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Carbon Tax

Global Warming is a pressing problem facing the world presently. It’s existence and linkage to human activity is now largely scientifically verified, and the potential damages have been calculated to be very costly (Stern Report & IPCC) . That is why economists, scientists, politicians, and many in the general public are urging action on this front.


Carbon Dioxide is the main greenhouse gas from the U.S. , with 80% of it coming from fossil fuel compustion. So any action on global warming must deal with CO2 coming from sources like power plants and automobile tailpipes.

One technique that is advocated is the use of a carbon tax, meant to reduce the consumption of CO2 causing fossil fuels. A carbon tax that is applied to “upstream” producers like oil extractors, importers, and refineries would incorporate the external costs that CO2 causes. These increased costs would eventually be reflected in increased consumer prices for gas, oil, and plastics. While there has been considerable debate over this subject, it has been shown that consumption of gasoline isn’t perfectly inelastic, so an increase in prices should decrease consumption in the long run.

Face-off with Cap-and-Trade Approach

Many experts advocate a carbon tax over a cap-and-trade system, giving several reasons. These include:

  • A cap-and-trade model can only be applied to large point sources such as power plants and factories. These sources have been shown to contribute less than 40% of the CO2 pollution. The sources of carbon dioxide from fossil fuels (the only gas that can be feasibly, economically focused upon) are so numerous, diverse, and widespread that it would be hard to encompass them within a market system. While these markets thrive if there are many emitting sources, this could be a case of too much of a good thing. A carbon tax regulates almost all carbon dioxide sources, from the smokestacks of industry to the tailpipes of automobiles.
  • The issue of whether to compensate an owner of a carbon sink for his pollution mitigation further complicates a market-based system. If credit (carbon offsetting) is given for firms who mitigate their carbon footprint, then a whole monitoring and insurance system will have to be developed and implemented alongside such a permitting system.This question of whether the offsetting from carbon should be compensated or accounted for will get even trickier in the future, when gas sequestration of carbon dioxide into underground aquifers becomes further developed.
  • There is similar difficulty with market-based systems with the possible measuring and accounting for agriculture’s CO2 contribution.
  • A carbon tax gives one more control over gas and other consumer prices versus a price uncertainty with the Cap-and-Trade method.
  • The new tax will represent a kind of tax shift with the inflow of revenue into the treasury offsetting such regressive taxes as the Social Security and Sales Taxes, the so-called double dividends effect. The revenue can be used to either lessen the reliance on these taxes, used to support other tax cuts, redistributed to the taxpayers, or utilized to promote environmentally friendly sectors like public transportation and hybrid vehicles (the feebates mentioned in Green Taxes) .  
  • Many argue that a tax would lead to quicker reductions in pollution with less rent-seeking and corruption from industrial and special interest groups than would a market-based system. They argue firms will just artificially elevate emissions while the particulars of the cap-and-trade program are being formulated in order to grandfather in larger permit allocations.  
  • A international agreement is desirable, but not necessary for implementing a carbon tax in a country, while it is highly recommended for a cap-and-trade market. So lengthy and contentious international negotiation could be side-stepped temporarily.

As is often the case policy makers and politicians aren't following the technical advice of the field researchers. The general momentum has been for market-based solutions, while a lot of economists recommend green taxes. They also question whether the success of the SO2 cap-and-trade program can be translated into success against global warming. They contrast the existing SO2 program and the hypothetical market by saying that  a carbon cap-and-trade regulation would be prohibitively complex for the above reasons.

Sources: William H. Schlesinger,Carbon Tax Center

Response of the No-Pigou Club and others

Many of those members of the NoPigou Club are total free-market believers who oppose any central government intervening in market actions, and as such may even oppose cap-and-trade measures. There are some, though, who have other reasons for their opposition to green taxes.

  • Some economists and other participants in the debate say even if the Pegovian taxes were appropriate (which they can't agree upon), they never will be politically viable. This is the bulk of the opposition: that no politician would dare to institute a new tax if that person values his or her seat. Business groups would fight tooth and nail against any new tax, and it couldn't even be levied on the lowest level- consumption- as the American public already complains of high gasoline prices absent a gas tax.
  • Other free market economists prefer the cap-and-trade method over taxes as the lesser of two evils: the one that affords businesses the most leeway and intervenes the least. They view green taxes as having prohibitively high information and administrative costs. See related material.
  • There are many who question the validity of the double-dividends effect in light of the historical progression of more forms of taxes being instituted, not less. They also hold that carbon taxes would still have their own distortionary effect on the market, even if they lessen the burden of other distortionary taxes. (Hanley,29)
  • Many environmentalists oppose taxes because it doesn't guarantee the targeted reduction in pollution that a cap does.
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Gasoline Elasticity:
Espey, Molly. "Explaining the Variation in Elasticity Estimates of Gasoline Demand in the United States: A Meta-Analysis." Energy Journal. 1996, Vol.17 No. 3: pp 49-61.

Espey, Molly."Gasoline Demand revisited: An international meta-analysis of elasticities." Energy Economics. 1998. Vol. 20, No. 3: pp. 273-295.

Goodwin, Phil; Joyce Dargay and Mark Hanly. "Elasticities of Road Traffic and Fuel Consumption with Respect to Price and Income: A review." Transport Reviews. May 2004. Vol. 24, No.3: pp.275-292.

Other Sources:
Hanley, Nick, Jason F. Shogren, and Ben White. Introduction to Environmental Economics. 2001. Oxford University Press, NY.
Schlesinger, William H. "Carbon Trading." Science 24 November 2006: Vol 314, no. 5803, p. 1217.
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