What I find fascinating about a “Pigovian” carbon tax is that if it is implemented in a “revenue neutral way” (reducing the total take of other taxes as much as the carbon tax raises), it’s a much easier sell than other approaches to mitigating climate change because you can tell the voters how bad it can get — a 30 cent per gallon tax on gasoline and proportionate taxes on other carbon-based energy sources, with the tax rate fixed by the more-or-less computable cost of damage caused by CO2. With most other approaches, the political task is harder, getting permission from the voters for an open-ended authorization to “fix the problem” with no limitations on what might be required.

An array of US federal government agencies recently came out with an assessment of the costs of climate change if we continue with “business as usual”. According to press reports, the rough estimate is the costs rise to 10% of the GDP by the year 2100. Not horrendous, but given that the US GDP is likely to be around $100 trillion per year in 2100, that’s $10 trillion per year, which is in the neighborhood of $30,000 per capita per year.

Less well publicized is what it would cost to avoid climate change, but some friends supplied me with links to a number of studies ([1][2][3]). Those are even rougher, but by 2100, it’s about 5% of the GDP. So the net savings from avoiding climate change is something like $5 trillion per year, which is enough money we really should set about capturing that profit.

So far, none of my readers will be surprised. But it struck me that a particularly effective approach would be to adopt a “Pigovian tax“. Sadly, that’s not a tax in Pigovia, but rather a tax on an activity that compensates for the “externalized” costs of the activity, the harm that is caused to people who aren’t parties to the activity. The cool thing about a Pigovian tax is that if it’s set correctly (to the cost of the harm to others), it causes the Free MarketTM to reduce the amount of the harmful activity to the amount that is “efficient”, that is, optimal when you total up the costs and benefits to all of society.

There are several advantages to this approach: (1) Since it discourages (in this case) emitting CO2 directly by charging money, there is no need for further regulations on CO2-emitting activities, which would inevitably be technically complex and subject to political wrangling. (2) Since it financially rewards any reduction of CO2 emissions, it fully motivates everybody to devise and use new ways of reducing emissions, without having to convince a bureaucracy to require that everybody use it. (3) It properly handles the rare, annoying case when the total benefits of emitting CO2 exceed the total costs, because in that rare situation, the person doing it will still have a net profit after paying the tax.

The crux of a Pigovian tax is to get a close estimate of the externalized costs. In theory, this is a knowable number, but of course it’s harder in practice. Conveniently for me, Wikipedia presents estimates of this “social cost of carbon“, and we can take $100 per ton of carbon emitted (= $27 per ton of CO2 emitted) as a plausible estimate.

From this we can calculate what the carbon tax would be on specific types of energy: A ton of coal produces about 8100 kWh, so the tax on coal-generated electricity would be 1.2 cents/kWh. A gallon of gasoline weighs about 6 pounds, and most of that is carbon, so the tax on it would be 30 cents/gallon. The conventional retail unit of natural gas is the “CCF”, which weighs 0.0026 ton, so the tax on it would be 26 cents/CCF. (My gas bill for October was 30 CCF, so the tax would be an additional $7.80 on a bill of $52.00.)

What I find fascinating about a Pigovian carbon tax is that if it is implemented in a “revenue neutral way” (reducing the total take of other taxes as much as the carbon tax raises), it’s a much easier sell than other approaches to mitigating climate change because you can tell the voters how bad it can get — the price increases listed above. With most other approaches, the political task is harder, getting permission from the voters for an open-ended authorization to “fix the problem” with no limitations on what might be required.

(How much money is involved? The annual consumption of gasoline in the US is 150 billion gallons, on which the carbon tax would be $45 billion. The annual consumption of coal-generated electricity in the US is 2 trillion kWh/year, on which the carbon tax would be $24 billion. The annual consumption of natural gas in the US is 27 trillion CF, on which the carbon tax would be $70 billion. The total of these is $139 billion, which is small enough that it would be easy to make equal reductions to e.g. the Social Security tax.)

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