Carbon Taxes and Carbon Offsets -- A Path to Net Zero?

Posted on July 18, 2019 by Jeffrey C. Fort

Two recent press pieces caught my eye.  “UK Signs Net-Zero Emissions Requirement into Law,” and “GOP Pollster pitches Republicans on carbon pricing.” The first reflects recent studies with respect to a potential [or even likely] environmental calamity; the other suggests signs of political reconsideration on climate change.  As welcome as the latter is, and most economists praise the use of a carbon tax, it is likely not nearly enough.

According to the latest scientific forecast, meeting the Paris objective of no more than a 2 C increase in global temperatures from pre-industrial temperature levels will require worldwide net zero emissions of carbon-dioxide-equivalent (CO2e) gases by 2050.  In any event, the UK, France, Norway and Sweden have adopted a net-zero requirement to be achieved no later than 2050 and more than a dozen large US cities have done likewise.

How a net-zero requirement can be met, with all the extant emissions from industry, transportation and buildings, is perhaps the most important research and development task facing us.

Consider whether another approach should be considered. In a 2017 op-ed Wall Street Journal piece, James Baker and George Schultz recommended a “carbon tax” on emissions of carbon dioxide equivalent gases.   This recommendation is the centerpiece of a memorandum to “Interested Parties” by a Republican pollster and strategist suggesting that the Republican Party should heed polling results and embrace the Baker/ Schultz suggestion that the Republican Party ought to support a “Carbon Dividends” proposal. This proposal would feature “four pillars”: a tax (of $42/ metric tonne of CO2e, indexed to rise with inflation), an equivalent “dividend” to working class Americans, a border adjustment for carbon content of imported goods, and elimination of EPA’s regulatory authority concerning climate issues.  The tax revenues would be returned to private citizens with the lowest incomes, as a “Carbon Dividend” to mitigate the increased energy costs.

However, the Carbon Dividend proposal says nothing about reducing emissions other than by raising a “price on carbon.”  But will a tax achieve that goal? Some parties may choose to emit and pay the tax so there is no guarantee that emissions will be reduced and certainly not to achieve net-zero emissions. Any reduction in energy use by businesses would depend on the elasticity of the market for other inputs and competition for the output products. For businesses that have inelastic demand curves the costs just get passed through with no or little emission reduction.  In other words, a carbon tax will not yield significant environmental results, however admirable its intentions.

However, emission reduction credits, or “offsets,” is a tool which has been used for nearly 50 years under the Clean Air Act.  Verified offsets provide real reductions.   Verified offsets have been used to allow large new construction projects in dirty air areas, to reduce the costs of compliance measures in state implementation plans, and now as a means of reducing costs in most of the climate legislation around the world.  Offsets are not easy to create.  Using standard protocols, there must be a scientific method which has been adopted in a public process and adherence to that methodology then for a project to be undertaken.  Both are validated and verified by an independent third party. Only then is the “offset credit” created.  Offsets seem to attract entrepreneurs who have a “better idea” of what projects can be implemented at a much lower cost that an EPA-approved, command and control requirement.   The U.S. now has three independent offset verifiers which have produced millions of tonnes of extra reductions -- proving that the concept can work at scale.   These are real and verified reductions and the current prices are a small fraction of the $42 per tonne price in the Carbon Dividend proposal.  Verified offsets are a much better and cost-effective way to produce reduce real emission reductions.  

For a “tax” on carbon emissions, we would start with an existing and established measuring tool; those sectors covered by the Mandatory Reporting Rule (MRR).  The covered sectors have already been established as the most carbon-intensive industrial activities.  The MRR is established and tested and would not require a new system.

A proposed carbon tax systems could then allow a credit or a “deduction” for other state requirements for GHG controls.  State carbon reductions requirements (e.g. AB32 in California and RGGI in the Northeastern states or other state adopted requirements, see) could be recognized, which would reduce the taxable quantity.  Allowing offsets, including those purchased from sources “outside the [MRR] cap” would provide further reductions, and further reduce net taxable emissions.   But a complete elimination of taxable carbon emissions appears unlikely in the near term.

There are many sectors who now perform “voluntary” projects, at a cost far below $42/ metric tonne.  Among the sectors outside the MRR list, are:

  • agricultural and forestry programs (famers and foresters have produced substantial volumes of offset credits to date);
  • unregulated industrial processes, such as those emitting methane, nitrous oxides and hydrofluorocarbons, which are not subject to the MRR; and
  • abandoned coal and gas well vents.

Not only would using offsets provide an incentive for extra reductions on a voluntary basis, the existing voluntary programs are examples of innovation. Small businesses, new ideas, and new ventures have created most of the offsets now used in compliance and voluntary systems.

Carbon offsets are real reductions, and not just a fiscal policy redistribution.  In addition to providing a “dividend,” a carbon tax offset policy could stimulate new ideas and businesses as well as substantially reduce carbon emissions.  This would align sound climate policy with sound tax policy by using a tool developed long ago, updated based on recent experience.

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