The Economics of a Carbon Tax
Air Date: Week of November 16, 2012
Pollution coming from factory smoke stacks (photo: Bigstock)
Environmentalists have been talking about a carbon tax for years. The idea may finally be getting traction in Washington, as economists consider various tools to balance the budget this spring. Joe Aldy, a professor of Public Policy from Harvard’s Kennedy School joins Steve Curwood in the studio to discuss whether a carbon tax stands a chance.
CURWOOD: It’s Living on Earth, I'm Steve Curwood. For years there’s been talk of a tax on carbon pollution as a way to fight global warming. But it’s gotten little traction until recently when both conservative and liberal economists have argued that a carbon tax could help cut the federal deficit and keep other taxes low. Joining us to discuss all this is Harvard economist Joe Aldy, a former aide to President Obama. Welcome to Living On Earth!
ALDY: Thank you, it's my pleasure to be here
CURWOOD: Professor Aldy, we asked you to come in because there seems to be all this excitement now in Washington about the prospect of carbon tax. There’s been a series of meetings and recently there was a standing room-only meeting at the American Enterprise Institute, which is known for being very conservative and skeptical of the whole notion of dealing with climate issues. Why is Washington suddenly so interested in a carbon tax?
ALDY: Well, I think there are a couple of reasons why Washington is interested in the carbon tax. One is, if you paired it with reducing tax rates, you can actually make our tax system more efficient. I think also it’s a function of the math; that when you look at all the alternatives to raising revenues or cutting spending in the tax or fiscal reform debate, there are actually not a lot of very palatable alternatives.
And all of a sudden a carbon tax looks more appealing when you compare it to, say, increasing the payroll tax by two percent. People have talked about the reduction in spending on defense and on entitlements; it’s also on par with the home interest deduction. Some people say if we got rid of the home interest deduction that would help close the budget deficit and deal with our long-term debt problems.
None of those are easy options, and I think that when you look at the potential revenue that a carbon tax can raise, that looks more appealing than having to go down some of these other avenues.
CURWOOD: So explain to us a the concept of a carbon tax – how would this work?
ALDY: So the basic idea of a carbon tax is to say that all of the sources of carbon dioxide ¬– the most important greenhouse gas – would actually have to bear the cost that they have on the global environment. So, you would actually impose a tax for every ton of carbon dioxide that’s emitted when we burn a ton of coal, or natural gas or we burn oil and petroleum products.
CURWOOD: So where in the world has a carbon tax been used so far?
ALDY: So we’ve seen it in a number of places. A number of northern European countries have actually had a carbon tax on the books and in place dating back to the early 1990s. So, Sweden, Finland, Norway and Denmark have all had carbon taxes in their energy system. Some of the carbon taxes range anywhere from 20-100 dollars per ton of CO2, which are actually quite meaningful, and in some cases larger than what we would consider here in the United States.
I think most relevant when we think about it in the context of the current fiscal environment, is what British Columbia implemented in 2008. The province of British Columbia imposed a carbon tax, and they used all the revenues to reduce existing household taxes on…for family income, and business taxes, a 50-50 split between families and businesses.
They ramped the tax up, it’s now 30 dollars a ton of CO2, so they set at the beginning a schedule where the price would increase over time. But at the end of the year, they take all of the revenues, they don’t increase the size of the government, they’re actually saying we’re going to reduce the taxes that families and businesses pay, and it’s actually had a pro-growth impact.
And I think that’s one of the important things about this in fiscal reform, is by raising revenues through carbon tax – by putting a tax on something bad like pollution – we can reduce taxes on things that are good, like the income that families earn and that businesses earn.
CURWOOD: So how successful has the carbon tax been in places like British Columbia?
ALDY: Well, you’ve actually seen their emissions go down, you’ve seen their consumption of petroleum actually go down relative to other parts of Canada. Even if the price starts out modest at the beginning, if you show the schedule of how the price will increase overtime, when businesses are making investments, when a family is thinking about buying a new car or a new home, they can take this into account in their planning. And that means they’ll make prudent investments in energy efficiency and alternative energy sources that help reduce their emissions over time.
CURWOOD: Professor Aldy, you’re an economist, so help us with some math here: How could a carbon tax help reduce this enormous deficit that we have?
ALDY: So I was at this conference in Washington that discussed a carbon tax. The kind of magnitude of carbon tax that was commonly raised was on the order of about 100 billion dollars or 150 billion dollars a year. This would be associated with a tax that would increase in the price of gasoline, maybe 15 cents a gallon. So this is something that people would actually see, but if you actually raise the tax on the order of 100-150 billion dollars a year, over a decade, that’s more than a trillion dollars.
When you look at the kinds of proposals on the table to reduce taxes, to shore up the long-term deficit outlook, having a trillion dollar piece of the pie there, if you will, that helps make all the math add up, is going to be really important.
CURWOOD: Carbon tax would inevitably mean higher price at the pump, more expensive electricity - how are people going to come to accept this?
ALDY: Well, I think the important thing is that we’re discussing a carbon tax in the context of what would be a very large tax and fiscal deal. So when one says: ‘Well, look, I’m going to be paying a little bit more for gasoline, or a little bit more for electricity,’ it may be in the context of a deal that also keeps the income tax rates for the vast majority of Americans at the level we’ve enjoyed over the past decade. If we don’t do anything, they go up on January 1.
So, it’s recognizing that there are going to be these trade offs and for a lot of people they’ll find that they may be better off if they face lower rates of tax on their income, even if that means they pay a little bit more for the energy-intensive, emissions-intensive consumption that they entertain.
CURWOOD: Some folks will say, though, this is a regressive tax, especially for really poor people who don’t have the benefit of other tax rates. If you don’t pay tax already and the price of gasoline goes up because there’s a carbon tax, it hurts you. How do you address that?
ALDY: Well, I think that there are a number of ways in which one can try to mitigate these concerns. I’ll note that in 2009, several Republicans in the House introduced a carbon tax bill. One of whom was recently elected to be the junior Senator from Arizona, Jeff Flake. In that bill, they were concerned about the impacts of a carbon tax on the elderly, on people who collected social security. So cutting the payroll tax doesn’t really benefit you if you’re retired. They actually take some of the revenues from the carbon tax and increase the benefits that would be paid out to social security.
CURWOOD: And what about somebody who’s living from paycheck to paycheck, you know, a young person who’s got a very low income job, maybe working in a fast food restaurant and needs to put gas in that car to get to that job, he’s not going to get to Social Security, he doesn’t even have to pay taxes… all he sees is the price going up.
ALDY: Well, let’s be clear, though, that person who is working minimum wage, might not be paying income taxes, but that person is paying payroll taxes. One could actually look at using a carbon tax, in part, to reduce the tax on labor, which a lot of economist would say: ‘Hey, that could actually be good for jobs, it would be good for the economy if we reduce the taxes on labor,’ and so, even if you’re not paying income taxes every April, you’re paying with every paycheck; your employer is withholding payroll tax. So there’s a way in which you can actually help out even those individuals by the way you take the carbon tax revenues and bring them back into the economy.
CURWOOD: It takes a long time to get things done in Washington. I’m guessing this doesn’t happen in the lame duck session we’re looking at over the next couple of weeks.
ALDY: You know, it’s one of these things where sometimes it takes a while for the impossible to become plausible, and then become inevitable. Sometimes it happens very quickly… I’m probably not going to go to Vegas and bet on it happening in the lame duck, but it depends on how these talks evolve. I think it’s probably more likely that we’ll do a short-term fix in the lame duck, but we’ll probably structure it in a way where we’re going to see a bigger, longer-term, more robust agreement, hopefully in 2013.
CURWOOD: How much do you think superstorm Sandy has affected the debate on carbon tax?
ALDY: You know it’s interesting. When I talked to a friend about some of the images that we saw from New York and New Jersey, he actually said, these pictures remind me of Bangladesh after a bad monsoon season. Just seeing this unbelievable amount of destruction of the roads and the bridges and the infrastructure, and houses completely wiped out… and I think it’s important to really say: ‘We know climate change can actually pose real damage to us here in the United States.’
And whether we say Sandy was the function of climate change or not, we do know from the best scientists out there that storms like Sandy are going to become more common. Being able to say, ‘Wait, if we don’t do anything about this, we’re going to see more storms like Sandy. We’re going to see more droughts, like what we’ve been experiencing here in the United States over the last couple of years.’
I think that actually will create more interest for people to say: ‘Well, what can we do about this? How can we take action?’ And being able to identify some of the policy tools at our disposal, I think we’ll encourage the public to say, ‘You know what? Let’s try that idea. Let’s make a difference in terms of how we produce and consumer our energy, and recognize that we can do this in a way that’s actually good for our economy.’
CURWOOD: Joe Aldy is an economist who teaches at the Kennedy School of Government at Harvard. Thanks so much for coming in, Joe.
[MUSIC: Neil Young “Ramada Inn” from Psychedelic Pill (Reprise Records 2012).]
ALDY: Thank you for having me, I've enjoyed it.
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