Blog Post

A Tool for Meeting Emissions Reductions Targets under a Carbon Tax

Oct 17, 2016 | Marc Hafstead, Gilbert E. Metcalf, Roberton C. Williams III

US climate goals are often stated in terms of emissions targets. As part of the recently ratified Paris Agreement, the United States pledged to reduce greenhouse gas emissions to 26-28 percent below 2005 levels by 2025. A cap-and-trade program (which sets a cap on aggregate emissions, equal to the target, and allows market forces to set a price on emissions) would be an obvious mechanism to achieve this target (or other longer-term targets). The market price raises the private cost of emitting greenhouse gases and reflects the social cost of meeting the emissions target.

Alternatively, policymakers could implement a tax on greenhouse gas emissions; we will use the term “carbon tax” to refer to either a tax just on carbon dioxide emissions or a tax more generally on greenhouse gas emissions. Under a carbon tax, policymakers fix the price on emissions over time. In contrast to a cap-and-trade program, this ensures price certainty, which is helpful for businesses or households making choices about low-carbon investments, but it does not ensure that targets expressed as emissions quantities will be met. Given uncertainties over future emissions trajectories, damages, and mitigation technologies, we cannot know ex-ante what price level would be necessary to meet such targets.

In our latest discussion paper, "Adding Quantity Certainty to a Carbon Tax", we define and discuss the design elements for a Tax Adjustment Mechanism for Policy Pre-Commitment (TAMPP), an adjustment mechanism for the tax rate of a carbon tax to ensure that emissions target milestones are met over the next few decades. Such a mechanism could address concerns that a carbon tax does not provide certainty as to the quantity of emissions reductions achievable under the policy. The basic principle is simple. In addition to setting a time-profile for tax rates as under a standard carbon tax, policymakers specify a final emissions target and intermediate benchmarks. If, at specified times, emissions deviate sufficiently from the intermediate benchmarks, the tax rate adjusts in order to bring emissions back towards the next benchmark.

In our paper, we discuss the types of targets and interim benchmarks that could be set, different types of adjustments to the tax, the frequency and size of the ideal adjustment, and what would trigger an adjustment. Despite the numerous choices, we argue that the approach should be rule-based with a clear and transparent adjustment process that reduces unnecessary uncertainty for investment. Finally, we lay out a research agenda for future work on TAMPPs to evaluate different design choice under a TAMPP and to compare TAMPPs to alternative policies such as a simple carbon tax or a cap-and-trade program.