Impose a Tax on Emissions of Greenhouse Gases

CBO periodically issues a compendium of policy options (called Options for Reducing the Deficit) covering a broad range of issues, as well as separate reports that include options for changing federal tax and spending policies in particular areas. This option appears in one of those publications. The options are derived from many sources and reflect a range of possibilities. For each option, CBO presents an estimate of its effects on the budget but makes no recommendations. Inclusion or exclusion of any particular option does not imply an endorsement or rejection by CBO.

Billions of Dollars 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2017-2021 2017-2026
Change in Revenues 57.4 90.3 93.6 96.5 98.6 101.3 104.6 108.1 111.5 115.2 436.5 977.2

Sources: Staff of the Joint Committee on Taxation; Congressional Budget Office.

This option would take effect in January 2017.

Many estimates suggest that the effect of climate change on the nation’s economic output, and hence on federal tax revenues, will probably be small over the next 30 years and larger, but still modest, in later years. Nonetheless, significant uncertainty surrounds those estimates. The accumulation of greenhouse gases (GHG) in the atmosphere—particularly carbon dioxide (CO2), which is released when fossil fuels (such as coal, oil, and natural gas) are burned, and as a result of deforestation—could generate damaging and costly changes in the climate around the world. Although the consequences of those changes are highly uncertain and would probably vary widely across the United States and the rest of the world, many scientists think there is at least some risk that large changes in global temperatures will trigger catastrophic damage. Among the less uncertain effects of climate change on humans, some would be positive, such as fewer deaths from cold weather and improvements in agricultural productivity in certain areas; however, others would be negative, such as the loss of property from storm surges as sea levels rise and declines in the availability of fresh water in areas dependent on snowmelt. Many scientists agree that reducing global emissions of greenhouse gases would decrease the extent of climate change and the expected costs and risks associated with it. The federal government regulates some of those emissions but does not directly tax them.

This option would place a tax of $25 per metric ton on most emissions of greenhouse gases in the United States—specifically, on most energy-related emissions of CO2 (for example, from electricity generation, manufacturing, and transportation) and some other GHG emissions from large manufacturing facilities. Emissions would be measured in CO2 equivalents (CO2e), which reflect the amount of carbon dioxide estimated to cause an equivalent amount of warming. The tax would increase at an annual real (inflation-adjusted) rate of 2 percent. During the first decade the tax was in effect, the Congressional Budget Office estimates, cumulative emissions from sources subject to the tax would fall by roughly 9 percent.

According to estimates by the staff of the Joint Committee on Taxation and CBO, federal revenues would increase by $977 billion between 2017 and 2026. (The tax would increase businesses’ costs, which would reduce the tax bases for income and payroll taxes. The estimates shown here reflect the resulting reduction in revenues from those sources.)

The size of the tax used for these estimates was chosen for illustrative purposes, and policymakers who wanted to pursue this approach might prefer a smaller tax or a larger one. The appropriate size of a tax on GHG emissions, if one was adopted, would depend on the value of limiting emissions and their associated costs, the way in which the additional revenues were used, the effect on emissions overseas, and the additional benefits and costs that resulted from the tax.

One argument in support of the option is that it would reduce emissions of greenhouse gases at the lowest possible cost per ton of emissions because each ton would be subject to the same tax. That uniform treatment would increase the cost of producing and consuming goods and services in proportion to the amount of greenhouse gases emitted as a result of that production and consumption. Those higher production costs, and corresponding increases in prices for final goods and services, would create incentives for firms, households, governments, and other entities throughout the U.S. economy to undertake reductions of greenhouse gases that cost up to $25 per metric ton of CO2e to achieve. This approach would minimize the cost of achieving a given level of emissions because the tax would motivate reductions that cost less than $25 per ton to achieve, but not those that would cost more than $25 per ton. An alternative approach to reducing GHG emissions that is currently being pursued by the federal government is to issue regulations based on various provisions of the Clean Air Act (CAA). However, standards issued under the CAA (for example, specifying an emissions rate for a given plant or an energy-efficiency standard for a given product) would offer less flexibility than a tax and, therefore, would achieve any given amount of emission reductions at a higher cost to the economy than a uniform tax that was applied to all sectors of the economy.

Another argument in favor of a GHG tax is that such a program could generate “co-benefits.” Co-benefits would occur when measures taken to reduce GHG emissions—such as generating electricity from natural gas rather than from coal—also reduced other pollutants not explicitly limited by the cap, thereby reducing the harmful effects estimated to be associated with those emissions. However, measures taken to decrease CO2 emissions could also result in additional costs depending on how the emissions were reduced. For example, increased use of nuclear power could exacerbate potential problems created by the lack of adequate long-term storage capacity for nuclear waste.

An argument against a tax on GHG emissions is that curtailing U.S. emissions would burden the economy by raising the cost of producing emission-intensive goods and services while yielding benefits for U.S. residents of an uncertain magnitude. For example, most of the benefits of limiting emissions and any associated reductions in climate change might occur outside of the United States, particularly in developing countries that are at greater risk from changes in weather patterns and an increase in sea levels. Another argument against this option is that reductions in domestic emissions could be partially offset by increases in emissions overseas if carbon-intensive industries relocated to countries that did not impose restrictions on emissions or if U.S. reductions in energy consumption led to decreases in fuel prices outside of the United States. More generally, averting the risk of future damage caused by emissions would depend on collective global efforts to cut emissions. Most analysts agree that if other countries with high levels of emissions do not cut those pollutants substantially, reductions in emissions in this country would produce only small changes in the climate (although such reductions would still diminish the probability of catastrophic damage).

An alternative approach for reducing emissions of greenhouse gases would be to establish a cap-and-trade program that set caps on such emissions in the United States. Under such a program, allowances that conveyed the right to emit 1 metric ton of CO2e apiece would be sold at open auction, and the cap would probably be lowered over time. If the caps were set to achieve the same cut in emissions that was anticipated from the tax, then the program would be expected to raise roughly the same amount of revenues between 2017 and 2026 as the tax analyzed here. Both a tax on GHG emissions and a cap-and-trade program for those emissions would represent market-based approaches to cutting emissions and would achieve any desired amount of emission reduction at a lower cost than the regulatory approach described above. In contrast with a tax, a cap-and-trade program would provide certainty about the quantity of emissions from sources that are subject to the cap (because it would directly limit those emissions), but it would not provide certainty about the costs that firms and households would face for the greenhouse gases that they continued to emit.