Fossil fuel combustion and the consequent release of carbon dioxide continues as the dominant cause of increasing amounts of greenhouse gases in the atmosphere. Each year the United States releases into the atmosphere over 6 billion tons of carbon dioxide, roughly a quarter of global emissions. After years of inaction on this problem, Congress now appears poised to seriously debate legislation designed to reduce greenhouse emissions.
The only effective way to begin reducing greenhouse gas emissions and slow global climate change is to make it more expensive to emit carbon dioxide. Unless businesses and consumers pay a price for carbon dioxide, neither will make the investments in technology and changes in energy use needed to dramatically reduce emissions.
Most of the climate change legislation currently before Congress proposes a complicated "cap-and-trade" system. This would set a limit on emissions below current levels and then allocate permits to pollute that could be bought and sold. The alternative would be to impose a direct tax on carbon dioxide emissions.
In either case — tax or trade — electricity and gasoline prices would rise. A tax of $30 per ton — a level MIT suggests would make clean coal technologies an attractive investment to power companies — would raise gasoline prices by 35 cents per gallon and household electricity bills by 20 to 30 percent. Under cap and trade, prices would have to rise by the same amount to get the same result.
The attraction of cap and trade for its supporters is that the cap sets a limit on emissions of carbon dioxide. But it's difficult to get the limit right. The cap may be set too high to induce firms to make the large investments needed to reduce emissions. Or it may be set so low that costs skyrocket and political support to combat climate change falters.
The major disadvantage to cap and trade is that the price tag for reaching the target is highly uncertain. In contrast, a tax on emissions provides businesses and consumers with certainty about costs, while leaving the size of the reduction less certain.
After the failed attempt to pass the Clinton administration's 1993 proposal to tax energy, energy taxes have become a highly partisan issue, and congress has shunned the mere mention of a carbon dioxide tax ever since. But times have changed. For compelling environmental and economic reasons, it's high time to put a tax back on the table.
Putting a price on carbon dioxide creates winners and losers. All of the cap and trade bills before Congress would award permits to energy companies. But any cap on energy use will cause fuel prices to rise. So consumers will pay for this through higher prices for electricity and gasoline.
Instead, we suggest a tax on carbon dioxide in which all the proceeds collected by the government would be returned to Americans each year when they file income taxes. In contrast to current congressional proposals for cap and trade, a tax on carbon dioxide refunded directly to individuals would cut emissions while cushioning the impact on the pocketbooks of American families. For example, a $30 tax that reduces emissions by 20 percent would provide a refund of about $500 for every American: a family of four would get back $2,000.
A carbon dioxide tax with refund is fair because the people responsible for the most emissions would pay the most. The tax would also be progressive. Many Americans with lower incomes would find the refund would more than defray the higher costs of gasoline and electric power.
A tax is simple and can be phased in quickly. It encourages individuals and businesses to make long-term decisions with confidence, rather than trying to guess what the future price of permits will be. With a tax and refund, consumers would only pay the extra costs associated with carbon abatement measures.
A carbon dioxide tax with refund can be implemented easily. It can be collected at a few key links in the supply chain: refineries, power plants or pipelines. As shown by last year's refund of excess telephone taxes, the Internal Revenue Service can efficiently refund payments to all taxpayers. If passed by this Congress, taxpayers could see their first refunds in the Spring of 2009.
A carbon dioxide tax can be easily adjusted as lower-cost means of reducing emissions are tapped and new technologies become available to tackle more difficult sources. The tax could be started low, but with a clear schedule of increases so that individuals, local governments and businesses will begin now to make the changes and investments required to dramatically reduce emissions within 15 years.
Partial refunds could be targeted to U.S. producers in industries like petrochemicals, steel and aluminum so that they remain competitive with imports, while pushing them to invest in reducing emissions. These targeted refunds would prevent highly polluting foreign plants from destroying efficient energy-intensive industries in the United States.
U.S. consumers and industry need to reduce carbon dioxide emissions. A refunded carbon dioxide tax is the best way to achieve reductions. It is simple, good for the planet, and imposes the least additional costs on the American economy as compared to any other policy alternative. Most importantly it can be crafted to ease the burden on families and protect industries from unfair competition in the global marketplace.
Keith Crane is a senior economist and James Bartis is a senior policy researcher at the RAND Corporation, a nonprofit research organization.
This commentary originally appeared on Washingtonpost.com on November 29, 2007. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.