Carbon Taxes Cut Emissions, Not Jobs or Economic Growth

It’s easy to poke fun at some economists’ apparent obsession with carbon taxes as the sole climate policy tool. Some appear to revel in making the case that we should tax carbon and only tax carbon. Meanwhile, it’s clear that carbon taxes alone aren’t enough, because more must be done than “just” price the negative emissions externality, and because of politics. Taxing something bad might be objectively good, but “tax” still appears to be a four-letter word in Washington, D.C.

But among all of these arguments, it would be too easy to overlook a simple fact: carbon taxes, done right, work. They cut CO₂ emissions. More surprising still, they might even boost the economy at the same time.

To see how, look to the European Union, and not to its flagship emissions trading system, the world’s largest carbon market. EU ETS, too, has cut emissions, even before its historically low prices began their continuing rally after some significant policy reforms. Emissions trading, however, does not stand on its own. EU ETS is part of a much more comprehensive climate policy package, including direct energy-sector policies and, in part, significant national legislation.

Carbon taxes constitute part of those national climate policies. They typically focus on sectors not captured by EU ETS, implying a focus outside the power sector and away from some of the most cost-effective emissions reductions. They also vary enormously by country, ranging from under $0.25 per ton of CO₂ covering a mere 4% of Poland’s CO2 emissions to over $125 per ton covering around 40% of Sweden’s. That coverage is only topped by Norway’s 62% at a level of around $50 per ton.

The wide range in levels and coverage is any environmentalists’ nightmare, pointing to the inadequacy of overall climate policy. Variability, meanwhile, is an economists’ dream, allowing them to estimate the impact of carbon taxes.

Gib Metcalf, an economics professor at Tufts University, and Jim Stock, an economics professor at Harvard, have done just that, estimating the climate and economic impact of Europe’s carbon taxes. Their verdict: raise taxes to $40 per ton CO₂ covering 30% of emissions, watch cumulative emissions go down by between 4% and 6%. That’s both a lot, and a little.

Carbon taxes lower emissions. That much is clear. Higher taxes, like those in Sweden, have larger impacts, lowering emissions by almost 11%. Smaller taxes, like Poland’s have almost zero impact. It is also evident that even the reductions in countries with ambitious taxes are not nearly “enough” in any sense of the term, pointing either to the need for significantly higher carbon prices still or to complementary policies that go well beyond carbon pricing itself.

Another recent analysis is clarifying there. Economists Ryan Rafaty, Geoffroy Dolphin, and Felix Pretis from Universities of Oxford, Cambridge, and Victoria, respectively, have analyzed the emissions impact of all carbon pricing policies, including carbon taxes and emissions trading systems like the EU’s over several decades. They find that all existing carbon pricing policies, from Poland to Sweden and in 37 other countries with levels in between, have reduced CO₂ emissions by between 1% to 2.5%. That’s “disappointingly small,” and  it leads the authors to a clear conclusion: carbon taxes alone won’t do.  It takes much more comprehensive climate policies that go well beyond carbon taxes and emissions trading alone.

Another conclusion, though, is at least as important, and Metcalf and Stock’s analysis is uniquely able to provide it: carbon taxes, even without any complementary measures like refunding tax revenues by lowering other taxes, do not lower either jobs numbers or GDP growth. If anything, they have a “modest” positive impact on both.

This conclusion goes counter to what might still be considered “standard” economic thinking. Climate policies might do a lot of good. Lower CO₂ emissions, after all, come with real, quantifiable benefits. But standard logic says that there must be costs. Tradeoffs, after all, are as ingrained in economic thinking as the logic that carbon taxes imply lower carbon emissions. Not so. 

Most strikingly, that evidence here is not linked to a major investment package like the American Jobs Act. It might be obvious to conclude that over $2 trillion in additional spending implies more jobs. Here, though, it is carbon taxes alone that do the trick. They not only come with no overall economic costs, but potentially with positive effects on both employment and GDP growth.

None of that means that carbon taxes or emissions trading could or should stand on their own. They don’t, can’t, and shouldn’t. It is equally clear, though, that supposed economic costs are no excuse not to include them as part of comprehensive climate policy.

Gernot Wagner writes the Risky Climate column for Bloomberg Green. He teaches at New York University and is a co-author of Climate Shock. Follow him on Twitter: @GernotWagner. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

©2021 Bloomberg L.P.

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