With the diminished chances of GHG cap-and-trade legislation passing Congress in the near future, the talk in Washington has turned again to the possibility of a carbon tax. 

A carbon tax has appealing elements, according to a recent report from the Congressional Research Service (CRS), Carbon Tax: Deficit Reduction and Other Considerations.  First, it could be designed to be far more administratively manageable than a cap-and-trade program.  Second, and more relevant to the nation’s current economic condition, it could provide substantial help in reducing the federal budget deficit.  Third, revenues from a carbon tax could be used to offset reductions in existing taxes (e.g., labor, income, and investment). 

On the downside, approaches to a carbon tax that yield the greatest overall benefit could impose disproportionate costs on lower-income households.  In addition, carbon-intensive industries with foreign competition may face a disproportionate impact with a unilateral carbon tax system. 

Whom to tax?

A carbon tax could apply directly to CO2 and other GHG emissions, or to the inputs (e.g., fossil fuels) that lead to the emissions.  Unlike a tax on the energy content of each fuel (e.g., a Btu tax), a carbon tax would vary with a fuel’s carbon content, which relates directly to CO2 emissions.

According to the CRS, important issues to consider in developing a carbon tax include the following:

• Point of taxation.  When determining which sources and GHG gases to control through a tax, policymakers would need to balance the benefits of comprehensiveness with administrative complexity and costs. Applying a carbon tax at the points of emissions from all GHG sources would present enormous logistical challenges.  CO2 emissions are fairly easy to verify from large stationary sources, such as power plants.  For smaller sources, CO2 emissions are a straightforward and accurate calculation based on the carbon content of fossil fuels consumed. Other GHG emissions, such as methane, nitrous oxides, sulfur hexafluoride, and others, could be more difficult or less reliable to verify.
• Rate of taxation.  As a public finance instrument, the tax rate could be based on the estimated revenues needed to reduce or eliminate projected budget deficits.  This approach would be challenging, because estimates of future budget deficits (and thus, the revenues needed to address them) are inherently uncertain.  Alternatively, the tax rate could be tied to climate change objectives.
• Adequacy.  Carbon tax revenues would vary greatly depending on the design features of the tax as well as market factors that are difficult to predict.  One study used by the CRS estimated that a tax rate of $20 per metric ton of CO2 would generate approximately $88 billion in 2012, rising to $144 billion by 2020.  Depending on the budget deficit projection used, these revenues could reduce the deficit by between 12 percent and 50 percent, according to two studies.

International competition

The CRS points out that without some tax revenue redistribution, carbon taxes are generally considered to be regressive because lower-income households typically spend a higher percentage of their income on energy-related goods and services than higher-income households.

               Also, carbon-intensive industries would likely face disproportionate impacts within a United States carbon tax system.  Trade-exposed industries that contend with international competitors would be particularly challenged because they would be less able to pass along the tax in the form of higher prices.  Possible remedies include distributing the carbon tax revenues to these industries and applying a tariff to carbon-intensive imported goods.