View all Articles
Commentary By William O'Keefe

Why a Carbon Tax Is the Wrong Solution

The release of the National Climate Assessment this year and the recent formation of the new bi-partisan, pro-business advocacy group Americans for Carbon Dividends have given new life to promoting a carbon tax as the best approach to reducing carbon dioxide emissions. Climate change activists will endorse any policy that they believe will reduce fossil fuel use. But others should be cautious in embracing a complicated and unnecessary tax scheme.

The goal of Americans for Carbon Dividends is to advocate for the “Baker-Shultz carbon dividends plan,” a proposal put together by the Climate Leadership Council and, specifically, two of its founding members, former Secretary of Treasury James Baker and former Secretary of State George Shultz. The plan would impose a tax on carbon-based fuel wherever it first enters the economy, whether it’s the oil refinery, the mouth of mine, or the port of entry. The starting fee would be $40 per ton of carbon dioxide, which would gradually increase as the tonnage increased. The revenue generated would be returned to all Americans monthly on an equal basis. In exchange for passing the carbon tax, Congress would phase out regulations on carbon dioxide emissions.

Anyone who knows how Congress operates knows that it is extremely unlikely for Congress to enact a simple carbon tax that gives the proceeds back to taxpayers and simultaneously eliminates regulations on carbon emissions. Congress simply does not operate that way. Being able to get broad based support for legislation involves making deals across the aisle to get votes. This means that obtaining votes for a bill enacting the Baker-Shultz plan would probably involve provisions that would benefit low income earners, farmers (because they use a lot of carbon-based fuels), coal miners (whose industry will be negatively affected), and other special interests where a plausible case for exemptions can be made. It will also be difficult to roll back existing regulations because of opposition from environmental advocacy organizations, members of Congress who have strong environmental interests, and organizations that have already made significant investments to comply with those regulations..

But this is simply how Congress works. Consider the history of ethanol subsidies. Members of Congress sold ethanol subsidies by initially claiming ethanol production would reduce the imports of oil, and then by saying it would reduce carbon dioxide emissions as a cleaner form of energy than fossil fuels. It does neither, but subsidies and mandates on use continued to be expanded to benefit corn farmers and ethanol manufacturers while costing motorists billions of dollars annually.

Even if there was a way to get Congress to enact the kind of carbon tax favored by the ACD, there are other reasons to oppose the plan. The size of the tax is supposed to be based on an assessment of damages that are reflected in the social cost of carbon. EPA defines the social cost of carbon as “an estimate of the economic damages associated with a small increase in carbon dioxide (CO2) emissions, conventionally one metric ton, in a given year. This dollar figure also represents the value of damages avoided for a small emission reduction.” But the estimates for the social cost of carbon calculated by the Obama administration for the period from 2010 through 2050 ranged from $11/ton of carbon to $90.  But how do you decide which is the more realistic damage estimate?

The social cost of carbon is based on model calculations that involve numerous assumptions. The damages that advocates cite, such as those in the National Climate Assessment, are based on higher temperatures than have been observed since 1998. For example, although the sea level is estimated to have risen by about 7 inches since 1900, the National Assessment states that it could rise by 4 to 8 feet by 2100. Based on the work of oceanographers such as Carl Wunsch, a reasonable person would have to conclude that such an increase is unrealistic.

Fossil fuels produce both positive and negative externalities. An honest calculation of the social cost of carbon would incorporate the benefits they produce and the net damages after the costs of regulations are taken into account. That is a very challenging analytical task.

If most economists were honest on the subject, they would admit that with the exception of a very low probability outcome—e.g. the collapse of the West Antarctic ice sheet—the benefits of fossil fuels outweigh the costs: that is, realistic economic growth is going to be far greater than the projected damages from climate change. The magnitude of damages to the United States from climate change are 1.2% for every 1 degree of temperature increase according to an article in Science. If we double GDP by 2050 to about $40 trillion, which is an achievable goal, but lose as much as 6% GDP to climate damages, that means GDP would come to $37.6 trillion—not that big of a difference.

Finally, a carbon tax that is based on assumed damages over the next century can never be right because the future reveals uncertainties and unknowns that are impossible to incorporate in model calculations. Given that, the carbon tax exercise violates a basic principle of planning—as uncertainties increase, the planning horizon should be reduced. A Lewis and Clark approach is best. In their explorations, Lewis and Clark made decisions based on the best information available, collect new information as they moved west, and then adjust their decisions based on that new information. In the case of climate change, we should use the knowledge at hand for short-term decisions and invest in research that can be used to make better informed decisions down the road.

That is not a do-nothing strategy. If sea levels are rising, we have solutions: dikes and man-made dunes. If we fear climate change causing drought, we can genetically engineer crops that are drought resistant. If we are worried about climate disasters, we can focus research and development on mitigation strategies. There are many other ways to address climate change without passing a new, costly piece of legislation.

William O’Keefe is the former CEO of the George C. Marshall Institute.

Interested in real economic insights? Want to stay ahead of the competition? Each weekday morning, e21 delivers a short email that includes e21 exclusive commentaries and the latest market news and updates from Washington. Sign up for the e21 Morning eBrief.