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The Evergreen State’s Golden Opportunity to Lead on Climate

Time for Washington to become the first U.S. state with a carbon tax. 

How often do you have an opportunity to change history? The Washington State legislature does right now.

Back in my old home state of Washington, Senate Majority Leader Sharon Nelson and the rest of the State legislature has an opportunity to make Washington the first U.S. state with a carbon tax.

The bill has made it out of a Senate committee, but the legislature still has a lot of work to do. I hope they can get this passed. Like most economists, I strongly support the idea of putting a price on carbon. Let’s go Washington State. These opportunities don’t come along often.

ferry.pngNote: Ferry headed for Seattle. Image licensed under creative commons.

 

How Would the Tax Work?

Under the current proposal, the carbon tax would start low at only $10 per ton but then increase at $2 per ton each year until reaching $30 per ton in 2030. Economists differ in opinion about the right level for a carbon tax, but several studies have put the number at about $30 (e.g. here and here). Initially, the Washington State proposal would be well below this.

The tax would apply not only on the electricity sector and natural gas, but also on gasoline and diesel. The idea is to tax the carbon content of energy consumed within the state, so imported energy would be taxed; while exported energy would be exempt. Aluminum producers and certain other energy and trade-intensive industries would be exempt. My colleague Meredith Fowlie has written extensively about how to best include energy and trade-intensive industries in state-level carbon policies and on this issue Washington may be able to benefit from California’s experience.

This is not the first time that Washington State has tried to pass a carbon tax. But this time Washington State Governor Jay Inslee is pushing hard, Democrats control both houses of the Washington State Legislature, and the bill is being supported by the state’s largest utility as well as many of the state’s major companies.

WA.PNGNote: Washington State Governor Jay Inslee and Senate Majority Leader Sharon Nelson.  Images public domain here and here.

The clock is ticking. The legislature has only until March 8th after which the legislative session ends for the year.

 

Yes, Economists Love Carbon Taxes

Economists disagree about a lot of things, and love to be contrarian, but in a survey of economists, 90+ percent said they support a carbon tax. This is a remarkably high degree of consensus. Why?

“Totally basic economics!” as Stanford Economist Robert Hall puts it. One of the first lessons from any introductory economics class is that you want to tax activities that have bad side effects on other people in society. Over and over studies have shown that putting a price on externalities is lower-cost, and more efficient than other forms of regulation.

mankiw500wideNote: Harvard Economics Professor Greg Mankiw is a vocal advocate for the carbon tax, and founder of the “Pigou Club”.

 

Price Stability

Don’t get me wrong; I like cap-and-trade too. Both put a price on carbon emissions. Both are preferred to other more prescriptive forms of regulation. For economists, the two policies are very similar. But, if I could choose, I’d pick a carbon tax.

The advantage of a carbon tax is price stability. You know exactly how much it will cost to emit a ton of carbon dioxide. You know this for 2019, for 2020, etc. Not true with cap-and-trade. With cap-and-trade, the price of a permit depends on supply and demand and permit prices historically have been very volatile. This is true not only for the European Union’s Emissions Trading System (EU-ETS), but also for California’s cap-and-trade program, and for the Northeast U.S.’ Regional Greenhouse Gas Initiative (RGGI).

Two recent Energy Institute working papers here and here make this exact point. Authors Severin Borenstein, Jim Bushnell, Frank Wolak, and Matt Zaragoza-Watkins show that normal fluctuations in the economy mean that permit prices in a cap-and-trade program are very likely to end up at the ceiling or the floor.

 

Stable Prices Help Firms Make Investments

Stable prices make it easier for companies to make investment decisions. Imagine being a company in an energy-intensive industry, and not knowing whether next year’s carbon price will be $0 or $50 per ton. Makes it hard to act, no?

Economists have long shown that when there is uncertainty, companies invest less. See here and here. Why? Because when there is uncertainty, there is “option value” to delaying irreversible investments. Better to wait and see what happens, than to make a costly mistake.

Stable prices are even more important for innovative activities. It takes a long time and money to navigate the so-called valley of death – so a stable carbon price can be the difference between success and failure. We need big, game-changing technologies and a stable carbon price makes these more likely to happen.

fordNote: Ford recently invested $1 billion in an energy-efficient aluminum F150. Stable carbon prices encourage firms to make this type of investment. Image licensed under creating commons.

 

What to Do With the Revenue?

The one part of the bill that I’m not crazy about is the plan for the revenue. Under the current proposal, carbon tax revenue would go to green energy projects (50%), water and natural resource projects (20%), low-income programs (15%), and rural economic development (15%).

When Washington State voters failed to pass a carbon tax in November 2016, this was for a policy that would have been “revenue neutral”, returning all of the carbon tax revenues to households by lowering the sales tax by one percentage point and funding a $1,500 annual tax credit for low-income households.

I like the revenue neutral approach better. It may not be as politically popular, but decreasing the sales tax is good for the economy and good for households, particularly for low-income households who pay a disproportionate share of sales taxes. Moreover, the $1,500 tax credit would have made it a very progressive policy, reducing inequality in the state.

Instead, the current proposal puts revenue toward government spending. Hopefully this will be mostly “non-additional”, addressing existing funding needs. Many of the categories of spending certainly sound like good use of public funds, but as with all government spending it depends exactly how the money is used.

 

Golden Opportunity

But there is enough good here that I really hope the Washington State legislature can get this passed. If the legislature can’t get it done, then I look forward to seeing it back on the November 2018 ballot.

rainierNote: Autumn at Mount Rainier National Park.  Image licensed under creative commons.

Lucas Davis View All

Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.

10 thoughts on “The Evergreen State’s Golden Opportunity to Lead on Climate Leave a comment

  1. A simple carbon tax framework taxes natural gas at about half the rate as coal. This doesn’t make any sense considering the externalities associated with coal emissions go well beyond CO2.

    Gas Emissions compared to Coal
    Zero Mercury
    99% less SOx
    80% less NOx

    Why not implement a pollution tax on coal specifically? Didn’t California do this?

  2. It’s understandable that states, and even cities, are considering their own carbon pricing mechanisms given current federal dysfunction. But I wish leaders like Jay Inslee and Jerry Brown would at least level with citizens and point out that we are in emergency crisis mode and ONLY the federal government has the power to effectively respond. And that response should be a national, predictably rising, fully refunded, revenue neutral carbon fee, dividend and border carbon duty as advocated by the Citizens’ Climate Lobby and the Climate Leadership Council. As Dr. James Hansen laments, anything short of that amounts to “fatal incrementalism.”

    These two governors are to be praised for bringing the climate crisis to public attention, but they should simultaneously emphasize the need for action in Washington D.C., and keep shouting.

    See: Bending the Emissions Curve: Revenue Neutral Carbon Fee and Dividend
    https://climatecolab.org/contests/2017/carbon-pricing/c/proposal/1333986/edit

    • Inslee and Brown already get support in their states. It’s other states where they are disdained where the resistance is. Their speaking out doesn’t help. Their actions show that this can work.

  3. It would be good to have a state with a carbon tax but the modesty of this effort compared to their border neighbor British Columbia is unfortunate. The Washington State goal of $30/ton in 2030, 12 years from now, is equivalent to what BC will have in place this year–$C35/ton ($US 28/ton). Canada’s national carbon tax policy to start this year will go from $C10/ton to $C50/ton in 2022.

    The article continues the widespread narrative that cap and trade and carbon tax are essentially equivalent policies and cap and trade prices are volatile (based on 2013 article sourced in your blog). In fact, the prices are not so much volatile except early in the programs before they drop and become chronic low prices around the world. A decade into cap & trade in Europe (EU ETS) and New England/Mid Atlantic (Regional Greenhouse Gas Initiative) have resulted in low allowance prices for years: ETS around $4-9/ton and RGGI at $3-7/ton despite efforts to reform. Similar results around the world indicate systemic weaknesses with the cap and trade approach — not just vulnerability to economic swings (per your colleague Borenstein regarding California). The inherent errors and biases in the business as usual process (Wara, Michigan Journal of Environmental and Administrative Law), combined with energy trends that elude accurate prediction (natural gas prices, renewable costs) and “complementary ” renewable policies that undermine cap and trade create circumstances that cap and trade programs cannot cope with (despite banking, borrowing, . If the richest, best educated, most sympathetic political and public environments in Europe, New England and California can’t get cap and trade to work, what are the probabilities that developing countries with weak institutions and serious corruption will? The theory that cap and trade provides environmental “certainty” in reductions remains an academic postulation that ignores the empirical outcomes, considers only the institutional setting in advanced economies and ignores the assymmetry of information required. If there is no such environmental certainty (even when “properly designed”), what rationale remains for the complexity of cap and trade vs. the transparency, simplicity and certainty of an escalating carbon tax?

    Robert Archer

    • Robert, I have to agree with you on practical advantage of carbon taxes over cap and trade. I wrote my dissertation on comparisons of different permit trading regimes, e.g., emission reduction credits (ERCs and RTCs) and water transfers and the need to design complete sets of market institutions (published a paper on it in 1996). And I was involved in the implementation details of the AB 32 CTP. I came to see how complex the system would become, and that the simplest implementation method–awarding and trading allowances at the fundamental fuel source–was really no different than having a carbon tax with a variable rate. I think too often economists recommend policy actions without completely understanding full institutional and transactional implications. We made the same mistake in the 1990s after the Berlin Wall fel as Dan Bromley has pointed out, when we opined that markets would spontaneously arise without institutional and legal structures first.

      • I’m not familiar with the Bromley piece regarding the post-Soviet Union but I assume it applied to agriculture and/or land rights. I worked on the legal/regulatory/institutional reforms related to the electricity sectors in Central/Eastern Europe, Eurasia and the Balkans from 1990-2013. I must note your observation that legal and institutional requirements were ignored does not generally apply to the energy sector (Gazprom excepted). For the electricity sectors, the old centralized political/social utility in most countries were unbundled, modern legal frameworks put in place, separate competent energy regulatory bodies created, grid codes, market rules and licenses developed and partial privatization of distribution companies achieved with international strategic investors. This had a major impact on squeezing out some of the corrupt and environmentally disastrous practices. Despite this progress, I remain convinced that cap and trade remains a bad fit in such environments and in developing countries with weak institutions and serious corruption. See the website of the Energy Regulatory Regional Association (ERRA) at erranet.org for what was achieved in energy regulatory development over the 20+ years.

  4. This is indeed bold legislation, but the version that passed out of committee is far from an effective carbon pricing mechanism.

    Most significant: it exempts coal generated electricity from the carbon tax. There is one coal plant in Washington, and it is specifically exempt. This means that natural gas power plants will operate at a cost disadvantage to the coal plant, and emissions will actually go up under the legislation if the price differential is enough to make coal more competitive in the market. This ends in 2025 when that coal plant is required to cease burning coal, but until then, this legislation will cause an increase, not a decrease. Lawyers disagree whether this exemption will provide a basis, under the Commerce Clause, for out-of-state coal producers to claim the same exemption. If that happens, then the results are worse still.

    Second, the bill exempts dozens of industries from the carbon tax. This will not likely increase emissions, as those industries are unlikely to expand in any event, but it does eliminate their incentive to improve the efficiency of their operation or choose alternative fuels that would be the result of a carbon price.

    Finally, all agricultural fuel use is exempt, so incentives to improve fuel use in that large economic sector are being lost.

    The bottom line is that it’s about a twenty-cent increase in the cost of gasoline and diesel fuel, hardly enough to be noticed, much less make a big difference. And, it’s about enough to offset the effect of the recently-adopted tariffs on imported solar panels, by driving up the cost of natural gas generation, which is the swing fuel (after the coal plant is fully dispatched).

    To this economist, it’s one step in the right direction, one step in the wrong direction, and some immaterial dancing around in-between.

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