When it comes to “doing something” about global warming, two approaches are usually trotted out. One is trading permits to emit carbon dioxide (CO2) and other greenhouse gases. Yet it now appears that most existing carbon trading schemes are vastly inefficient, open to fraud, or both. Thus, it is worth looking at the other option, a tax on carbon emissions, to be levied on gasoline and most electricity use. A quick survey of the realities of carbon taxes reveals that the game might not be worth the candle.
Economists attempt to account for the “social cost” of carbon dioxide emissions — that is, the economic value of the damages caused by global warming that many attribute to CO2. Many studies have shown wildly varying results due to the various uncertainties surrounding the topic, and also depending on whether each study takes mankind’s innate ability to adapt and innovate into account.
A leading expert in the economics of climate change, Dr. Richard Tol, reviewed these studies and found that there were significant uncertainties. He concluded that it “is unlikely that the marginal damage costs of carbon dioxide emissions exceed $50/tC [dollars per ton of carbon] and are likely to be substantially smaller than that.” One indicative smaller figure is $16/tC, which represents the mean estimate of all the studies at a discount rate of 3 percent, which is consistent with how governments value future costs and benefits. Because a ton of CO2 contains less than a third of a ton of carbon, these figures translate to a maximum of $14 and just under $5 respectively.
Another recent review, the “Stern Review,” which was commissioned by the British government, estimated the marginal social cost per ton of CO2 emissions at $85. As Dr. Tol’s research shows, this is actually an outlier in the literature and outside the mainstream of economic thought. Nevertheless, because the Stern Review has been so widely cited, it needs consideration here.
Many economists believe that to account for those costs, governments should levy a tax — called a Pigou Tax after its inventor, a 19th century British economist, Arthur Pigou — to deter or at least bring home to people the cost of their activity.
How big would a Pigou Tax have to be to account for the social cost of household electricity use? One megawatt hour (MWh) of coal-fired electricity use produces 0.95 metric tons of CO2, so the tax would need to be levied per kilowatt hour (KWh) of electricity used, depending on the social cost of carbon used. At Stern’s figure of $85, the state should levy a tax of 8 cents per KWh. At $14, the tax would be a cent-and-a-half, and at $5, a half cent.
According to the 2001 census, the average American household uses 10,660 (KWh) of electricity per year. This means that at the social cost level of $85, the average household would see its electricity bills rise by $852 a year. At $5, the increase would be $53.
Turning to gasoline, a social cost of $85 per ton of CO2 implies a gas tax of 74 cents per gallon, a cost of $14 implies a tax of 12 cents and $5 a tax of 4 cents. The average household uses 1,143 gallons of gas a year, which means that at the Stern Review level, the household’s annual fuel expenses would increase by $845. At the social cost levels of $14 and $5, the bills would increase by $140 and $45.
For the average family on median income ($44,334), the extra burden of energy taxation at the level implied by the Stern Review would represent a loss of about 4 percent of total household income — an unconscionable rise in taxation that would need to be offset with taxation reductions elsewhere. Taxation hikes at the more realistic estimates of social cost, however, are unlikely to affect consumer behavior. At the lowest, but still respectable, estimate of social cost, bills would increase by a mere $98 a year, a sum likely to be absorbed. The same is likely true of the $300 increase implied by a social cost of $14.
The effectiveness of a Pigou tax in reducing carbon emissions is questionable. A tax high enough to force reductions in energy use would greatly burden the poor and obstruct economic growth, while a lower tax is unlikely to lead to emissions reductions at all.
Attempting to moderate behavior through carbon pricing will either fail or impose significant social costs of its own. If we need to do something about global warming, it is to move on from talking about forcibly reducing emissions and working instead to see how we can reduce any possible impacts on the world. A rich and resilient world will be better than one made poorer through overpriced carbon constraints.