A Carbon Tax Alone Will Not Solve Climate Change

It’s simplistic and insufficient, and it endangers net-zero emissions.

BY JOHN MILLER | July/August 2024

This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

This article is from the
September/October 2024 issue.

Subscribe Now

at a 30% discount.

Most everyone who has taken a course in microeconomics, apparently including Elon Musk, is taught that there is a “simple” solution to a pollution problem: All we have to do is to impose a tax equal to the cost of the damage caused by pollution that goes unaccounted for by market prices. Then market prices will once again create results that are the best of all possible worlds, just as promised in economics textbooks. That’s the message of Elon Musk’s X post from February 2024 that has reached 23 million viewers.

Amateurs like Musk aren’t the only evangelists for market solutions to climate change. In 2019, some 3,649 U.S. economists, including 28 Nobel Laureates, signed the “Economists’ Statement on Carbon Dividends,” published in the Wall Street Journal, that assured us that, “A carbon tax will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors towards a low-carbon future.”

If only it were so. Crafting an effective response to the existential threat of climate change is an enormously complex undertaking. The difference between efficient carbon prices (which correct for the cost of pollution and fuel subsidies) and the actual price of fuel in today’s global economy remains large and pervasive, as an August 2023 report by the International Monetary Fund (IMF) emphasized. Beyond that, without environmental regulations, public subsidies, and public investments, a carbon tax is neither a cost-effective nor feasible policy for affecting the massive technological transformation our economy needs to meet the goal of net-zero emissions by 2050. In addition, their estimated price of carbon, when Musk and the authors of the Carbon Dividend statement bother to mention one, is far too small to sufficiently reduce greenhouse gas emissions. Worse yet, neither Musk’s carbon tax nor the economists’ carbon dividend plan would provide the funds needed to make the public investments that are crucial if we are to effectively deal with climate change.

At the risk of being excommunicated from the church of the invisible hand, let’s take a closer look at just why these efforts are bound to fail.

Carbon Prices and the Environment

There are profound differences in how environmentalists and orthodox economists view today’s environmental problems. An environmentalist would demand pollution standards that would protect the health of all citizens, rich and poor, for this generation and future generations, much like other activists demand universal access to basic health care. To orthodox economists, however, any claim about citizens’ rights to breathe clean air makes little sense. As they see it, one can’t just say no to pollution. Pollution, a “bad,” is the inevitable byproduct of the production process that makes the “goods” we want. What’s called for instead is to manage that trade-off.

Economists reason that charging a fee for each ton of carbon emitted increases the price of carbon, which will in turn encourage emitters to undertake reductions in pollution that would cost less than the corrected price of carbon. It would also provide an incentive for producers to develop cleaner energy sources and technology. In the language of Economics 101, the government would levy a tax on the “negative externality” that goes unaccounted for in the market price. These corrected market signals would optimize social welfare by guiding output to a level that equates the costs (including climate change) and the benefits of additional output.

That’s not easy to do, anywhere other than on a blackboard. And it was too much for Musk. He never mentions the size of the carbon tax that will solve climate change. For Travis Fisher, a blogger for the libertarian Cato Institute, that’s “a glaring omission.” It surely is, and one that allows Musk to sidestep the complexities of an actual market solution to climate change. (See sidebar, “A Carbon Tax, Gas Prices, and the Elasticity of Demand for Gasoline,” on the next page, for more on the effect of a carbon tax on gas prices, gas purchases, and carbon emissions.)

Sticker Shock

In their August 2023 update, IMF researchers estimated that fossil fuel subsidies across the globe added up to $7 trillion in 2022, or 7.1% of global gross domestic product (GDP). Undercharging for global warming and local air pollution were the chief source of these subsidies. According to the IMF figures, imposing prices that fully accounted for the cost of global carbon dioxide emissions would reduce global emissions in 2030 to well below the level needed to keep global warming to 1.5 degrees Celsius, raise revenues worth 3.6% of global GDP, and prevent 1.6 million air pollution deaths per year.

But what carbon price, corrected for its damage to the environment and the effects of fuel subsidies, could make this happen? In their 2015 study, the IMF researchers settled on an efficient price for carbon of $43 per metric ton in 2020 and reaching $52 in 2030. These are the prices estimated by the U.S. Interagency Working Group on Social Cost of Carbon. Ted Halstead, the CEO of the Climate Leadership Council, which organized the “Economists’ Statement on Carbon Dividends,” proposed a similar carbon fee starting at $40 per metric ton and rising each year after that in his May 2019 testimony before Congress.

Mind you, a carbon price of $43 per metric ton is an estimate that is highly sensitive to how it evaluates social costs and future costs. To determine the “optimal” carbon tax requires taking a wide view that calculates a vast array of economic and social costs of climate change, including the value of shortened and lost lives. For instance, the current practice of the Environmental Protection Agency (EPA) is to calculate “the value of a statistical life” as the “aggregate-dollar” amount that a large group would be willing to pay to reduce their individual risk of dying within a year. But their measure varies with the income of the affected group. Surely 100,000 rich people would be willing to pay more to avoid an increased risk to their life than 100,000 poor people. And that difference would be even greater for people in rich countries and people in poor countries.

These estimates also require a long view, which takes into account current costs and those in the future. To do that, economists employ a “discount rate,” similar to the interest rate on a loan, which is meant to reflect the importance society places on the present and the rate of return of possible alternative uses of those funds. The choice of a discount rate is crucial for environmental policy. For instance, the $43-per-metric-ton price of carbon was calculated using a 3% discount rate, which assessed the value of $1,000 of damage from global warming in 2050 as a present value of $437 in 2022. But discounting the value of the environment of future generations is fraught with problems. To begin with, future generations are absent from these decisions about what will become of their environment and if it will remain inhabitable. On top of that, future generations would surely place more value on the future (their presence on Earth), than today (their past). To assign an equal value to the future environment and the present environment would require not discounting costs. That way, $1,000 of environmental damage in 2050 would have had a present value of $1,000 in 2022. And that would make the optimal price of a ton of carbon far higher.

A couple of things are certain, however. At $43 per metric ton of carbon, the global price of carbon that accounts for the damage to the environment would be far higher than the current average global carbon price, which reached a peak of $18.97 per ton in 2021, and then plummeted to $4.08 a ton in 2022, as tracked by Kepos Capital’s Carbon Barometer. On top of that, the cost of continuing to make progress toward net-zero carbon emissions after 2030 will push the global price of a ton of carbon higher yet. In its September 2022 report that incorporated “recent scientific advances,” the EPA estimated the social cost of carbon to range from $190 per metric ton in 2020 to $310 in 2050. The Stanford Energy Modeling Forum conducted a study of models of deep decarbonization that allows for economy-wide, net-zero carbon emissions by 2050. They found that, “for the eleven models that provided carbon prices, nine report a price of at least $400/tCO2 [i.e., $400 per metric ton of CO2] in 2050.”

Carbon Prices Are Not Enough

Writing for the Institute for Global Politics, economists Joseph Stiglitz, Scott Barrett, and Noah Kaufman argue that “Carbon prices work best when combined with other policies to support the development of infrastructure, institutions, regulations, and alternative technologies.” IMF director Kristalina Georgieva agrees. For her, that carbon taxes can generate revenues to fund the public investments needed to support the transition to a green economy is one of its chief benefits. The editors of The Economist, the British pro-market weekly, agree as well. In their 2019 brief “on the climate issue,” the editors warn that, “the decarbonization it [a carbon tax] brings will need to be accelerated through well-targeted regulations.” Martin Wolf, the economic commentator for the Financial Times, the British business daily, is also in agreement. In a 2021 article, Wolf told his readers that reaching a net-zero carbon emissions economy “will require huge investment by both public and private sectors, with the latter guided by the right incentives and regulations.”

None of that cuts much ice with Musk or the economists who signed the statement on carbon dividends. Musk’s proposal is revenue neutral. He would cancel out any increase in government revenues from a carbon tax that might have financed green investments by lowering other taxes, such as the value-added tax or the sales tax. The economists’ statement on carbon dividends proposes returning all the revenue from a carbon tax directly to U.S. citizens through equal lump-sum rebates. While those rebates would likely allow the majority of families to benefit financially, they also ensure that carbon tax revenues would not be available to fund green investments. Carbon tax rebates need to be accompanied by other funding to make sure that crucial green public investments get made. (For a proposal that does that, see the sidebar, “A Progressive Global Green New Deal Proposal,” on the next page.)

But shouldn’t using a carbon tax to remove the mammoth fossil fuel subsidy be sufficient to put alternative clean technology on an equally competitive footing with fossil fuel energy sources?

The answer is no. Even prohibitively high carbon prices would not undo the cost advantages afforded to the fossil fuel industry by the public funding of infrastructure, research and development, and tax breaks. Those public expenditures that benefited the fossil fuel industry locked in longstanding advantages and foreclosed more investments in clean energy alternatives. To overcome that “path dependency,” as economists call it, robust public supports are needed to further develop industries in solar, wind, batteries, electric vehicles, and other green technologies. With clean energy alternatives in place (from an extensive network of charging stations for electric cars to mass transit), higher carbon taxes would do much more to reduce the use of gas-fueled vehicles and carbon emissions.

Incremental price changes will not undo the head start that public-sector support afforded fossil fuel technologies. Stiglitz and his co-authors are convinced that, “a lower-cost approach would combine lower carbon prices with measures to tackle these additional barriers.”

A Different Shade of Green

In 1997, on the occasion of his 80th birthday, Barry Commoner, the environmental scientist and 1980 Citizens Party presidential candidate, gave an interview to Scientific American. Commoner argued that:

What is needed now is a transformation of the major systems of production. Restoring environmental quality means substituting solar sources of energy for fossil and nuclear fuels; substituting electric motors for the internal-combustion engine; substituting organic farming for chemical agriculture; expanding the use of durable, renewable and recyclable materials—metals, glass, wood, paper—in place of the petrochemical products that have massively displaced them.

Since Commoner wrote those words, the “fierce urgency of now” has only become more urgent. It is past time for the Green New Deal to be new. A program of massive investments that will create a clean-energy economy supported by a carbon tax and other funding needs to be in place now.

JOHN MILLER is a professor of economics at Wheaton College and a member of the Dollars & Sense collective.

Please consider supporting our work by donating or subscribing.