A Carbon Tax In Time, Saves Nine
By Paul R. Portney
Inside EPA
Wednesday, June 23, 2005
As an economist trained to look for the most efficient solutions to policy problems, I'm always delighted when I can say, however softly and cautiously, "Eureka!" As I've learned in my 33 years in Washington, D.C., highly efficient solutions aren't often found -- that is, seldom can we economists and policy analysts say, to paraphrase Benjamin Franklin, "A policy in time will save nine." While the policy I am proposing here won't take care of nine different public policy issues, I'm delighted to say that a single policy solution -- a carbon tax on fossil fuels -- will help deal directly, immediately, and efficiently with a number of the most pressing problems facing our nation: the federal budget deficit (in excess of $400 billion), the equally alarming trade deficit (now running at an annual rate of nearly $700 billion), a dependence for much of our oil on countries that should make us nervous, and -- incidentally -- a growing concern about carbon dioxide emissions in the atmosphere.
Most senators and members of Congress from both parties know they must tackle the twin problems of the budget and trade deficits, and for those who haven't yet gotten the picture, Federal Reserve Chairman Alan Greenspan has been issuing a steady barrage of warnings. In remarking on the aging of the baby-boom generation and its impact on the federal budget, Greenspan warned Congress earlier this year, "This demographic change is certain to place enormous demands on our nation's resources -- demands we almost surely will be unable to meet unless action is taken" as soon as possible.
More recently, in a May 18 news article, the Washington Post reported that a bipartisan panel of "eggheads of the left and right" agreed "with startling unanimity" that the United States "will fall victim to the huge debt and soaring interest rates that collapsed Argentina's economy and caused riots in the streets a few years ago" unless our nation tackles what the panelists called a budget "nightmare."
While there's no easy way to deal with either deficit, a federal tax on the carbon content of fossil fuels -- one that starts small and grows over time -- would help on both counts and have other favorable effects as well, most notably environmental. It's worth noting that the bipartisan panel described in the May 18 Washington Post article -- including panelists from the Heritage Foundation and the Brookings Institution -- were unanimous in concluding that a combination of big tax increases and major cuts in Medicare, Social Security, and most other government spending will be necessary to forestall a most serious economic problem.
It's also worth noting that, on the issue of environmental gains that also could be achieved with a carbon tax, Duke Energy's chairman and CEO, Paul Anderson, in an April 7 speech said, "From a business standpoint, it makes sense to advocate a carbon tax -- even if it costs our business more and is harder to sell politically -- than to accept alternatives that fall short of achieving real results in an equitable, efficient manner." If a carbon tax makes sense to someone upon whose own company it would fall heavily, it's worth sketching out.
Here, in broad-brush strokes, is the kind of carbon tax that I'm suggesting. Under the proposal, the government would tax domestic producers or importers of coal, natural gas, and petroleum based on the carbon content of the fuel they sell. For illustrative purposes, let's assume the tax would be levied starting in 2006 and would be initially set at a level of $5 per ton of carbon in the fuel. Under this scenario, the price increase households would pay for electricity generated from coal would amount to less than one dollar per month during the initial period. Natural gas prices would increase by much less than that (because it has much less carbon per unit of energy than coal), and gasoline price increases would be on the order of a penny per gallon. I think most would agree that the price is well within the boundaries of acceptability for American consumers.
The relatively small tax of $5 per ton would enable the proposed carbon tax to raise no more than $9 billion in 2006. But what would happen if the tax rose by $5 per ton every two years for the next twenty years? Simple calculations show that by 2010 the tax would be raising $25 billion annually and by 2020 revenues would grow to $75 billion each year (when the federal budget will be under much greater pressure than today from the rapidly retiring baby boomers). Of course, each dollar collected through a carbon tax is one dollar less that must be raised through higher taxes on work or savings; it is also one dollar less that must be cut from already pared-down discretionary spending or popular entitlement programs.
It's noteworthy that a carbon tax will also help deal with the fact that a significant portion of our trade deficit is energy-related. Consider, for instance, that the U.S. is currently sending $190 billion overseas each year for imported oil. Of that amount, nearly $40 billion goes to Saudi Arabia, Iraq, and Kuwait alone. Furthermore, policymakers and others are now becoming increasingly concerned that the market for natural gas -- a market in which current supplies come exclusively from North America -- is also becoming a global market in which the major suppliers to the U.S. will be many of the same OPEC producers upon whom we currently, and reluctantly, rely for so much petroleum. Raising the prices of gasoline and natural gas with a carbon tax will dampen demand for both petroleum and natural gas; as a result, the trade deficit will shrink as the U.S. government collects dollars that would otherwise be pumped abroad.
But that's not all the benefit the U.S. would reap from a carbon tax. By slowly but steadily increasing the price of gasoline, a carbon tax would raise consumer demand for more fuel-efficient vehicles, eventually making it unnecessary to tighten fuel economy standards for new cars, trucks, and SUVs. Additionally, it would support President Bush's commitment to a hydrogen-powered future for motor vehicles. And by making electricity from fossil fuels more expensive, a carbon tax would give a boost to wind power and other renewable sources of electricity as well as nuclear power, because all of these energy sources are carbon-free and therefore would escape the tax. Last, but by no means least, a carbon tax would provide significant environmental benefits. Within a decade, carbon dioxide emissions in the United States would be 5 percent lower than they would be without a tax (and even lower in future years). Emissions of nitrogen oxides, mercury, and other heavy metals would be reduced as well, bringing attendant health benefits.
Political benefits might ensue as well. British Prime Minister Tony Blair, who cares deeply about climate change, would see a carbon tax as supporting his G-8 leadership priorities and thus would, indirectly, demonstrate our appreciation for his steadfast and courageous support for the Iraqi war. A carbon tax would immediately establish the United States as a fully engaged participant in international climate discussions, a desirable outcome at many levels.
Naturally, economists -- myself included -- will tell you that it's always wise to reach for your wallet whenever someone describes a plan that's a "winner" for everyone. A carbon tax plan is no different. There's no denying this proposal will involve costs. Coal, our most abundant domestic energy source, is high in carbon; thus, under a carbon tax regime, electricity from coal will become more expensive, especially in later years when the tax has grown. For the southeastern and midwestern states this will pose problems because that's where much of their electricity comes from and where a lot of coal is mined. Electricity customers will also feel the pinch of higher natural gas prices, especially petrochemical manufacturers who depend on natural gas as their principal feedstock. And, lastly, a carbon tax -- like almost any consumption levy -- will fall more heavily on the poor. Knowing this, we would have to give careful thought to how we can cushion these distributional impacts.
Those costs aside, ask yourself this important question: If we want to reduce the serious budget and trade deficits, and achieving this goal will require expenditure cuts and tax increases -- unpleasant options all around -- shouldn't one of the measures we use to attack these problems be something that will also help reduce our dependence on possibly unreliable foreign energy suppliers, encourage cleaner power and more fuel-efficient cars, homes, offices and factories, protect the environment and even politically reward a steadfast ally? As an economist whose 33 years in Washington has enriched his sense of a winning proposal, I'd say the answer is clear. And the sooner we act the better. As Mr. Franklin well knew, a stitch in time does, indeed, save nine.
Paul R. Portney is President of Resources for the Future, a Washington, D.C., think tank, and is co-editor of New Approaches on Energy and the Environment: Policy Advice for the President, recently published by RFF Press.
RFF is home to a diverse community of scholars dedicated to improving environmental policy and natural resource management through social science research. Resources for the Future provides objective and independent analysis and encourages scholars to express their individual opinions, which may differ from those of other RFF scholars, officers, and directors.
