Brave New Policy: An Assessment of The Economic and Political Impact of A Carbon Tax


Louis Noirault traces the optimal path to a carbon tax given the current state of academic research on energy policy.


“American energy policy must balance environmental protection with economic growth in order to encourage innovation, discovery, and prosperity”
The website of the White House on Energy and Environment [1]

Despite the rhetoric of the White House, an overview of US energy policy in the recent years seems to reveal that it has put the emphasis on not impeding economic growth rather than on fostering environmental protection. 

The Trump administration’s landmark achievements in this domain include the use of the Congressional Review Act to disapprove Obama-era “midnight” regulations which mandated disclosure of transactions with foreign government by energy companies and another which was meant to protect stream water from coal industry wastes.[2] Donald Trump, with the republican-dominated Senate’s approval, also appointed Scott Pruitt as the head of the Environmental Protection Agency (EPA). When he was attorney general of Oklahoma, Pruitt had, for instance, sued the EPA’s endangerment finding under the Clean Air Act about the impact of greenhouse gases on public health. As administrator of the EPA, he played a significant role in the implementation of Trump’s executive order to rescind the Clean Power Plan whose objective was to curb the carbon emissions of power plants. [3]

On the other hand of the policy spectrum, Germany has announced a plan to phase out coal power by 2038 with more than €40bn worth of compensation to coal producing regions.[4] This decision came a mere 8 years after the law limiting the use of nuclear power in the wake of the Fukushima accident. 

These diametrically opposed approaches raise the question of what path seems optimal given the current state of academic research on the question of energy policy. More specifically, the goal is to try to elucidate what the challenges and tradeoffs of a carbon tax would be, given the wide support it gathers among prominent experts.[5] In doing so, I illustrate theoretical intuitions developed by scholars with instantiations thereof in European countries or in the US. 

The inefficiency of energy subsidies

Subsidizing new renewable energies is currently a very common policy. Such subsidies have been adopted by the US as well as by France and Germany. In France for instance, it has been hinted in the most recent pluriannual energy program that the government would pursue its subsidy program for renewable energies both at the R&D and at the commercialization levels. [6]

However, the soundness of renewable energy subsidies is increasingly contested. Gilbert E. Metcalf has highlighted the fact that low-carbon technologies subsidies lower the average cost of energy and thereby increases the demand for it, which goes against the original purpose of the policy.[7] He also pointed out that subsidies could arbitrarily favor some technologies over others such as hybrid vehicles over some other high-mileage vehicles. They can also be inframarginal when they incentivize behaviors that would have been adopted even in the absence of subsidy and they may interact with other policies in a way which undermines their efficiency. 

This makes subsidies a relatively costly solution to abate carbon emissions. In the case of Germany, it has been estimated that the cost of abatement of CO2 by promoting photovoltaic energy through the Erneuerbare-Energien-Gesetz (Renewable Energy Sources Act) is 716€ per ton. [8] This comes in contrast to the optimal carbon price which ranges between $34,2 and $36,1 per ton of CO2 in August 2018 according to William Nordhaus.  [9]

Likewise, the US subsidy on biofuel has been found ineffective in reducing carbon emissions because the decrease in gasoline price pushed demand up, which is in line with Metcalf’s argument. [10]

The carbon tax solution and its multiple challenges  

While subsidizing renewable energy does not seem to be the most efficient approach, these sources of energy are interesting because they do not release as much greenhouse gases in the atmosphere as fossil fuels. It has been long established, especially on the basis of Pigou’s work, that these greenhouse gases constitute externalities since the emitters do not bear the cost of the damages to the environment they are doing. [11]

A straightforward and even-handed policy? 

If correctly devised, a carbon tax would have many advantages including simplicity, transparency and fairness. [12] The latter is very important and requires that the carbon tax be applied to all activities which involve emissions of carbon dioxide. Indeed, the catalyst for the gilet jaunes crisis in France was the adoption by the government of a carbon tax whose incidence was rather unequal because of the numerous exemptions it included, such as road freight transport, as pointed out by a report from the Institute for Climate Economics. [13] As a result of these exemptions, the burden of this carbon tax fell disproportionately on poorer households and this led to protracted upheavals. 

In addition, unlike an emission permit trade system, a carbon tax has low administration costs due to the experience government have with taxation. A carbon tax also limits the effect which the volatility of carbon price could have in a permit trading system. The tax should however be pegged to inflation to ensure it does change in real terms and readjusted when new participants start emitting to prevent an uncontrolled increase in the volumes of CO2 emitted.

Carbon tax across borders

A carbon tax would also have to overcome the challenges of international trade since local producers could be disadvantaged if foreign products do not incur the same cost and they could suffer a “carbon leakage” whereby the local market is flooded by products from countries with lower environmental requirements. [14] On the other hand, a tariff on foreign products applying unilaterally to external products would be incompatible with World Trade Organization rules. Compliance would be easier if the carbon tax applies equally to local and foreign products. This would nonetheless still hurt local competitiveness on the export market. Therefore, a country with high exports and a trade balance deficit such as the US would have to take this into account before implementing a carbon tax. A potential solution is to compensate losing industries with the tax revenues generated.

CO2 is not the only evil

A carbon tax is no panacea to all environmental problems since carbon is not the only environmental threat linked to the production of energy. Two specific cases are particularly relevant to this caveat. 

The first is hydraulic fracturing, more often referred to as “fracking”. This technic is prominently used to retrieve natural gas trapped in shale formations. 

The shift from coal to natural gas in the US energy mix has often been regarded as positive in terms of carbon emissions since the latter releases about 50% less carbon dioxide than the former. [15] This means that natural gas could become even more attractive than coal if a carbon tax is adopted. However, a comprehensive carbon tax should account for the methane leakages which occur in the extraction process, with estimates of the leakage rates going as high as 7,9%. [16] This is significant because methane emits more than 30 times more CO2 than coal combustion.

Fracking requires the injection of very high volumes of water into the ground and this water is mixed with various chemicals, many of which are known carcinogenic. [17] If the wells are properly drilled, leakages of this dangerous liquid can be limited but it has not always been the case. Although research on the matter is still relatively limited, a study has shown that the quality of surface water is impacted in areas of intense shale gas exploitation. [18] There is however no need for precise data studies to know that people living nearby fracking sites should not be able to set their tap water on fire as shown in the documentary Gasland. [19]

This is a case of non-uniformly mixed surface pollutants and this local externality could be internalized by a tax proportional to the damage done to the local environment. While regulations under a command-and-control may seem more straightforward, as it does not require computing the optimal tax amount, this model has proven prone to exemptions. The 2005 Energy Policy Act for instance included an exemption for fluids used in fracking from the Safe Drinking Water Act. This exemption has even been nicknamed the “Halliburton loophole” as it benefited the energy company formerly led by then vice-president Richard Cheney. Such a tax would be a middle ground between the current state of legislation and the French ban on the exploitation of shale resources since 2011. 

The second major non-carbon source of environmental hazard in the energy sector is nuclear power. One of the limitations of instituting a carbon tax is indeed that it lowers the relative cost of nuclear power, which is also potentially dangerous for the environment. The accidents of Chernobyl and Fukushima are reminders of this harsh reality. US policymakers should pay attention to the effect of increasing carbon price and make sure that the externalities of the nuclear industry are taken into account in deciding what share of the energy mix it represents. While Germany has fully opted for the development of renewable energies, France still invests massively in modern nuclear plants. Indeed, the European Pressurized Reactor of Flamanville has seen its budget progressively increase to $12,3 billion. [20]

Conclusion 

Ex-post evaluation of renewable energy subsidies has led to what is at best a mitigated conclusion. Although a carbon tax would seem more commendable, it does not come without challenges and limitations. This paper is intended to make a fair representation of some them and hint to areas where further research is needed. 

Ultimately however, the most daunting challenge to a policy shift might be political. A study estimates that more than $2 billion were spent to lobby climate change legislation in the US between 2000 and 2016, with fossil fuel interests outspending environmental advocates on a 10:1 ratio.[21] Another study evaluates the returns to lobbying in the energy sector to more than 130%.[22] In these conditions, regardless of the cost / benefits analysis of the policy considered, the support of fossil fuel companies might be determining. 

References

Featured image: Unsplash.com

[1] See https://www.whitehouse.gov/issues/energy-environment/

[2] For more details on the Trump administration’s rollback on regulations see Anderson, Scot, et al. “The America first energy policy of the Trump administration.” Journal of Energy & Natural Resources Law 35.3 (2017): 221-270.

[3] Ibid. p. 229

[4] Buck, Tobias. “Germany strikes €44bn deal to phase out coal use in energy supply” Financial Times, January 16 2020

[5] See Nordhaus, William D. “Carbon taxes to move toward fiscal sustainability.” The Economists’ Voice 7.3 (2010); Metcalf, Gillbert E., and David Weisbach. “The design of a carbon tax.” Harv. Envtl. L. Rev. 33 (2009): 499.

[6] See PPE pour consultation publique p. 245 at https://www.ecologique-solidaire.gouv.fr/programmations-pluriannuelles-lenergie-ppe and the website of the Ministry of the ecological and united transition at https://www.ecologique-solidaire.gouv.fr/dispositifs-soutien-aux-energies-renouvelables

[7]  Metcalf, Gilbert E. Tax policies for low-carbon technologies. No. w15054. National Bureau of Economic Research, 2009.

[8]  Frondel, Manuel, et al. “Economic impacts from the promotion of renewable energy technologies: The German experience.” Energy Policy 38.8 (2010): 4048-4056: 13

[9]  Nordhaus, William. “Projections and uncertainties about climate change in an era of minimal climate policies.” American Economic Journal: Economic Policy 10.3 (2018): 358
[10] Murray, Brian C., et al. “How effective are US renewable energy subsidies in cutting greenhouse gases?.” American Economic Review 104.5 (2014): 572

[11]  Pigou, Arthur. The economics of welfare. 1920.

[12]  Ghosh, Koushik, and Peter Gray. “Rushing to Copenhagen? Is Cap-and-Trade the Answer?.” Challenge 53.1 (2010): 24

[13]  Rogissart Lucille , Postic Sébastien and Julia Grimaul « La composante carbone en France : fonctionnement, revenus et exonerations » October 2018, Institute for Climate Economics : 1

[14]  Guarascio, Francesco and Ekblom, Jonas “Explainer: What an EU carbon border tax might look like and who would be hit” Reuters. December 10 2019.  

[15]  Anthracite coal emits 228.6 pounds of CO2 per million British thermal units (Btu) and natural gas 117 pounds per million Btu according to the US Energy Information Administration see https://www.eia.gov/tools/faqs/faq.php?id=73&t=11


[16]  Howarth, Robert W., Renee Santoro, and Anthony Ingraffea. “Methane and the greenhouse-gas footprint of natural gas from shale formations.” Climatic change 106.4 (2011): 679. cited in Muller, R. A., and E. A. Muller. “Fugitive Methane and the Role of Atmospheric Half-Life. Geoinfor Geostat: An Overview 5: 3.” of 7 (2017): 2.

[17]  Elliott, Elise G., et al. “Unconventional oil and gas development and risk of childhood leukemia: Assessing the evidence.” Science of the Total Environment 576 (2017): 138-147.

[18]  Vengosh, Avner, et al. “A critical review of the risks to water resources from unconventional shale gas development and hydraulic fracturing in the United States.” Environmental science & technology 48.15 (2014): 8334-8348.

[19]  Fox, Josh. Gasland. 2010. 

[20]  Samama, Pascal « EPR de Flamanville: la facture dépassera bien les 12 milliards d’euros, soit trois fois le budget initial » BFMTV. 10 September 2019  

[21] See Brulle, Robert J. “The climate lobby: a sectoral analysis of lobbying spending on climate change in the USA, 2000 to 2016.” Climatic change 149.3-4 (2018): 289-303 cited on the Yale School of Forestry and Environmental studies website https://e360.yale.edu/digest/fossil-fuel-interests-have-outspent-environmental-advocates-101-on-climate-lobbying

[22]  Kang, Karam. “Policy influence and private returns from lobbying in the energy sector.” The Review of Economic Studies 83.1 (2016): 269-305.

Leave a Reply

Your email address will not be published.

Close

Categories

Recent Posts

[wpgmza id="1"]
[contact-form-7 id="4" title="Contact form 1"]