As seen in our discussion of a social cost of carbon, the CO2 emissions of today will cause a lot of problems and cost a great deal of money in the future. And these emissions have mostly been seen by individuals and businesses as externalities, meaning that those creating the emissions haven’t been the ones responsible for the costs. Carbon taxes are one way of solving these problems.
The basic idea of a carbon tax is to make individuals and businesses pay to pollute. Government works with businesses to track how much CO2 their activities emit, and then to tax each ton of emissions. This makes all carbon emissions intensive activities more expensive because one has to pay something closer to the ‘true’ price (that true price is the social cost of carbon). Following the principle of the demand curve, when the price of something goes up people will consume less of it. For instance, people will choose to use less fossil fuels in their homes, cars, and factories. It will make more economic sense for people to drive less, purchase more fuel efficient cars, eat less meat, etc. At the same time, more sustainable options will become cheaper by comparison, and this will encourage more renewable energy, electrification, and much more.
For those who appreciate how well the free market can work and prefer it to top-down regulation, all of these effects emerge in the marketplace just by properly pricing pollution and making the polluters pay for it. The status quo, where pollution is being ignored, is a failure of the market and a carbon tax simply improves how the economy functions.
How high should a carbon tax be? If we actually want to stop subsidizing CO2 pollution, then this ought to be based on the social cost of carbon, perhaps $100 or $200 per ton. Of course one has to stay within the realm of what is politically achievable, so most actual carbon tax plans start with a much lower value that will rise over time. A good discussion of the CO2 reductions from carbon taxes can be found here and here.
Revenue neutral carbon tax. We haven’t yet discussed what the government will do with all of the money raised from these carbon taxes, which could easily go into the many billions of dollars. This could be used for any government spending and could just go into the general treasury. Some campaigners want these tax dollars to go into further sustainability projects, so as to get a double whammy of the carbon reductions from the tax followed by further reductions from government renewable energy or sustainable infrastructure programs. However, this double whammy is doubly unpopular with political conservatives who may be resistant to climate change policy in general, as well as increased taxation in particular. So, we at Sunshine Saved think that the version of a carbon tax that has the best chances of success at winning politically while still achieving massive CO2 reductions is what is called a ‘revenue neutral carbon tax’.
In a revenue neutral carbon tax, the tax revenues are immediately returned back to the populace as cash or tax rebates, and have already been implemented in British Columbia and now are being adopted more broadly in Canada. This sort of tax is then primarily about fixing that failure of the market to account for the cost of carbon pollution, and on average, won’t cost consumers anything. The typical household will spend a few hundred dollars more per year on all of their carbon-intensive goods and services because of the tax, but then get a similar amount back from the government as a dividend. A family that is already living a low-carbon lifestyle will come out a bit ahead, while a family that incurs high emissions will come out a bit behind. And everyone will be nudged to emit less carbon just by the way that prices will adjust because of the tax. A revenue neutral carbon tax isn’t enough to solve climate change all by itself, but it is a very powerful tool in the toolbox.