GHG emissions taxation is the right idea but it is too late

Economists are almost unanimous in their recommendation of a GHG emissions tax if the goal is to reduce GHG emissions. Today, I read the latest example of this support. But to work effectively, this tax should ideally be economy-wide and global.

A GHG tax should be economy-wide because electricity generation has accounted for about 30 percent of GHG emissions in recent years. Transportation has been responsible for another 30 percent, followed by industry (22 percent), agriculture (10 percent), and residential and commercial sectors (each with about 6 percent). These are aggregate numbers for the United States. Each industrial or commercial activity contribute to emissions at differing rates and their emissions will differ across the world, for example depending on technology.

Importantly, as consumers, we all are ultimately responsible for buying goods and services, the supply chain and consumption of which cause the emissions. As such, rapid progress in emissions reduction is only possible if consumers can see the negative impact of emissions on their pocketbook. Consumers, including businesses, with most GHG-intensive activities should be expected to react quickest to manage costs. The same principle applies to all negative externalities.

Clearly, these are not popular ideas among politicians. Hence, an economy-wide carbon tax has not been feasible in many jurisdictions. Not surprisingly, making it global seems impossible. However, the Climate Leadership Council has a plan that addresses the lack of a global agreement: a border carbon adjustment to prevent international free riders. The plan’s other pillars are: gradually increasing GHG emissions tax, replacing less-efficient carbon regulations, and returning all revenues to U.S. citizens via lump-sum rebates. The proposal has the support of 3,600 economists, including 27 Nobel laureates, 15 former chairs of the Council of Economic Advisers, and 4 former Federal Reserve chairs. As these economists put it, an economy-wide GHG emissions tax “will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors towards a low-carbon future.”

Innovation that will follow from a market price signal is indeed very important but often overlooked by policymakers. Although I can be more cynical, let’s assume they are risk-averse and think “a bird in the hand is better than two in the bush.” Unfortunately, there have been many promising ideas from the technology R&D space across all energy value chains that could have been unleashed over the years in response to market price signals. Many failed, some succeeded. Many failures were due to lack of sufficient funding. Government funding for specific R&D is as fickle as political and macroeconomic cycles. Private funding is difficult to sustain in the absence of the profit motive. Pricing the externality in the market creates the incentive to innovate, which supports R&D targeting a fix for the externality, and induces consumers to adjust their behavior to avoid the externality. In contrast, subsidizing installment of existing technology does not support fundamental R&D and innovation and does not nudge consumer response.

If the politics is the art of the possible, a policy based on market efficiency with an economy-wide GHG emissions tax does not seem attainable today. Not even a federal RPS, which would be more efficient than independent state RPS programs, is likely to get much traction. There is already too much at stake for too many interests. The Clean Energy Technology Center at the North Carolina State University documents several thousand programs on supporting renewables and energy efficiency across the United States.

Costs of these policies are becoming increasingly visible, partially because such policies promote currently available technologies regardless of their operational and capital efficiency, fit for the energy systems, and sustainability from a supply chain perspective. Unlike pricing externalities economy-wide, most of these policies leave consumers out of the equation, who always bear the cost as ratepayers or taxpayers but do not fully participate in decisions. Consumer groups are voicing concerns about the rising cost of energy despite low wholesale prices of electricity. This has become an equity issue for some politicians. This is certainly a contributing factor to divergence even among states that individually support renewables (e.g., New Hampshire blocking the transmission line from Québec, Arkansas and other states forcing the cancellation of DOE support for Clean Line Energy, and the failure to grow the Regional Greenhouse Gas Initiative).

Therein lies the challenge for a GHG emissions tax now rather than 20–30 years ago. A GHG emissions tax today can avoid wasteful use of limited productive and financial resources only if it substitutes for all other out-of-market incentives. The four pillars of the Climate Leadership Council include replacing inefficient regulations such as the Clean Power Plan but not any of the other market distortions. This is a gaping hole in an otherwise rational proposal. Not only the social cost of support programs will remain a burden for consumers, they will undermine the technological innovation and economy-wide efficiency improvements expected from the tax because many programs support specific existing technologies, even in regions where they are less productive, and others are duplicative.

In a review of 20 years of restructuring, Borenstein and Bushnell (2015) argue that “the greatest political motivation for restructuring was rent shifting, not efficiency improvements, and that this explanation is supported by observed waxing and waning of political enthusiasm for electricity reform.…[A] similar dynamic underpins the current political momentum behind distributed generation (primarily rooftop solar PV) which remains costly from a societal viewpoint, but privately economic due to the rent transfers it enables.” Plus ça change, plus c’est la même chose. Today, “smart money” seems to be tracking the next government mandate or subsidy without a restraint from a competitive market.