A Viral Carbon Tax Strategy for Dealing with Climate Change

This post was inspired by the 2013 Economist article “Carbon Copy,” which discussed the internal prices that businesses are assessing on carbon emissions for their own projects.  This isn’t a universal thing, yet, but the fact that many large firms are actively thinking about what a price on carbon will do to their future business is immensely heartening – and gives me hope that we’ll eventually see the US and the international community actually place a price on carbon in order to keep climate change from getting worse than it already will.

Copenhagen

Some background:  Four years ago I was finishing my Masters in Strategic Foresight.  My focus in the degree program was on environmental and resource issues, and climate change in particular.  As such, when I got an invitation to attend the climate change negotiations in Copenhagen in December 2009, I jumped at it.

Of course, those negotiations didn’t really end up doing anything.  President Obama, then on his first year in office and still the shining hope for most of the environmental activists in attendance, made a brief appearance and rubber-stamped the Copenhagen Accord that resulted from it.  The Accord wasn’t really much more than a prettied-up “agreement to do more next year,” which was just about the only thing the negotiators could agree on.

I don’t think that the word “disappointed” has sufficient strength to describe the reactions amongst the crowds of young people in Copenhagen.  COP15 (as the negotiations were called) had been supposed to be the big breakthrough – the time when our new, Democratic, environmentalist president would show the world that America really did care about climate change, and that we would stand up to the fossil-fuel industry and prevent the calamity that we could all see approaching.

But… reality has a nasty habit of triumphing over hopes and dreams, especially when large sums of money are involved, and especially when money and politics are involved in equal measure.  The simple fact was that Obama, while he might have supported a climate deal, wasn’t going to agree to something without being relatively certain that it would be ratified by the Senate – and nothing on the table in Copenhagen had a chance in hell of passing that bar.

In truth, even if there’d been no other people at the table arguing with the American negotiators, the US wasn’t capable of coming up with anything that had much of a chance of passing the Senate.  The President and the Democrat-controlled Congress had attempted to get a climate-change bill (which used a cap-and-trade system to limit carbon emissions) through Congress earlier in 2009.  They successfully got it through the House, but it died in the Senate.

The House passed the American Clean Energy and Security Act (also known as “Waxman-Markey”, after its creators) in June 26, 2009, with a vote of 219 to 212.  While it passed, it did so only because 8 Republicans voted for it – 44 Democrats voted “No.”  In the Senate, this arithmetic was even worse: despite having a 58 to 42 advantage, the Democrats couldn’t get enough votes to pass the bill because so many Democratic Senators were from states that depended on fossil fuels (especially coal) or energy-intensive industries that they couldn’t afford to vote for the bill, despite the sales job President Obama did to try to win them over.

That Senatorial arithmetic hadn’t changed by December, when COP15 was starting, and was made worse by the demands being made by the developing and under-developed nations, led by the “BASIC” nations (Brazil, South Africa, India, and China).

America vs China

The problem facing the negotiators was that the poor and developing nations demanded an exemption from any restrictions on carbon emissions, on the basis that they had not profited from the Industrial Revolution as Europe and the US had, and were entitled to their fair share of pollution in support of economic growth – more, that they were entitled to some form of wealth transfer from the developed nations to make up for their industrial late start.  (A number of labels were used as buzzwords to describe this general idea of a right to exemptions and compensation – “Climate Justice” and “Climate Debt” are the best examples.)  China, where the governing Communist Party is obsessed with maintaining economic growth in order to preserve social and political stability, was at the forefront of this negotiating position.

The negotiators for the developed world were faced with an ultimatum:  pledge to reduce carbon emissions in the rich nations and help the developing nations with technology transfers and financial aid for mitigation and adaptation efforts, and in return the developing world would (eventually) get around to pledging to reduce their own emissions.  While the part about technology transfers and financial aid might have been negotiated, China (which was at that point fast approaching becoming the world’s biggest emitter, and which is now fast approaching the largest cumulative emissions) steadfastly refused to make a binding agreement on emissions reductions.  They worked hard to persuade the rest of the BASIC nations and the developing world as a whole to side with them, and built a united negotiating front against the developed world.

Faced with this, the US negotiators’ position was untenable.  The Senate had already rejected an emissions-control bill passed by the House, in large part on the grounds that it did nothing to prevent Chinese firms from out-competing American firms that would have had to pay more for energy.

The US negotiators might have had some sympathy with the other side’s position, but unless China and the rest of the developing world were willing to accept binding emissions limits, the Senate was going to throw the proposal in the trash without bothering to read it.  Obama wasn’t willing to waste any real political capital on another failed attempt to get a climate change bill through the Senate.

So COP15 was a bust – America and China, the two biggest polluters, and the two nations that any agreement simply had to have on board, had mutually exclusive negotiating positions, and were unwilling to budge.  I went home with some nice photos of Copenhagen, a lot of fond memories of the city and the people, a strong desire to go back where winters were merely chilly instead of freezing, and a healthy dose of cynicism about the possibility of a global climate change deal happening before it was too late.  While my hopes had never been very high to begin with, that week spent watching the negotiations spiral down the drain drove home the point that achieving anything within that kind of global, all-or-nothing framework was going to be effectively impossible.

After Copenhagen

The next semester I began working on an article on the politics of climate change that used four scenarios to look at what might happen in the next two decades.  While I was writing it, my experiences in Copenhagen the previous December were a big influence.  To me, the problem of getting the global community to do something about climate change wasn’t going to be solved by having meetings and forming some miraculous consensus that required every nation to agree to sacrifice its own self-interest.  To achieve something like that, you would have to change the perception of each and every nation’s self-interest – something the environmentalist movements had been attempting to do by trying to convince world leaders that preventing climate change was the best long-term option, despite the short-term costs.

But that method of altering perceptions isn’t very effective when the costs to the politicians in question are immediate and the benefits are a long way off and hard to pin down.  What is needed is something that forcibly alters the economic reality of dealing with climate change – something that would create a common self-interest in reducing GHG emissions (besides preventing climate change) that leaders could point to and steer their nations towards, without (too much) fear of losing power.

In After Copenhagen, the fourth scenario I described was titled “Stick and Carrot.”  In it, I put forth a possible future in which the US adopts a carbon tax, and then uses its huge domestic market as a carrot to convince other nations to adopt similar taxes… with the alternative being to deal with the stick of paying a stiff tariff on any goods sold to the US.  I used the idea of a trade union – the “World Carbon Tax Association,” or WCTA.

From the article:  “Put simply, members of the WCTA must all charge a uniform tax on carbon emissions internally, must all eliminate subsidies for carbon-based energy, and must all place a uniform tariff on goods imported from outside the union.  Both the internal tax rate and the tariff began at low levels and have been gradually increased according to the original timetable, intended to ease the initial impact and provide businesses and consumers with a predictable future.”

The idea of the US leveraging its position in the world economy isn’t such a far-fetched idea.  That’s essentially what the fair-trade agreements we’ve been building over the last several decades have been.  We’ve been saying to other countries, “We have lots of people who want to buy your stuff, and and all you have to do to get unfettered access to that market is to get rid of your own tariffs!”

Building a Viral Carbon Tax

First, the US needs to agree internally that putting a price on GHG emissions is necessary and a good thing in the long run.  In my view the best way to do that is a carbon tax – a tax on any fossil-fuel produced in or imported by the US, with the value of the tax based on the amount of CO2 produced when that fuel is burned.  Ideally, many of the other forms of GHG emissions would be taxed as well, but fossil fuels would at least be a place to start.

Just as opponents of this idea claim, this would increase energy prices.  Producers and importers of fossil fuels would increase their prices when they sell to energy producers, and that would in turn increase the price of energy for consumers, as well as the price of goods and services that have a high energy production cost.  This is, in fact, the point:  an increase in the price of energy makes reducing energy use and using clean energy a way to save money.

While becoming greener is all very well and good, instituting a carbon tax would still drive prices up, which would cost people money.  When I wrote After Copenhagen, there hadn’t been much research done on carbon taxes and their impacts.  Plenty had been done on cap-and-trade, because that was the system that most environmentalists and climate activists preferred and that Waxman-Markey was based on, but the differences between cap-and-trade and carbon tax systems are significant enough that I wasn’t prepared to rely on those estimates.

Since then, however, carbon taxes have received considerable scholarly examination.  The best starting point is the Congressional Budget Office’s examination of carbon taxes, published in May 2013 – the footnotes can be mined for a large number of other related studies, and if you’re interested in reading further I would recommend you do so.  If you aren’t interested in reading lots and lots on the subject, I’ll point you to a Cliffs-notes version by the Washington Post, which hits the critical numbers.

The chief criticism of a carbon tax is that it would add to energy costs, make all products made in the US more expensive, make the US less competitive, and thus reduce US economic growth and cost us jobs.  To be viable any carbon tax proposal has to deal with these issues, and a great deal of thought has been put into the proper design of a system that would not have these effects.

To understand how that is possible, it is important to understand that shifting a tax from one part of the economy to another can actually be beneficial to the economy and to society as a whole.  For example, taxes on cigarettes and alcohol are high because they are intended to reduce the use of those products.  On the face of it, these taxes reduce sales, which reduces GDP, but in practice, that loss is more than balanced by the reduced drag on the economy from automobile accidents, hospital admissions, and illness that result directly and indirectly from the consumption of these products.

Furthermore, governments have to get their money from somewhere.  If they get it from these kinds of punitive taxes (called “Pigovian taxes” after English economist Arthur Pigou), they can lower tax rates on other things.

The idea is to increase taxes on things that hurt the economy and reduce taxes on things that are good for the economy, in such a way that government revenues remain roughly the same.  If we do that, less bad stuff will be produced, more good stuff will be produced, and the net effect on the economy will be beneficial.

We can call this a “tax swap.”  Which taxes might the US be better off without?  One possibility would be to cut the payroll tax, which significantly increases the cost of hiring people.  As a general rule, taxing something is a way to discourage it.  Do we want to discourage employment?  Of course not!  So why do we tax it, and rather heavily at that?

If we implemented a carbon tax and used the funds it brings in to reduce the Social Security tax, dollar for dollar, government would raise the exact same amount of money, people would pay the same amount of money for taxes, and we would make employment cheaper, reducing the cost of providing goods and services and giving businesses an incentive to hire more people (or, in some industries that compete for scarce labor, an incentive to pay existing workers more).

Most serious attempts to model tax shifting of this kind agree that if it is phased in gradually, such a shift would boost the economy, reduce CO2 production, and provide a mild boost to employment.  The price of energy would go up, but so would take-home wages.  It sounds like a win-win situation for everyone but the coal companies.  But the drawback to this proposal is significant:  people who are unemployed or retired would have to spend more for energy and energy-intensive goods and services, and would get little or nothing back.

The problem is that the carbon tax is, by its nature, a regressive tax:  it hits the poor harder, because they have less money to spare to pay for an increase in the price of energy (the “direct cost” of the tax) and an increase in the prices of goods and services (which would be an “indirect cost”).  According to that CBO report, a tax rate of $20 per ton of CO2 would increase gasoline prices by 20 cents/gallon, and increase the average cost of energy in the US by 16%.  The total cost to consumers would be somewhere between 1.8% and .7% of a household’s before-tax income, depending on where on the economic spectrum the household was (poorer households spend relatively more on energy-intensive goods and services, so they’d be hit harder).

By my interpretation of the CBO’s estimate, the poor would pay (very roughly) $100 extra every year for each $5/ton increment in the carbon tax.  So a tax starting at $20/ton and increasing gradually to $40/ton would cost poor families $400/year at first, rising to $800/year, out of budgets that are already tight.

So the version of the carbon tax favored by more liberal groups tends to be one that rebates the proceeds of the tax directly to the population instead of doing it through a tax swap, like a reduction in the payroll tax.  The simplest and most equitable way to do this would be to divide the proceeds of the tax and pay the entire sum back to the legal residents of the US in equal amounts.  By definition, then, the average person would get back as much as he paid out in higher taxes.  Those who use very little energy would come out ahead.  Those who use a lot would lose out.

How much money could you give back to Americans with your newfound source of revenue?  According to the CBO, once again, a carbon tax would generate $1.2 trillion over a decade if it started at $20/ton and increased at a nominal rate of 5.6% annually.  That would be enough to pay every American a bit less than $400 per year.

Either of these systems (or a combination of the two) would work, and there are others that are possible that are also revenue neutral and either beneficial or neutral for the economy.

Competition

Once you’ve settled how you’re going to put a price on emissions, and what you’re going to do to mitigate the increase in prices, you then run into the problem of competitiveness:  putting a price on carbon emissions would make American goods less competitive compared to goods produced in nations that don’t put a similar price on carbon.  This would create an economic downturn in the US, even if all of the money from the tax were returned to the public as a tax reduction or rebate.

In order to deal with the competitiveness issue, then, something has to be done to level the playing field.  One idea that’s been bandied about in economic and environmentalist circles is something called a “border adjustment.”  It would have two parts.  Exports from the US to non-carbon-tax nations would receive a refund of the carbon tax paid for energy used in making the product.  On the other hand, imports from non-carbon-tax nations would be hit with a tariff equal to the carbon tax that would have been paid if they had been made in the US using the most carbon-intensive fossil fuels.  In effect, we would be telling other countries, “if you won’t tax your pollution, we will.”

This screams protectionism, of course, and would risk starting a trade war with some nations.  But don’t forget that the border adjustment has an escape clause.  If another nation puts in place a carbon tax identical to the US tax, it wouldn’t have to pay the border adjustment on its goods.  And then that government would be able to decide what to do with the money from its own carbon tax, giving the money back to its citizens or using it to pay down its debts or to reduce other taxes, as it chose, rather than letting the US take the money.  From the US perspective, because that nation put a price on its emissions, American firms would still be protected from being outcompeted (or at least as protected as is possible in a globalized economy).

The bonus is that nations that agreed to adopt the carbon tax would be effectively required to adopt the border adjustment as well, so as to protect their own firms.  This would increase the incentive for other nations to pass a carbon tax and border adjustment, so as to avoid having to pay tariffs in that market, as well as the US.  If North America and Europe were to adopt such a system together, that would be more than a third of the global economy throwing up trade barriers against nations without a carbon tax.  Developing nations would be desperate to avoid those tariffs… desperate enough to put in place carbon taxes of their own.

(Whether those carbon taxes would be fully enforced is another question, of course.  But the carbon tax/border adjustment system would at least give those nations who were serious about reducing global emissions a way to police those who were more lax about it.)

Would it Work?

Is this a politically viable way to get to a global agreement?  Although there would be some resentment about the US (and other early adopters) being high-handed and dictating the rules for the rest of the world, the fact is that we do that all the time, and we do it in a way that has been remarkably restrained and, on the whole, beneficial to world trade.  The US may be a superpower, but that just means we are stronger than any one opponent.  We absolutely do not have the power to impose our will on the world unless most countries agree that we are doing a pretty fair and competent job of leadership, and that it is in their interests to go along with us.  If many countries, or even a handful of large countries, refuse to follow our lead, we have no way to make them do so.

What makes the viral approach to a world carbon tax agreement feasible is that it would be in the interests of other countries and leaders to go along with us.  Pretty much every nation already knows that climate change will be damaging to them and to the world economy.  The problem is getting to a deal that is politically palatable and doesn’t put them at a competitive disadvantage.

The proposed deal would impose the same rules on everyone who joined it, so none of them would gain or lose with regard to the others.  However, early joiners would gain privileged access to US markets (and the markets of other early joiners), gaining an advantage over non-joiners.  As more countries joined, the price of being excluded would rise.  And politicians hate being seen as advocating tax increases, but love having additional revenues to play with, so many national leaders would see a big political advantage in being “forced” by the US and other rich countries to impose a carbon tax and tariff.  They could blame us for the tax, and still claim credit for whatever they spend the money on.

But is it politically feasible in the US in the first place?  It is hardly inevitable, but I would argue that the conditions that could lead to creating such a system are becoming quite a bit more likely.

To begin with, a unique situation has developed recently due to the explosion of natural gas production using fracking technology.  The US is about to become the world’s leading producer of oil and is close to becoming a net exporter of oil and gas products.  We already have one of the lowest energy costs for manufacturing, make production in the US suddenly much more attractive.  If we took advantage of this window to create a carbon tax and put it in place while energy prices are cheaper here than in almost all other countries, we would eliminate the marginal risk that the tax would hurt US competitiveness during the first few years before other countries joined us.

In addition to the economic factors, there are some crucial changes in attitudes by some powerful interest groups.  Many leading environmentalists and environmental groups who once passionately favored a cap-and-trade approach are now coming around to supporting a carbon tax instead.  A surprising number of energy companies – essentially everyone outside the coal industry – have quietly come around to supporting the idea.  As mentioned in my 2009 article, ExxonMobil has supported it for years.  And support from organized labor seems highly probable.

The other key political question is the effect on the voters.   Lobbying groups supported by the coal companies and by some energy-intensive manufacturers and service industries would mount a fierce and well-funded campaign to convince the general public that any tax increase is always bad, that the government would not keep its promise to balance out or give back the tax revenues by tax reductions or rebates, and that any form of energy tax would be a “jobs killer.”

Senators and representatives from coal states would fight the legislation tooth and claw, and anyone supporting the bill could expect a well-funded anti-carbon-tax primary challenger.  A lot would depend on how smart, articulate, and well-funded the supporters of the carbon bill were, but even more, its success would depend on the public’s perception of climate change itself.  There is a gradually increasing awareness that weather is becoming more violent, more damaging, and more unpredictable.

As we get more Superstorm Sandys, more hurricanes moving farther up the coast than in the past, more unseasonal blizzards, more outbreaks of monster typhoons and tornadoes, more record droughts and wildfire seasons, continued rising sea level and warming seas, more northward migration of tropical insects and other pests, more invasions by tropical diseases, and less and less summer ice in the arctic, public tolerance for the simplistic message that “global warming is a hoax” may well decline.

My sense, however, is that this battle will be won or lost in the boardrooms of American businesses.  The energy companies know quite well that climate change is real.  They employ more geoscientists than anyone else, and their own scientists are telling them exactly the same thing that virtually all other earth and climate scientists have concluded:  climate change is real, it is caused by human emissions of GHGs, and if left unchecked it will cause an economic disaster.  It may be in the oil and gas companies’ short-term interest to deny climate change, but it is definitely not in their long-term interests, and they know it.

In fact, the oil and gas companies will benefit from a carbon tax in a number of ways.  The tax will effectively force the coal companies out of business, greatly increasing the market for natural gas in the short run.  It will also slow the depletion of oil and gas reserves, preserving those assets for higher-value future use as chemical feedstocks.  Meanwhile, the companies will be expected to pass on the tax to their customers, so the tax will have little or no impact on their revenues per unit sale.

The tax will have several contradictory effects on production and sales volume.  Total production of oil & gas will go up in the short run, as coal is phased out, but will go down in the long run as the tax rises high enough to discourage wasteful use.  (That’s the point of the tax, after all.)  But most of these companies have been working hard on alternative sources of energy for years, and many of them would benefit from seeing those investments pay off, so a lot of them expect to break even or come out ahead in the long run if a higher price is put on carbon.

Outside of the energy industry, there is growing appreciation for the fact that doing nothing about climate will be disastrous and that a carbon tax would be the least harmful/most beneficial way to address the problem.  In particular, many of Silicon Valley’s growing crop of young billionaires and multi-millionaires seem to be especially frustrated by the lack of action, and appear to be more willing to consider putting their money into direct lobbying.  Their sheer star power and visibility would give any campaign they support some additional clout and credibility.

Which brings us back to our starting point:  many of the large corporations around the world are already acting internally as if they expect a carbon tax.  They have done the accounting to know how it is going to affect them and what they will have to do to remain competitive in that environment, and they have nearly all concluded that it is something they can live with.  When push comes to shove, we may see the coal companies fighting a very lonely battle against the combined might of the rest of the US Chamber of Commerce for the heart of conservative America.

My sense is that a well-run, well-financed, broadly-based campaign by business, labor, and environmental groups to pass a revenue-neutral carbon tax would succeed more easily than almost anyone currently expects.  I wouldn’t be at all surprised to see such a measure pass by 2018.

Fingers crossed, right?

Advertisements

One thought on “A Viral Carbon Tax Strategy for Dealing with Climate Change

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s