Why and How to Tax Carbon

Increased concern about possible global warming due to rising levels of greenhouse gases such as carbon dioxide ( CO2 ) suggests the need to control emissions of CO2. This article explores a system of revenue-neutral carbon taxes as a supplement or alternative to other CO2 control systems such as subsidies, regulation, and cap-and-trade. A system of carbon taxation should be, the Article suggests, sufficiently fairer and simpler and more efficient than the other possible systems of CO2 control and that it merits serious consideration. Because the carbon tax that is suggested would be revenue neutral, it should be politically acceptable. Problems with a carbon tax such as regressivity, possible disruption of international trade, and impact on other societal values are explored. The carbon tax, it is suggested, should be enacted along with a Value Added Tax ( VAT ) for two reasons. First, the carbon tax should start low (so as not to disrupt the economy) and increase steadily (to create substantial incentives to reduce CO2 emissions). Revenue from the carbon tax will rise initially as the rate increases, but eventually the expected reduction in carbon use will cause carbon tax revenues to fall even though rates remain high and even increase. To keep the carbon tax revenue-neutral, other taxes will have to fall as carbon tax revenues rise, then rise as carbon tax revenues fall. To avoid upsetting the expectations that underlie long-term investments and planning, it may be desirable to have relatively stable income tax rates, and thus it would be best to have the variation occur in the VAT rates. Second, the carbon tax will be regressive, so it should be accompanied by some form of rebate or income maintenance program for people with low incomes. The carbon tax initially will generate too little revenue to justify creating such a program, but the VAT will be similarly regressive and from the start it can generate enough revenue to justify and fund such a rebate program