Why a Price on Carbon?

Carbon emissions are not being curbed nearly fast enough (even with the Paris agreement) to fundamentally alter the current path that will take us past the 2 degree Celsius mark. We live in a market-based economy in which the majority of states do not place a price on carbon emissions. In this sense it’s reasonable to think of CO2 pollution as a massive economic externality. Externalities are costs — health impacts from air pollution, or coastal Florida going underwater in the not-too-distant future, for example — that are not currently priced into the market. When you pay for gasoline at the pump, you don’t pay for the environmental damages caused by burning it.

Putting a price on carbon changes incentives. It encourages everyone — individuals, government agencies, and most importantly companies — to curtail their use of fossil fuels. Something that used to be free — our use of the limited carbon absorptive capacity of the biosphere — now costs money. By turning what used to be an open-access resource into a form of property, putting a price on carbon compels us as a society to decide how this new property right will be distributed, above all who will get the money that people pay to emit carbon.

Choosing a Plan

Carbon pricing can be achieved via either a tax or a cap. A tax sets the price of carbon and allows the quantity emitted to vary. A cap sets the quantity of carbon that can be emitted and issues permits up to that cap, allowing their price to vary. The two can be combined, for example by setting the tax rate (or “price” or “fee”) so that it automatically increases if targets for reducing the quantity of emissions are not achieved, as is done, for example, in Switzerland’s CO2 levy.

Commentators frequently assume that a cap means cap-and-trade. This need not be the case. When the government caps carbon emissions by issuing a limited number of permits, trading is needed only if permits are given away free to corporations — typically according to a formula based on past emissions.

This model is not a given. Rather than giving the permits away, we can sell the permits via auctions (as has been done since 2008 in the northeastern US states under the Regional Greenhouse Gas Initiative). With permit auctions no trading is necessary; firms simply buy what they want at the auction. Without trading, there is no scope for market speculation or profiteering.

Regardless of whether permits are auctioned or given away, the cap results in higher prices for consumers. As the quantity of fossil fuels is reduced by the cap, their price goes up. Firms pass along the cost of buying permits at the auction — or, in the case of cap-and-trade, the “cost” of not selling permits they got for free — to consumers, who pay in proportion to the carbon embedded in the goods and services they buy.

The difference is who gets the money. When permits are given away to polluters in cap-and-trade, the corporations get to keep the money — they get the permits for free, and pocket the higher prices paid by consumers. When permits are auctioned, the money is available to the public.

A cap-and-auction permit system, like a carbon tax, allocates rights to the limited carbon absorptive capacity of the biosphere to the public, but what the government does with this money matters. Congressman (now Senator) Chris Van Hollen (D-MD) introduced the Healthy Climate and Family Security Act of 2015 — a bill to implement a carbon cap to reduce economy-wide emissions by 40 percent by 2030, selling the carbon permits at auction. The bill does not propose that the government keeps the money, but instead that the carbon revenue will go to all of us in equal and common measure in the form of a dividend — an equal payment to every woman, man and child with a Social Security number.

Benefiting the People, Not the Corporations

Many economists worry more about the size of the pie than about how it’s sliced. Growth — how fast we can expand the pie — is their obsession. Reading the Wall Street Journal we see economists poring over the recent GDP numbers. Even tuning into “Marketplace” on your local public radio station you’ll be bombarded with “the numbers” — how the stock market is doing. They’re not focusing on Main Street, where distribution matters. How are ordinary Americans faring?

We believe that in the United States today, the distribution of the pie is what matters most. After all, despite the growing pie, most Americans today are no better off than forty years ago. As Nobel laureate Joseph Stiglitz argues, “inequality is a choice.”

We face this choice in carbon pricing, too. We can choose a carbon policy that benefits all Americans, not just corporate shareholders. Due to consumption patterns, a carbon price in itself is a regressive tax: it falls disproportionately on lower-income households, because they spend a larger share of their income on carbon-intensive goods than do the rich. The average worker spends $2,600 a year commuting, but that’s a larger share of one’s income for the middle class than it is for the rich. But the net distributional impact of carbon pricing — how much money one has after taking account not only of higher prices for fossil fuels but also of where the money goes — depends crucially on who gets the revenue.

If the money is returned to the people as equal dividends per person, the policy’s net impact is progressive: the poor receive more in dividends than they pay in higher fuel prices, while the rich pay more than they get back as dividends for the simple reason that they consume more of just about everything, including carbon. Calculations reveal that the majority of households in every state would be better off under such a policy.

A carbon price-and-dividend policy would not only make a modest contribution to reducing income inequality, but would also help to ensure that carbon pricing remains politically sustainable even as higher fuel prices kick in across the economy. In this respect, as Suresh Naidu wrote a few years ago, “[t]he political economy of climate change looks a whole lot like the political economy of redistribution.” Who will come out ahead depends on who will get the revenue from a price on carbon.

No Free Rides for Polluters

There’s no need to rely solely on carbon prices to solve the problem, but they’re surely part of the solution. In fact, when we decide as a society to use prices as a remedy for externalities, we invariably combine them with regulations. For example, when we install parking meters to allocate scarce parking space along our streets, we also have rules about parking between the lines in designated spaces. A combination of prices and rules can be applied to parking carbon in the atmosphere, too.

Regulations, like fuel economy standards for automobiles or the Clean Power Plan for electricity producers, can be important tools in pushing technological change in specific directions. Regulations, like prices, provide incentives — but only to comply with the regulations, nothing more. These alone have proven inadequate to address the climate crisis. Carbon pricing provides incentives to reduce the use of fossil fuels across the board — oil, coal and natural gas alike — and also to figure out new ways to reduce their use.

Regulations alone, in the absence of carbon pricing, are like dams against a river’s flow: they may hold the water in check, but it always wants to flow downhill — in this case, towards the cheapest energy source. Carbon pricing levels the terrain for clean energy. And it has the support of a majority of rank-and-file Republicans, whereas regulations do not.

Moreover, when regulations are the only game in town, polluters continue to use the scarce carbon absorptive capacity of the biosphere for free. Those who pollute the most get the biggest free ride. With carbon pricing, the polluters pay. If we design it right, the public gets the money via dividends, government revenue, or a combination of the two.

Redistribution

Putting a price on carbon by means of a tax or auctioned permits does not mean turning nature into a commodity, any more than installing parking meters turns our public streets into a commodity. It means protecting nature from abuse.

Implementing a carbon price and returning all or most of the money to the people as dividends, similar to the dividends that are paid annually by the State of Alaska to all its residents in the Alaska Permanent Fund — an institution that is supported across the state’s political spectrum — will curtail the use of fossil fuels and speed investments in energy efficiency and clean renewables. At the same time it will put a dent in inequality, by charging for use of our atmospheric wealth and returning the money to all of us on the principle that we own it in common. It’s a win for the environment, and a win for most people.

There is one powerful group for whom it’s not a win: owners of fossil fuel reserves. Keeping these under the ground will substantially reduce their value. This distributional conflict is at the heart of climate policy.