretary for Environment and Energy at the U.S. Department of Treasury in the Obama administration and is currently an economics professor at Tufts University. First he laid out the long-term plan for his ideal energy tax policy: “Current energy tax policy can perhaps be best viewed as a transitional policy until policies such as carbon pricing are put in place. A carbon tax would provide the correct signal to the economy about the social cost of energy production and consumption and so improve economic efficiency.”[2]

Metcalf’s justification for the carbon tax will sound familiar to anyone who has taken an entry-level microeconomics course. He argues that a carbon tax “‘internalizes’ the externality’ by forcing firms to take into account the social costs of pollution by raising their private costs by the value of the social damages that are generated by the pollutant.”[3] He does not however specify how to calculate the amount needed to “internalize the externality”. In fact Metcalf admits, “Estimating the social marginal damages from greenhouse gas emissions is an immensely complex task and all integrated assessment models that undertake that challenging task make clear that considerable uncertainty exists with respect to estimates.”[4]

Metcalf also admits that a domestic carbon tax by itself will have no discernable impact on global emissions, but says if the United States does not act first that “will mean other major countries will not take action.” If the United States does take action they could punish countries who do not act through “border tax adjustments on imports from countries not pricing emissions or carbon tax credits for energy intensive and trade exposed sectors competing with those countries.”[5] Metcalf’s analysis neglects the dubious legality of these types of tariffs.

Overall, Metcalf’s testimony in favor of a carbon tax seems to be a non-solution to a stipulated problem.

Anti-Carbon Tax Testimony

To counter that narrative, economist David Kreutzer testified against carbon taxes and argued that carbon taxes do serious damage to the economy. Using the same modeling techniques employed by the government, Kreutzer outlined some of the effects of the carbon tax proposed by Senators Barbara Boxer and Bernie Sanders. His analysis found a family of four would lose more than $1,000 of income per year, a loss of over 400,000 jobs by 2016, a rise in gas prices by $0.20 by 2016, and a 20 percent rise in electricity prices by 2017.[6] In addition to these findings he noted that a $25/ton carbon tax would only result in a 0.05 degree centigrade change in temperature.

EPA’s Coal Rule
The Environmental Protection Agency’s (EPA) proposed power plant rule regulating carbon dioxide emissions, if implemented, may provide carbon tax advocates another reason to justify a carbon-pricing scheme.

EPA promotes the alleged “flexibility” states have to determine how to achieve their emissions reductions. However, this state-based “flexibility” ignores the interconnected regional nature of the electric grid and the power sector. Andy Weissman, senior energy policy advisor for Haynes and Boone LLP, explains, “It doesn’t make sense to talk about power plants in any one state if you can’t talk about the utilization of plants across the region.”[7]

The state-based nature of the rule is already causing confusion for utilities and states as they try to come up of compliance plans. David Thornton, the assistant commissioner at Minnesota’s Pollution Control Agency, commented on problems such as: how states will get credit for renewables, nuclear energy, and energy efficiency. He said, “And we’re still sorting through a lot of these details, because quite frankly, EPA’s proposal isn’t clear on how it treats a lot of things.”[8]

A regulatory legal expert summed up the extent of compliance problem upon reviewing the proposed rule:

“The rule, the way it’s crafted, does make cap-and-trade appear as sort of an elegant solution to the problem of how to incentivize reductions in demand and increased renewable generation from the affected sources, which are only fossil fuel generating units.”[9]

EPA’s Onerous Carbon Dioxide Regulations are an Excuse for a Carbon Tax

Groups that support the carbon tax are already using the weaknesses of EPA’s carbon dioxide restrictions to present the carbon tax as the superior alternative. For example Michael Wara, an attorney at green group, Resources for the Future, wrote:

To me, this whole thing is reminiscent of California- lots of shadow carbon prices that are higher and lower than the visible power sector price that’s driving the cost-effective abatement strategy- redispatch. And it makes a fantastic argument for legislative action to implement a simpler and more cost-effective policy. Why can’t we just have a carbon tax and cut my FICA withholding already?[10]

Here the author is showing that poorly designed regulations, essentially act as a surrogate (or “shadow”) carbon tax by making carbon-intensive activities more expensive. One problem with Wara’s argument is that he ignores an important element in the economic literature of carbon taxes. As IER’s Robert Murphy has explained many times, the so-called “tax interaction effect” (the way new carbon taxes interact with pre-existing taxes on labor and capital) means that  we don’t get a win-win or a cost-effective policy from just reducing FICA and imposing a carbon tax. Wara and others who write in praise of a carbon “tax swap” often lead their readers to believe that using carbon tax receipts to offset pre-existing tax rates is a “no brainer” to promote conventional economic growth, but actually the peer-reviewed literature says the exact opposite. Carbon taxes are so destructive to the conventional economy that they magnify the damage that labor taxes cause, even if the labor tax rate is reduced with carbon tax receipts.

Conclusion

Even with the bipartisan defeat of cap-and-tax, the threat for similar legislation in the future continues to be real. Dissatisfaction with the patchwork of energy incentives in the tax code, coupled with increasingly onerous regulations such as EPA’s coal rule will help carbon tax proponents continue to bring up the idea of a carbon tax. It is important not to lose sight of the fact that a carbon tax is essentially the same as cap-and-trade, which the American people loudly rejected. Now Washington is attempting to dress the wolf in sheep’s clothing in order to get what they want.

This post was authored by IER Policy Associate John Glennon.