Time to Give Up on a Carbon Tax?

by Ben Ho |April 26, 2021

Since 2006, economist and former Bush-era White House adviser Greg Mankiw has been encouraging economists and policy makers to join the Pigou Club, which advocates for a tax on carbon. The idea goes back to economist Arthur Cecil Pigou, who, in 1920, proposed to tax market activities that generate externalities — costs that are not included in a product’s market price, such as the healthcare costs of using tobacco. In the case of carbon, such a tax would raise revenue for the government while making sure those who choose to burn fossil fuels (say, when you drive your car to work) adequately take into account that choice’s damage to the environment and the health and safety of others.

A sign on a building says "no carbon tax"

Photo: pblakez/Global Panorama

Although fundamentally a good idea, carbon tax proposals have repeatedly failed to gain political momentum — and they may not even be the best solutions available. Maybe it’s time to retire the Pigou club.

A carbon tax is an idea with some consensus from economists on both the right and the left. It’s an easy sell for most Democrats, since it increases government revenues while working to fix climate change, but it’s also appealing to Republicans because the revenue it raises would allow the government to cut taxes on things we want more of, like income and investment. Also appealing to free market types, no bureaucrat or congressional lobbyist would be picking which companies win or lose in the marketplace. The government simply sets a price that allows consumers and firms to make the right choice when deciding how much to pollute — it lets the market decide. Little wonder this idea has gotten support from prominent Republicans.

Despite its advantages, the U.S. has seen little progress in passing a carbon tax. Some conservatives dislike the imposition of a tax that would likely produce a massive (e.g., trillions of dollars) source of new government revenues that might be used poorly. Conservatives also worry about the harm it would cause to workers in fossil fuel industries and the increased prices faced by consumers. Liberals also object to the higher prices, which could disproportionately harm those with the lowest incomes.

In 2018, a tax designed to fight climate change in France led to weeks of violent “yellow vest” protests against rising fuel prices, among other concerns, causing the French government to back down. A plan for an E.U.-wide carbon tax has never been successful. Recent referenda in Washington State have failed again and again. In fact, no U.S. state has successfully passed a carbon tax (although many U.S. states and the E.U. have passed cap and trade policies).

Because for all of their vaunted benefits, carbon taxes have substantial drawbacks. I suspect that a carbon tax would be less transformative than its advocates promise. Economists Kenneth Gillingham and James Stock find we already have dozens of existing policies that place high implicit prices on carbon reductions: e.g. renewable portfolio standards that regulate electricity (with an implicit carbon price of $0-$190/ton), tax credits for solar power ($140-$2100/ton) or wind ($2-$260/ton), fuel economy standards ($48-$310/ton), corn ethanol standards ($-18 to $310/ton), or subsidies for electric cars ($350-$640/ton). The additional impact of a carbon tax at say the $51/ton social cost of carbon recently adopted by the Biden administration could have a smaller effect on these specific sectors relative to the policies already in place. It is true that a carbon tax would incentivize reductions in other sectors, but there are few major sources of carbon emissions in the U.S. that aren’t already regulated by existing policies.

A carbon tax on its own isn’t even the first best policy option because it doesn’t target other externalities that are potentially more important than the direct damage of climate change. In particular it doesn’t do enough to encourage the benefits that come when new technologies are invented, such as the innovations that have brought the price of solar down by 90% or more in the past 10-20 years. It also does little to address the infrastructure needed for a low carbon economy — infrastructure like a smarter grid, or a network of electric vehicle charging stations. Perhaps we should be focusing on those market failures first. For example, the innovation and network benefits associated with buying an electric car today is far greater than the direct benefit from reduced use of fossil fuels. Buying an electric car today does have a direct effect on reducing emissions, but the indirect effect of making electric cars affordable to all may be far more important.

In many ways, the types of policies that politicians tend to favor — policies that heavily target innovation and then phase out (such as subsidies for solar electricity or electric vehicles) or infrastructure projects like power grid upgrades — are preferable to Pigouvian taxes. Especially since the biggest political hurdle is getting international buy-in — getting countries like India, Nigeria and Saudi Arabia to adopt climate-friendly policies as well. Yes, passing a U.S. carbon tax might encourage other countries to pass similar policies of their own, but a more effective way to get other countries to go green could be to spur innovations like the ones that have made solar one of the cheapest forms of energy in much of the world and electric cars a viable alternative to gasoline-powered ones. While these seemed like pipe dreams not long ago and advocates were derided as techno-optimists, these goals now seem readily within reach (for example, GM just announced it plans to end production of gasoline powered cars by 2035 in favor of electric). Maybe it’s time to redouble our efforts.

It’s not that a carbon tax is a bad idea; in an ideal world, Pigouvian taxes are still part of a first-best policy solution. A uniformly applied carbon tax has benefits that the current hodge-podge of targeted government programs just doesn’t. A clear price on carbon would encourage innovation in areas the government has never heard of, and create a much more efficient channel for government revenues than distortionary taxes on income and capital. It’s just that there are other externalities with higher potential impact that maybe we should be focusing our attention on, especially since there are political costs that make subsidies and infrastructure projects more attractive than a massive tax increase. I am still a supporter of the Pigou club, but maybe it’s time for the club to rethink its plan of action.

Benjamin Ho is an associate professor of economics at Vassar College, an adjunct at Columbia University’s Center on Global Energy Policy, and former lead energy economist at the White House Council of Economic Advisers. His new book, Why Trust Matters: An Economist’s Guide to the Ties that Bind Us, is forthcoming from Columbia University Press.

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Jonathan V Marshall
Jonathan V Marshall
1 year ago

Ben Ho’s argument is hard to address because it’s so incoherent. At the outset, and throughout much of the article, he argues that “it’s time to retire the Pigou club.” By the end, in contrast, he admits that carbon taxes may be “part of a first-best policy solution” and he’s “still a supporter of the Pigou club.” It never occurs to him that he has created a false dichotomy, that carbon taxes and other measures (e.g. grid modernization) are not mutually exclusive.
Ho notes that Harvard economist Greg Mankiw advocates for a carbon tax. That’s true but only .03 percent of the story. Nearly 3,600 U.S. economists, including 27 Nobel laureates, 15 former chairs of the Council of Economic Advisers, and four former chairs of the Federal Reserve Board, signed a statement declaring that “carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary.”
Ho makes the astounding error of confusing the estimated costs of regulations and subsidies in various sectors with a carbon tax of similar magnitude imposed on those same sectors. One reason many regulations impose a high cost per ton of CO2 is that they have small effects on total emissions. For example, subsidies for electric cars do very little to discourage the purchase and use of gasoline and diesel-based vehicles, whose fuel continues to enjoy huge subsidies. A substantial carbon tax would have far greater impact on emissions, and on adoption of electric vehicles, as proven by the experience of many countries around the world with higher fuel taxes.
His argument soon devolves into a plea for relying largely on innovation to address the impending climate disaster. Virtually every serious economist supports public spending on R&D. But innovation alone will achieve results far too slowly if fossil fuels continue to enjoy hundreds of billions of dollars in subsidies by allowing their environmental damage to go unpriced.
Glenn Hubbard, former chairman of the Council of Economic Advisors in the George W. Bush administration, observed, “business people don’t innovate because it feels good; they innovate because there’s a return to that innovation. If you want a return to that innovation, . . . you will need to put a price on carbon.” Or as Bill Gates once put it, “Without a carbon tax, there’s no incentive for innovators or plant buyers to switch” to clean energy.
A report by the Department of Energy in 2017 concluded that the most aggressive “stretch” national technology policies would reduce CO2 emissions less than 30 percent by 2040. By comparison, the Stanford Energy Modeling Forum found that a carbon tax of $50 per ton, increasing 5 percent annually, would achieve better results in just 10 years, even without counting the impact of technology breakthroughs.
It’s true that that carbon pricing policies, though common in much of the world (including Canada, the UK, and EU), have had little success in the United States. The same could be said for most other serious climate policies. The way to achieve enact a carbon tax in the United States is not to look backward at failed models, but to heed the political experience of countries like Canada, which make such taxes popular by returning the revenue to individuals in the form of equal dividends or tax credits. A 2017 study by the Treasury Department estimated that such a scheme would make roughly two-thirds of households financially better off, net of higher direct and indirect energy costs. That could be a winning political formula. In short, it’s not time to “give up.” It’s time to promote national carbon fee legislation like HR 2703, the Energy Innovation and Carbon Dividend Act.

Ben Ho
Reply to  Jonathan V Marshall
1 year ago

Sorry for the slow reply. I hadn’t seen these comments but they are excellent and thoughtful. Some brief replies.

I agree we could do both, but political capital and legislative time is finite. A lot has been written for example about how Obama used up his capital on healthcare reform, leaving little capital and time for anything else (like climate change).

I did also say in the piece that the direct effects of electric car subsidies on emissions is quite small. The main effect is the cross country spillovers. The US accounts for only 14% (and falling) of global emissions. China has mandated that 40% of cars sold will be electric by 2030. Major car companies plan to phase out gasoline powered cars globally by 2035-2040. 2/3 of all new electricity generation (globally) is now solar (and wind).

That kind of innovation is hard for conventional models to capture.

I agree that a carbon tax will speed things along, but I don’t see how a US carbon tax will speed things along very much in places like China or Africa, whereas innovation will.

It’s a common mistake that revenue recycling/carbon dividend would be politically appealing. A recent Yale poll (YPCCC) found that option to be the LEAST politically popular way to spend carbon tax revenues (even with Republican voters).

Ray Welch
Ray Welch
1 year ago

Criticizing carbon taxes because they haven’t succeeded in the U.S. is a bit like criticizing one-legged, six-inch stools for not reaching the bar top. The problem isn’t with stools as a concept. The problem is bad design, compounded by bad implementation.

The most critical component that carbon taxes have lacked is a mechanism for economic justice. Most carbon tax proposals have been regressive.

This design flaw is easily corrected. Put the carbon tax on the fossil fuel companies where they extract or import the fuels. Then, return the collected revenue to individuals to give them a way to cope with cost increases, to the extent the FF cos pass them along. The less carbon your purchases represent, the more money you retain.

How will you recognize low-carbon goods and services? Easy. They’ll tend to be cheaper.

A monthly “carbon dividend” also confers a clear sense of agency to consumers. By buying low-carbon, they benefit both themselves and the climate.

This economic justice element was lacking in France. The Yellow Vests were reacting to the government imposing a direct tax on consumers at the fuel pump, while at the same time it was reducing other taxes on the wealthy. They were not objecting to a carbon tax, per se.

A monthly dividend would make the carbon tax as politically durable as Social Security. Small carbon users will be net earners, while only big carbon users will be net payers, which seems the essence of justice to me.

The second necessary carbon tax design component to add is a border tariff on goods from exporting countries, like China, who don’t have an equivalent carbon tax. This serves two purposes. It prevents U.S. manufactures from fleeing overseas, and it incentivizes foreign exporters to put their own carbon reductions in place.

A tax designed like this will have three legs (fee, dividend, border tariff) and be at the scale needed to reach the bar.

Will other polices be required? Yes, of course. Prof. Ho says, “A carbon tax ON ITS OWN [emphasis added] isn’t even the first best policy option…” I would say no policy, on its own, will reduce fossil fuel usage at the required scale and pace. EV subsidies alone certainly wouldn’t do it. Testing a tax as a single measure, but not applying the same test to other single measures, seems tendentious.

The “innovation and network benefits” Prof. Ho speaks of would be greatly enhanced by a properly designed and (therefore) politically durable carbon tax. Fee-and-dividend would support every green endeavor, not just EVs, because it would provide a reliable planning horizon and a clear economic trajectory for the future for all players, especially businesses. It would reduce investment risk and elevate the likelihood of a good return from all green investment. If we’d have had a national fee and dividend in place for the past ten years, I suspect EVs, charging infrastructure, battery storage, and transmission build-outs, along with other innovations, would be all substantially further along than they are now.

But here’s the biggest drawback of the sectoral approach: it can’t be implemented at the scale or speed required to meet President Biden’s goal of 50% carbon reductions (basis 2005) by 2030. Subsidies tend to focus on future assets. All future energy and products are *additive* unless there’s a direct incentive to substitute and retire existing ones. An annually escalating, socially just carbon fee on fossil fuels (rather than on downstream products and services) would incentivize such substitutions. If polluting remains free, businesses and individuals will tend to hold onto present assets to maximize their return. Innovation efforts will tend to focus on retaining those FF assets (and their massive free pollution subsidy) rather than on green alternatives.

Another risk is that the sectoral/subsidy approach, at the scale needed to hit Biden’s targets, would attract the same or greater opposition as a socially just carbon fee, plus run the risk of being used as evidence that the “elites” are trying to hoodwink the populace.

In past alternative energy subsidy programs, tax increases and debt have been relatively easy to obscure. “Hide-the-money” worked because ambition was low, and the programs correspondingly small. But with the scale of ambition going up an order of magnitude or two, a lot more people are going to care. Reactionary right-wing populists in particular will highlight the enormous tax and debt increases, just like they hyped the “lies” that the “elites” told (at first) about masks NOT being effective for the coronavirus pandemic. If green subsidies fall prey to this kind of attack, they’ll be very difficult indeed to push through and sustain.

Ben Ho
Reply to  Ray Welch
1 year ago

Sorry for the slow reply. I hadn’t seen these comments but they are excellent and thoughtful. Some brief replies.

I agree that an upstream carbon tax and dividend scheme would be ideal (from an economist’s perspective). There was a push by some prominent republicans for such a scheme back at the end of the Bush administration (that went nowhere). It’s also politically unpopular. In a recent Yale YPCCC poll, using carbon revenues for dividends was the LEAST politically popular way to spend carbon tax revenues (Even among republican voters).

I take your point that we need to worry about existing pollution sources, but I do think innovation has gone surprisingly far. 2/3 of all new electricity generation (globally) in solar (and wind). Car companies will phase out all gasoline car sales globally by 2035-2040.

But I agree that we need to do something to retire existing capital (coal plants, cars, etc) more quickly. A carbon tax would help, but it’s not necessarily the most targeted policy to do so there either. A friend of mine at the Rocky Mountain Institute has been working on financing plans to help speed up coal plant retirement. In their estimates, a moderate carbon tax (in the $50 range), would do relatively little to shut down a large number of existing coal plants because the fixed costs of those plants are already paid for and the plants are relatively new. So more targeted policies are needed.

And a policy like Cash for Clunkers (which economists hate for its inefficiency) was much beloved by voters and politicians. In an era where 2 trillion spending packages has become normalized, similar policies are floating around Congress currently, and I suspect are far more likely to be passed than a carbon tax.

Robert Archer
Robert Archer
1 year ago

It is hard to discern the merit in this opinion piece. It appears to contribute to some of the unsupported narratives concerning the need for regulatory/subsidy approaches instead of a carbon tax. That narrative and this piece rely on a flawed policy approach: you can have either regulatory/subsidy policies or a carbon tax but not both.

Following are some brief comments on just a few of the views quoted below.

Quote: “…carbon tax proposals have repeatedly failed to gain political momentum…”

Comment: The emergence of the carbon tax policy has only occurred in the last 3-4 years against strong headwinds of the previous administration. Several serious Bills have emerged in Congress, the political context has changed significantly both internationally (EU, UK and Canada) and domestically. Possibly this was written before the endorsement of carbon pricing by API, Business Roundtable and Chamber of Commerce. A carbon tax by a few states would be interesting but limited and irrelevant for the global problem which requires a national price and border carbon adjustment. The Biden commitment to a 50% reduction won’t be met without a steadily rising carbon tax, household dividend to protect the bottom 65% and a Border Carbon Adjustment to maintain competitiveness (see the

Quote: “In 2018, a tax designed to fight climate change in France led to weeks of violent “yellow vest” protests against rising fuel prices, among other concerns, causing the French government to back down.

Comment: The “yellow vest” canard is unfortunate and misleading. The French carbon tax began in 2014. No protest. It rose every year to 2018. No protest. It now stands around $50/ton/CO2. Why the protest? It was because the ham-handed political decisions of a tax cut for the wealthy followed by a carbon tax increase hitting the middle class provided the fuel for the protest. It also confirms the importance of applying the revenues to a household dividend which holds the bottom 2/3 harmless as done in Canada and proposed in the U.S.

Quote: “A plan for an E.U.-wide carbon tax has never been successful.”

Comment: This is a straw man statement and shows a lack of knowledge of the EU system and the role that Al Gore played as Vice President in steering the EU away from a carbon tax to the inherently flawed cap and trade program approach during the run-up to the Kyoto Protocol. It is one of the most significant diplomatic foul-ups on record. While the EU might have been able to put a carbon tax in place back then, it is highly unlikely now because it requires a unanimous vote of all 27 members (recent Central European members will oppose). The author might have noted the initiatives of several EU countries to put in place significant carbon taxes on their own.

Quote: “The additional impact of a carbon tax at say the $51/ton social cost of carbon recently adopted by the Biden administration could have a smaller effect on these specific sectors relative to the policies already in place.”

Comment: This is baseless based on my reading and does not reflect experience particularly in California. Few want to recognize how little is being achieved in terms of causing emission reductions by the regulatory programs. Just recently the California Legislative Analysts’ Office published their report indicating that transportation emissions continue to rise despite the 21 regulatory and 21 subsidy programs designed to reduce such emissions.

Quote: “Yes, passing a U.S. carbon tax might encourage other countries to pass similar policies of their own, but a more effective way to get other countries to go green could be to spur innovations like the ones that have made solar one of the cheapest forms of energy in much of the world and electric cars a viable alternative to gasoline-powered ones.”

Comment: This is far from reality in terms of the economic behavior of developing countries in particular. Because fossil fuels will be left with a large subsidy (see IMF for discussion of massive subsidy through external costs of fossil fuels), new technology market penetration will be between very slow and never. Free rider behavior prevails. Without a carbon price soon along with a Border Carbon Adjustment, the global problem will not be mitigated in any significant way. The author’s focus on solar technology fails to recognize the strength of incumbents and sectors with minimal or no incentive to change, e.g., industry, buildings and commerce.

Quote: “It’s just that there are other externalities with higher potential impact that maybe we should be focusing our attention on, especially since there are political costs that make subsidies and infrastructure projects more attractive than a massive tax increase.”

Comment: This sums up the flawed view well. There is no basis for saying there is higher potential in dealing with “other externalities” (a grid upgrade?) to the exclusion of a carbon tax, household dividend and BCA. This either-or postulation is false and damaging. The author may want to refer next time to Canada’s success in putting in place its carbon tax and how they sold it politically by returning 90% of the revenues to households. Any opinion piece that discusses the carbon tax policy without addressing the revenues and household impact and without dealing with the industry competitiveness issue (addressed through a BCA) is not advancing the critical climate dialogue. Finally, the failure to mention the regressive character of most all subsidy/regulatory programs and their impact on lower income households ignores one of the most significant factors in climate policy dialogue–equity. (see Borenstein, “The Distributional Effects of U.S. Energy Tax Credits”)

Ben Ho
Reply to  Robert Archer
1 year ago

Sorry for the slow reply. I hadn’t seen these comments but they are excellent and thoughtful. Some brief replies.

The Carbon tax is hardly new. A serious republican proposal was made when I worked for the Bush administration (it included a Dividend) the EU had a serious push for a carbon tax in the 1990’s. The Dividend does not make it more popular, a recent poll out of Yale (YPCC) finds that the dividend option is the least politically popular option for how to spend it.

I agree that it would be hard to change foreign behavior, but I really don’t see how a US carbon tax (even with Border adjustment) would be that persuasive. A border adjustment would just be another small tariff among many tariffs importers already face.

I think you underestimate though the impact on technology. China has already mandated that 40% of all cars sold by 2030 will be electric. Major car manufacturers plan to discontinue gasoline cars by 2035-2040 (globally). Solar and Wind currently make up 2/3 of all (global) new electricity generation.

The point is, the US only accounts for 14% of emissions (and that is declining).. I care about the other 86%. I agree a carbon tax and dividend would be a good policy, but it continues to be politically unpopular in the US (especially the dividend part).

Davio S
Davio S
1 year ago

Just push HR 2307…it charges a fee on fossil fuels, and rebates the fee back to the citizenry. Poof, there goes half his argument. Remember, there’s no reason that pollution should be free.
The US is one of the two major world economies without a carbon fee. We’ll be paying a border adjustment to other countries because we don’t have our own fee.

Last edited 1 year ago by Davio S