Blog Post

Addressing Uncertainty in Carbon Tax Design

Jun 23, 2017 | Joseph E. Aldy

A carbon tax can promote efforts to reduce greenhouse gas emissions by delivering a clear, predictable price signal to businesses and families. Certainty about a carbon price, however, comes with uncertainty about the level of emissions and related environmental benefits that the carbon tax would deliver. Questions about the economic costs as well as the actions and progress of other countries toward mitigating their emissions also have important political implications for policy design in terms of how a carbon tax may be initially set and updated over time.

Ongoing dialogue about how to best design carbon tax policies is critical. The Harvard Environmental Law Review recently published a symposium on Resolving the Inherent Uncertainty of Carbon Taxes. This forum includes four essays, one on the symposium’s overarching theme that carries the same title, which I coauthored with RFF’s Marc Hafstead and Rob Williams, RFF University Fellows Gib Metcalf (Tufts) and Billy Pizer (Duke), and Brian Murray of Duke and Christina Reichert of the Southern Environmental Law Center. Here’s a brief overview of the balance of the essays.

Increasing Emissions Certainty under a Carbon Tax
Brian Murray, Billy Pizer, and Christina Reichert highlight three general approaches to increase certainty about emissions. First, a carbon tax could be adjusted based on a formula—one that would be transparent and could be tailored to deliver a desired degree of certainty. Second, regulatory tools could be deployed as a backup mechanism in the event that the carbon tax failed to meet emissions benchmarks. For example, the US Environmental Protection Agency could implement regulations under the Clean Air Act to address emissions concerns. Third, some of the revenues from a carbon tax could be used to finance other emissions mitigation activities, such as underwriting efforts to offset emissions from the agricultural and forestry sectors that fall outside of the scope of the carbon tax itself. The paper closes with a discussion of automatic and discretionary triggers for activating the emissions certainty mechanism.

Adding Quantity Certainty to a Carbon Tax through a Tax Adjustment Mechanism for Policy Pre-Commitment
Marc Hafstead, Gib Metcalf, and Rob Williams discuss a carbon tax schedule that automatically adjusts the carbon tax when emissions exceed specified benchmarks. Their tax adjustment mechanism for policy pre-commitment would increase the likelihood of meeting targeted milestones for emissions reductions over the next few decades. A country could, for example, implement a carbon tax through 2030 to meet an emissions target in that year, but implement the mechanism if an interim benchmark is not met. They discuss how the Swiss carbon tax law incorporates such interim benchmarks for 2012, 2014, and 2016, as well as review and provide guidance for key design elements to ensure that the mechanism is cost-effective and politically realistic. They argue that frequent interim benchmarks triggering small tax adjustments would likely provide lower costs and better environmental outcomes.

Designing and Updating a US Carbon Tax in an Uncertain World
I start with a similar premise—that the government sets a carbon tax rate over time. In the future, a higher (or lower) carbon tax could be politically justified under a number of scenarios: if climate change turns out to be worse (or better) than current projections; if the costs of the carbon tax are lower (or higher) than expected; and/or if other countries implement more (or less) ambitious carbon mitigation programs. I propose and outline how a carbon tax in the United States could be updated through a “structured discretion” approach: every five years, the president would recommend an adjustment to the carbon tax—based on analyses by EPA, Treasury, and the State Department on the environmental, economic, and diplomatic dimensions of climate policy. Similar to the expedited, streamlined voting on trade deals under trade promotion authority, Congress would vote on the recommended adjustment to the carbon tax, without the prospect of filibuster or amendment. Synchronizing this process with the updating of national emissions pledges under the Paris Agreement could leverage greater ambition by other countries to mitigate their emissions.

The views expressed in RFF blog posts are those of the authors and should not be attributed to Resources for the Future.