Designing and Evaluating a US Carbon Tax Adjustment Mechanism
A tax adjustment mechanism automatically adjusts the tax rate based on where actual emissions are relative to a legislated target. This paper discusses the role for tax adjustment mechanisms in carbon tax design and trade-offs across alternative designs.
Abstract
There is increasing political interest in the United States in an economy-wide carbon tax. Notably, two center-right Republican proposals are attracting attention: the Climate Leadership Council’s Carbon Dividends plan, and Rep. Carlos Curbelo’s (R-FL) MARKET CHOICE Act. But the emissions uncertainty under a carbon tax is a significant disadvantage, especially since these proposals eliminate or suspend existing regulations, leaving many environmental groups reluctant to embrace them.
This creates a demand for ways to reduce a carbon tax’s inherent emissions uncertainty. One leading approach is a tax adjustment mechanism (TAM), which automatically adjusts the tax rate based on where actual emissions are relative to a legislated target.
This paper discusses the role for TAMs in carbon tax design and trade-offs across alternative designs. We use the TAM in the Curbelo bill and a TAM proposed by Metcalf (2018) for the CLC proposal as illustrative examples to show that TAMs can substantially reduce emissions uncertainty. We then consider variations on these mechanisms, illustrating how different design choices affect expected costs and emissions outcomes. Most design dimensions show clear tradeoffs, improving some outcomes while worsening others. Thus, the optimal design varies substantially based on what goals the TAM is intended to achieve.
This article has been accepted for publication in Review of Environmental Economics and Policy published by Oxford University Press (doi: 10.1093/reep/rez018).
