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WILLIAM TUCKER: CRS Evaluates the Carbon Tax

By William Tucker

The Congressional Research Service is a fairly neutral body insulated from the pushes and pulls of Washington and they’ve done a very nice job of evaluating a carbon tax.  In a report issued two weeks ago, CRS considered several different approaches to a carbon levy and ended up concluding that the tax could play a part in cutting other taxes or providing deficit reduction.

Unfortunately, the report went with two different scenarios for the budget deficit over the next decade.  One almost completely unrealistic scenario said that Congress will make all kinds of spending cuts and eliminate the Bush tax cuts, with the result that the deficit returns to 1990s proportions.  Under those circumstances, by 2020 the $170 billion in carbon tax revenues would amount to half the $350 billion deficit.  “Carbon Tax Could Halve the Deficit” was the resounding headline in The Hill.  

But all that is extremely unlikely.  Much more probable is the second scenario, where things consider pretty much as they are and the deficit remains in the trillion-dollar range for the entire decade.  In this case, the modest $170 billion raised by the carbon tax is barely a drop in the bucket.  

So don’t get too excited about the carbon tax as an all-purpose solution to our fiscal problems.  At best, it could serve as a small part of a much larger package of tax reform that would encourage work, free up investment dollars and promote job creation without blowing an even bigger hole in the federal budget.  That would be an accomplishment in itself.

The first question asked by the CRS study is where to apply the tax – upstream, midstream or downstream.  “Upstream” would mean at the wellhead, coal mine or port of import for any fossil fuel.  There are ample records kept of production and import and it would be supremely simple to apply.  (Australia apparently didn’t think so and has applied it at “midstream,” which has caused a huge mess as described two week ago.)  

“Midstream” would mean at major choke points such as oil refineries, natural gas pipelines and utilities coal boilers.  This is what Australia has tried and it presents problems.  How do you measure emissions?  This creates disputes.  And since the tax is so heavily concentrated on a few industries, those industries begin to ask for compensation and exemptions.  Australia gave in to this and the first reports were that major polluters were making out better than before the tax was applied.

Finally, “downstream” would be at the exhaust pipe of every vehicle, the exhaust vent of every industrial and commercial establishment, and the chimney of every household.  This is a virtually impossible task and not even Australia tried it.  One major reason was that the politicians didn’t want to burden car owners, who form a vast majority of the electorate.  That’s fine but it also ends up exempting auto exhausts, which form about 40 percent of a nation’s emissions.  So the effects of the tax become very uneven.

The upstream application seems by far the best.  There is only one problem that occurs to me, although it was not mentioned in the report.  If you simply tax the fuel as it is produced, you miss any efforts at carbon capture.  A coal plant that somehow managed to trap all its exhausts and bury the carbon dioxide deep in the ground would still end up paying the tax.  There would be no financial incentive.  So you’d probably have to add a credit for captured carbon.  Since no one has yet managed to do this, however, it is not an immediate problem.  

The CRS projects that a $25-per-metric-ton carbon tax would be a reasonable rate that would raise revenue while discouraging the use of fossil fuels without falling particularly severely on any portion of the economy.  This is important, since the golden rule of taxation is to try to spread the levy as widely as possible while keeping rates relatively low.  

A $25 per ton rate would add $47.50 to a short ton of coal, $10.75 to a barrel of oil, $1.25 to a thousand cubic feet (mcf) of natural gas and – perhaps most importantly – only 25 cents to a gallon of gas.  With oil at $90 a barrel, natural gas at $3 per mcf and the price of the pump around $3.65, these are not overwhelming market changes.  The $47.50 does add almost 30 percent to the current $168 price of coal, but coal is bound to suffer worse for its high carbon content.  (For some reason, the prices used in the report – $37 for bituminous coal, $47 per barrel of oil, $8 per mcf of gas and $2.15 at the pump are about five years out of date.)  Which is preferable?  Putting a 30 percent premium on coal for its carbon content or having the EPA tour the country closing down coal plant-by-plant?

Oddly, perhaps the biggest problem the CRS foresees is if the levy becomes too successful.  If the purpose is to level the playing field for non-carbon fuels, the tax could be doing just fine.  But if it leads to sizable moves away from fossil fuel consumption, the revenues could dry up.  This would shrink any deficit reduction or tax substitution.  Of course the tax could always be raised – and CRS does include a 2.6 percent annual increase in the rate – but long-term it may not be good to count on perpetual revenue.

On most other counts, CRS finds that a carbon tax far superior to the cap-and-trade system that Congress tried to impose in 2010.  “Potential complexity and opaqueness of a cap-and-trade program was one factor that led some advocates of GHG control policies to prefer carbon taxes as a policy instrument.”   Another nice touch is the generational equity of the measure.  “[A] carbon tax could potentially support generational equity by helping to slow or reduce GHG-induced climate change and by potentially reducing the deficit.”  

The only possible glitch is imposing the tax in this country could handicap American businesses on the world market if other manufacturing countries become fail to do anything and become “carbon havens.”  This is indeed a problem but at some point I think we have to trust that the rest of humanity to make some attempt themselves – and that there will be some kind of punitive measures if they don’t.  In any case, if the tax is used in part to reduce other business taxes, the ledger may even out.

Several prominent Republicans are now supporting a carbon tax as part of a general tax overhaul.  Former Secretary of the Treasury and State George Schultz is one of the most prominent.  And one can assume that Democrats will jump at the chance to allay their concerns about global warming.  So the possibility of an effort after a victory by either candidate in the Presidential Election is not remote.

Most important, a carbon tax would finally put nuclear energy on a level playing field with coal, natural gas and renewable energy.  Once this was accomplished, the argument for throwing money at fatuous renewable energy projects would also disappear.  Government could be content to play the neutral arbitrator instead of picking and choosing winners in the subsidy game.  That could make nuclear once again an attractive investment for utilities and merchant company investors.