Democratic Senators Introduce Carbon Tax Bill

Posted on June 16th, 2015 by Jennifer Klein

Dane Warren
Sabin Center Summer Intern & Rising 2L at Columbia Law School

Prim_GRESOn Wednesday, June 10, two Democratic Senators (Sheldon Whitehouse of Rhode Island and Brian Schatz of Hawaii) introduced a bill that would impose a carbon tax of $45 per ton of carbon emissions. For other greenhouse gases, the bill imposes a carbon dioxide equivalent fee. The sponsors claim that the bill would cut carbon emissions at least 40% by 2025 (compared to 2005 base levels) and raise $2 trillion in revenue over ten years. The tax would increase by 2% each year, adjusted for inflation, until emissions fall 80% compared to 2005 levels. Whitehouse and Schatz promise emissions reductions far exceeding the Obama Administration’s target of 26-28% over the same period.

The contours of this new proposal are intriguing to say the least. The American Opportunity and Carbon Fee Act, as its titled, would levy a $45 tax on upstream sources of emissions, namely coal, petroleum products, and natural gas. The $45 number comes from the Federal Government’s estimate of the social cost of carbon[1] – or the overall cost of carbon not internalized by market forces. Notably, calculating the social cost of carbon remains an elusive and complex task.

In an effort to garner Republican support, the bill includes provisions that counter many popular criticisms of a carbon tax. Many oppose a carbon tax on the grounds that it would hurt American competitiveness abroad, grow the size of the Federal Government, and harm low-income families. Addressing these concerns, the bill uses some of the savings to cut the top marginal corporate tax rate from 35% to 29% and provide a $500 tax credit to workers, social security beneficiaries, and veterans. The bill also includes a state subsidy for rural and low-incomes households.

Additionally, the bill would impose the same tax on imports of energy-intensive goods and provide a refund for energy-intensive American goods exported to countries without a pricing mechanism on carbon. Supporters contend that this ensures that American businesses stay competitive in the world trade markets. However, some commenters have claimed that the “border adjustments” would still lead to higher prices for consumers on imported goods and could harm developing countries.

The bill also surprisingly considers carbon capture and storage (CCS) and escaped methane offsets. Companies can offset their carbon tax bill by utilizing carbon capture and storage technology. Additionally, the bill addresses the consequences of escaped methane, a potent greenhouse gas, by imposing a carbon-equivalent fee for escaped methane from coal, petroleum, and natural gas extraction processes.

The economic case for a carbon tax is simple. Burning fossil fuels releases carbon dioxide into the atmosphere, which in turn contributes to climate change. However, the full cost (i.e. the health and environmental cost) of burning fossil fuels is not built into the price, leading to more carbon dioxide emissions than is socially optimal. Economists call this a negative externality, which creates market failure (a situation where unregulated markets produce inefficient outcomes). However, a properly set tax can erase the market failure by including the negative cost of the activity into the market transaction. At least in theory, the price of consuming fossil fuels would then reflect the “true” cost of the emissions.

Supporters of a carbon tax argue that it is the most economically efficient way to address climate change, especially over “command and control” regulatory approaches like fuel standards. A 2011 poll of leading economists found that 90% of them believe that a carbon tax would be a less expensive way to reduce emissions than “corporate average fuel economy” standards. Further, a carbon tax could eliminate the need for complex subsides for alternative energy programs, as the tax places all technologies on a level playing field.

Among supporters of climate change legislation, perhaps nothing is more controversial than the carbon tax versus cap and trade debate. Carbon tax and cap and trade programs seek to do the same thing – put a price on carbon to correct for a market failure and incentivize the economy to switch to alternative energy sources. Both act as “market oriented” strategies, distinct from command and control regulatory programs common in the United States today. A carbon tax directly regulates price, whereas a cap and trade scheme directly controls the quantity of emissions (a trade-off between cost-certainty and environmental-certainty). Further, both shift emissions reductions to the lowest-cost producers; this represents the most fundamental benefit over command and control regulation.

The famed Waxman-Markey bill (essentially a cap and trade scheme) that failed to pass the Senate in 2009 was perhaps the closest the United States has come to taking serious action on carbon emissions. Additionally, the U.S. has experience with a cap and trade through the highly successful Acid Rain Program. Many other countries have implemented both types of schemes with varying degrees of success. The EU created the largest cap and trade scheme to date, although early results were plagued by difficulties with credit allocations due to the economic downturn. Australia famously passed and then repealed a carbon tax scheme after a rise in prices made consumers turn on the program. British Columbia passed perhaps the most successful carbon tax scheme to date, reducing emissions 16% between 2007 and 2013, while the rest of Canada’s emissions rose 3%.

Some economists believe that a carbon tax would represent a more efficient system than cap and trade, but the jury is still out. For one, many have noted that a carbon tax could spark comprehensive tax reform by replacing less efficient taxation methods. Further, some fear that a cap and trade scheme would be more susceptible to manipulation by industry interests – although an overly complicated tax code could certainly lead to the same problems.

The American Opportunity and Carbon Fee Act will almost certainly face staunch opposition from much of Congress, especially among those who do not see climate change as a serious concern. For climate change skeptics, a carbon tax would harm the economy without providing any benefit at all. While many conservative members of congress staunchly oppose any climate legislation, some conservative think tanks and political backers now support a carbon tax as the most efficient way to stem the tide of anthropogenic climate change. Jay Faison, a Republican entrepreneur, has pledged $175 Million in campaign donations to convince Republicans to support climate legislation generally.

While this latest effort to combat climate change faces long odds in Congress, supporters of comprehensive climate legislation certainly hope that this will, at the very least, spark a much-needed conversation around the topic.

[1] The Federal Government calculates the social cost of carbon to range from $12 to $116 depending on the statistical model and the related assumptions.

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