Ask a Professor: Why a Carbon Tax?

Ask a Professor: Why do economists advocate for a carbon tax?

Heading off climate change is going to be costly, although not nearly as costly as letting it continue unchecked. We need to drastically shift our production and consumption patterns toward lower-carbon goods and services. A carbon tax is the cheapest way to do this. It does so by forcing the prices of goods to include the damage the good incurs on the climate.

Last year, more than 3,000 economists of all backgrounds (specialties and political parties) signed a statement in favor of a carbon tax. This broad support indicates both the severity of the situation (we can observe the negative economic consequences of climate change in current data) and the strength of the carbon tax as a solution.

From the gasoline that fuels our cars to the electricity that powers our homes, a vast number of goods we consume directly or indirectly generate greenhouse gases and therefore impose costs on current and future generations. Because neither producers nor consumers are responsible for these costs, markets underprice polluting goods, and too much pollution is generated. For example, a large fraction of our electricity comes from burning coal because it appears cheap, if we don’t account for its considerable impact on the climate and human health. A carbon tax corrects this problem by adjusting the prices of goods to reflect the greenhouse gases they generate and tilts the market in favor of lower-carbon goods.

The carbon tax’s impact on most goods would not be huge. Like any climate policy, it would raise price levels for energy-intensive goods, so the cost of gas or electricity, for example, might increase approximately 20 percent. We expect this will place a disproportional burden on households at the lower end of the income distribution. To address this issue, economists recommend rebating the carbon tax revenues (which would be substantial) back to households or cutting other taxes.

A carbon tax is the cheapest way to lower greenhouse gases because it induces reductions across all activities and sectors, provided they are regulated. With a tax on carbon, solar panels and windmills, efficient vehicles and homes, biking to work, vegetarian meals, and putting research dollars toward low-carbon innovations will become more appealing. Other policies, such as emissions standards or clean energy mandates, could also drive a transition toward low-carbon goods. But, this approach would require a daunting number of policies to induce the same adjustments as the carbon tax. Moreover, standards and mandates may be onerous for consumers and industries with limited low-carbon alternatives. With a carbon tax, these goods can still be consumed if one is willing to pay for the goods’ true cost.

Rick Klotz, an assistant professor of economics, researches environmental economics with a focus on climate, energy, and environmental policies.

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