Should We Swap Energy Subsidies for a Carbon Tax?

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