Friday, May 25, 2007

Why Carbon Taxes are Superior

I recently had a discussion with David Kroodsma (who recently finished biking from Palo Alto, CA to Tierra del Fuego, Argentina to raise awareness of the impacts of climate change on the poor, and is now biking across the USA to promote energy efficiency and other solutions to climate change, check out his blog) about the difference between mandated energy efficiency standards vs. a carbon tax. Here is my opinion on the topic.

The fundamental problem of climate change is that we release too much carbon into the atmosphere from burning too many fossil fuels. I believe a carbon tax is the most direct solution to this problem. Why? Because the fundamental law of economics is that prices matter; as the cost of doing something goes up, people will respond and do less of it or find substitutes. Mandating increased efficiency is another way to reduce consumption, but I believe a carbon tax has several advantages.

A carbon tax will affect all sources of carbon emissions, whereas efficiency standards only affect the regulated uses. For example, a carbon tax will raise the price of gasoline which will affect the driving habits of all car owners. This will have immediate results as all of us try to find ways to reduce our consumption and save on gasoline costs. On the other hand, a fuel efficiency standard only applies to new cars, which means that the results of the increased efficiency will not be felt until the new cars become a large proportion of the car fleet.

Second, part of any gains from increased efficiency standards will be lost to the “rebound effect.” If we increase the fuel efficiency of your car but keep the price of gasoline the same, the cost to you of driving one more mile has actually gone down. If the price of driving has decreased, I predict you will drive more. Driving more will begin to burn up some of the gasoline savings from the increased fuel efficiency, which we call the rebound effect.

Third, carbon taxes will encourage more technological innovation, increases in efficiency, and research into alternative fuels. Under efficiency standards the only incentive a firm has is to comply with the law and no more. A firm has little incentive to develop technologies and products that go beyond the efficiency standards. It is little wonder that the fleet average fuel efficiency for U.S. automakers has closely tracked the Corporate Average Fuel Efficiency standards. They stop as soon as they satisfy the law. They have no incentive to produce more fuel efficient cars because consumers do not demand them. And why should they when fuel is cheap! Under a carbon tax, firms and consumers are rewarded for any and all methods of reducing consumption. Further increases in efficiency always create real savings since fuel is expensive. A carbon tax also encourages more research into alternative fuels, another way to reduce consumption of fossil fuels.

Fourth, the costs of an efficiency standard are hidden and lumped into the purchase price of the car. This affects everyone who purchases a car equally. On the contrary, the heaviest burden of a carbon tax is born by those who consume the most fossil fuels. Those who respond to the tax most, by driving less and purchasing more fuel efficient vehicles, will bear less of a burden. Those who change their behavior (the goal of our policy) are rewarded by paying less total carbon tax. It is more equitable to financially punish those who use their cars not simply those who purchase a car.

If those effects weren’t enough to convince you that a carbon tax is a superior policy, there is also the revenue generated by a carbon tax. Taxing all those carbon emissions will result in a lot of revenue. The government could use this money to shore up Social Security and Medicare or spend it on alternative energy research and development. Or, we could use this revenue to offset other taxes. My preferred use of carbon tax revenue would be to reduce other taxes and make the taxes revenue neutral. In this sense a carbon tax is not a new tax but simply replaces other taxes.

The government has to generate money to perform many valuable services for the country. Let’s raise that revenue by taxing activities we want people to do less of, like burning fossil fuels, and reduce the taxes on things we want people to do, like working. We shouldn’t discourage people from working, but that is exactly what we do when we tax income. I would use the revenue created from a carbon tax to reduce income taxes such that net taxes do not increase. In fact, citizens who reduce their consumption of fossil fuels most are likely to even receive a tax break!

One of the biggest complaints about a carbon tax is that it might be regressive (poorer people might spend a larger percentage of their income on the tax than richer people). This is a valid concern but is easily remedied by reducing other taxes on the poor to offset their extra carbon tax expenditures.

A revenue neutral carbon tax, with the greatest income tax reductions for the poorest and those least able to change their behavior, is the best strategy for reducing our consumption of fossil fuels and combating climate change. If we want people to do less of something we should increase the cost of doing it. This is exactly what a carbon tax will do and exactly why I support it.

1 comment:

David Kroodsma said...

Aaron - how much would someone in the lower income brackets need to have their income taxes cut? Would it be big enough that we would have to have a 'negative tax' (a very difficult thing to do right, I think) or would it be sufficient just to cut their taxes?