Ask an Economist: Carbon tax or permits?

James Boyce

Triple Crisis Blog invited readers’ questions in advance of the April 24-25 IMF/World Bank meetings in Washingon. See all of the questions and answers here. A reader asked:

Q: Do you think that carbon/pollution/energy taxes could be a mechanism that helps us reduce our use of fossil fuels, while bringing funds to the governments that need them to pay their climate debt?

Boyce: Pricing carbon – via taxes or permits – is crucial to reduce the use of fossil fuels. Taxes and auctioned permits are equivalent: the only difference is that taxes set the price and let the quantity of emissions vary, whereas permits set the quantity and let the price vary. Both yield revenues to governments.

But it is important to recognize where these revenues come from: carbon taxes or permit prices will be passed by firms to consumers. And because fuels generally are necessities rather than luxuries, carbon pricing will hit the poor harder than the rich as a percentage of their incomes. In other words, it’s a regressive tax.

From the standpoint of political sustainability as well as distributional fairness, it would be a mistake to rely mainly on carbon revenues to fund international transfers for climate change mitigation and adaptation. A cap-and-dividend policy (like the CLEAR Act proposed by U.S. Senators Maria Cantwell and Susan Collins) or the tax-and-dividend alternative (advocated by climate scientist James Hansen) would reverse the regressive impact of carbon pricing by returning most of the carbon revenue to the people as equal per-person dividends. Such a policy would affirm the principle of equal and common ownership of each country’s share of the atmospheric commons. Payments on the climate debt are another important element of policies to combat global warming. These transfers can and should be financed by progressive taxes, just like other government expenditures.