This brief is the first in a 4-part series on carbon tax and credit policy in the United States: carbon tax, carbon fee & dividend, cap & trade, and discussion.

A carbon tax is a fee on emissions that aims to reflect the additional costs created by fossil fuels while also providing a financial incentive to switch to more renewable sources of energy. There are several aspects of a carbon tax to consider: 

1. The scope: which types of greenhouse gases and industries are subjected to the tax 
2. the point of taxation: the part of the supply chain being directly taxed 
3. Border carbon adjustments: a tool to maintain global competition by taxing imports and compensating exports that are coming from and going to countries without a similar carbon tax 
4. Regulatory pauses: a pause on overlapping EPA emissions regulations
5. Distribution options: how the tax revenue is distributed

Currently, no carbon taxes have been implemented in the United States at a federal or state level, but multiple bills have been recently introduced in Congress.

Figure 1: Highlights the tax rates under the many carbon tax proposals introduced in Congress, which range from taxing carbon at $20/metric ton to $150/metric ton.

Figure 2: Highlights specified allocation strategies under the many carbon tax proposals introduced in Congress, including tax cuts, national deficit reduction, subsidies to renewable energy, and lump-sum dividend payments.

Benefits of Carbon Taxes

First, carbon taxes have the potential to raise a large amount of revenue, which can be used to reduce other taxes, subsidize green energy, or pay costs related to pollution, such as oil spills and contaminated air. A 2017 study by the U.S. Department of Treasury estimated that a $49/metric ton tax on carbon dioxide (that steadily increases to $70/metric ton after 10 years) could raise nearly $2.2 trillion in net revenue from 2019 to 2028. 

Second, carbon taxes have the potential to reduce emissions quickly; however, this depends on the tax rate and how much the tax increases over time. One example of these drastic emission reductions was highlighted in a joint paper from the Urban Institute and Brookings Institution. The estimate found that an initial $20/metric ton tax that grows 5% faster than inflation per year could reduce emissions by over 20% after 15 years and over 30% after 35 years. Sweden implemented a carbon tax in 1991 and has seen a 25% reduction in emissions since 1995, while their economy expanded 75%. Today, Sweden taxes carbon at USD $127/metric ton.

Downsides of Carbon Taxes

First, without implementing certain allocation strategies, a carbon tax can be regressive. Firms which produce carbon-intensive goods (like energy companies) will be forced to raise their prices if they are unable to sufficiently reduce emissions. Lower-income households spend a larger proportion of their income on carbon-intensive goods, such as gasoline and electricity, so a tax on carbon would burden those individuals more than high-income households by making the goods they purchase more expensive.

A carbon tax may increase the risk of potential outsourcing. Companies may relocate their manufacturing processes to countries with fewer restrictions on emissions, making the U.S. less competitive in the global market. In theory, border carbon adjustments attempt to reduce this outsourcing risk through taxing imports based on their carbon footprint, levelling the playing field for domestic industries by raising the price of goods produced in countries without a carbon tax. However, there are still numerous complications in determining the taxes and rebates to be implemented. 

Carbon taxes have historically been politically unpopular in the United States. Many consumers are adverse to new taxes, especially if they believe the tax is not “revenue neutral,” meaning that overall tax revenue to the government does not change. However, recent polling by the Yale Program on Climate Communications found that 67% of registered voters supported a tax that forced fossil fuel companies to pay for their emissions as long as that revenue was used to reduce other taxes to remain revenue neutral. More recently, a 2020 Pew Research Center poll found, for the first time ever, more than 50% of Americans reported that protecting the environment and combating climate change should be a top priority for the President and Congress.