Should We Swap Energy Subsidies for a Carbon Tax?

The Surprising Reality

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A Breakthrough analysis finds that carbon taxes are more costly and less effective at driving deployment than energy subsidies.

September 13, 2012 | Michael Shellenberger & Ted Nordhaus

Over the past few months there has been increased talk in Washington of taxing carbon emissions. Rep. Jim McDermott (D-WA) has introduced legislation, while former Rep. Bob Inglis has proposed replacing today's subsidies with a carbon tax.

The view among most economists is that a tax would be more efficient at reducing emissions than subsidizing clean energy. Over the years, Harvard economist Greg Mankiw, an advisor to George W. Bush and now Mitt Romney, along with President Ronald Reagan's economic advisers, Martin Feldstein and Arthur Laffer, have all endorsed carbon taxes, along with environmental economists, like Harvard's Robert Stavins.

Breakthrough Institute is on the record supporting a low carbon tax (here and here), subsidy reform, and increased federal spending on energy innovation. We were thus interested in calculating how much of a price incentive a carbon tax would offer for the deployment of solar, wind, nuclear, and natural gas, the leading low-carbon technologies.

What we found surprised us. A $20 per ton carbon tax would offer just one-half to one-fifth the incentive of today's zero carbon subsidies — but at nearly 10 times the cost. (Our full analysis can be read here, and an Energy and Environment story on the study follows below.)

In order to make an apples-to-apples comparison between the disincentive provided by a carbon tax and the incentive provided by subsidies, we converted the subsidies into their "carbon tax equivalent," a commonly used conversion among climate and energy analysts. Breakthrough examined the effect of a carbon tax in the range of $10 - $20. Europe has a carbon price of about $10/ton. Climate legislation that passed the House and failed in the Senate in 2010 would have set a carbon price around $12 per ton, and McDermott's legislation references a $15/ton price.

Current annual federal spending on clean tech deployment subsidies totaled $11 billion in 2012, which is equivalent to a tax of $2.10/ton of carbon dioxide. At its 2009 stimulus peak, federal spending on clean energy subsidies amounted to $29.6 billion, equivalent to a tax of $5.50/ton CO₂.

A $20/ton carbon tax would impose a cost of $100 billion annually on the economy. That number is 900% more than the carbon tax that would be required to simply fund today’s subsidies.

What a $20 carbon tax might do is modestly accelerate the switch from coal to natural gas. But that trend is already underway, and the existing incentive provided by today's price gap between coal and (cheaper) gas is about twice large as the one that would be provided by a $20 carbon tax.

Our findings are consistent with the findings of other recent studies (MIT 2012) that find that a $20 per ton carbon tax — rising slowly to $90 per ton by 2050 — would have a modest effect on emissions.

Breakthrough's analysis likely underestimates the incentive provided by direct subsidies. Renewable subsidies help developers and utilities overcome the economic and technical challenges to deployment. Loan guarantees, and insurance subsidies help lower the risk and finance costs of nuclear projects. By contrast, a carbon tax simply raises the cost of the incumbent without helping the challengers cover the costs of first entering the market.

There are good reasons to tax carbon — we favor a low one (e.g., $5/ton) to raise money for energy innovation. But what this analysis shows is that the deployment of low-carbon energy is not one of them.

 

 

Photo credit - graphic designer Dita Borofsky


Comments

  • The citations in this article have no links. I am referring to BT’s support of a carbon tax, and the MIT 2012 study. Please update the article with links.

    By Kevin Davis on 2012 09 15

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  • Interesting analysis, but how many tons of CO2 in total do the solar, wind and nuclear ITC reduce, vs. a $20/ton carbon tax?  The carbon tax has a much broader base - I’d have to assume it would have more impact.  Also, we all know that a $20/ton carbon tax wouldn’t move the needle much, but it would be a great first step towards getting people comfort that we can tax pollution.  IF the people become comfortable with the concept, that tax could be ramped if more drastic emissions reductions are needed.  Either way - I think we need both carbon pricing and energy innovation.  Lately there seems to substantial backlash from the environmental community about a carbon tax because it’s not perfect.  Let’s not let the perfect be the enemy of the good…

    By Patrick Leslie on 2012 11 30

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  • Over the years, Harvard economist Greg Mankiw, an advisor to George W. Bush and now Mitt Romney, along with President Ronald Reagan’s economic advisers, Martin Feldstein and Arthur Laffer, have all endorsed carbon taxes, along with environmental economists by direct çamaşır suyu
    subsidies. Renewable subsidies help developers and utilities overcome the economic and technical challenges to deployment. Loan guarantees, and insurance subsidies help lower the risk and finance costs of nuclear projects

    By Temzzzz on 2013 01 07

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  • I live in British Columbia Canada and yes, we all get to enjoy a boatload of taxes. Federal, provincial and municipal. That trusty old carbon tax is right there with the rest of them.

    All you hear is complaints from the public about taxes. A carbon tax to me? That just makes sense. To move anything forward towards green, it takes money and it takes political will. Well right now in our country our politicians have that political will.

    More taxes always hurt. But then again if we don’t pay, who will? Fact is green movements will stagnate without income and frankly there isn’t a ton of profit to be made by going green (to speak generally).

    In my province of BC, I operate a BC Fishing Reports website, so obviously to keep fishing, I need people to care about the environment. I’m lucky in that the politicians have the political will to do the right thing. I don’t mind spending a bit more on taxes that are good for the planet. Paying for higher salaries? Then I have an issue.

    By Justin McDaniels on 2013 02 18

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  • You said, “A $20/ton carbon tax would impose a cost of $100 billion annually on the economy. “

    Obviously you have no idea of the definition of the word “cost”. A tax is by definition costless, as it is merely a transfer of money from one taxpayer (or loanholder) to another. Well, yes, there is a tiny administration cost, but a carbon tax is essentially free.

    Or, please tell me how that $100 billion “evaporates”?

    By Jim Larson on 2013 03 21

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  • “Paying for higher salaries? Then I have an issue.”

    Paying for higher profits? Then I have an issue. Raise wages, lower prices, and SLASH profits.

    By Jim Larson on 2013 03 21

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    • A carbon tax will impact the economy, with directionality and extent depending on alternatives available to energy consumers, and the allocation of carbon tax receipts by the government.  In addition, increased taxation reduces the velocity of money in the economy, which reduces economic activity.     

      The impact of a carbon tax on energy consumers depends on available alternatives and opportunities for switching.  In the short term, a carbon tax would have a negative effect on the economy, diverting financial resources away from household budgets, reducing discretionary spending, and reducing profits for businesses.  The effect of a tax on gasoline for consumers, for example, results in reduced driving, or reducing other expenditures.  Wealthy consumers can offset increased gasoline costs by purchasing a hybrid car, overcoming the increase in gasoline taxes.

      Over time, leveraging market forces to identify and source lower carbon alternatives can be the most effective means to obtain the greatest return on deployed capital and resources.  If there are no lower cost forms of energy available, or capital for improving efficiency is limited, then the overall effect of a carbon tax will be reduced economic activity. 

      A carbon tax is regressive, as economically disadvantaged people do not have the capital and resources to acquire lower cost alternatives, resulting in their otherwise being stuck with a higher cost life.  This points to the need for the government to dampen the negative impacts of the carbon tax. 

      The choice of what the government does with carbon tax receipts is critical, informed by the potential economic pratfalls associated with instituting the carbon tax.  Overcoming the dampening effect of a carbon tax is accomplished by making lower cost energy resources available as well as loosening up capital resources to accelerate investments in improving energy efficiency and productivity.  A 5% carbon tax, for example, can be overcome by a 7% improvement in energy efficiency, for example, with the added 2% to cover capital costs. 

      A 5% carbon tax may encourage certain switching behaviors, but as an incentive, is not sufficient to encourage investment in alternative energy technologies that have larger price/performance gaps.  For example, there was a time when wind turbines were three times more expansive than what is needed to compete on the grid.  A 5% carbon tax would really not be enough to encourage investment to bridge a 200% price/performance.  Hence, there is a reason for governments to participate implement policies targeting closing the price/performance gap on emerging clean energy technologies.  Wind and solar technologies, for example, have both benefitted from favorable financial policies on the part of governments.  As such, in certain markets around the world, both wind and solar power technologies are achieving grid parity economies.  These cost reductions have been achieved by the government priming market demand, resulting in scale economies and continuous movement down the learning curve. 

      In summary, it is not a question of swapping energy subsidies for a carbon tax.  It is recommended to have both policies, with receipts from a carbon tax providing energy subsidies to encourage lower cost alternatives, encouragement of investments in energy efficiency and productivity, as well as addressing regressive nature of the tax.  For more on energy and economics, see my blog: http://bit.ly/Brads_Energy_and_Economics_Blog

      By Brad Bradshaw on 2013 10 23

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  • Michael & Ted:
    I know that I’ve come into this discussion pretty late, but I was wondering if your analysis changes in any way if look at “carbon tax and dividend” espoused by James Hansen.  It would use our revenue collecting agencies to give equal refunds to all taxpayers in the country instead of being used for “energy innovation” administered by the DOE.  This would put the incentive at the household level in terms of alternative energy use.  It would allow people to forego the impact of higher fossil fuel prices by becoming more efficient, buying electric cars, installing solar panels, become supporters of nuclear energy etc. Some households would come out ahead; others not.

    Is a follow-up article in order?

    By William Vaughn on 2014 02 27

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About Michael Shellenberger & Ted Nordhaus

Ted Nordhaus and Michael Shellenberger are leading global thinkers on energy, climate, security, human development, and politics. They are founders of the Breakthrough Institute and executive editors of Breakthrough Journal.

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