Taxing fossil fuels: bad policy or simple solution?

When you think about going green, you might picture wind turbines on the horizon or solar panels on your roof. You probably don’t picture yourself getting taxed when you pay at the pump. But in the world of climate policy, there’s a school of thought that teaches this is the simplest, most effective way to reduce greenhouse gas emissions using current technology. After all, instead of subsidizing the so-called good stuff, why not tax the bad?

 

That’s the idea behind a “carbon tax”, or a tax on the biggest greenhouse gas contributor, carbon dioxide. Under a carbon tax regime, about 70-90% of the energy you use (anything that comes from fossil fuels like coal, oil, and natural gas) would be taxed. The price of gasoline, along with a number of goods and services, would increase.

 

While this might sound unpleasant, that’s the whole point: the increase in prices – meant to account for the true environmental cost of what you’re purchasing – is supposed to cause you to reduce your consumption of fossil fuels and thus your carbon footprint. Likewise, it aims to incentivize companies to develop environmentally-friendly innovations to avoid paying the tax.

 

Why should this matter to you? In November 2016 -- at the same time Americans were all voting for the next president -- Washington state voters rejected what would have been the United States’ first carbon tax, called Washington Initiative 732. I-732 made its way to the ballot after supporters submitted a petition with over 350,000 signatures. The movement was started by comedian and environmental activist Yoram Bauman.

 

Although I-732 failed (for reasons I will explain), it’s not the first time a carbon tax has come to bat, nor will it be the last. The states of Oregon, New York, Masachusetts, Rhode Island, Colorado, and Vermont have all seriously considered implementing a carbon tax.

 

Carbon taxation is already a reality in parts of Canada and Europe. Finland was the first country to implement a carbon tax in 1990, followed by Sweden in 1991. The Canadian province of British Columbia (BC) has had a carbon tax since 2008, and Ireland since 2010. Alberta’s controversial new carbon tax came into effect just a few days ago, on January 1, 2017.

 

The policy is slowly gaining political traction. In the next few years, a carbon tax could show up on your ballot, if it hasn’t already. So let’s take a look at how the tax is meant to function and discuss the potential pros and cons compared to other types of climate policy.

 

For starters...“tax” is a nasty word. At first glance, though, a carbon tax seems even worse than usual. It’s a kind of sin tax, like taxing cigarettes or alcohol, with one crucial difference: you have no choice but to consume fossil fuel products, whereas most other “sins” are your left to your discretion. Furthermore, carbon taxes, like all sales taxes, are inherently regressive – meaning they hurt poor people the most. And any tax by itself is going to have a net negative impact on the economy.

 

For these reasons, some carbon taxes, such as those of BC and Washington state, are designed to be “revenue neutral”. This means (in theory) that 100% tax revenue that is collected is rebated to taxpayers or even compensated for by reductions in other kinds of tax, like sales or income tax.

 

In fact, BC’s and Washington’s would-be carbon tax were actually revenue-negative because of how far they went in progressively redistributing revenue earned from the carbon tax. Washington state’s Office of Financial Management stated that “during the first six fiscal years [under I-732], state General Fund revenue would decrease by a net amount of $797.2 million.” Ouch. On the other hand, by some measures, BC’s economy actually grew slightly faster than the rest of Canada’s after the tax was implemented. Some argue this was because of the overall lower tax rate.

 

Other nations’ carbon taxes do collect revenue. In Ireland, a carbon tax was used in place of increasing income tax to generate much-needed revenue during a fiscal crisis. And Australia’s dismally unpopular (and short-lived) carbon tax was used, in part, to buffer up certain government programs.

 

In Alberta, as in BC and Washington, those with income below a certain level will receive a cash rebate equal to or greater than the estimated cost of the carbon tax to the individual or family. But the rich receive no rebate, and some of the revenue will be reinvested in green infrastructure projects and other climate-related initiatives.

 

Of course, the economic impact of a carbon tax depends largely on the amount of the tax itself. BC’s carbon tax started at $10 per ton and increased by $5 each year until it reached its current level of $30 per ton.  Alberta’s starts at $20 and will rise to match BC’s at $30 per ton by 2018. Washington state’s I-732 proposed a $15 fee that would rise to $100 over the next 40 years.

 

How much is this in terms of everyday costs? Under Alberta’s new tax, gasoline and diesel prices will each rise by 5 cents per litre (about 20 cents per gallon) for now – rising to 7 and 8 cents respectively by 2018. The CBC news “Carbon Tax Calculator” projected the indirect effect on the cost of groceries would be an increase of 1.5%. Estimates for electricity range from nothing to 7.5%.

 

Regardless of how large or small the economic effects, however, here’s the really important question: do carbon taxes actually do anything to help the climate?

 

This is where things get interesting.

 

In the case of BC, the carbon tax appears to have been successful in reducing emissions. From 2008-2013, BC’s per-capita carbon emissions decreased by at least 13%, whereas the rest of Canada’s decreased by less than 4%. Since BC has so much hydropower, the effect was smaller than it might have been if it were more dependent on fossil-fuels based electricity.

 

But until policymakers raise the BC carbon tax up from $30 per ton, I guess the success stops there.

 

In fact, climate scientists say to prevent global warming above the dreaded 2 degree limit, we need a carbon tax of $100 per ton starting right now and rising to $1000 per ton by 2050! Worldwide, the closest anybody comes to this is Sweden, which has an estimated carbon tax of $150 per ton. This is thought to have reduced carbon emissions by 20% from what they would have been otherwise, but some still don’t believe that’s enough.

 

This brings me to why the Washington state effort failed. You might assume that fossil fuel advocates were the ones who opposed it -- that they did, but it was major environmental groups, like the Sierra Club, that really tipped the scale. They said it didn’t do enough to fight climate change while unduly hurting the poor.

 

Yet, energy politics are endlessly interesting. Where environmentalists oppose a carbon tax on one ballot, fossil fuel advocates support it on another.

 

Exxon Mobil – the world’s biggest oil company – is a major advocate of a carbon tax. Why?! Out of the possible clean energy policies, it’s considered the least harmful to business because it causes the least amount of market distortion. Sure, it’s a tax, so it’s distorting the market. But subsidies that come and go are more disruptive. They make long term investments more challenging because you can’t predict what the rules of the game are going to be, and the rules always seem to be changing. According to ExxonMobil’s website, “A properly designed carbon tax can be predictable, transparent, and comparatively simple to understand and implement”.

 

That being said, I’m guessing they support the $10-20, rather than the $100-$1000 version.

 

ExxonMobil also opposes “cap and trade” -- which is the competitive fraternal twin of a carbon tax that is more popular in some circles. Cap and trade operates by setting a “cap” on carbon emissions. Companies then have to “trade” carbon credits to allow them to emit more, or else find innovative ways to emit less. While cap and trade has a less direct impact on consumers, real-world implementation shows that it is more convoluted and less transparent than a carbon tax. ExxonMobil executive Rex Tillerson, among others, argues that the cap and trade system creates a “new Wall Street of emissions brokers”.

 

Beyond carbon tax and cap and trade, are there any other options? Well, there are always ethanol subsidies that incentivise the use of ethanol in gasoline. Ethanol and other biofuels emit significantly less carbon dioxide than traditional fuels. Following this line of thought, the U.S. Renewable Fuel Standard (otherwise known as the “ethanol mandate”) requires refiners to blend an increasing amount of biofuels into the U.S. gasoline supply each year.

 

But quite a few people agree that ethanol subsidies are a disaster. For starters, ethanol comes from corn, and corn is also used to make food. So ethanol subsidies indirectly drive up the price of basic food products which unequivocably hurts the poor.

 

Ethanol subsidies aren’t easy on consumers at the pump, either. While the price tag of ethanol-based fuel makes it look cheaper, it actually takes about 1.5 gallons of ethanol to produce the same energy contained in a gallon of pure gasoline. Depending how much ethanol is in your gasoline, it could negatively affect your mileage.

 

But most consumers aren’t going to make that calculation every time they tank up. This, again, is why proponents of a carbon tax argue it is ultimately the most transparent approach.

 

Before closing, it’s worth mentioning that nuclear energy advocates also tend to favor a carbon tax. Nuclear energy is carbon-free, but hasn’t benefited from many of the climate-related subsidies or tax credits under the Obama administration. It can’t compete with cheap natural gas and subsidized renewables. For nuclear energy, a carbon tax across the board would “level the playing field” by addressing the core issue – carbon dioxide – in a way that’s fair for all types of energy.

 

Well, that’s my analysis. So what can we conclude about carbon taxes?

 

First of all, even though it does not lack its critics, it seems widely accepted that BC’s revenue-neutral approach has been successful, economically and environmentally. Maybe it could even keep working this well if the tax was increased to $40, or even $50 per ton. Whatever happens, it should serve as a model for others, like I-732.

 

As for I-732, regardless of whether or not this was the right policy for Washington state, it was a great example of how far a grassroots effort, starting with a petition, can really fly – from the passion of a comedian-turned-environmentalist to a presidential ballot.

 

Regarding carbon taxes that aren’t revenue-neutral, it seems that these can work, as in Ireland, but they require serious consensus amongst citizens to function, as demonstrated by Australia (which abolished theirs after two years). To avoid hurting GDP, the carbon tax must contain some form of relief for taxpayers. But it’s largely untested whether using some of the revenue to stimulate green energy projects will help or hurt GDP in the long term. As always, this will depend largely on implementation.

 

There are certainly other, and some argue, better options. But, at least compared to other types of climate policy that directly address fuel, a carbon tax seems to be the best way to know what you’re getting yourself into.