Working Paper

Designing and Updating a US Carbon Tax in an Uncertain World

Jan 31, 2017 | Joseph E. Aldy

Summary

A carbon tax policy that accounts for new scientific, economic, and political information can both send necessary price signals to reduce US carbon dioxide emissions and create incentives to leverage meaningful mitigation efforts by other countries.

Key Findings

  • Under this “structured discretion” approach, every five years the president would recommend an adjustment to the carbon tax based on analyses by EPA, Treasury, and State on the environmental, economic, and diplomatic dimensions of climate policy.
  • Congress would vote up or down on the presidential recommendation for a carbon tax adjustment, without the prospect of filibuster or amendment, similar to the expedited, streamlined consideration of trade deals under trade promotion authority.
  • The timing of this process could be synchronized with the updating of nationally determined contributions under the Paris Agreement in a manner to leverage greater emissions mitigation ambition by other countries in future pledging rounds.
  • The communication of guiding information and the latest data and analysis from EPA, Treasury, and State could serve as “forward guidance” for carbon tax adjustments, akin to the Federal Reserve Board’s communication strategy.
  • Structuring the discretion through the scheduled reporting and presidential recommendation process can ensure that businesses and households can anticipate and credibly predict the evolution of US carbon tax policy.

Abstract

A carbon tax provides certainty about the price of emissions, but it does so in a context characterized by uncertainty about its environmental benefits, economic costs, and international relations implications. Given current knowledge, suppose that the government sets a carbon tax schedule. In the future, a higher (lower) carbon tax could be justified by the resolution of uncertainty along the following ways: climate change turns out to be worse (better) than current projections; the economic costs of a carbon tax are lower (higher) than expected; other major economies implement more (less) ambitious carbon mitigation programs. This paper describes the design of a predictable process for updating the carbon tax in light of new information. Under this “structured discretion” approach, every five years the president would recommend an adjustment to the carbon tax based on analyses by the Environmental Protection Agency, the Department of the Treasury, and the Department of State on the environmental, economic, and diplomatic dimensions of climate policy. Similar to the expedited, streamlined consideration of regulations under the Congressional Review Act and trade deals under trade promotion authority, Congress would vote up or down on the presidential recommendation for a carbon tax adjustment, without the prospect of filibuster or amendment. This process could be synchronized with the timing of updating of nationally determined contributions under the Paris Agreement in a manner to leverage greater emissions mitigation ambition by other countries in future pledging rounds. The communication of guiding information and the latest data and analysis could serve as “forward guidance” for carbon tax adjustments, akin to the Federal Reserve Board’s communication strategy.