Back to Plan A: The Revenue-Neutral Carbon Tax

by James Handley

"If we can design a policy that is transparent and easy for people to understand, puts an effective price on carbon, and reimburses average Americans for all or nearly all of their increased energy costs, we have a chance to reverse climate change in a timely manner." So concludes political scientist Elaine Kamarck, PhD, lecturer in public policy at the Kennedy School of Government, and former head of the national performance review "reinventing government" (1993-97) in the Clinton Administration.

Kamarck's new paper, "Addressing Climate Change: The Politics of the Policy Options," begins by reviewing three decades of evolving public consciousness about global warming. She reminds us that cap-and-trade didn't start as the front runner. In his 1992 book "Earth in the Balance," Al Gore proposed a carbon tax with revenue used to reduce other taxes, an approach backed by most economists and policy analysts. But two events changed this; the apparent success of the acid rain (SO2) cap-and-trade program written into the 1990 Clean Air Act, and the political failure of Clinton's BTU tax.

Kamarck points out the key factors behind the success of the acid rain cap-and-trade program: only a few hundred sources had to be "capped," SO2 scrubber technology was readily available, and deregulation of rail freight prices slashed the cost of western low-sulfur coal. She notes that these factors don't apply to carbon emissions. Curbing CO2 will require a vast array of new technologies at both the energy production and user levels, along with widespread behavioral changes. Beyond the technology differences, the number of entities regulated in a carbon control system would be many times larger than for acid rain.

Kamarck concludes that policymakers have taken the wrong lesson from the failure of the BTU tax proposal. The measure was complex, for example, taxing gasoline at a higher rate than other fossil fuels without a clear rationale. Policymakers could not answer basic questions about its effect, specifically about its cost to consumers. Kamarck says politicians incorrectly concluded they couldn't touch tax policy; in fact, we generally accept the idea of "sin" taxes, for example on cigarettes, as both good health policy and an appropriate way to generate revenue.

Complexity, exceptions and inability to demonstrate effectiveness are very serious political disadvantages of cap-and-trade that began to surface as the Lieberman-Warner bill failed in the Senate. Kamarck observes that these drawbacks are becoming even more glaring as the Waxman-Markey bill works its way through the legislative process. Whereas politicians must be able to answer constituents' question What will this cost me?, the complexity of cap-and-trade invites opponents to make outrageous claims about the cost that are almost impossible to persuasively refute. Moreover, in the wake of the collapse of the financial system, the public is extremely wary of trading systems that appear capable of wreaking financial havoc.

The public is also properly skeptical about a policy whose effectiveness requires the rest of the world to follow suit. Since cap-and-trade systems depend on well-developed regulatory and enforcement systems that are far beyond the capacity of many governments, the prospects for an international system based on cap-and-trade are tenuous, Kamarck concludes. In contrast, most nations have a reasonably effective tax collection system that could be used to administer a carbon tax.

Under any carbon pricing system, revenue recycling is essential, Kamarck concludes, not just for the poorest quintile as Waxman-Markey provides, but for virtually everyone, in order to put the policy on a broad political footing. She refutes cap-and-trade architect Robert Stavins' assertion that giveaways of allowances don't affect the integrity or effectiveness of an emissions cap. She cites the European Union's experience where emitters overestimated past emissions to garner more free allowances which led to a very loose cap. That, in turn, brought about virtually negligible carbon prices with virtually no effect on emissions. Indeed, investment in new coal-fired power plants has increased in the EU, a sign that investors expect carbon permit prices to remain low.

Don't assume that Waxman-Markey can be made effective, fair and transparent enough to be enacted, Kamarck warns. She suggests we start now to work out an effective system under which we can answer the question How much will it cost? with enough certainty to win enactment. Her, and our "Plan B" is, of course, a revenue-neutral carbon tax which as she points out was the original "Plan A."