Green Taxes

Green Taxes

If the tool of choice for governments is a tax, then they are trying to set a price that they think will give people the right incentives to reduce the amount of emissions they produce. Some of the desired changes will take time. If the price of gasoline quadruples tomorrow, many people cannot immediately change where they live and work, and many will not immediately change how they commute. But high carbon prices inevitably alter behavior and lead firms to alter how and what they produce. People in Europe drive smaller and more fuel-efficient cars than Americans do in part because they have had higher fuel taxes for decades. Using a tax as the way of setting incentives also has the advantage of bringing in revenues to governments that ran large deficits fighting the Great Recession and COVID-19. A particular advantage of a carbon tax is that it would create incentives to innovate—for example, by producing cheaper sources of energy that produce little or no carbon emissions. In many nations, incentives, including taxes, have helped spur innovation with respect to solar, wind, and other forms of green energy, and have also helped spur the rise and spread of electric vehicles.

We leave it to others to decide how to structure any carbon tax and what to do with the tax inflows. We would favor structuring the tax in a way that makes sure that the tax burdens do not have adverse effects on poor people. To assure progressivity, and to overcome loss aversion, we believe that a carbon tax should be “bundled” with economic help, so as to ensure that lower-income people are not net losers from the tax (at least on average). For example, it might be possible to bundle the carbon tax with a combination of payments to lower-income people who are hurt by that tax and expenditures on government programs that benefit them or that are otherwise popular. Free high-speed internet, anyone? Because wealthier people engage in actions that result in more carbon emissions, they would generally pay more than their per capita share of the total bill, but we would also favor making some portions of a carbon tax explicitly progressive (for example, by taxing emissions from larger houses and more expensive cars at a higher per-unit rate). In some cases taxes can be negative, such as with subsidies. At the time of this account, the United States subsidized the purchase of electric cars and home solar energy systems, for example. The fact that the tax would raise revenues creates opportunities for creative use of that money. The tax approach sets the price and then lets the market react, leaving the aggregate level of emissions uncertain. Over time, if emissions do not fall enough to reach appropriate targets, or if the climate crisis grows even more urgent (alas, this is entirely possible), then the tax rates can be adjusted.

Some environmentalists are deeply suspicious of carbon taxes. They want strong and immediate reductions in emissions, and they doubt that taxes can get us there. In our view, their skepticism is unwarranted. If you want strong and immediate reductions, taxes can definitely get us there; everything depends on their size. The higher the tax, the greater the reduction in emissions. In view of the magnitude of the problem, a low or nominal tax would be tough to defend. While many people, and some nations, embrace the goal of “net zero” emissions by a specified date, the world cannot, and should not, try to reduce global emissions to zero in the next year; humanity is not ready to immediately do without transportation and electricity, for example (sacrifices we might have to make to get to zero very quickly). But we can reduce emissions significantly with a stiff tax that becomes increasingly stiffer over time. That could drive carbon emissions way down over the next decade or two.

In theory, the tax should be equal to the “social cost of carbon,” a number that is designed to capture the damage done by a ton of carbon emissions. Of course, reasonable people disagree about how this number should be calculated, and numerous assumptions, not always based on clear evidence, have to be made before an estimate is produced. In 2016, the United States chose a social cost of carbon of about $50, and that figure influenced the assessments of a number of other nations. Many experts discussed in this account think that $50 is too low and that in light of new scientific findings, continuing uncertainty, and the risk of catastrophe, nations should choose a much higher figure. A chosen date for carbon neutrality can guide the design of an array of taxes intended to reach that target.

At the time described here, Sweden had what the authors report as the world’s highest carbon price, about $130 per metric ton. Since the tax was introduced in 1991 at about $28, and gradually increased to that level, the country had seen an 83 percent increase in real GDP—comparable to that of other OECD member countries—and a 27 percent decrease in emissions. Though the tax increased gasoline prices, the response to the tax promoted significantly larger behavioral changes than would be expected under a gasoline-price increase alone. There is a general lesson here. If a tax is understood to be responding to a serious problem, people might respond even more than they would to the purely economic incentive. In this context, they might hear a signal that it’s good to reduce greenhouse gas emissions—and they might be willing to do that even if it’s not in their economic interest. Humans are like that.

The timing of Sweden’s tax increases also matters. Since 1991, Sweden’s carbon tax had nearly quintupled by the period described here. The basic idea of starting with a low carbon tax and increasing it over time makes a lot of behavioral sense, and it has been adopted or given serious consideration in several countries, including Germany. Maybe it should be called Green More Tomorrow. Alert to present bias and loss aversion, policymakers (and private companies) might impose relatively low costs today, or soon, while committing to increase those costs over time. In an illuminating, broad-ranging essay on the use of behavioral economics to combat climate change, Helga Fehr-Duda and Ernst Fehr note, “The basic principle of committing to a policy today but delaying the consequences is routinely used by politicians, for instance to increase retirement age without losing voters.” They add that the principle can be used in multiple areas, including climate change policy. In nations in which the idea of a climate tax runs into serious political opposition, and in which less efficient alternatives are more popular, Green More Tomorrow might be the best path forward.