Two events this week raised the profile of carbon taxes. The first was a report by the UN that warned of catastrophic effects if the world does not cut carbon emissions in half in just the next dozen years. The second was that Yale professor William Nordhaus shared the Nobel Prize for economics for his pathbreaking work on carbon pricing.
Nordhaus has been writing for four decades about climate change and the value of using prices to reduce carbon emissions. His research shows that raising prices through, say, a carbon tax, is a far more effective and efficient way to lower carbon emissions than direct government controls on the quantity of emissions through, say, regulatory limits on cars and power plants. Higher prices will encourage firms and consumers to find alternatives to carbon-based products as well as encourage new technologies that will make those substitutes competitive. This has become the mainstream view among economists.
Free-riding
Unfortunately, controlling the world quantity of carbon emissions is the common scientific shorthand for the steps needed to limit climate change. And direct limits on emissions became the primary mechanism of both the 1997 Kyoto Protocol and the 2016 Paris Accords that supplemented it. As the UN’s recent report shows, these agreements have fallen far short of their emissions reduction goals.
The UN’s Intergovernmental Panel on Climate Change concluded that the world must decrease net carbon dioxide (CO2) emissions by nearly 50 percent by 2030 and eliminate them by 2050 to maintain much of the planet’s livability. But how to get there?
Nordhaus is relatively agnostic about whether the best mechanism is a direct tax on carbon or its cousin, a cap and trade system. But either way, he has argued that nations must raise the price of fossil fuels to protect the climate, a global public good. If not, firms, individuals, and even countries will free-ride, taking the benefits of using fossil fuels without paying for their environmental costs. Unless those global costs—externalities in econo-speak—are built into the price, there is no incentive for individual carbon users to reduce their consumption, and all humanity may suffer the consequences.
A climate club
One Nordhaus solution: A global climate club. A critical mass of countries would participate by agreeing to an international target carbon price. They could meet that price, say $25 or $30 per ton of CO2, any way they want—with a tax, a cap-and-trade system, or some combination. Countries that refused to join such a pricing system would be punished, perhaps by club members imposing stiff tariffs on all goods imported from non-members. If the cost of refusing membership is high enough, most nations would join the club.
As Nordhaus readily acknowledges, a carbon tax raises many practical design and implementation questions. My Tax Policy Center colleague Adele Morris looks at cross-border taxes on carbon emissions here. My TPC colleagues Donald Marron and Eric Toder analyze how best to collect the tax, what an optimal rate should be, and what to do with the revenue here.
Beyond those broad technical issues, some climate economists question whether his climate club idea is realistic at all. And if the UN projections are correct, the price level Nordhaus suggests (most recently $30 per ton) likely would be far too low to avoid catastrophe.
Killing three birds
With President Trump and the big majority of congressional Republicans dead set against a carbon tax, and even, to one degree or another, denying that climate change is a problem, Nordhaus’ ideas won’t become law any time soon.
But climate change is real. So is the US budget deficit. And so is the need for additional tax revenue to support the needs of aging Baby Boomers. Somewhere along the way, lawmakers will realize that they can kill all three birds with one stone. Plus, for conservatives, a carbon tax may have the added bonus of replacing at least some regulations that seek to limit fossil fuel use.
When the time comes for Congress to take the idea of a carbon tax seriously, they’ll look back on the work of Bill Nordhaus beginning in the late 1970s and perhaps wonder: What took us so long?
