1.11: Carbon tax

Subsidizing R&D into decarbonization technologies is the key alternative suggested by Noah Smith — if you get a breakthrough towards lower-cost technology, that can be adopted anywhere in the world. This thread has a coherent discussion about why carbon taxes can help to scale existing technologies but, for areas where truly new technologies are needed (of which there are many), targeted R&D and highly specific subsidies can be better.

How can rapid decarbonisation be incentivized? There are powerful arguments in favor of a carbon tax. Specifically, one can do a gradually scaled-up, revenue-neutral carbon tax that would, for instance, return the revenues back to consumers as rebates or tax reductions in other kinds of taxes — this could be important as almost any form of carbon tax would¹ see stuff on incidence of tax  ultimately be passed at least in significant part onto the consumer¹, and many consumers are cash-strapped already, e.g., struggling to afford gas for their commute.

The current average price of gas in the USA is around $2.50/gallon, and there is already an excise tax on it of about 1/10 thatHow big a carbon tax, and what effects would that have on citizens? That’s a complicated question and not one I have found a full answer to. Typical values suggest something like $10-$100 per tonne of CO2, meant to offset widely-varying estimates of the social cost of carbon. That would apparently increase, say, the gas bill for your car by roughly 10 cents to 1 dollar per gallon of gas

Alas, consumers in the USA seem wary of changes in that range. It is unclear if they would still be wary if they were presented with a rebate (remember, the carbon tax can be revenue-neutral, or at least with significant offsets to give cash back to citizens, although some would hope to use revenues from a carbon tax to fund climate-related programs and deployments) that would on net leave most people’s bank accounts the same or fatter, not thinner.

A few points of comparison:

  • We’ll see in the next post that technologies aiming to scrub carbon from the atmosphere are shooting to get their cost of CO2 produced into this same range, say <$100/tonne CO2.
  • If the US is currently emitting 6 GigaTonnes of CO2 and we had a $40/tonne CO2 carbon tax right now, that would presumably be something like $240 billion per year in carbon tax revenue, or a bit under 1/10 of all US federal tax revenue of ≈ $3 trillion. Could we restructure the rest of the tax code to give back 1/10 to consumers, as a rebate, so that their bank accounts (and the overall size of government) stay roughly flat? I bet we could. But this puts into perspective that, if someone is instead talking about a $400/tonne CO2 price of carbon (see the Stern Review item in the table below), that’s approaching the totality of all other tax revenue in the USA at current emissions levels.
  • That $240 billion paid against the $40/tonne carbon price is around 1.2% of US GDP of around $20 trillion.

There are also some arguments against a carbon tax, e.g., that a carbon tax in the US doesn’t impact other countries like China and may simply shift international trade balances, or that they might be revoked, as well as the need for them to be sufficiently large and thus correspondingly painful to the consumer in order to make a difference. They are also empirically not easy to pass, and economists are studying why.

This may of course be specific to the kind of fuel tax they imposed and the particular situation thereFrance had a fuel tax of about $60/ton CO2 equivalent, but when Macron tried to double that over the next 4 years, the Yellow Vest protests happened. Canada did pass a carbon tax starting at below that level and rising to near it over a few years (“start low at $20 per ton [tonne of emitted CO2] in 2019, rising at $10 per ton per year until reaching $50 per ton in 2022”). Recently, some major fossil energy companies started lobbying in favor of a carbon tax, which I found surprising — alas, it looks like they are putting in pennies compared to their fossil-fuel-promoting endeavors, in a bid to insure themselves against future climate-related lawsuits!

Before we finish this first post, let’s take a look at how economists estimate how big a carbon tax we really should have? Consider this snippet from the Nobel Prize announcement for economist William Nordhaus, who pioneered this area:

Emission scenarios under different carbon taxes
Nordhaus uses coupled climate + economic activity and growth models to evaluate “optimal” scenarios — ones with the maximum overall growth in the economy, factoring in the effects of damage from climate change and the costs of introducing decarbonization approaches. His optimal overall economic scenario (“Opt”) is the one shown in red in the plot above, with a global carbon tax starting at $30-40/tonne CO2 or so (and rising to about $50/tonne by 2030 and then further afterwards, see table below). Note, though, that this pathway massively overshoots the orange and black pathways in terms of emissions — the black and orange pathways look more like the other graphs we’ve seen for full decarbonization by 2050. Here is a table from his 2017 PNAS paper with a comparison:

Indeed, the optimality of an Opt-like pathway is a subject of great controversy. Nordhaus’s “optimal” carbon pricing, in that model, would get us to a temperature rise of 3.5C (!) or so from preindustrial, while pushing to full decarbonization by 2050, in order to stay below 2C, would require roughly an order of magnitude higher carbon price. Staying below 1.5C would seem, according to such models, to imply a need for even higher carbon prices. From a recent review:

carbon prices needed for different scenarios
Now, obviously, if Nordhaus’s model had included, say, Antarctica completely melting and many major cities going completely underwater due to a series of major sea ice and other tipping points being crossed, the social cost of carbon would need to be a lot higher. So implicitly the risk of such scenarios is considered low in such models. At a more subtle level, the particulars of these optima depend on the expected cost of decarbonization (which depends on the rate of technological innovation), on the temporal discount rates used (you can see in the table above that prices rapidly rise with decreasing discount rate), and on other factors.

There are some good-sounding arguments for having carbon prices instead start high, and then decline, political difficulties notwithstanding — I haven’t understood the full details, but this approach seems to focus on mitigating risk and to take into account more of the variance in scenarios and our finite but improving knowledge thereof.

The fact is, as the Nobel Prize announcement notes, there are huge uncertainties in what would really be optimal (even within the philosophical frame that underlies Nordhaus’s analysis, e.g., with the type and rough magnitude of the discount rate he uses, and even neglecting the politics of passing such taxes) — it depends on the cost of decarbonizing quickly, and on the climate damage cost of not decarbonizing quickly, both of which are highly uncertain at present. So we have to take a best guess — but that best guess should incorporate the uncertainty.

This brings us back to the role of technology: it can reduce the cost of decarbonization, and it can mitigate tail risks from climate damage. Advanced technology is crucial to allow us to decarbonize safely and quickly, with minimal economic cost. It allows a lower self-imposed carbon price to have greater benefit, shifting the estimated-to-be-economically-optimal pathways to overlap those that strongly limit the risk of crossing catastrophic climate tipping points.