Re-evaluating the "Answer" to Climate Change

By Elliot Witter

Free money is never really free. In an opinion piece for the February 8th print edition of the Wall Street Journal, former U.S. Secretaries of State George P. Shultz and James A. Baker III make the case for a “Conservative Answer to Climate Change”. In their argument, they propose a gradually increasing carbon tax, carbon dividend payouts to the American people, border adjustment taxes for carbon content, and a rollback of government regulations (1).  While their points have merit in the abstract, I contend that the details within their article paint too rosy a picture for solving an immensely complex issue such as climate change. In this article, I’ll attempt to lay a groundwork for viewing a carbon tax, as well as some of the economic implications that Mr. Baker and Mr. Shultz’s plan would bring.

In general terms, a carbon tax is a dollar amount assessed per unit of weight of carbon dioxide released into the atmosphere as a result of combustion ($15 per ton, for example). This tax can be applied to producers or consumers, but for simplification purposes, we’ll treat it as a tax to the companies supplying the carbon-rich fuels. The idea behind this tax is to shift the burden of emissions from the population to the companies. Fundamental to this idea is the assertion that increased CO2 in our atmosphere creates negative externalities; some of which may be damage to crops, rising sea levels, flooding, higher health-care costs from heatwaves, damage from droughts, etc. (2). When companies are taxed on the amount of carbon dioxide they emit into the atmosphere, they will be pressed into either curtailing emissions or finding alternative fuels and energies in order to maintain profitability in the long run.

Going back to the article, we can see how Shultz and Baker would make a carbon tax work in practice. Companies would pay taxes on the weight of CO2 emissions they produce, and the proceeds from this tax would be paid directly to all Americans in the form of a carbon dividend. They suggest that if a $40-per-ton carbon tax were in place, it would provide a typical household with around $2,000 in dividends its first year. This sounds fantastic, and the numbers check out, given that Americans produced roughly 16.4 metric tons of CO2 per capita in 2013 (3). However, we must be wary of their pivotal conjecture: $40-per-ton.

In theory, their assumption of a $40-per-ton carbon tax is not unfounded, seeing as the U.S. government places the social cost of CO2 to be $37 per ton (4). This means that a ton of atmospheric carbon dioxide creates additional costs to society (some of which are noted above) of $37 above what it actually cost to produce that ton through combustion of petroleum, coal, and/or natural gas. By assessing a $40 tax on each ton, I assume they are attempting to get companies to completely internalize the cost of CO2. In practice, however, a $40-per-ton tax across the board is where their logic breaks down.

Different fuel sources have vastly differing rates of efficiency. For instance, in order to produce 1 million Btu’s (British Thermal Units; a measure of heat) with natural gas, you would create 117 pounds of CO2 in the process (5). To get the same amount of heat with coal, however, you would create around 210 pounds of CO2 in the process (6). This difference in efficiency has been a major factor behind our nation’s shift towards natural gas; it burns relatively cleaner. When looking at carbon taxes, a flat application would impact some industries far more than others, specifically due to these differences in efficiency. I will illustrate this with some numerical examples.

The U.S. Energy Information Administration reports that one short ton of coal with a carbon content of 78%, which is a very reasonable amount for anthracite, will produce 5,720 pounds or 2.86 short tons of carbon dioxide (7). If you multiply the tonnage of carbon dioxide produced by a $40-per-ton carbon tax, you will find that for every ton of coal burned, you will face a tax of $114.40. Seeing as the price of Central Appalachia coal was around $50 per ton as of February 10th, a $114.40 tax would increase costs by over 228% (8). Clearly, a tax of this magnitude would be absolutely devastating for any company in the coal industry. Looking at petroleum and natural gas offers great concern for the $40-per-ton tax as well.

One ton of CO2 is produced for every 2.33 barrels of crude oil consumed (9). This equates to $116.50 in crude for every ton of CO2 produced, assuming an oil price of $50. A $40-per-ton tax in this instance would therefore be a tax of 34%. Finally, one ton of carbon dioxide is produced for every 17.1 million Btu’s of heat produced from natural gas (10).  Using the industrial price of natural gas from November 2016, which is $3.86 per thousand cubic feet, translated into the cost per million Btu’s ($3.74), we can calculate a cost of $63.93 for every ton of CO2 produced (11). A $40-per-ton carbon tax would mean a 62% increase in price for companies that rely on industrial natural gas.

Looking at the respective price increases as a result of a $40-per-ton carbon tax, we can see that its implementation would be extremely damaging, not only for companies, but for consumers as well. It is foolish to expect a company to survive a 228% tax without passing most of the costs over to the consumer in the form of higher prices.  With this tax in place, we could expect much higher utility and gas prices, as well as higher costs across the board due to energy’s pervasiveness in our lives. The costs would quickly eat up the dividends received, and would hit lower-income families especially hard, since utility and energy expenditures represent a greater share of their income than those with greater means.

I believe a carbon tax would be an effective means of making the transition to a more sustainable planet, but the way we implement it must be subject to intense evaluation. The $40-per-ton figure that Shultz and Baker used was merely a means to reach the $2,000 dividend payment for each family. In reality, it should be the other way around. Carbon needs to be taxed at rates that take into account the relative efficiency of each fuel (i.e. carbon from coal must be taxed at a lesser rate than carbon from natural gas). Doing so would produce an average carbon tax amount of far less than $40-per-ton, meaning dividends would be much lower than the $2,000 per family figure.

In addition to their support of a carbon tax and carbon dividend, Shultz and Baker advocate the implementation of a border adjustment tax. Companies would receive carbon tax rebates for exporting energy to countries that do not have similar carbon-tax laws in place, and would have to pay a carbon tax on imported carbon. This proposal would not only diminish the carbon dividends paid to the American people as a result of companies’ lowered tax burden, but it would also encourage the selling of energy to countries that have not taken similar steps to reduce atmospheric CO2. One could make the argument that selling cheaper energy to countries with less regulation, who are usually developing, could make the world more equitable. On the opposite side, it is encouraging the use of fossil fuels for countries that have the least infrastructure in place to mitigate their social costs.

In many respects, I agree with Shultz’s and Baker’s call for carbon taxation and the reduction of federal regulations. A gradually increasing tax that starts small would indeed send a powerful message to companies, while simultaneously giving them time to pivot their production and consumption of energy in a more natural way. Still, I argue that it is important to understand the complexity of instituting such a task, rather than abstracting away the essential details. Carbon dividend payments, while a brilliant political move, would not approach the $2,000 mark per household as suggested by the article. This is because a $40-per-ton tax would be wholly unreasonable if applied broadly. It needs to differ with the relative efficiency of the fuel in question. In the end, American families may have to settle for a fraction of $2,000, but it's a worthwhile reduction to pursue a sustainable planet in the fairest way.

Works Cited:

  1. George P. Schultz and James A. Baker III, “A Conservative Answer to Climate Change,” Wall Street Journal, February 8, 2017.
  2. “Pricing Carbon,” The World Bank, accessed February 11, 2017, http://www.worldbank.org/en/programs/pricing-carbon#WhyCarbonPricing.
  3. “CO2 Emissions (Metric Tons per Capita),” The World Bank, accessed February 11, 2017, http://data.worldbank.org/indicator/EN.ATM.CO2E.PC.
  4. Ker Than, “Estimated social cost of climate change not accurate, Stanford scientists say,” Stanford News, January 12, 2015, http://news.stanford.edu/2015/01/12/emissions-social-costs-011215/.
  5. “Carbon Dioxide Emissions Coefficients,” U.S. Energy Information Administration, accessed February 11, 2017, https://www.eia.gov/environment/emissions/co2_vol_mass.cfm.
  6. “Emissions Coefficients,” U.S. EIA, February 11, 2017.
  7. “Carbon Dioxide Emissions Factors for Coal,” U.S. Energy Information Administration, accessed February 11, 2017, https://www.eia.gov/coal/production/quarterly/co2_article/co2.html.
  8. “Coal Prices and Charts,” Quandl, accessed February 15th, 2017, https://www.quandl.com/collections/markets/coal.
  9. “Greenhouse Gases Equivalencies Calculator - Calculations and References,” U.S. Environmental Protection Agency, accessed February 11, 2017, https://www.epa.gov/energy/greenhouse-gases-equivalencies-calculator-calculations-and-references.
  10. “Emissions Coefficients,” U.S. EIA, February 11, 2017.
  11. “United States Natural Gas Industrial Price,” U.S. Energy Information Administration, accessed February 11, 2017, https://www.eia.gov/dnav/ng/hist/n3035us3m.htm.