A tool to heal, A tool to steal: Thoughts on a Carbon Tax

Carbon taxation is in the news, for some good and bad reasons.

One bad reason is that now that the US election season has ended, policy discussion season is just starting; further evidence that elections are considered no time to discuss policy, as short-term Canadian Prime Minister Kim Campbell is accused of claiming.

A second, I think mostly bad reason, is that following months of denials that the US is increasing it's energy production, the latest outlook from the International Energy Agency acknowledges US energy self-sufficiency is a plausible outcome within a decade.  Certain groups, broadly perceived as "environmentalists," had been arguing the necessity of making drastic changes to our lifestyles because we were running out of available oil and gas.  Now that doesn't seem to be the case, it should be added impetus to strengthen attempts to curtail consumption.

One good reason a carbon tax is newsworthy is if putting additional CO2 (and other greenhouse gases) into the atmosphere is to be discouraged, there's a valid argument that we should tax putting CO2 into the atmosphere to discourage it.  

My inspiration to finally address a carbon tax comes from an article in Forbes, Creating Better Climate Policy: Linking Carbon Taxes to Investments in Clean Energy.  The article ties taxing carbon emissions to funding "clean energy innovation" and paying down government debt:

...the message of a new white paper by Brookings Institution scholars Mark Muro and Jonathan Rothwell:"

“Numerous scholars have demonstrated that, while the scale of the needed carbon emissions reductions is extremely large, price-based systems by themselves are not likely to induce sufficient technology change to deliver the needed reductions, particularly given the “lock-in” of cheap, readily available dirty technologies and the modest pollution prices that are tolerable to politicians…A major problem with all carbon pricing solutions is the fact that the private sector will not (for recognized reasons) invest adequately on its own in low-carbon solutions and technology change – even in the presence of carbon pricing.”

Instead, as the authors argue, a carbon price can be used as a vehicle for investing in clean energy technologies. Muro and Rothwell propose implementing a gradually increasing carbon tax starting at $20 per ton CO2 to raise an average of $150 billion per year in revenue. The first $30 billion of revenue, or 20 percent, would immediately go into a trust fund to support clean energy innovation programs.

What does "support clean energy innovation" mean?

Academics would, I think, largely agree that investing in study, testing programs and pilot projects offers not only the greatest probability for a return on expenditures, but the greatest probability of a revolutionary energy breakthrough - which would be energy that is abundant, cheap, and environmentally benign.  An example of this approach might be Germany's efforts towards increasing the use of electric cars, which is a program going back to 2008 that looks to 2017-2018 to start seeing results on the road from it's focus of coordinating stakeholders in industries and funding research and development (here).  Another example might be seen in Bill Gates' nuclear endeavors (TED talk here)

I would contrast this with Germany's approach to renewable energy - which was to encourage a building boom with feed-in tariff contracts - an approach that has been expensive and not particularly encouraging of technological advancement (see section of program starting on page 13 of 2010-2011 Annual Report from the German council of Economic Experts - ).

There is also the contrarian problem in sporadically pricing externalities to prevent a "tragedy of the commons," which is annunciated by the German Council of Economic Experts regarding the "extremely costly promotion of alternative energies" :

...as climate protection is a public good, the costs of its provision must be borne at the national level alone, whereas its benefits accrue to all nations. It follows that the European Union's pioneering role in respect of climate protection can only represent a transient situation and should not be pursued further unless it is guaranteed that other major polluters will, in turn, launch comprehensive initiatives to cut emissions.

Graphic From "Our Finite World"

There's more than a little injustice in this statement, as CO2 content in the atmosphere is cumulative and the richest countries have contributed by far the most to the elevated levels, but ... it's also the case that China, which only recently passed the United States as the planet's #1 emitter, reportedly emitted 50% more than the US in 2011.  Recent growth in emissions are largely from developing regions that feature large numbers of people moving out of poverty, which most consider a good thing.  There are many more still in poverty - a bad thing.  I suggest this is further evidence that the goal of policy, including tax policy, should be scalable and affordable power.  Unless the carbon tax implemented offers that possibility, I would not consider it good policy.

The European Union has an Emissions Trading System (EU ETS), which is a carbon quota system.  In recent years, with recession (2009) and slow economic growth, there has been frequent criticism of the ETS as supplies have dropped.  Recently Australia committed to joining the EU ETS as a retreat from the more strident carbon tax their government introduced this year.  The ETS is now as likely to keep emissions from dropping as it is from capping emissions, as displayed by a very, very low value on carbon in the ETS.  It is problematic that a wealthy country can set policy with the position it can purchase quota from poorer areas of Europe because the ETS is regional.

A raw carbon tax has this inequity on a personal level.  Because lower income households spend a far greater share of income on energy, policies that inflate the costs of energy are regressive.

The Brookings Institution White Paper that Forbes reports on suggests introducing a carbon tax without some complimentary introduction of income support programs - which introduces other problems.  The circle of government action is to raise the cost of energy, and then introduce programs to pay poorer households enough to afford energy and food - and inevitably, due to the nature of politics and people, those programs expand beyond the households that need targeted assistance, or neglected (for examples of the former, see entries from OXFAMand Christian Science Monitor - for the latter the exchange noted here) - there's a real danger that the cost of compensating for energy taxes will exceed the revenue from the tax, and much of that compensation will be subsidizing fossil fuel consumption to compensate for taxing fossil fuels.

I would suggest that there's little evidence carbon taxation has accomplished anything in the longer term, as Europe is not reducing emissions at the rate the US is.  In the short term the accomplishments are as likely to be from the anti-emissions advertising value from introducing a tax to promote reduced consumption as to be from the minor consumption reduction economist would expect from a minor increase in pricing.  British Columbia's young carbon tax has been the subject of at least one study finding early success, without harm to the economy, but as one critic noted, respondents to a survey had generally not noticed any impact of the tax on consumption and had no knowledge of changed emissions - but they liked that there was a carbon tax.

The economics are questionable partially because of both the elasticity of demand, and the elasticity of supply.  On the demand side there is relatively little elasticity in the short term; in the longer term the elasticity is greater, probably due to households that can afford to spend on efficiency upgrades (causing concerns from the left on replacing "consumption with an investment").  The elasticity of demand amongst industrial users can be far greater in the short run (and for some businesses time-shifted loads may be pursued because of this); in the long run very few jurisdictions maintain high prices for industry long enough to figure that out; Germany exempts industry from the EEG (renewables) charge, the US average rates for electricity are $120/MWh for residential use, and $70 for industrial, and in Ontario the government introduced a program to lower rates for the largest users in 2011 (Class A global adjustment), and plans on introducing another.  Theoretically industry has a greater elasticity of demand - in reality some reduce their consumption to 0 if rates aren't competitive.

The price elasticity of demand is not very elastic, and industrial demand can be elastic, but it requires working with industry as they have the mobility to move to other jurisdictions.

The current glut in North American natural gas supplies, and improved oil outlook, were as predictable in 2012 as they were in 1974, when the Economist magazine ran an article at the height of the oil pricing during the oil crisis titled, "The Coming Glut of Energy."  The argument is as prices increase new energy supply will be produced to more than compensate for the depletion of existing resources, combined with the slight decrease in demand from higher rates.  Because demand is inelastic and reserves are known (but many difficult to get at), this is likely to remain the case for some time.  Peak oil theory doesn't necessarily contradict that - it's just a cycle of depleting resource at one price level leading to higher prices and another category of resource become economical to extract.

The United States is reducing emissions partly because of technological advances in extracting natural gas - a carbon tax would elevate consumer pricing without providing the price/purchase signal to develop more supply.

Unfortunately, it's unclear that other sources of energy can substitute for the role filled by fossil fuels.  As oil prices have spiked, we have not seen replacements of oil so much as the improved ability to extract oil elsewhere.  Tax policies make gasoline pricing far different in different countries, yet expensive countries aren't dominated by non-fossil fueled transportation.  It's unclear why a carbon tax would suddenly change that metric - thus the increasing skepticism that an energy revolution can be addressed by taxing fossil fuel.

That's not to indicate countries with more expensive gasoline don't have less gasoline consumption - but  most are also older, more densely populated, societies.

The wealth/power impact shows itself in societies in other ways.  I think Clay Shirky's popular TED talk's Israeli daycare section provides a very real possibility that the message of a regressive tax would be that poor people shouldn't use energy they can't afford, while people who can afford it should go ahead because they pay for it (from minute 7 through minute 10).

If you want somebody to do less of something, add a punishment and they'll do less of it.
Simple, straightforward, commonsensical -- also, largely untested.
...
If you pick your kid up more than 10 minutes late, we're going to add a 10 shekel fine to your bill.
Boom. No ifs, ands or buts.
And the minute they did that, the behavior in those daycare centers changed.
Late pick-ups went up every week for the next four weeks until they topped out at triple the pre-fine average, and then they fluctuated at between double and triple the pre-fine average for the life of the fine.
And you can see immediately what happened, right?
The fine broke the culture of the daycare center.
By adding a fine, what they did was communicate to the parents that their entire debt to the teachers had been discharged with the payment of 10 shekels, and that there was no residue of guilt or social concern that the parents owed the teachers.

While pricing carbon does have the support of many economist, that is unlikely to be as relevant as a social consensus that emissions are a bad thing.  That consensus exists, but it is muddied by the 'buts' 'ands', 'ifs' ... 'but' nothing is worse than nuclear, 'and' we can do something to solve it all (renewables); 'if' only either of those were true.

I don't see consensus building on meaningful action to address emissions coming from a carbon tax while most voters are suspect politicians would use a carbon tax to buy votes/fund frivolously selected objectives.  The suggestion in the Forbes article called for only 30% of the tax to be spent - and it would be spent politically - while the other 70% would pay down debt, as if the accumulation of debt had something to do with burning carbon!

James Hansen has a more socially conscious suggestion on the disposition of carbon tax revenues:

Disposition of the money collected from fossil fuel companies is thus the most critical matter. You can be certain that politicians and economists will come up with all sorts of suggestions about how they will cleverly use the money (investments in renewable energies, reduction of other taxes, etc.). Do not let them get away with it. The fee will only reach required levels if the money is going to the public. Let the motto be "100 percent or fight!"
The money collected from fossil fuel companies should be distributed electronically each month to bank accounts or debit cards of all legal residents. My suggestion is that each legal adult resident get an equal share, with families getting an added half share per child up to a maximum of two such half shares per family.

Hansen's suggestion eliminates many historical problems in growing government programs to compensate for a regressive carbon tax because while lower income people spend a greater share of their income on energy, they consume less energy.

If the mechanism of a carbon tax has utility in reducing emissions, this will reduce emissions.
I am not opposed to this form of a carbon tax.

The argument that it will not do enough to lower emissions significantly is probably valid - but the jump to there being something better that can be done in disbursing the revenues does not necessarily follow.

Some economic theory indicates other things would be more powerful than a carbon tax in designing lower impact societies and reducing fuel use.  Aldyen Donnelly argued, I think convincingly, that taxing the vehicle, or residence, should be more effective than taxing the fuel:

After one spends a little time calculating paybacks for different vehicle purchase options under different energy and vehicle price, tax, emission rating and purchase incentive scenarios, it becomes obvious — I believe — that any tax measures intended to change consumer energy use should focus on car purchase and annual re-registration, not fuel purchases.
Interestingly enough, if you go back to your Econ 300 micro and macro economic textbooks, you might discover that the economic theory we were taught a few decades ago actually suggest the same thing. The older textbooks (from back when I was young and Jesus was a baby too!), suggest that for a tax/price increase to effectively and efficiently impact consumer demand, the tax/price impact has to be revealed to/experienced by the consumer at a point of a “primary” consumption decision, not a “secondary” or derived consumption decision. Most fuel/energy purchases by non-industrial consumers are secondary or derived from their decisions to locate their home and the vehicles they buy. So even the traditional general economic theorists told us, so many years ago, that if we want to change energy demand in as economically efficient a fashion as possible, we likely would need to tax (to the extent this is the policy mechanism of choice) home and car purchases (primary capital expenditure decisions) and not energy/fuel purchases (secondary, variable, operating costs).

This is not an either or argument, but it is a prioritization.  A carbon tax is likely not the singularly best way to reduce emissions.  Aside from the point above, it's also clearly true that regulation itself is a good weapon, currently being used in regulating emissions from power plants, and automobiles.

In the end I would probably vote against a carbon tax, due to two very basic issues.

The first is costing externalities.  In Ontario's electricity sector history, pricing externalities was a major push in the 1990's, which somehow seems to have led to 7 nuclear reactors being shut down and a consequent surge in the use of coal - until the units were brought back into service.  The claim that a "full cost analysis" was guiding policy accompanied increased emissions.

The second issue is the disposition of the revenues, which are often lobbied to be spending on 'alternative' wind and solar energy.  But energy is not power, which is what people want.  The difference is the ability to do work over time as needed, instead of the ability to do work.  The generation technologies currently trending as 'green' are energy technologies - the additional systemic requirements to make them power technologies, dispatchable to meet demand, are not frequently, or adequately, addressed.  I refer to this as the second issue, but in reality the spending on energy, when power is required, has preceded the revenues throughout the debt-ridden west.

A tax to support the current renewables industry is as likely to prevent a drop in emissions as anything else.  The experience in Germany is instructive: while a nuclear phase-out policy was in effect from 2000, the strong performance of nuclear power plants in the following decade led to a grudging extension of their phase-out period, but with a new tax on nuclear fuel because it was felt non-carbon emitting nuclear had unfairly benefitted from the EU ETS price on carbon.  When the government reneged on the life extension, it left in the fuel tax.  Germany is left with more of a hope than a plan of reducing emissions.

More important than the carbon tax tool in the electricity sector is an understanding of the pros and cons of generation technologies, and the requisite market design that would encourage the development of technologies that can actually replace fossil fuels; this being a critical tactical shortcoming "at the interface of economics and engineering of electricity markets."

The option of pricing externalities, admittedly seen as 'first best' by a number of economists, is prevented by the difficulty in calculating that price, and in the gaming of existing electricity markets.  The most contentious aspect of a carbon tax is the disbursement of the revenues, and that should be a contentious issue.  There is disagreement over the extent to which a carbon tax will reduce emissions, but there needs to be another recognition that this 'first best' market option of addressing emissions is suggested in an environment where electricity markets are not functioning, in large part due to technologies politicians unwisely support as the 'winners' of the future.

Instead of pricing externalities, the far more prevalent government response has been targeted programs to promote specific alternatives to conventional electricity generation technologies. Justifications for such programs have generally begun with environmental concerns, but have often expanded to energy security, job creation, and driving down fossil fuel prices, generally without support of sound economic analysis. Such targeted programs also seem especially vulnerable to political manipulation.

If governments are to implement reasoned renewable generation policy, it will be critical to understand the costs and benefits of these technologies in the context of modern electricity systems. This requires developing sophisticated levelized cost estimates, and adjusting for both the market value of the power generated and the associated externalities, so they can be usefully compared across projects and technologies. Such adjustments are complex and frequently controversial. More research at the interface of the economics and engineering of electricity markets would be very valuable, particularly on the cost of intermittency, the benefits of end-use distributed generation, and the economic spillovers from learning-by-doing and network externalities. Progress on these questions would enhance renewable energy public policy and private decision making, particularly in a world where first-best, market-based options are greatly restricted.

"The Private and Public Economics of Renewable Electricity Generation."