Using the Free Market to Affect Change: An Argument for Environmental Taxes

The past two years have yielded unprecedented executive and regulatory engagement in the climate change discussion. In November 2014, the United States and China—two of the world’s most significant emitters—jointly committed to reducing their carbon emissions. In August 2015, the Obama administration announced the Clean Power Plan, which will implement national standards to govern carbon pollution from power plants. Two steps forward, one step back: In February 2016, the Supreme Court issued a stay on implementation of the Plan, pending judicial review.

Nevertheless, in December 2015, 195 countries adopted an international climate change agreement (the Paris Agreement) that will require periodic, rigorous accounting and management of total national emissions. Equally exciting, in August 2016, the Seventh Circuit Court of Appeals upheld agencies’ ability under the Energy Policy and Conservation Act to include the social cost of carbon in determining whether a rule is economically justified. Most recently, on September 3, 2016 the United States and China honored their earlier agreement by depositing their instruments of ratification with the United Nations to formally join the Paris Agreement.

But in the wake of all of this activity and diplomatic positing, many people are left wondering what happens next. Once all these new rules take effect, how do we actually achieve the emissions reduction goals?

"The world is not given by his fathers, but borrowed from his children." - Wendell Berry

“The world is not given by his fathers, but borrowed from his children.” – Wendell Berry

One option is to engage the free market to help reduce greenhouse gas emissions. Critics of environmental policies often draw upon the tension between economic security and environmental conservation to generate opposition to such policies. The fiscal conservative theory is that increased regulation to protect the environment will restrict the market and prevent capitalism from operating efficiently. Yet, by internalizing environmental externalities (often referred to as market failures) and properly pricing pollution, regulators can work synergistically with capital markets to induce consumer behavior change without compromising market efficiency.
The two predominant types of market mechanisms to achieve this end are fees and taxes. Fees are typically payments made in return for the provision of a good or service. In comparison, a tax is typically a compulsory payment to the state made with the primary purpose of raising revenue. Historically, the United States has implemented a variety of fees and taxes for policies with environmental goals (e.g. user charges for services like wastewater treatment or effluent charges used as enforcement mechanisms for statutes and regulations).

But the most direct way to catalyze behavior change is to implement an environmental tax. Environmental taxes are levied on a physical unit of anything that has a proven negative effect on the environment, such as carbon dioxide. Air pollution generally has many proven environmental effects, including urban photochemical smog, acid rain and increased tropospheric ozone, and climate change at the local, regional, and global level respectively. Air pollution also impacts vegetation, ecosystems, and soil productivity and causes damage to buildings, materials, and cultural heritage. Furthermore, the specific effects of carbon emissions on global climate change are also well documented and widely accepted.

Thus, to utilize the free market to reduce the effects of climate change, neoclassical economics would suggest increasing the price of carbon. Notwithstanding the assured political battles, one way to increase the price of carbon is through an economy wide carbon tax. The ultimate objective would be to charge individuals based on their consumption (usually of fossil fuel) as a proxy for their total carbon emissions. Such a tax would relate directly to environmental behavior change, and would raise revenue as an ancillary effect. That revenue might subsidize other efforts to reduce climate change, such as tax credits on renewable energy infrastructure and other spending programs. Or, the revenue might offset compliance costs with new regulations under the Clean Power Plan or the Paris Agreement. Alternately, the revenue could be used to fund infrastructure improvement to the nations roadways, utility grids, or telecommunications networks, all of which would help improve energy efficiency. Regardless of how the money is used, a carbon tax would pass through to consumers the true cost of energy and consumer goods and allow them to make more informed decisions.

And we may not have to wait for the nation’s divided Congress to pass such measures. Initiatives are already under way in six states to pass a tax or fee on carbon pollution. These market leaders are paving the way to introduce statewide legislation that will effectively address tradeoffs between environmental benefits and economic growth, leakage through imports and exports, and potential distortions in investments and trade. As states begin to understand how to craft and implement successful policies, the federal government may take note. In fact, British Columbia’s foray into carbon taxes in 2008 has been so successful that many other provinces have committed to implementing similar mechanisms and the federal government may even look for ways to nationalize and standardize the system.

The United States is facing mounting pressure from its citizens and from the international community to begin seriously addressing climate change. While the view expressed here is an oversimplification of an extremely complicated issue, an economy-wide tax on carbon could represent a smart and efficient mechanism for initiating a response to this global call to action.

SBarnowski-Photo-2015Sara Barnowski ’17 is a third-year JD candidate and is focusing her legal studies on energy and natural resources law and on business law. She is originally from Connecticut and studied environmental engineering and environmental public policy first at the Massachusetts Institute of Technology, then at Stanford University. Sara hopes to use her legal education to identify and deploy market mechanisms that will lead to more sustainable economic development worldwide.