Since 1896, when global warming was first publicly shown to be a consequence of burning fossil fuels, humanity has wrestled with the conundrum of how best to respond to this looming threat. Against the background of politicisation associated with climate change, economists have argued over the benefits and detriments of introducing a carbon tax: a way of taxing companies which emit greenhouse gases so as to create an economic incentive to reduce carbon emissions. While the UK has instituted an emissions trading scheme (ETS), the US is yet to see a nationwide deployment of market-based approaches to controlling pollution. Under the threat of long lasting consequences at the hands of global warming, the necessity and effectiveness of a carbon tax in the US is vital in helping to fight climate change.
Carbon pricing seeks to address the issue that CO2 is what economists call a negative externality – a phenomenon when production or consumption imposes external costs on third parties outside of the market for which no compensation is paid (such as the effective costs of drinking alcohol that is incurred in car accidents and social disorder). As a consequence of not being priced, there is currently no federal system which responds to the damaging costs of carbon dioxide emissions in the US – a dangerous phenomenon to economists and environmentalists as companies prioritise maximising profit over responding to externalised consequences.
As of April 2021, only California, Washington, Virginia, Maryland, New York, Delaware, New Jersey, Connecticut, Rhode Island, Massachusetts, Vermont, New Hampshire and Maine deploy fully-implemented cap and trade systems (13/50 states). Indeed, it can be argued that carbon pricing is ethically just, as it helps shift the burden of environmental damage back to those who are responsible for it, and those who can reduce it. So, in a capitalist fashion, carbon taxes and ETSs give an economic signal to polluters who can then decide whether the cost is economically viable. Therefore, the overarching environmental goal of net zero emissions is achieved in a more flexible way for society.
A carbon tax works like a classic Pigouvian tax (a tax levied on private individuals or businesses for engaging in activities that create adverse side effects for society), which is levied on the carbon emissions of fuels. It does this by shifting the supply inwards thereby making production more expensive and profit margins smaller (see Fig. 2 below).
In turn, this reduces greenhouse emissions and makes cleaner alternatives more competitive.
Emission Trading Schemes (ETSs)
Another form of Carbon Pricing is an emissions trading scheme (ETS), (also known as cap and trade). ETSs are a market-based approach in which a central authority caps the total level of greenhouse gas emissions per business. These quotas are limited, but give polluters the right to increase their emissions provided they buy more permits from other companies who are willing to sell theirs. Consequently, by creating supply and demand for emissions allowances, an ETS establishes a market price for greenhouse gas emissions (financial derivatives of permits can also be traded on secondary markets). ETSs are a type of flexible carbon pricing that allow organisations to decide how best to meet policy targets as opposed to command-and-control environmental regulations which are far more restrictive and unpopular. In a 2020 research paper, the European Union Emissions Trading System proved that CO2 emissions had been successfully reduced even with the prices for carbon initially valued bearishly by the government (so as to avoid making the ETS unpopular), thereby proving that this form of carbon pricing works.
Regression and Politicisation of Carbon Pricing
Carbon taxes can however be regressive, taking a proportionately greater amount from lower income households. By making fossil fuels more expensive, a harsher burden is imposed on those with low incomes. They will pay a higher percentage of their income for necessities like gasoline, electricity, and food. This has proven to politicise carbon pricing as some claim that lower income households are disproportionately affected which has led to regression in Federal progress.
Nevertheless, in January 2019, a bipartisan group in the US House of Representatives introduced H.R. 763, the Energy Innovation and Carbon Dividend Act of 2019 which could pave the way for a carbon tax on fuels that emit greenhouse gases into the atmosphere. In order to address the impact on consumers, H.R. 763 proposed an economic redistribution mechanism by establishing a Carbon Dividend Trust Fund in which revenues from carbon fees would be paid out as dividends to US citizens and lawful residents.
Effects on American business
Yet another problem is that carbon taxes might hamper the international competitiveness of US firms that either produce or rely on fossil fuels, as many trading partners of the US, such as China, have no carbon pricing schemes. Thus, introducing carbon pricing laws could harm US-based companies, even inducing them to move to countries where fees are non-existent, causing job losses, reducing investment, and lowering economic growth (commonly measured as GDP).
To avoid these negative effects, a carbon tax would need to be accompanied by a border adjustment tax. This would ensure that carbon-intensive imports cost as much as similar domestically produced goods. H.R. 763 envisions such provisions. While border adjustments may dampen trade, those costs will be outweighed by the social benefits they create in reallocating resources to the production of less carbon-intensive goods. Indeed, if set high enough, a carbon tax may generate significant revenues that could be deployed to stimulate investments in renewable energy. A recent study by the Congressional Budget Office (CBO) showed that setting a carbon tax at $25/metric ton on most emissions of greenhouse gases in the US, while adjusted annually for inflation, could generate over $1.1 trillion in 10 years. H.R. 763 proposes a tax of $15/metric ton during the first year with an annual increase of $10/metric ton, envisaging $2.5 trillion after 10 years.
Climate change is one of the great global challenges of our time, jeopardising livelihoods, economic growth and decades of progress. Since record keeping began over 1300 years ago, 14 out of the 15 hottest years have occurred since 2000. Recent reports from the Intergovernmental Panel on Climate Change, “IPCC”, and the “Turn Down the Heat” reports, prepared for the World Bank by the Potsdam Institute for Climate Impact Research, warn of dangerous impacts on ecosystems and human health if action is not taken. If the world warms by just 2°C (which may happen within 20-30 years), we could see widespread food shortages, unprecedented heat waves and more extreme weather events. Some studies suggest we have already surpassed the threshold for 1.5°C according to Nasa’s Global Climate Change research.
Carbon taxes are not the final solution: alone they cannot affect reduction of greenhouse gas emissions sufficiently to avert the consequences of climate change. Nonetheless, they should certainly be included in a larger toolbox of measures to achieve climate goals. H.R. 763 is therefore a first step in the right direction, making it a priority for any administration that is truly concerned about climate change. Already, 13 percent of annual global greenhouse gas emissions are covered by a carbon pricing program. So, America, as a pioneer of innovation, should finally consider the real implementation of national carbon pricing schemes so as to inspire change throughout the rest of the world. In a world ever-succumbing to nationalism and division, America must forge a way to unite and fight a true danger that threatens us all: climate change.
An earlier version of this article won the 2021 Junior Keynes Prize, the Eton College Economics Department’s annual essay competition for Year 8 – Year 10.