Dublin City Schools

AP Environmental Science
Dublin Jerome High School

A Carbon Tax for the Future: the economic and environmental

implications of a carbon tax in the United States
Andrew Fua
a

Class of 2016, Dublin Jerome High School, 8300 Hyland Croy Rd, Dublin Ohio 43016, United States

A R T I C L E
I N F O
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Article History
Received 18 March 2016
Publication Pending
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Keywords:
Carbon Tax
Revenue Neutral
Integrated Assessment Models (IAMs)
Demand inelasticity
British Columbia

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K E Y F I N D I N G S
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The demand inelasticity of energy commodities, including oil, natural gas, and coal, may
hinder any economic de-incentivization of hydrocarbons futile in reducing actual carbon
emissions

While a carbon tax may lead to initial economic losses, with a robust tax and
accompanying shifts in energy consumption habits, economic growth may be achieved in
the long term

The current models we have to predict the effects of a carbon tax or other reduction
programs rely on dubious assumptions and ad hoc procedures that lack true scientific basis

Furthermore, limited case examples of a carbon tax exist. The most well-known example is
that of British Columbia, introduced in 2008.

The most propitious solutions to reducing carbon emissions are paradigm shifts in lifestyle
habits and societal norms.
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Introduction
With increased consumerism and industrialization
worldwide, the effects of global climate change have
already begun to affect countries such as the United
States. Within the past 50 years, average US temperatures have risen by 2F, and are projected to rise an
additional 4-11F by the end of this century, depending on the level of intervention taken1.
According to the Intergovernmental Panel on Climate
Change, a coalition of 1,300 scientists from the US
and a variety of other countries, the effects of increased global temperatures due to increasing levels of
carbon emissions will lead to an rise in the number of
floods & droughts worldwide, losses of irreplaceable
polar ice leading to increased sea levels, and more
intensive heat waves. Ultimately, the IPCC reports
that the range of published evidence indicates that

the net damage costs of climate change are likely to

be significant and to increase over time.2
Recognizing the urgency of the situation, policy makers have turned to the energy and industry sectors as
a potential source of emissions reductions. Currently,
the two sectors combined represent 60% of total CO2
emissions worldwide, with coal being the biggest
culprit of the three major hydrocarbon fuel sources
oil, natural gas, and coal3.
The idea of a carbon tax, however, is not new. Most
notably, British Columbia adopted a carbon tax in
2008, which sets a $30 additional tax on energy commodities for each ton of equivalent carbon emissions.
The BC carbon tax is designed to be revenue neutral,
meaning any tax revenue generated by the tax would
be returned to the public through the form of tax
2

Stanton and Ackerman, 2009

NASA, 2016
Gale, 2005

breaks. The idea has quickly gained traction within

Washington as well, with Carbon Washington, a
lobbyist group for the aforementioned tax, having
gained 304,000 of its needed 330,000 signatures to
submit a petition to Congress for a ballot on the issue,
as of 20154
A carbon tax for the United States, however, entails
its own challenges. Not only are our population
demographics different than those of British Columbia, Americas heavy industrial sectors depend on
Carbon fuels are the current energy supply, and
without a robust green energy sector, a rapid shift
seems impossible.
Reducing Emissions?
The world runs on energy. Energy commodities such
as oil, natural gas, and coal, have incited wars and
civil conflict. The average American will use the
energy equivalent of 15,370 lbs. of coal in 2012, and
the amount only rises with each passing year. 5
Electricity has become the lifeblood of industrialization and urbanization.
Our reliance on energy to power our lives, so to
speak, has increased dramatically as well, insofar as
commodities such as the aforementioned coal, natural
gas, and oil have become demand inelastic. Demand
elasticity refers to the relationship between the
demand and the price of a commodity. Commodities
that are inelastic see very minimal changes in
demand with an associated change in price. Energy
commodities, because of their ubiquity and
importance in the 21st century, are highly demand
inelastic. For example, the U.S. Energy Information
Administration found that to increase automobile
travel by 1% annually, gas prices would have to be
decreased by 25-50%. Inelasticity of gasoline has
increased four-fold since the 1990s, indicating a
growing dependence on such energy commodities6.
Carbon taxes would have trouble actually decreasing
the consumption of hydrocarbons without over inflating prices to the point of irreparably harming industrial sectors. Cases where a carbon tax did seem to
reduce consumption within a jurisdiction had actually
only shifted consumption to other jurisdictions. The
2008 carbon tax in British Columbia initially decreesed carbon consumption by 16% compared to pre-tax
levels, and was regarded as a success by many. Most
analyses of the initial effects of the carbon tax, how-

ever, ignore the idea of carbon leakage. Border crossings from BC to the US, which lacks a carbon tax,
went up by over 136% in 2013 relative to 2007 levels,
whereas border crossings from Ontario only increaseed by 22%, indicating that BC residents were simply
getting their fuel from other locations without carbon
taxes, still increasing overall carbon emissions. Additionally, by 2014, fuel consumption levels in BC had
returned to only 2% below pre-tax levels, suggesting
that the initial decrease was only temporary, as citizens adjusted their lifestyles to accommodate for
increased fuel prices7.
To effectively reduce emissions using a carbon tax
would require as close to worldwide participation in
such a policy as possible. Adopting a carbon tax in
only the United States could prompt US corporations
that rely on hydrocarbon fuel sources to simply outsource their plants and production facilities overseas
to jurisdictions that lack a tax, a method similar to
what BC residents did.
Economic Cost
There is a general consensus among economics and
environmentalists that the true economical cost of
burning a ton of carbon, factoring in short- and longterm harms to the environment, is greater than the
price we as consumers pay for commodities such as
oil, natural gas, and coal. A carbon tax, by increasing
prices to the true or social cost of carbon (SCC),
would therefore internalize these costs by putting the
economic burden on consumers rather than on the
environment.
Before we begin any analysis of the economic effects
of a carbon tax, we will assume that that such a tax
will effectively reduce consumption and carbon emissions. Most of the economic arguments against a
carbon tax stem from US overdependence on fossil
fuels, which currently produce 85% of our nations
energy 8 . Researchers from Yale University provide
individual analyses for several different carbon taxes.
For example, Al Gores 2007 proposal to reduce
carbon emissions by 90% within the next four decades, an ambitious plan that would more than likely
create huge shocks to current US energy consumption
habits, could potentially sustain over $21 trillion in
economic losses worldwide due to a combination of
harms to US industry and reduced global trade9.

Chelsea Harvey, 2015

US Department of Energy, 2013
6
US Energy Information Administration, 2014

Murphy, Michaels, & Knappenberger, 2015

Institute for Energy Research 2009
9
Nordhaus 2007

Such economic harms have been seen in practice.

Before the implementation of a carbon tax, British
Columbias economy had been outperforming the
rest of Canada, with output growth outpacing the rest
of Canada by nearly 6%. From 2008-2013, the
lifespan of the BC carbon tax, the BC economy only
maintained a 0.3% lead over the rest of Canada.
Additionally, BC labor market advantage halved after
the introduction of a carbon tax, with their lead on
unemployment dropping from 1% to 0.5% while
compared to the rest of Canada10.
The economic harms caused by the BC carbon tax
may simply be attributed to a poorly formulated
carbon tax. The MIT Joint Program on the Science
and Policy of Global Change, an organization for
research, independent policy analysis, and public
education in global environmental change, finds
annual welfare increases in all eight potential scenarios of a correctly formulated, revenue-neutral carbon
tax, with welfare increasing by $5.8 billion in the
worst case scenario by 2050. These simulations also
find short term economic losses in the first 10 years
of the introduction of a carbon tax, reflecting the
situation in BC 11 . The long term benefits the MIT
Joint Program cites are attributed to diversification
within the energy sector. A carbon tax forces innovation within energy markets, causing more investment
and development into renewable energy sources,
which not only benefits the environment, but also
leads to job creation and economic growth.
Once again, the effects of a carbon tax are dependent
on the price level of a carbon tax. Finding the delicate
balance between too high of a tax, which would create substantial economic harms, and too low of a tax,
which would be useless in actually deterring the
consumption of carbon, should be the goal of policy
makers and economists.
Integrated Assessment Models
Because of a general lack of empirical examples of a
carbon tax in action, much of the economic and environmental analysis of a potential carbon tax is highly
reliant on risk assessment and climate change models,
bundled together into what are known as integrated
assessment models, or IAMs.
Indeed, the $20 tax per ton of carbon figure that the
US Department of Energy concluded as an ideal
starting tax for carbon relied on results from three
IAMs the Dynamic Integrated Climate & Economy

(DICE) model developed by Yale professor William

Nordhaus, the Policy Analysis of the Greenhouse
Effect (PACE) model developed by Cambridge
Professor Chris Hope, and the Climate Framework
for Uncertainty, Negotiation, and Distribution
(CFUND) model developed by University of Michigan Professor David Anthoff. IAMs describe the
effect of greenhouse gas emissions on climate and on
economic habits, such as consumption and out-put12.
Obamas own policies to introduce a carbon tax were
reliant on these models, specifically the DICE model
developed by Yale University.
These models simulate scenarios within a 90% confidence band and output suggested initial carbon taxes
ranging anywhere from $5-$40 per ton, depending on
the projected Fed discount rate inputted. Even if we
ignore their fluctuation and assume that their climate
science models are in fact accurate, the IAM models
previously cited are flawed for two main reasons 13.
First, IAMs lack any real scientific or mathematical
backing to justify their economic impacts, and
instead rely on ad-hoc methods to offer approx.imations at best. Most IAMs have a loss function
to account for statistical error, however these functions have no empirical data backing and instead correlate input values to outputs arbitrarily, according to
an analysis conducted by students and professors at
MIT, are heavily flawed. Reasonable estimates are
given for various climate scenarios. An increase in
global temperatures by 2C, for example, is correlated to a decrease in GDP by 1% without any justification or economic theory. IAMs also provide no
conclusions for larger temperature increases, anything upwards of 5C, and instead rely on total guesswork.
Second, IAMs make the dubious assumption that the
possibility of an environmental catastrophe, anything
large enough to significantly change human welfare,
is negligible. The SCC, however, must reflect the
possibility of such a catastrophe, and must be adjusted accordingly. A carbon tax is not necessary simply
a way to reduce carbon emissions. In realm of eminent climate change provided we continue on our
current trajectory, a carbon tax acts as an insurance
policy against possible disasters.
Because the flaws of the IAM models essentially
make it impossible to predetermine an ideal starting
value for a carbon tax, which threatens to harm to
12

10

Murphy, Michaels, & Knappenberger, 2015

11
Rausch & Reilly, 2012

13

Pindyck 2013
Ibid

economy, the goals of policy makers should not be to

seek perfection in a single carbon tax, but to create
some kind of economic plan that not only deincentivizes the consumption of carbon, but also is
flexible enough to adapt to changing economic and
environmental conditions.
Conclusion
Creating a carbon tax at the incorrect price level may
do little to reduce actual consumption of hydrocarbons while simultaneously stunting industrial
sectors, leading to potential short term economic
losses. Unfortunately, as researchers at MIT have
found, determining this perfect carbon-tax is nearly
impossible because of a lack of reliable models. It is
still essential to impose a carbon tax in the US, even
a tax set at initially the incorrect level, because it is
essential to establish the idea that there is a signifycantly higher social cost of carbon than what consumers pay for at the pump, or for their electricity bills.
Lifestyle shifts to change carbon consumption habits
can only be attained if consumers first recognize that
their energy consumption habits have a much larger
cost to humanity than what they pay out of their
wallets.
Not all hope is lost, however; there exist case
examples of a well-planned, robust carbon tax that
not only reduces emissions but do so without significant harms to the local economy. A carbon tax
introduced in 2008 has reduced Irelands annual
emissions by over 15% as of 2012 as the economy
has continued on its pre-tax trajectory. By 2011, the
tax had generated over one billion euros in tax revenue, which will be used to help reduce the countrys
deficit. Irish officials correlate the success of the carbon tax with the accompanying shifts in Irish lifestyle
following the introduction of the tax. Automakers
such as Mercedes and Volvo, for example, have begun to change the design of their vehicles to fit the
Irish demographic, outfitting them with smaller, high
efficiency diesel engines. Ireland has also made significant investments into the green energy sector,
specifically with initiatives to use biomass to heat
homes. Household trash is now weighed and recorded, and residents are billed accordingly for anything
that isnt recycled14.
A successful carbon tax for the United States is
possible, but it requires several prerequisites. First,
extensive analysis must be conducted on an appropriate initial tax level to ensure the safety of American industry while also reducing the inelasticity of
14

New York Times 2012

oil, natural gas, and coal. Second, accompanying

endeavors into green energy must be initiated, which
will eventually serve as a replacement for current US
dependence on fossil fuels. Third, public education
must be provided on the true impact of carbon usage
to internalize the externality of carbon consumption
currently in place in society. Finally, a multilateral
coalition, with support globally to impose some sort
of carbon restriction policy, must be created to
occlude carbon emissions leakage. Together with
these goals in mind, a carbon tax may serve as the
bridge for the United States away from unsustainable
energy consumption habits into the clean and limitless world of renewable energy.