Guest commentary from Yoram Bauman
Everyone from Treasury Secretary Janet Yellen to Elon Musk thinks that putting a price on carbon is an important step in tackling climate change. Politically, however, carbon taxes and cap-and-trade systems face an uphill battle, in part because they could drive up the prices of household basics like gasoline and electricity. There are many worthy proposals for addressing this concern, mostly focused on the idea of using carbon pricing revenue to pay for things like per-capita dividends, green investments, or reductions in payroll taxes.
But what if you could put a price on carbon without driving up consumer prices? In California, for example, the impact of the cap-and-trade system on residential electric bills is reduced substantially by the semi-annual Climate Credits that households receive on their bills.
The purpose of this post is to invite feedback on and ask for help with an even more direct way to do this that might work in about 20 states, some cities, and perhaps in other countries as well. The gist is that many jurisdictions impose taxes on electricity consumption—sales taxes, gross receipts taxes, value-added taxes—and that replacing these existing taxes on electricity with a carbon tax on fossil-fuel generated electricity can come close to delivering a carbon tax “for free”.
Table 1 shows some preliminary numbers for 18 states (and two municipalities, New York City and Washington, DC) that have significant taxes on residential electricity. The table shows that in Alabama (for example) the existing 4% state sales tax on electricity is the rough equivalent of a $12 carbon tax on electricity. By “rough equivalent” I mean that in 2019 those two taxes would have generated about the same amount of state revenue and so would have had roughly the same impact on consumer prices.
Details and Caveats
- The main impact of carbon pricing in the electricity sector is changing utility behavior rather than changing consumer behavior, i.e., making renewables more attractive than fossil fuels rather than reducing the amount of electricity consumption. This situation is arguably unique to the electricity sector, so this tax-swap idea is probably not applicable in other sectors.
- These carbon prices—mostly in the range of $10-$20 per ton CO2—are modest but not insignificant. A $10 carbon tax is approximately 1 cent per kWh of coal-fired power, half that for natural gas, and nothing for non-fossil sources.
- The analysis above focuses on residential consumption of electricity but could be broadened to cover commercial consumption of electricity (and in rare cases even industrial consumption) as long as they also pay existing taxes on electricity that could be swapped out for a carbon tax. Note that many jurisdictions exempt entities like industrial consumers, schools, hospitals, and government agencies from existing electricity taxes; these same exemptions could be carried over to the carbon tax.
- In the short run, the carbon tax rate could be set to generate roughly the same amount of revenue as the sales tax or other existing tax that it’s replacing. In the long run, carbon tax revenue would decline as carbon emissions decline. It’s possible to reduce these losses—for example, by increasing the carbon tax rate over time, or by reinstating the existing sales tax after, say, 20 years—but there’s also a strong case for simply sunsetting taxes on electricity. For one thing, the push to “electrify everything” will be easier if electricity is cheaper. Perhaps more importantly, most states exempt grocery store food from sales tax because of regressivity concerns about impacts on low-income households, and taxes on residential electricity are even more regressive. The revenue loss from sunsetting taxes on residential electricity would be roughly one–third of the revenue loss from existing tax exemptions for groceries.
- The carbon tax would ideally be based on the carbon content of electricity consumed by each utility’s customers in the state (e.g., on data similar to what’s in these ESG reports) rather than on the carbon content of electricity generated in the state. As a result, the tax swap works best in states where electric utilities have similar carbon profiles. To the extent that they have different carbon profiles, there would be a net savings for customers of low-carbon electricity and a net cost for customers of high-carbon electricity.
- It might be possible to pursue similar ideas at the municipal level—where there are often extremely high taxes on electricity—but municipalities may be limited by state law regarding the types of taxes they can impose. Municipalities may also have a stronger reliance on this revenue than states.
How you can help: Do you have questions or concerns that aren’t addressed in the Details and Caveats? Can you think of a good analogy to help explain this idea? Do you live in any of the states listed above and if so do you want to help push this idea forward with legislators or NGOs or perhaps even (if applicable) with a ballot measure? (FYI I’ve been involved in ballot measure efforts in Washington State and Utah and am exploring “24/7” opportunities for 2024 ballot measure efforts in at least 7 states.) If you live outside the USA, can you say if there’s VAT or other taxes on your residential electricity bill and if so do you want to help explore this idea in your country? I’ll do my best to engage in the Comments section and I’m also available via email.