How much are you willing to spend to save the earth? How about an extra 89 cents per gallon? That’s about how much a nationwide carbon tax would cost every time you stop for a gasoline fill up. Whether or not you think that’s affordable could very well presage how well you’ll adjust to a hypothetical Biden administration.
Source: Forbes
Joe Biden’s plan for climate and energy broadly proposes a carbon price. The mechanism is so far unclear, but will be informed by established carbon pricing measures enacted by state and local government, as well as protocols adopted at universities and corporations.
There are many misconceptions. Some environmentalists and fossil fuel producers fervently believe that a carbon price will spell the end of fossil fuels. No. It will raise the cost for consumers, who will then follow their wallets to change their energy consumption.
Carbon Pricing—The Proper Mechanism
The Waxman-Markey bill of 2008 was passed by the U.S. House of Representatives but not taken up by the Senate during the financial crisis. Under that bill, the carbon pricing mechanism would have been cap-and-trade, whereby the federal government would set specific carbon emission limits and provide a marketplace for the trading of credits among the market participants. An emissions source that stayed under its cap would earn credits that could then be sold. The less carbon emitted, the more credits. The dirtiest of coal-fired power plants, for example, could make more money from the credits by shutting down and not producing electricity.
In practice, cap-and-trade markets are fraught with bureaucracy, extreme price volatility for the credits, and occasionally fraud. Caps are notoriously difficult to set and perhaps subject to politics. In economic downturns, such as during this pandemic or as was demonstrated in the European Union in 2008-09, the decline in economic activity means that the caps are not binding and therefore ineffective. The value of the credits plunges to zero. Enforcement mechanisms are vague. In an analogous market involving the Environmental Protection Agency’s Renewable Identification Numbers (RIN) market, Philadelphia Energy Solutions flagrantly ignored the federal requirements and left the government holding the bag on more than $350 million in unpaid obligations during its first bankruptcy in 2018 and an additional $25 million in the most recent bankruptcy.
But while MBAs, accountants and day traders love the prospect of cap-and-trade, economists, industry and consumers prefer the certainty of a carbon tax. Politicians love the ability to curry favor with well-heeled constituents and hedge funds, and they persist in thinking that consumers do not see the carbon price because cap-and-trade is imposed at the industrial level. As the real world has shown with cap-and-trade around the U.S. and the world, consumers always pay.
Economists prefer a tax because it is easier to gauge results and easier to administer. Think about the state and federal alcohol tax—could you really imagine a cap-and-trade tax for alcohol in practice at a Wall Street bar? A college bar? On this basis alone, a carbon tax makes sense!
A carbon tax would be administered at the point of production, where all of the other taxes on a fuel resource are collected: at the mine for coal; at the wellhead or import terminal for oil and gas. There would be a certain cost per ton of coal, per barrel of oil, and per thousand cubic feet of natural gas. There would be no ephemeral markets trading derivatives upon derivatives. The price would show up at the pump or electricity meter for all consumers on the pure basis of their consumption. The government would not be picking favorites.
Corporate managements and shareholders do not like uncertainty. A carbon tax would provide certainty. Even 12 major oil companies have come out in favor of a carbon tax.
Cost of Carbon—The Industrial Version
On a heat equivalent basis the Energy Information Administration publishes a table of carbon dioxide emissions and fuels per million British thermal units. Applying a carbon tax here is an easy exercise for industrial users who think in terms of heat equivalents. For the ease of calculation, assume a carbon tax of $100 per metric ton of carbon. At a conversion rate of 2,204.62 pounds per metric ton, a carbon tax of $100 per metric ton equates to 4.54 pennies per pound of carbon, and per 1 million Btu—
Cost of Carbon—The Consumer Version
Let’s calculate the cost of carbon for everyday activities so that you can look at your bills and estimate what the added expense of a carbon tax will be. Again, at 4.54 pennies per pound, the consumer will face the following carbon taxes for transportation and home heating—with heat content noted—
Consumer Carbon Tax HIRS
For electricity, the EPA and the EIA have several websites for calculating greenhouse gas emissions for different electricity generation sources. Assuming a monthly bill for 2,000 kWh of electricity, a homeowner would have produced 4,420 pounds of carbon dioxide if fueled by coal and 1,840 pounds of carbon dioxide if fueled by natural gas.
Carbon Tax Per Electricity Generation Source HIRS
Filling up a 15-gallon gasoline tank twice a month under this carbon tax will add $26.70 each month. And the addition to the electricity bill could be as much as $200.49 for those utilities that rely exclusively on coal. In practice around the country, the mix of generation sources will result in a much lower carbon tax bill.
For consumers, energy demand is very inelastic in that it takes major price changes before a consumer changes behavior. Will an additional $26.70 per month result in consumers switching to electric vehicles, especially when the cost of carbon is included in the electricity charge? The use of biofuels will change the calculations. Fossil fuels make use of carbon that has been effectively stored for 3 to 4 million years while biofuels from agriculture and animal fats make use of carbon that has been in the atmosphere for 1 to 4 years. Biofuels will not be subject to a carbon tax except to the extent the producers have to pay for fossil fuels in their production processes. Will utilities retire their fossil fuel mix of generation to help consumers avoid the high carbon charges? The low price of natural gas has almost eliminated coal from the power mix already, and any carbon price would surely finish coal.
These numbers are just orders of magnitude reduced to the consumer’s perspective. Implementation would likely be phased in over time to lessen the immediate impact, but carbon pricing is already here for many Americans, and it is on the horizon for the rest.
