October 17, 2016

Policy Brief Looks at Increasing Emissions Certainty under a Carbon Tax

Nicholas Institute for Environmental Policy Solutions

While there’s growing interest in the use of a federal carbon tax as a means to reduce greenhouse gas emissions, some uncertainty exists about how the economy would respond to such a tax, in particular, just how much emissions would be affected. A new policy brief by researchers at the Duke University’s Nicholas Institute for Environmental Policy Solutions examines options for increasing emissions certainty under a carbon tax. Authors Brian Murray, Billy Pizer, and Christina Reichert discuss mechanisms that could increase emissions certainty under a carbon tax and the challenges and opportunities associated with each.

Various entities have released proposals on how to handle a carbon tax. Why was it necessary to write a policy brief that tackled the idea further?

Without weighing in on whether a carbon tax is the best policy choice, now is a good time to look more in depth at key design features in advance of more vigorous policy discussions. At the Nicholas Institute, we see our role as providing the kind of neutral policy analysis necessary to inform these discussions. One of the potential issues that a policy debate could discuss is how to deal with the tradeoff between the emissions certainty of a standard cap-and-trade approach to emission reductions and the price or cost-certainty of a carbon tax approach.

In the policy brief, you draw parallels to the idea of allowance price reserve. Can you explain how the parallel of an allowance price reserve, a feature of some cap-and-trade programs, is relevant to a carbon tax?

A carbon tax establishes a fixed fee per unit of emissions and thereby provides a certain price incentive to cut emissions. However, one possible concern regarding a carbon tax is that it does not ensure that the nation will achieve a specific emissions goal because uncertainty exists about the economy’s response to such a tax. This concern mirrors the reciprocal apprehension over allowance-price uncertainty (and ultimately cost uncertainty) under a cap-and-trade program, which does provide for a certain emissions outcome but the allowance price that will produce the emissions outcome is not known in advance because of uncertainties related to economic shocks, technological advances, and alternative policies. Moreover, just as policy mechanisms such as the allowance price reserve, which introduces additional allowances into the market when prices get high, can increase price certainty under a cap-and-trade program, so too can policy mechanisms increase emissions certainty under a carbon tax.

Describe in more detail what you discovered when you looked more closely at policy mechanisms for increasing the emissions certainty of a carbon tax.

If emissions outcomes under a carbon tax are above or below a given goal, policy makers have several policy mechanisms they could use to guide the emissions level toward the goal. These mechanisms include changing the tax rate or schedule, using traditional regulatory tools, using revenue spending, or applying hybrid approaches that combine elements of all three. Each mechanism comes with associated challenges and opportunities, which are identified and discussed in the brief.

If including any of the above mechanisms in a carbon tax, policy makers will need to determine the conditions that initiate their use. The brief initially discusses use of an automatic trigger codified in legislation, but the trigger could also be discretionary in response to changing conditions. Because Congress can always undo its own laws, discretionary adjustment could be viewed as the default. However, the discretionary option also includes variations that would either delegate authority or create nuanced differences in the kind of congressional action required.

What type of future work could one expect from the Nicholas Institute on carbon tax?

Given the growing discussion around a possible federal carbon tax, the Nicholas Institute expects to focus on issues that are likely to be important for policymakers and stakeholders but that need new research to provide insights into the consequences of key policy design options. This research could include, for example, additional work on mechanisms for adjusting a carbon tax to increase emissions certainty, how a carbon tax would interact with overlapping federal and state climate and energy policies, what the emissions, cost and revenue implications are for different tax scenarios, and how the use of collected revenues could affect the level and distribution of costs of the policy.

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This analysis was partially supported financially by a grant from the Environmental Defense Fund. To read this policy brief, visit our website. Brian Murray, Billy Pizer, and Christina Reichert are available for comment by contacting Erin McKenzie, erin.mckenzie@duke.edu or 919.613.3652.