nalin bhatia_nre_510_policy brief

NRE 510 POLICY BRIEF December 13 2016

Enactment of carbon tax on CO2 emissions to reduce carbon footprint contributions from large emitters.

Summary

Climate change has become a pressing concern today as a significant part of the economy and livelihoods rely on industries and business which are heavy carbon emitters. United States is the second largest emitter of CO2 after China with 17% overall contribution to the world’s total Carbon emissions, however, it still doesn’t have a nationwide carbon tax. The paper examines the idea of carbon pricing schemes and the current scenarios in the world and U.S. Finally, the paper outlines a carbon tax policy and what roles are played by the federal and state governments for which the policy is meant.

Introduction

Climate change has become a pressing concern today as a significant part of the economy and livelihoods rely on industries and business which are heavy carbon emitters. Natural phenomenon such as sea level rise, global warming, glacial retreat etc. has provided scientists with concrete evidence that climate change is happening and could continue to worsen if carbon emissions are not regulated One of the major scientifically established and most widely accepted consensus behind climate change is the trapping of heat by greenhouse gases (GHGs) in the atmosphere. Carbon dioxide (CO2), one of the many GHGs is considered to have the most prominent effect on climate. Therefore, it has now become imperative that all industrial and business practices aim towards reducing CO2 emissions. Carbon tax is one of the policy frameworks implemented by the government to curb carbon emissions.

Background

A carbon tax can be understood as essentially a kind of penalty imposed on businesses for causing pollution. It is a form of a pollution tax levied on the usage of fossil fuels depending upon the amount of carbon their combustion emits as carbon is the primary contributor to pollution. Usually, these costs are expressed in multiples of the costs incurred by a ton of CO2, and hence, are also referred to as ‘carbon pricing’.1

The rationale behind this implementation is to encourage businesses, industries, and utilities to opt for cleaner and renewable energy by making carbon intensive fuels more expensive. Presently, investments in renewables are although growing,

KEY FINDINGS:

Investment in clean energy is quite

inconsistent at present and requires

heavy capital for infrastructure.

Currently, only a small part of the world

has carbon tax policies in place.

There is no nationwide carbon tax levied

in the United States, although a few

states and localities have introduced the

tax.

Carbon taxes aren’t easily manipulated

by special interests, whereas the

complexity of cap-and-trade leaves it

susceptible to exploitation by the

financial industry.


are still quite inconsistent since most of the renewable technologies initially require intensive capital for infrastructural investments and is heavily dependent on government subsidies.2 Bloomberg estimates a two-third drop in solar installation in 2017 if the Investment Tax Credit (a form of incentive on tax provided for solar installations) expires.3 Therefore, a carbon tax will tend to increase cost-competitiveness between clean and dirty energy in order to impair heavy usage of fossil fuels.

So far, the world has not effectively responded to this challenge. Because of the global nature of climate change, most countries have been reluctant to undertake significant effort to reduce emissions without a guarantee that others will do the same, perceiving that most benefits from such an effort will accrue to other countries.

Apart from carbon pricing, another popular system is the emissions trading scheme(ETS) or cap and trade system. In such a system, laws and regulations put a limit or ‘cap’ on the amount of carbon emissions for companies/industries which act as sources of emission and issue allowances or permits to emit carbon which are matched with the cap. Companies buy allowances through auctions and can further trade these allowances with other

eligible emitters.4 Some economies also have a hybrid system which is broadly a combination of the carbon pricing and cap and trade system.

Where is Carbon taxed? The recent years have saw an increase in the number of carbon pricing schemes being implemented especially across the developed world (see Figure 2). As of 2015, many developed and few developing nations have implemented some sort of carbon pricing with a total of 46 carbon markets established.5 However, these schemes cover only 12 percent of the world’s total emissions.6

In Europe, several countries like UK, Sweden, France and Ireland have implemented a hybrid system of carbon pricing and the ETS. Sweden has the highest carbon tax in the world at $168 per ton of carbon dioxide emitted.7 Other large emitters like Australia, China, and Canada (5 states) have also implemented carbon pricing policies. China in fact implemented 6 carbon trading schemes recently

Figure 1: Annual increase in carbon dioxide emissions per decade: Source: https://skepticalscience.com/anthrocarbon-brief.html

Figure 2: Carbon pricing policies in effect from 1990 to 2017. Source: http://www.ucsusa.org/global-warming/reduce-emissions/cap-trade-carbon-tax#.WFBs_uYrJPY


which makes it the second largest carbon market in the world.8

Current Scenario in the United States The U.S. does not have any nationwide price on carbon expect for a few states like Colorado, California, Maryland and Washington which have had some sort of success in the introduction or at least proposal of such schemes. The only system in function currently is California’s cap and trade system which came into effect in 2013. The first two years saw a 3 percent drop in emissions surpassing targets.9 The case for U.S. is a crucial one since it’s the second largest emitter after China and one of the most powerful economies of the world.10

Implementation challenges There are several challenges associated with implementation in a country such huge and diverse. The first is the presence of the left and right groups having two opposing ideologies. A large segment of the population believe that climate change is not real or not amenable to government response.11 In such a situation, such schemes can take a long time to come into effect as people are not willing to pay for pollution. Political instability and policy inconsistency is another detriment to implementation. Even if the government in power agrees to implement such a policy, there is no guarantee it will stay in effect if a conservative government replaces it. Therefore, carbon pricing remains and also other climate mitigation policies remain politically vulnerable which is precisely the situation faced by the country post the 2016 election results. The economy still relies on fossil fuels for power generation and production of goods since investment in renewables is still insignificant (around 8 percent) as compared to European economies. Rendering a price on carbon means

significantly increasing energy costs which will hit the lower income groups.12 Why need a Carbon Tax? Gregory Mankiw, one of the most influential economists in the world argues that carbon taxes are beneficial as they are nudging people in the direction of doing the right thing. Also, one should keep in mind that if you’re implementing a carbon tax, you can repeal other taxes in response. The U.S. is the second largest greenhouse gases emitter in the world, but what’s worse that carbon dioxide makes up around 80.9% of total U.S. emissions.13 Also, the grid right now heavily relies on fossil fuels. The fossil industry has always shifted the cost of polluting the environment onto the public while generating huge profits. The top 5 oil and gas companies alone made over $1 trillion in the past decade accounts to over $250 million per day.14 The price of fossil energy in the U.S. currently is way lower than renewables so a carbon tax would essentially promote more renewable investment by creating a parity in price with fossil energy.

Policy Recommendations The design of the carbon tax would be based upon the simple principal of imposing a regulatory charge on the combustion of fossil and other non-renewable fuels like coal, petroleum, natural gas etc. proportional to the amount of carbon contained in the fuel. The policy also draws upon the motivation to provide all emitters a uniform incentive to reduce emissions. The target group which the policy concentrates on is the federal and state governments since these are the prime implementing authorities. So, the key question that arises here is who is responsible for implementing what kind of tax?


A carbon tax implemented solely at the federal level could have negative consequences on the economies and become regressive since different states have different income distributions, income taxes, energy prices, electricity grid composition etc. Also, states with higher levels of pollution would resist such a system as they would end up paying significantly larger amount per capita than other states. A single federal carbon tax would, therefore, be an unjust and inequitable option. Another important consideration is the level of stringency of the tax. A higher level of tax is essential to effectively curb greenhouse gas levels; however, significantly higher taxes could damage economy particularly if imposed without adequate transition time.15Therefore, choosing the appropriate dollar amount requires a balance between the health of the environment and the economy. To tackle these concerns, one could be make the system more equitable by structuring it to permit equivalent carbon taxes in states to override the federal tax. This is where the concept of Social Cost of Carbon (SCC) comes into play. SCC is a tool used by the EPA and other federal agencies to estimate the cost of economic damages associated with increase in carbon dioxide emissions. It takes into account changes in net agricultural productivity, human health, property damages from increased flood risk, and changes in energy system costs,

such as reduced costs for heating and increased costs for air conditioning.16 For this case, the federal government would set a national carbon tax which would be equivalent to the SCC. In addition, states could implement their own carbon taxes based upon their own socio-economic conditions. Therefore, the total payable tax would be the SCC implemented at the federal level plus the difference between the SCC and the tax implemented by the state. For states having a tax equivalent or higher than the SCC, the federal tax is essentially eliminated. This approach would maintain the benefits associated with uniformly pricing carbon, and be more acceptable to states than a federal carbon tax without equivalency provisions. Finally, one has to consider that such taxes could also become regressive overtime in a country with such significant diversity in income groups. This issue could be solved by subsidizing the low-income groups for energy price hikes through the revenue generated from these taxes.

Conclusion It is evident that there are significant political, social and economic impediments to implementation of a carbon tax policy. However, one can also not deny the fact that current state of policies and practices in

Policy considerations/conclusions

The policy should follow the basic carbon tax design consisting of a uniform charge on coal, refined oil products, natural gas, and other fuels in proportion to the amount of carbon embodied in each fuel.

An appropriate level of stringency to balance the desire for deep greenhouse gas reductions with concern relating to transitory and longer term disruptions to the economy.

Level of carbon tax in terms of Social cost of carbon (SCC). Federally implemented tax at SCC alongside state level taxes and effective tax to be

the difference between the federal SCC and the state level tax.


place do not lead towards a carbon negative future. The new policy might initially face lot of resistance from the masses and companies but will overtime subside as costs of renewable technology drops and renewable investment becomes the status quo. An initial financial load on the economy would save us from multiple future loads.

References

1 Birr, S. (2015). Without Government Backing, Solar Power Can’t Compete. The Daily Caller. Retrieved from: http://dailycaller.com/2015/11/19/without-government-backing-solar-power-cant-compete/ 2 Birr, S. (2015). Without Government Backing, Solar Power Can’t Compete. The Daily Caller. Retrieved from: http://dailycaller.com/2015/11/19/without-government-backing-solar-power-cant-compete/ 3 Chediak, M. and Martin, C. (2015). Say Goodbye to Solar Power Subsidies. Bloomberg Businessweek. Retrieved from:

http://www.bloomberg.com/news/articles/2015-11-05/say-goodbye-to-solar-power-subsidies 4 Carbon Pricing 101: When carbon emissions cost money, we produce less of them. Union of Concerned Scientists. Retrieved from: http://www.ucsusa.org/global-warming/reduce-emissions/cap-trade-carbon-tax#.WFAws-YrJEY 5 Hope, M. (2014). The state of carbon pricing: Around the world in 46 carbon markets. Carbon Brief. Retrieved from: https://www.carbonbrief.org/the-state-of-carbon-pricing-around-the-world-in-46-carbon-markets 6 Hope, M. (2014). The state of carbon pricing: Around the world in 46 carbon markets. Carbon Brief. Retrieved from: https://www.carbonbrief.org/the-state-of-carbon-pricing-around-the-world-in-46-carbon-markets 7 Hope, M. (2014). The state of carbon pricing: Around the world in 46 carbon markets. Carbon Brief. Retrieved from: https://www.carbonbrief.org/the-state-of-carbon-pricing-around-the-world-in-46-carbon-markets 8 Hope, M. (2014). The state of carbon pricing: Around the world in 46 carbon markets. Carbon Brief. Retrieved from: https://www.carbonbrief.org/the-state-of-carbon-pricing-around-the-world-in-46-carbon-market 9 Cho, R. (2016). Carbon Pricing for the Climate: How It Could Work. State of the Planet. Retrieved from:

http://blogs.ei.columbia.edu/2016/06/27/carbon-pricing-a-no-brainer-for-climate-change/ 10 Each Country's Share of CO2 Emissions. Union of Concerned Scientists. Retrieved from: http://www.ucsusa.org/global_warming/science_and_impacts/science/each-countrys-share-of-co2.html#.WFA-weYrJEY 11 Benny, T.M. The Challenge of Putting a Price on Carbon Emissions in the United States. Scholars Strategy Network. Retrieved from: http://www.scholarsstrategynetwork.org/page/challenge-putting-price-carbon-emissions-united-states 12 Renewable energy's share of U.S. consumption up to 8 percent. (2011). Oil Peak. Retrieved from:

http://www.endofcrudeoil.com/2011/06/renewable-energys-share-of.html 13 Letzter, R. (2016). One of the most influential economists in the world explains why a carbon tax is a good idea. Business Insider. Retrieved from: http://www.businessinsider.com/gregory-mankiw-harvard-professor-carbon-tax-2016-11 14 Sanders, B. (2014). Why We Need a Carbon Tax. The Huffington Post. Retrieved from: http://www.huffingtonpost.com/rep-bernie-sanders/why-we-need-a-carbon-tax_b_5571408.html 15 Edenhofer et al. (2014). Climate Change 2014: Mitigation of

Climate Change. Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change. IPCC.

16 The Social Cost of Carbon. US Environmental Protection Agency. Retrieved from: https://www.epa.gov/climatechange/social-cost-carbon


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University of Michigan School of Natural Resources 440 Church Street, Ann Arbor, MI 48109

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Author contact: Nalin Bhatia [email protected]

Media contact: Nalin Bhatia [email protected]

nalin bhatia_nre_510_policy brief

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