Book Review: “Can We Price Carbon?”

That’s not a rhetorical question.  Jurisdictions around the globe have struggled for more than two decades to price carbon emissions.  The results are mixed and frankly disappointing, judging by the number of policy failures, the small tonnage of CO2 emissions avoided or the global trend of rising emissions.  But failure analysis can be a powerful teacher.[1]  The Wright brothers crashed a few airplanes and had to re-think their design before they built one that could stay aloft even for a short distance.  Thus, meticulous analysis of carbon pricing policy experiments would be reason enough to recommend “Can We Price Carbon?” by Barry Rabe, professor of political science at the University of Michigan’s Gerald R. Ford School of Public Policy.  But Rabe’s new book offers much more.  It’s a thorough, readable, balanced and remarkably well-documented comparative overview of attempts at carbon pricing policy, primarily in North America, with abbreviated examinations of carbon pricing attempts elsewhere, all viewed through the lens of political science.

Rabe, now steeped in climate policy, traces his interest in tax policy as a behavior-modifier to the 1970’s when he ghost-wrote for his father, a Chicago cigar salesman, under pressure to compose jeremiads against tobacco regulation and taxation.  Rabe opens his book by sketching the history of excise taxes on tobacco, which in four decades have more than quadrupled the price of cigarettes while funding programs to further discourage smoking, cutting in half the number of cigarettes smoked in the U.S. and reducing the number of new smokers even more dramatically.

After acknowledging the relentless chorus of entreaties from economists imploring climate policy to follow the tobacco example by “putting a price on carbon,” Rabe shows why carbon pricing poses a “super wicked problem” for political leaders.   They understandably are reluctant to impose immediate and highly visible costs on their constituents in order to avoid inchoate future harm.  And, of course, politicians also face a vocal minority who doubt that global warming is or will become a serious problem.  Instead of carbon pricing, elected officials tend to prefer policies like procurement mandates, such as “Renewable Portfolio Standards” (RPS) adopted by more than half of states, requiring utilities to buy a specified fraction of their electricity from “renewable” sources.  While RPS mandates offer a lighter political lift and have successfully expanded renewable electricity generation, economists point out that RPS’s represent a hidden, regressive cost, and do not push energy consumers to conserve and improve efficiency.  Finally, because RPS’s typically are limited to a set of existing technologies, they do not to tend to spur research and innovation on new options in the way that robust carbon pricing would.

Having set the stage, Rabe launches into “Why carbon pricing has often failed.”  For me, as a climate policy advocate, this chapter feels like a spooky graveyard tour, with stops at President Clinton’s “BTU tax,” the 1400-page Waxman-Markey cap-and-trade bill that passed the House but expired in the Senate, Canadian Liberal Party leader Stephane Dion’s ill-fated (perhaps politically suicidal) “Green Shift,” Australia’s carbon tax (enacted, then promptly repealed after a anti-tax wave election), as well as state and provincial efforts including Manitoba and Alberta, the Midwest Greenhouse Gas Reduction Accord as well as the 2016 Washington state initiative, I-732.

The graveyard tour foreshadows several of the book’s recurrent themes.  First, the “hubris” of early carbon pricing advocates (including myself) who embraced the compelling economic logic of carbon pricing, hoping that enactment would follow and be “sufficient to launch and sustain it… much as… earlier policies such as Nordic carbon taxes and [U.S.] sulfur dioxide cap-and-trade.”[2]  Second, citing Alberta’s carbon tax as an example, Rabe warns that carbon pricing can be “used for symbolic purposes, enabling a government to look good politically through use of a heralded policy tool while not really accomplishing anything.”[3]  And finally, Rabe suggests ever-so-gently, that political constraints may not allow carbon prices to rise to levels that would justify eliminating complementary policies such as regulations and mandates.

After his graveyard tour, Rabe turns the lights back on with “When Carbon Taxes Work,” focusing primarily on British Columbia’s “textbook” revenue-neutral carbon tax.  By 2007, warmer winters in the province had eliminated the extreme cold needed to control the mountain pine beetle, now wrecking highly visible and widespread damage on British Columbia’s prized forests.  Responding to public alarm, Gordon Campbell from the centrist Liberal Party campaigned on a carbon tax, inserting it as a “wedge” to win election in a three-way race.[4]  Campbell quickly enacted and rapidly implemented[5] the tax, initially set at $10 (Canadian)/tonne CO2 and scheduled to rise to $30 in $5 annual increments.  In 2009, Campbell handily won re-election, in what amounted to a referendum on the carbon tax.  In addition to its remarkable popularity, several credible analyses concluded that BC’s carbon tax was even more effective than expected at reducing emissions, while BC’s economy grew faster than the rest of Canada.[6]

The popularity and durability of BC’s carbon tax is widely attributed to Campbell’s decision to guarantee return of all carbon tax revenue via direct distributions, tax cuts and credits to individuals and businesses.  But a skeleton lurks here too.  BC’s carbon tax is not revenue-neutral, it’s revenue-negative, bleeding BC’s treasury from the start.  It’s becoming a fiscal hemorrhage as subsequent governments have stopped raising the tax rate and added numerous tax “expenditures,” costly exemptions or rebates for special interests including fossil fuel related businesses.  Rabe observes, “[c]hronic revenue negativity [of BC’s carbon tax program] may work to further deter future rate increases, given the likelihood that additional revenue would be used to reduce the fiscal imbalance rather than provide new benefits.”[7]

As BC’s carbon tax was ramping up, its shale gas (“fracking”) industry began to boom outside the purview (and carbon-reducing influence) of the tax.  Like most carbon taxes, BC’s carbon tax falls on fossil fuel consumers within the jurisdiction; it does not apply fossil fuel produced for export.  This underscores a key point Rabe makes later in the book about the advantages of severance taxes imposed on fossil fuels at the point of extraction.  Measured in total revenue, state severance taxes imposed by fossil fuel producing states are by far the largest “price on carbon” in North America.[8]  Seven, largely “red” states, including Alaska, North Dakota, Wyoming, Oklahoma and Texas have established durable and politically popular sovereign wealth trust funds.  Texas and Wyoming rely heavily on trust fund revenue to support education.[9]  Unlike carbon taxes or cap-and-trade systems that impose costs on in-state consumers, severance taxes offer a unique political advantage: they fall primarily on out-of-state fuel consumers.  Long before anyone proposed carbon taxes, severance taxes were established as important and reliable revenue sources in energy-producing states.  In the 1980’s, when severance taxes faced threats of federal preemption, Wyoming Senator Malcolm Wallop thundered, “No one can calculate the impact of oil loss, of erosion, of loss of habitat for wildlife. Who makes the judgment that it exceeds legitimate social costs? Have you been to Wyoming and seen those social costs?”[10]  As Wallop’s quote vividly illustrates, a severance tax can build its own political constituency even in conservative energy-producing jurisdictions.  A severance tax on BC’s shale gas production could surely offer enormous benefits, perhaps dwarfing the revenue and climate benefits of its now-stagnant carbon tax.

Having offered British Columbia as a hopeful example of a carbon tax that worked (at least initially), Rabe plunges into examination of two U.S. cap-and-trade policies that have endured and enjoyed a modicum of success.  In the Regional Greenhouse Gas Initiative (RGGI) an interstate emissions trading system covering the electricity sector in ten northeastern states,[11] over-allocation of “allowances” (permits to emit CO2) has resulted in tiny prices (approximately one fifth of the price set by British Columbia’s explicit carbon tax), leading some observers to characterize RGGI as a “toy” or a “joke” of a cap-and-trade system.  In response to such concerns, RGGI added a $2/T CO2 price floor which could be gradually raised to provide a more robust price signal while also augmenting its revenue stream over the long term.

Despite RGGI’s anemic price signal, Rabe suggests that it “revolutionized” cap-and-trade into a revenue-producing system by auctioning all permits, rather than distributing most of them for free to emitters as previous cap-and-trade systems including the European Union’s Emissions Trading system (“EU ETS”) did and the 2009 Waxman-Markey bill would have done.  Full auctioning of permits provides a steady stream of revenue for states to dedicate to energy efficiency, renewable energy and demonstration projects that have proven politically popular, contributing to the durability of RGGI, which at 16 years old, has outlasted every other cap-and-trade policy in North America.  RGGI’s efficacy at reducing emissions remains less clear; but one particularly enthusiastic study concluded that the region’s emissions would have been 24% higher without the program.[12]

Next up is California’s cap-trade-offset program, AB-32 which Professor Rabe aptly describes as “a work in progress.”  California chose cap-and-trade in part to work around the state’s requirement of a two thirds legislative majority to enact tax measures.  The resulting legislation and regulatory framework starkly represent the antithesis of a simple, explicit carbon tax.  By all accounts, AB-32 could not have launched and or been sustained without the diligent efforts of Mary Nichols, chair of California’s Air Resources Board (CARB), an agency whose resources and depth of expertise remain essential to administer the multi-faceted program.[13]  As in the EU ETS, “offsets,” which credit emissions reductions or carbon sequestration beyond the capped entities, offer an alternative compliance mechanism for emitters who would otherwise be required to buy allowances.  Cheap and often questionable offsets  have raised serious questions about the environmental integrity of California’s program.  In response, CARB ratcheted up its oversight of offsets and cut the fraction of offsets available in its carbon market.

California’s attempted linkages with other jurisdictions have also proved problematic.  The latest is a link with Quebec which seems to be seeking new markets for its abundant hydro-electric power.  Because much of California’s electricity is supplied from out of state, apparent “resource shuffling” to provide “renewable” energy to California while increasing fossil fuel generation for other states has raised concerns that net emissions reductions are chimerical.  And finally, recognizing that price volatility and extremely low carbon prices undermine the fundamental purpose to “price carbon,” CARB added a “price floor” of $10/T rising 5% above inflation annually.  These administrative “fixes” and “patches” illustrate Rabe’s point that cap-and-trade requires ongoing expert oversight and management to be workable and effective.

As with other carbon pricing systems, revenue use dominates political debate about California cap-and-trade system.  The lion’s share of auction revenue funds high speed inter-city rail, affordable housing and intra-city transit.  California’s ETS faces ongoing challenges from environmental justice advocates who suggest that emissions trading concentrates emissions of CO2 as well as conventional health-damaging pollutants in disadvantaged communities.  The Environmental Justice Alliance has called for replacement of California’s cap-and-trade system with a transparent carbon tax.  Severance taxes which might provide simpler, more transparent mechanisms to price carbon, have thus far failed to gain enough political traction for enactment.

Even with all its limitations, AB-32 wins accolades, having survived political upheavals, and like RGGI, has provided at least a modest “price on carbon” that could be augmented by revisions to the program, including a more aggressively-rising price floor.

Rabe concludes with a chapter entitled, “A Second Act for Carbon Pricing” describing a range of new and ongoing efforts at the state and provincial levels to enact carbon pricing.  Especially noteworthy are severance taxes in North Dakota and Colorado modeled on Norway’s politically-popular severance taxes that fund pensions.  Rabe also suggests taxing the carbon content of fugitive methane emissions from shale gas drilling which to date have drastically reduced the potential climate benefits of shale gas as a bridge fuel.[14]  Finally, Rabe observes that the political obstacles to carbon pricing in the U.S. are not unique to our political system or culture.  Carbon pricing remains challenging everywhere it is being attempted.

After taking in Professor Rabe’s whirlwind tour of carbon pricing history, I was struck by the absence, even after a decade of relentless advocacy by Citizens’ Climate Lobby and more recently by the Climate Leadership Council, of legislation to enact “carbon fee and dividend” anywhere in the world.  Perhaps returning revenue in lump sum “dividends” does little to help dissolve the “super-wicked” political dilemma that Rabe neatly articulated in chapter 2.  The enactment and durability of RGGI, AB-32 and BC’s carbon tax were all aided by public support for proposals to spend or distribute revenue.  Perhaps once a carbon price is established and is funding visible and popular programs, returning the additional revenue generated by a rising price might make political and economic sense.[15]  But given its almost total lack of political support to date, one has to question whether “fee and dividend” can serve as a starting point for politically-viable carbon pricing.

P.S. (5/24/18). Alaska’s oil severance tax, which endows the state’s Permanent Fund, enacted by Republican Governor Jay Hammond in 1976, can be viewed as an example of an easily-implemented, popular and durable upstream ad valorem tax that could easily be converted to a more stable carbon tax. The Alaska tax, assessed on the dollar value of the oil extracted rather than its carbon content, is equivalent to about $53/T CO2.* The Fund currently distributes a $1600/month “dividend” to  every eligible Alaskan.

* $72/barrel (current oil price) x 35% (Alaska tax rate) x 1 barrel/433 Kg CO2 x 907 Kg/Ton = $53/T CO2.  More than double BC’s “textbook” C$30/tonne ($22/T) CO2 tax!

NOTES: 

[1] See, Henry Petroski, “To Engineer is Human, The Role of Failure in Successful Design” (1985) extolling the virtues of rigorous failure analysis.

[2] Rabe, “Can We Price Carbon?” at p. 200.  As Rabe elucidates in detail, proponents of cap-and-trade as climate policy enshrouded the SO2 and CFC (“Montreal Protocol”) examples into exaggerated mythology that tended to overlook the more intractable problems of reducing CO2 emissions from a vast range of sources for which few ready replacements existed.

[3] See Rabe, “Failing the Performance Test,” pp. 74- 82.  The Alberta carbon pricing system “hasn’t reduced a single ton of emissions yet,” according to David McLaughlin, one of Canada’s leading experts on carbon pricing, and former director of National Round Table on Energy and the Economy, in a keynote address to Canada’s Climate Choices Conference in Waterloo ON, February 18-20, 2016.

[4] Of course, the U.S. has no “centrist” party. Thus, the BC example offers little guidance about political strategy here.

[5] Rabe points out that BC’s carbon tax was fully operational in just five months.  In vivid contrast, California’s cap-and-trade system with offsets took years to launch even with the heavy (and ongoing) staffing of its Air Resources Board. p. 95 and p. 168-9.

[6] See “All You Need to Know about British Columbia’s Carbon Tax in Five Charts,” by Alan Durning and Yoram Bauman, Sightline Institute (March 11, 2014).  http://www.sightline.org/2014/03/11/all-you-need-to-know-about-bcs-carbon-tax-shift-in-five-charts/

[7] Rabe, p. 113.

[8] See EIA, “Major fossil fuel-producing states rely heavily on severance taxes” (August, 2015). https://www.eia.gov/todayinenergy/detail.php?id=22612

[9] I am grateful for the legal education I received in Texas, whose public universities are generously endowed by the state’s oil severance tax, paid overwhelmingly by gasoline purchasers in other states.

[10] Rabe, p. 34.

[11] RGGI participants are Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont .  New Jersey has recently announced plans to re-join RGGI and Virginia is also considering that step.

[12] Rabe, p 157. Citing Brian C. Murray and Peter Maniloff, “Why Have Greenhouse Gas Emissions in RGGI States Declined” An Econometric Attribution to Economic Energy Market, and Policy Factors, Energy Economics 51 (2015).

[13] Rabe, pp. 168 – 9.

[14] See, “Would a Methane Tax Make Natural Gas a Green-Enough Bridge Fuel? (Carbon Tax Center, 2011).  https://www.carbontax.org/blog/2011/05/20/would-a-methane-tax-make-natural-gas-a-green-enough-bridge-fuel/

[15] See, James K. Boyce, “Carbon Pricing: Effectiveness and Equity” (April 2018). Boyce argues for distribution of carbon revenue in equal lump-sum “dividends” to assure political support for continually raising carbon prices to achieve climate stabilization goals and to counteract regressive distributional effects.  https://www.peri.umass.edu/publication/item/1069-carbon-pricing-effectiveness-and-equity