The Key to a Sustainable Economy

How a carbon tax can solve the climate problem

May 11, 2023

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In the battle against climate change, carbon taxes are a powerful and underutilized tool. By levying a cost on the negative externalities of emitting greenhouse gases into the atmosphere, households, businesses, and innovators will be nudged toward sustainable sources of energy. The key is designing the levy for maximum impact on pollutants while minimizing its impact on our lives.

Why A Carbon Tax?

One of the greatest achievements in human history was the ability to harness the power of fossil fuels. It was fossil fuels that enabled the Industrial Revolution, leading to dramatically improved living standards for most on Earth. But since then our industrial activity has spewed a growing amount of CO2 and other greenhouse gases into the atmosphere. The rising concentration of these gases threatens the climate as we know it.

Fossil fuels are essentially the remnants of ancient life on Earth that absorbed solar energy before dying. In essence, an indirect, but highly dense, form of solar energy. In the absence of a levy on carbon, the economy naturally favors fossil fuels because usage “costs” (pollution, climate change…etc) are borne primarily by others, including future generations. As a Pigouvian tax, a carbon levy will appropriately internalize these costs onto users.

Of course, it is certainly possible for the government to regulate its way toward sustainability. But armies of bureaucrats are ill-equipped to devise policies to solve every industry’s unique technical challenges. For example, President Obama’s “groundbreaking” fuel efficiency standards for autos, encouraged automakers to build larger vehicles to avoid them, negating any environmental gains.

Similarly, the National Environmental Policy Act, which was intended to give a voice to environmentalists before the construction of federally-funded projects, has been turned into a weapon against all forms of progress. NEPA reviews, paradoxically, now block or needlessly delay many green energy projects. It’s simply not possible to meet climate goals when something as simple as road congestion fees are held up for years by red tape and studies.

To circumvent the bureaucracy, a carbon levy is needed. It would align the problem-solving capability of the market toward more sustainable forms of energy, and accelerate the adoption of fuel-efficient planes, trains, cars, homes, and factories. We would need no hamfisted or half-baked regulations, biased judges, or elected officials. The problem would solve itself.

How It Works

There are two ways of imposing a carbon tax. In theory, we could tax the source of emissions, known as “downstream” taxation. But doing so would require a means to measure the exhaust of every vehicle, power plant, home, and factory. In the real world, such an approach would be administratively prohibitive.

Instead, a better approach is to impose the levy “upstream,” or directly onto the fuel supply in proportion to the fuel’s carbon content. Doing so limits administrative complexity as it reduces the collection points from hundreds of millions to just ~3000. The tradeoff is a slight reduction in efficacy, but the levy could still cover at least 80 percent of emissions.

The trick is determining the tax rate that would accurately “price in” the cost of carbon emissions. If priced at about $50 per metric ton and increasing at a rate of 5 percent per year, the levy could raise around $1.8 trillion over a decade, even when accounting for a reduction in fossil fuel usage that would gradually ensue.

A well-designed Carbon Tax would also offer a credit for Carbon Capture and Sequestration (CCS) and for businesses that have negative emissions or otherwise remove carbon from the atmosphere. The technology for CCS is well understood but is often unviable because of its cost. A credit could make CCS a viable and rewarding business opportunity. Thus, not only would a carbon tax give households and businesses proper incentive to reduce emissions, but it would also make it viable to remove existing CO2 from the atmosphere.

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Addressing the Criticisms

An upstream levy is not without its own challenges. For example, not all fossil fuel products are combusted downstream. Full or partial exemptions should be provided for the production of feedstocks, asphalt, lubricants, and waxes that are not ultimately released into the atmosphere.

Another challenge is regressivity. The poorest among us consume a larger portion of their income on goods and services affected by the tax. They are thus disproportionately taxed, but this is solvable. We could, for example, use the revenue raised to abolish or reduce payroll taxes to compensate. Alternatively, we could recycle the revenue progressively, using it to supplement a Negative Income Tax or provide a “carbon dividend” for all.

There is also the concern about “leakage,” the fear that companies may move production abroad to avoid the levy, negating the environmental benefits. This too is not insurmountable, as we could impose a “border adjustment tariff” on imported goods coming from countries that lack a similar carbon pricing mechanism.

As I have discussed ad nauseam before, tariffs are generally bad, but a tariff that serves as a carbon border adjustment would be justifiable, even if administratively complex to implement. The ultimate goal of a border adjustment is to encourage foreign nations to adopt substantially similar carbon levies of their own. In doing so they would be exempt from the tariff, and hopefully, the border adjustment could be eliminated entirely.

Other Sources of Emissions?

To reap the full benefit of a carbon tax, it must also be able to target emissions from non-combustion sources as well. Among the most significant of these is cement manufacturing. Here, we turn to a proxy measuring clinker, which is composed of lime and other silica-containing materials. CO2 emissions would be directly proportional to the lime content of the clinker, giving us a base upon which to levy.

Similarly, iron and steel production is a significant source of non-combusted carbon emissions. Here again, we must turn to indirect proxies, estimating emissions by analyzing the coke, pig iron, and total steel production. From there, we can impose the levy in accordance with the standard CO2 pricing.

We could also target sources of non-CO2 greenhouse emissions. One of the most significant of such is methane from “enteric fermentation.” Essentially, methane arising from the digestive processes of animals, primarily cattle used for meat production. To combat this, could tax cattle per head, helping spur the introduction of lab-grown meat, which would reduce emissions by up to 96 percent.

Concluding Remarks

Most don’t realize it, but fossil fuels are heavily, if indirectly, subsidized. A carbon tax is essential to placing fossil fuels on a level footing with renewables. If done correctly, the levy would make much government regulation in this area redundant. Instead, it would free the market and all of humanity to solve the challenge of a more sustainable future.

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