Washington Center for Equitable Growth

Climate change might be the world’s most complex public policy problem. It is more global, more long-term, more irreversible, and more uncertain than most other policy challenges and probably unique in the combination of all four factors. Given this daunting mix, it is all too tempting to look for a simple fix.

Economists have long pointed to carbon pricing as just such a fix: Increase the price of carbon emissions and watch emissions decline. The theory is indeed compelling. In fact, it is based on the one and only law in all of economics—as the price of something goes up, the quantity demanded goes down.

The practice, alas, is not quite as simple. For one, there are other market failures and hurdles to overcome in transforming the world’s economies from their current high-carbon, low-efficiency path toward a low-carbon, high-efficiency one. Second, politics. Despite the ample warnings and evidence we have been receiving for decades, the United States and others have taken only modest steps to reducing carbon dioxide and other greenhouse gases that contribute to climate change.

To help provide a path forward for policymakers, Jesse Jenkins of Princeton University, Leah Stokes of the University of California, Santa Barbara, and I convened a virtual workshop of academic and policy experts in March 2020 to discuss the current state of policy in the United States and around the world. The discussions addressed such challenges as how to:

• Price carbon and establish a politically viable regimen to significantly reduce its use
• Allocate any revenues that might accrue from a carbon pricing policy, including addressing effects on low-income households and communities, as well as those economically dependent on the production or use of fossil fuels
• Make such policies fit in with measures that regulate emissions and fuel use
• Foster low-carbon innovation

The participants included economists, political scientists, energy and innovation experts, lawyers, and leaders and experts from government agencies, nongovernmental organizations, foundations, and advocacy groups. More than 70 individuals gathered online to help make the workshop a success.

The convening was made possible by financial support from the William and Flora Hewlett Foundation, the Alfred P. Sloan Foundation, the Washington Center for Equitable Growth, and the Niskanen Center, and it was hosted and facilitated by New York University’s Robert F. Wagner Graduate School of Public Service. The resulting workshop report  summarizes the discussions and conclusions of the participants. I summarize these results below.

Carbon pricing

Carbon pricing can be one of many effective tools available for harnessing market forces to reduce the use of carbon-based fuels, drive innovation, and spur the adoption of clean energy technologies. Carbon pricing can be deployed through taxes or through a cap-and-trade system that limits overall greenhouse gas emissions from factories, utilities, and other facilities, and permits owners to buy and sell the ability to emit greenhouse gases within that overall limit, thus establishing a price for each ton emitted.

Political constraints, however, have made carbon pricing a difficult proposition in the United States and elsewhere for policymakers seeking to set either carbon taxes or cap-and-trade limits at levels sufficient to have a meaningful impact on emissions.

Carbon taxes are a direct means of both reducing the use of fuels that emit greenhouse gases and raising revenues to ameliorate the impact on low-income households—through such measures as “carbon dividends”—and invest in such initiatives as clean energy and mass transit. But while the public is supportive of some versions of a carbon tax, voters have a history of rejecting them at the polls when given the chance, often due to significant opposition from the fossil fuel industry.

The use of revenues can affect a policy’s effectiveness and political feasibility. Dedicating some of or all revenues toward clean energy projects, research and development, and such infrastructure investments as smart grids and mass transit not only contributes to decarbonization but also increases public support. But the use of revenue to ameliorate the inequitable distribution of the costs and risks of climate change across households, firms, and regions can help address the issues of fairness and environmental justice.

This can be achieved by, say, rebating some revenues in the form of income tax cuts for low-income families or providing support for businesses or regions that are heavily energy-dependent, or even addressing other spending needs. These revenue uses are not mutually exclusive. A hybrid approach can balance competing imperatives.

The most significant political problem facing measures that raise the price of carbon to reduce its use is that the organized interests that face the concentrated costs imposed by those measures marshal resources to weaken or defeat them. Moreover, in countries with high economic inequality, such as the United States, carbon taxes can result in an unequal tax burden if they are not accompanied by complementary policies to assist low-income households. The societal benefits of reduced carbon emissions—the goal of these measures—are well-recognized by the public, but they also are diffuse and often delayed.

The political challenges facing carbon pricing policies lead to significantly weakened versions, but they also point to a broader approach. Public opinion research shows the highest support for indirect measures of establishing a price, such as clean energy standards and investments in energy research and development. Advocates for standards combined with investments in clean energy argue that these policies can more effectively achieve the desired, popular outcomes and that they are more politically achievable. Meanwhile, when regulations do not produce revenue, they leave less room to address the potential regressive impact of those measures through benefits for affected populations. Advocates argue that using revenues from the existing progressive tax system can help to assuage those concerns.

Addressing environmental justice also needs to be a key component of climate mitigation measures. Communities of color are burdened not only by their disproportionate proximity to sources of air and water pollution, but also by the disproportionate impact they experience from such climate change phenomena as natural disasters, increasing heat waves, and rising sea levels.

Solutions have the same potential. For instance, if polluting facilities located in these communities have the option of maintaining or even increasing emissions at those facilities by purchasing allowances or paying a tax, then communities could see their disproportionate exposure maintained or increased. Likewise, these communities can suffer the regressive effects of a carbon tax if revenues are not used to ameliorate the distributive impact. So, another question policymakers face is how mechanisms can be designed to support environmental justice.