Please enable JavaScript to view this website.

Unpredictability in a Carbon Tax

This past September, Lindsay Graham called for a carbon tax.1 The Senator from South Carolina has discussed climate change openly, but has shifted his focus for the solution towards a carbon tax. A carbon tax is one of two currently proposed forms of carbon pricing, the other being cap-and-trade. The two are market-driven solutions which correct the market failure of producers emitting carbon pollution.

While both attempt to internalize the externality of carbon emissions, the carbon tax manifests itself very differently than cap-and-trade. Despite different manifestations, the most significant difference between the two approaches lies in which variable is exogenous and which is endogenous.2 More specifically, the two have opposite uncertainties.3 Cap-and-trade puts a cap on emissions, which therefore makes quantity certain but makes the price of CO2 emissions unknown. By contrast, a carbon tax makes the price per ton of CO2 known, but creates uncertainty in the quantity of CO2 emitted by a country.

Uncertainty in carbon emissions is a serious problem for any carbon-reduction plan. Following a schedule for reduction in carbon levels is important. Sketching out the projected level of carbon in the future from a schedule is key for policy-making because carbon is a stock pollutant.4 As a stock pollutant, damage is caused by the total stock of CO2 in the atmosphere.5 The flow from year to year is not an issue. Therefore, a long-term target closely relates to a determination of damages.6 Thus, a schedule which projects future emissions is quite clearly necessary.

A disadvantage of the carbon tax described above involves a level of environmental uncertainty. However, there are even more unknown elements such as changing international and economic conditions. For example, environmental conditions could become less dire and an easing of the amount taxed might ensue. Or, economic conditions in the U.S. might drastically improve, which could warrant an increase in the tax, since any increase in tax has thus far been considered sub-optimal due to the recent economic downturn following 2008. Finally, foreign countries could adopt carbon taxes greater than that of the U.S., which would allow the U.S.’s rate, which was chosen largely out of fear of a collective action problem, to rise. All of the uncertainty associated with the carbon tax shows that the tax needs to be adaptable.7

There are a few ways to create adaptability. One possibility is to bestow control of the tax rate to an administrative agency.8 The agency could turn the screws of the tax in order to help meet goals and to reduce the burden of the tax when possible. An example of this would be the 2007 Energy Independence and Security Act for appliances.9 The Act is updated every six years.10 However this option has a serious problem, since the U.S. Department of Treasury has never been given this amount of authority before.11. There may be constitutional problems associated with delegating the ability to control a tax rate.12 Additionally, Congress may not even be willing to part with the power to control the tax. Therefore, delegation to an administrative agency may create an uphill battle in terms of controlling a carbon tax.

Another option is for Congress to make adjustments as it sees fit.13 However, Congress is permitted to leave substantial gaps in legislation. Given the current political climate, it might be counter-productive to leave legislation in partisan hands. Finally, this makes tax and investment-planning very difficult because a rate change may or may not happen at any point in time. Therefore, transaction costs may increase with respect to planning for energy.

The third option involves adopting an emissions schedule like the one created by Professor Metcalf.14 The basic premise is that there are intermittent goals, and if the goal is not met then a rate increase will follow.15 The schedule approach lies in stark contrast to the discretionary approach of leaving control with an agency. However, these two options are not diametric opposites and could even be blended.

Assuming the constitutionality of congressional delegation of control over the tax rate to an administrative agency, a detailed comparison of the scheduling approach and the administrative discretionary approach may prove useful. Congressional rules are far more rigid than the flexibility of administrative discretion. Rules provide confidence to business leaders, investors, and innovators with regard to the price of carbon, but at the cost of having less flexibility. Specifically, rules enable firms to make better investment decisions, families to make better plans for their preferences, and rules allow innovators to focus on carbon-oriented inventions since a climate policy will predictably impact quality variation and prices in goods and services. However, should the science of climate change call for alternative regulation, then adjustments to the rates would need to traverse the gridlock of Congress to lead to an amendment to the law.

One author claims that discretion is valuable.16 Brian Murray believes that making the control narrow and precise, by limiting it to exclusively a rate change, would be optimal.17 Another set of authors agree with Professor Metcalf’s idea that a schedule is the best approach to a carbon tax. This is the idea of the Responsive Emissions Autonomous Carbon Tax (“REACT”).18. Upon passage of the bill, there were would be an initial tax rate which would grow alongside standard growth.19 Then as time progresses, there would benchmark targets of emissions spaced throughout a control period.20  Should emissions exceed those benchmarks, the tax rate would be increased until emissions fell below a subsequent benchmark.21

The control period is the time emissions are to be reduced by a certain level at a certain future time.22  For example, emissions in 2030 are to be 50% of the amount of emissions in 2005. For the following twelve years, there could be an annual benchmark where emissions have to reach a certain percentage of 2005 emissions. And, should the U.S. falter in 2021, the growth of the tax rate would rise above the annual rate of 3% (inflation), and instead amount to 10%. The rate would then return to 3% growth in 2024, when that year’s benchmark is achieved. Because carbon is a stock pollutant, the benchmarks are chosen to specifically meet the goal, and not use a year-to-year change. The hope is that the benchmarks and an increased tax rate would create certainty regarding the final goal, while the control period may have some uncertainty. Once the goal is achieved, the tax would just grow at the normal rate.

The example above involves many small choices in terms of adjusting the carbon tax control period so as to suit America’s needs. In this example, the tax change is discrete. The percentage chosen, 10%, is an arbitrary number that is unrelated to the delta of the benchmark and reality. A continuous function of the difference between the benchmark and reality may allow for more flexibility, say 7% or 15% depending on the needs, but will create more unknowns for investors in terms of taxes.

Additionally, the control period can be adjusted as well. The control period is meant to have a finite length that is intended to achieve a carbon emission goal.23 However, the length of the control period can be amended. A short control period makes it hard for long-term energy investments to achieve substantially lower carbon levels.24 For example, a firm in a country near the goal in a short-term control period may forego green energy investments because demand will drop precipitously. Therefore longer control periods will justify long-term investments in creating greener firms and developing greener technologies.25 However a control period is not useful if it is so long that technology and energy works become too abstract and speculative.26 In general, longer-lived general investments require longer control periods.27

Additionally, benchmarks can use year-to-year data or moving averages. The choice here, however, should be clear; the moving average is a superior method to a year-to-year number.28 Moving averages dampen changes from abnormal environmental and economic conditions. Exogenous shocks could prove detrimental and may lead to an unnecessary 10% rate increase.

There are a variety of ways in which a carbon tax can be adjusted to create certainty in terms of emissions outcomes. Therefore, it can still use market forces in a systematic way to achieve an emissions reduction.

  1. Justin Worland, Lindsay Graham Climate Change Carbon Tax, Time (Sept. 19, 2017),

  2. Joesph E. Aldy, Designing and Updating A U.S. Carbon Tax In An Uncertain World, 41 Harv. Envtl. L. Rev. F. 28 (2017). 

  3. Id. 

  4. Marc Hafstead, et al., Adding Quantity Certainty To A Carbon Tax Through A Tax Adjustment Mechanism For Policy Pre-Commitment, 41 Harv. Envtl. L. Rev. F. 42, 47 (2017). 

  5. Id. 

  6. Id. 

  7. See Aldy, supra note 2, at 29. 

  8. Id. 

  9. Id

  10. Id

  11. See Hafstead et al., supra note 3, at 45 

  12. James R. Hines & Kyle D. Logue, Delegating Tax, 114 Mich. L. Rev. 235, 268 (2015). 

  13. Aldy, supra note 2, at 29-30. 

  14. Gilbert E. Metcalf, Cost Containment in Climate Change Policy: Alternative Approaches to Mitigate Price Volatility, 29 Va. Tax Rev. 381, 391-92 (2009). 

  15. Id. 

  16. Brian C. Murray, et al., Increasing Emissions Certainty Under a Carbon Tax, 41 Harv. Envtl. L. Rev. F. 15, 18 (2017). 

  17. Id. 

  18. Hafstead et al., supra note 3, at 43 

  19. Id. 

  20. Id. 

  21. Id. 

  22. Id. at 46. 

  23. Id. 

  24. Id. 

  25. Id. 

  26. Id. 

  27. Id. 

  28. 47 

The following two tabs change content below.

Samuel Parks

Latest posts by Samuel Parks (see all)