What Would An International Carbon Tax Look Like?

There are two market ways to reduce C02 emissions (the other options, like “command and control” would involve more overt government intervention). The first is cap and trade. The U.S. tried, and failed to pass a cap and trade bill in 2009 (Waxman-Markey). In a cap and trade system, the government puts a “cap” on the amount of carbon that can be emitted and allows companies to trade permits that allow them to emit, say a ton of CO2, on a market. The idea is that companies that can cheaply reduce emissions will do so, and then sell their permits to those who can’t do so cheaply. It also allows the government to set a hard limit on emissions.

The second option is a “carbon tax,” where the government sets a price on carbon emissions and taxes companies based on how much they emit. The advantage with this system is simplicity.

A new column by John Hassler and Per Krusell adds new insights to the debate. The authors use current GDP, the expected economic costs of carbon dioxide and an estimate of how long carbon dioxide lingers in the atmosphere to come up with an optimal international carbon tax and find that the tax would be less than the tax rate currently imposed in Sweden ($150/T USD).

The chart shows what the carbon tax would be in both USD and Euros based on what is called the “discount rate.” Discounting is an economics concept that takes into account the fact that future generations will be wealthier than we are. If they are far wealthier (high discount rate) it makes sense to spend less mitigating climate change (so the tax is low). If they will be just about as wealthy (low discount rate) then the tax should be very high (the far left of the chart). Later in the column the authors use a 1% discount rate, so I’ve noted it.

They argue that a carbon tax is preferable because carbon trading markets are prone to wild fluctuations when new technologies are developed. The E.U. market crashed last year, partially because of new technological developments. International disparities between mitigation costs would make an international market even more difficult.

The column takes up another question as well: how much do rich countries owe for the massive emissions they’ve used to “get rich quick”? Fossil fuels cause global warming, which will disproportionately hurt poor countries. In one of the cruelest ironies known to man, the U.S. gets to burn cheap fossil fuels, and the Philippines gets hit by typhoon Haiyan. It’s like if you got to eat Twinkies all day and your neighbor got fat. Because of this, the authors argue that the global carbon debt is a whopping 40% of annual world GDP. It’s unlikely, however, that developing countries will ever see the money.

I would add that the insatiable demand for resources and growth is partially driven by our reliance on an increasingly out of date and incredibly flawed metric: GDP. If we had already adopted an alternative measure, we would have known long ago how profoundly unsustainable our growth was. Part of mitigating climate change is adopting measures that accurately show how sustainable current patterns of development are. Without such measures we trod forward, foresaking our future for the illusion of progress. Yogi Berra had it right, "If you don't know where you are going, you'll end up somewhere else."