Why the Carbon Tax is a Great Idea

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There are certain things in life that we all take as fact: smoking is bad, the sky is blue, sitting too close to the TV is bad for your eyesight, and so on. These are indisputable facts that nobody really doubts, and it is probably time to add “global warming is real” to that category. 10 years ago, if I were going to write a blog piece on global warming, it would probably be a piece that weighed the evidence on both sides to determine whether or not it was a real threat to us. Today, we all have the fortune of overwhelming evidence- evidence which states that global warming is a problem, and that man made emissions are the leading cause behind it. If you don’t believe me, please look at the graph above and give me your explanation for the explosion of carbon levels that perfectly coincide with society’s industrialization. So since I personally wouldn’t debate this point for the same reason why I wouldn’t debate whether or not cigarettes cause cancer, this piece will talk about one of my favorite ideas to deal with climate change. That is: the carbon tax.

 

So how exactly does it work?

 

One of the first lessons I was taught in microeconomics was that of externalities, both positive and negative. An externality is the impact an economic transaction has on a third party. For example, riding your bike to work every day creates a (very small) positive externality for society, since that much less carbon is emitted into the air, which is good for all of us. On the other hand, you driving your Hummer to work every day would create a negative externality to society because of all the carbon you were emitting. Now, say you wanted more people to ride their bikes to work, and less people to drive their Hummers, if you were a government, what would you do? Well, one thing you could think about doing was enacting a large excise tax on Hummers, forcing individuals who buy Hummers to pay a heavy tax on the good. This would do two things- first off, it would create a new source of revenue for the government, and secondly, it would disincentivize people from buying Hummers, since they’d become more expensive. Additionally, the money from this excise tax could be put towards a bicycle subsidy, in which the government helped everybody who wanted a bike buy one by offering to split the cost 50/50. This would then have the effect of inducing more and more people to replace their Hummers with bikes. If you followed this example, and think it sounds pretty reasonable, then you now have a basic understanding of the rationale behind the carbon tax.

 

Essentially, the carbon tax is designed to make carbon emitting products more expensive to their non carbon producing alternatives. This is done by taking the negative externality into account and taxing it. Now that some basics have been covered, we can get into the details about the carbon tax, how it works, and how we can make it feasible.

 

So how exactly do we tax an externality? This is more art than science, and there really is no right way to do it. The first thing one must do however, is to come up with a formula that equates each unit of an externality to a monetary value- in this this case, the monetary value is known as the “social cost of carbon”. Basically, were saying “every unit of carbon costs society X amount of dollars”. There is no consensus on how much one metric ton of carbon truly costs society, as the number ranges from $25-50 per metric ton (Fun fact: the average American emits 18 metric tons of carbon per year).

 

Now that we have an understanding of the thought process behind determining a social price of carbon, we can discuss how it would be implemented. I spent about 2 hours trying to find the most straightforward way to explain this – as it turns out, saving the world from impending doom is really complicated! Who woulda thunk it?! So instead of dragging you through a lecture on what a British Thermal Unit is, and how it is equated to the formula that derives a social cost of carbon, and how the combination of those two formulas yields a tax level for each source of energy, I’ll give you the Sparknotes version.

 

Basically, every form of energy have different emission levels. For a resource that is cheap and plentiful (like most fossil fuels), the price per BTU is low, meaning that is a cheap source of energy. However, this price does not take the negative externality of carbon pollution into account. By equating BTU to the price of carbon, we can then assign a tax to each form of energy. This tax would now force the market to “price in” the social cost of carbon, which would raise the prices of these goods.

 

Got it? Great!

 

There are many ways to collect this tax, but the best way (in my opinion) is through an “upstream supply chain” policy. How does this work?

 

The BTU formula I briefly laid out above allows us to determine the emission levels of raw materials when they are used for fuel. So for example, say an oil refinery purchased raw oil that we know would emit X amount of carbon when burned. Based on that equation, we would enact a tax on the raw amount of unrefined oil purchased. Now, say that refinery then sold some of that newly refined oil, we would then collect a tax from the purchaser on that amount as well.

 

If you’ve made it this far you have made it through the most difficult part of this discussion, the rest is cake!

 

The thing I personally like about this tax is that it is not a direct tax on consumers. However, when taxes are raised on a company, they will have no choice to raise prices on their consumers. The tax scheme I laid out above would have the effect of increasing energy cost in the short run. This means that it would become more expensive to heat/cool your house, fill your car up with gas, or use electricity in general. This is understandably a major point of criticism, especially because the carbon tax is a form of regressive taxation, which hurts lower income families most.

 

However, there is a fix to this! You see, taxes are categorized in three ways, they are either increases to revenue (tax hikes), decreases to revenue (tax cuts), or revenue neutral (burden shifting). If we were to enact a carbon tax by itself, it would cause an increase to tax revenues at the expense of higher energy prices. However, we could use these new revenues to help the consumers who saw their energy bill get more expensive. If we enacted a carbon tax of $15 per metric ton, we would raise $80,000,000,000 (eighty billion dollars) of revenue. This new revenue could then pay for large tax cuts for mostly middle and lower class Americans. Essentially, we could offset the impact of this tax, so while they’d be paying more for energy, they’d be paying less in taxes.

 

But what is the point of all of this?

 

Well, as I’ve written about in the past, the world is quickly moving towards renewable energy. There are two main benefits we stand to gain from investing in renewables now as opposed to later. First off, we will bring carbon levels back to normal levels, greatly decreasing the impact of global warming. Secondly, we will be entering a brand new market that has more room to grow than any other industry on earth. Think about it, how many people do you know own electric vehicles or solar paneled roofs? My guess is not so many.

 

By increasing the price of gas, we are indirectly increasing the cost of the vehicles that consume them. This is simply because you would now want to factor in higher gas prices when deciding between an electric vehicle or one that runs off traditional fuel. All of the sudden, we’ve made clean energy vehicles competitive in the open market. Since they are competitive, they will be bought more and more by consumers. As they are bought by consumers, profits rise, and as profits rise, companies will lower prices so they can sell more of their vehicles. This decline in price will make renewable vehicles even more accessible, and they will then be bought even more. This trend would continue until it literally wouldn’t make sense to buy a traditional vehicle because it would be so much more expensive.

 

This logic applies to all areas of energy. The reason we do not yet have widespread renewable options is because the industry hasn’t economized yet. The reason the industry hasn’t economized yet is because carbon emitting energy sources don’t have to pay for the externality they cause, which makes their market price inefficiently cheap. Once we force the fossil fuel industry (and the consumer) to pay for that externality, renewable resources will emerge as the predominant source of energy in the United States. If we can beat other countries to this punch, we would create a massive economic boom for ourselves, while also severely weakening our adversaries.

 

Take Russia and Iran for example. These two countries rely heavily on oil to keep their economy running. If the United States was able to replace the global demand for oil with a demand for clean energy, these two economies would be severely damaged. We would literally be taking business away from the countries that want to see us falter.

 

But the reason this tax has not been enacted is because we, in the United States, suffer from severe shortsightedness. Our country is notorious for our fixation on short term results, and it would take years for a carbon tax to have its intended impact. However, once that impact is realized, our country will be the benefit of the largest economic boom in history, all while saving the Polar Bears too.

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