David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the carbon cycle, part one. As reports of the devastating effects of climate change rise, so do the voices discussing how to tackle the anthropogenic causes of this phenomenon. One of the much discussed solutions today is a carbon tax, which would put a price on greenhouse gas emissions.
To further this discussion, we'll be dedicating the next two episodes of Tax Notes Talk to the issue, highlighting both the positives and negatives of a carbon tax. This week's episode, part one, features an interview with David Kreutzer, an economist at the Institute for Energy Research. David was on the Trump presidential transition team at the EPA in 2017, and previously was a senior research fellow in energy economics and climate change at the Heritage Foundation. He opposes taxing carbon emissions, which we'll get to in a minute.
Next week's episode, part two, will feature an interview with Shuting Pomerleau, a climate policy analyst at the Niskanen Center, who supports a carbon tax.
But before we get to our first interview, I'm joined by Tax Notes contributing editor Marie Sapirie for some background on the issue. Marie, welcome back to the podcast.
Marie Sapirie: Thank you. It's always good to be here.
David D. Stewart: So, let's begin with the basics. What is a carbon tax?
Marie Sapirie: The term carbon tax is essentially shorthand for a tax regime that makes it more expensive for producers of goods and services to emit greenhouse gases that contribute to global warming. Most proposals would likely also cover emissions of methane, nitrous oxide, and possibly other types of gas. Carbon dioxide is the gas that we admit the most of, according to a 2016 EPA report, and carbon dioxide emissions account for roughly 82 percent of greenhouse gases from human activities. And fluorinated gases make up a much smaller percent of emissions, but they're considered particularly potent. So it might make sense to include them too.
The basic idea is fairly simple. By making it more expensive to pollute, polluters will both one, be more active in searching for ways to cut emissions, which will incentivize more innovation. And two, will switch to less polluting options that are already available. That's what the OECD said in a 2016 report titled "Effective Carbon Rates: Pricing CO2 through Taxes and Emissions Trading Systems," which said that the principle appeal of using prices to induce carbon abatement is that this encourages emission reductions where they are cheapest. Both in the sense of using the cheapest available options today and steering innovation and investment towards lower carbon technologies.
The thought is that a carbon tax could get us to a place where there are lower global emissions without making dramatic changes to the way many people live. This type of tax will be recognized by students of economics as a Pigouvian tax. That's a tax on the negative externalities like pollution that aren't included in the market price, but end up being absorbed by society at large. The economist Arthur Pigou recommended taxing the producers whose processes produce such negative externalities by setting a tax to equalize the marginal private cost and the marginal social cost. The idea is to correct the market failure. But note that to apply Pigou's principle requires measuring the externalities so that the tax is set appropriately. That's the general concept. But there are potential wrinkles in putting that idea into action to protect the environment.
David D. Stewart: Well, that leads to the next obvious question. How would implementation of such a tax work? And is there an approach that's become prevalent?
Marie Sapirie: Implementation is one of the major open questions. How Congress might choose to design a carbon tax would necessarily drive what the implementation looks like. And we don't know yet where Congress might settle on the fundamental question of whether we should have a carbon tax in the first place. As far as the design options go, the main pieces that Congress would have to decide include the rate of tax on emissions, which is an area where there's a lot of debate because where the tax rate is set changes the impact on emissions, as well as the total revenues that would be raised. Next, whether the rate should increase over time, perhaps by starting low and gradually ratcheting up to give companies some time to adjust and seek out alternatives with lower emissions. And also, where the ratcheting should stop, which depends on whether the goal is to mitigate emissions to some acceptable level or to eliminate them entirely.
Another question is when to collect the tax. There are options all along the supply chain, from the point of extraction, to the point of sale of the final product to consumers, or some combination. How to provide a rebate for sequestering carbon emissions is another question. How to do a border adjustment, which is a way to prevent a carbon tax regime from resulting in American consumers shifting to purchasing more imported goods and services from places without a carbon tax. And American companies from moving abroad or becoming less competitive relative to their overseas competitors. And finally, how to solve the problem of regressivity, because the incidence of a carbon tax would end up falling more heavily on taxpayers who consume more of their income, unless a carbon tax were enacted with some sort of rebate mechanism.
David D. Stewart: Now, you alluded to some debate on this issue in the U.S. Could you give us an idea of where the various sides stand on this issue?
Marie Sapirie: Perhaps the chief point of dispute is around the fact that a U.S. carbon tax regime has the potential to raise a large amount of revenue. And that is either a point in favor of enacting a carbon tax or a point against it, depending on whether you agree with how the revenues might be spent. As we know, members of Congress are frequently looking for ways to pay for items of spending that are important to them and their constituents. So, this is an area of a lot of discussion. There are carbon tax proposals that rebate all of the revenue to American families, like the bipartisan climate roadmap from the Climate Leadership Council. But that's a feature of the climate tax regime that is up for discussion should Congress take it up in the future. The broader economic impact of the adding a carbon tax is another big question.
A new tax would certainly have costs, but the extent of those depends on how the tax is designed. Another issue that opponents point out is that there is uncertainty in the magnitude of the problems that climate change could cause for humans on the planet. So, the argument is that the focus should be on building a strong economy. That's better able to respond to adverse impacts of any sort, whether from climate change or some other disaster. That uncertainty could also be a potential argument for starting with a lower rate of tax. Even if Congress were to enact a carbon tax, there are of course, all of the other details in the potential design of a U.S. carbon tax that I mentioned earlier that are still debated.
David D. Stewart: Now, enacting a carbon tax is not just a U.S. issue. So, how are other places around the globe fairing when it comes to enacting such a tax?
Marie Sapirie: That's right. In order to achieve the beneficial effects of reducing greenhouse gas emissions, there would need to be some sort of coordination around the world so that the sources of emissions aren't simply shifted to jurisdictions where it's less expensive to emit. According to the World Bank's carbon pricing dashboard, 45 national jurisdictions have carbon pricing initiatives today, which is far from 100 percent of countries in the world. Some countries have adopted emissions trading systems instead of carbon taxes. That's another type of market-based approach that is sometimes called cap and trade. Of the countries that have implemented carbon tax programs, some have been around longer than others. Finland, Poland, Norway, Sweden, Denmark, the Netherlands, and Germany all introduced taxes on carbon in the 1990s. The results of these taxes in lowering emissions are kind of mixed. According to data from the World Bank, on a per capita basis, carbon dioxide emissions actually increased a bit Norway between 1990 and 2015.
They stayed about the same in the Netherlands, during the same time. Dipped in Germany, went down in Finland, Poland, and Sweden, and dropped dramatically in Denmark. It should be noted that Sweden started out much lower than the others. But even with its success, Denmark remained above the world average, and also above other European countries like France and Spain. By comparison, Belgium dropped its emissions during the same period in a pattern that was similar to Finland's, but they didn't have a carbon tax. One of the interesting points about Denmark's achievement was that part of the revenue was used to provide subsidies for technologies with lower environmental impacts. Since the first carbon taxes were introduced in the 1990s, there's been slow but steady growth in the number of taxes introduced around the world. Most recently in July, the European Union released a plan to impose a fee on imports of certain products as part of its climate package. That could be an opening for more global coordination on the cost of carbon.
David D. Stewart: Now, you interviewed both David and Shuting on this issue. The first of which will be airing this week. Could you give us some highlights of your interview with David?
Marie Sapirie: David discussed why he doesn't support carbon taxes as a climate policy tool. He doesn't dispute that human greenhouse gas emissions have caused and continue to cause global warming. The problem is the implementation of the carbon tax and the ways that could go wrong.
David D. Stewart: All right, we'll have that interview after a quick break.
Marie Sapirie: Thank you, David, for joining me today to talk about climate policy and how the tax laws might or might not be used to put limits on carbon dioxide and other greenhouse gas emissions.
David Kreutzer: Thanks for having me on.
Marie Sapirie: So, proposals for imposing federal taxes on greenhouse gas emissions have been around for quite a while, but none of them have been put into effect in the United States. And there are a number of reasons for that. Today we'll go over the history of carbon tax proposals. Then we'll cover the role of economic analysis in designing policies to regulate greenhouse gas emissions. And what that can tell us about the frameworks legislators might select to accomplish emissions reduction goals. Finally, we'll take a look at some of the challenges in implementing a carbon tax and consider alternatives. To get started, would you give us a brief history of carbon tax proposals, including where they came from and how interest in them has evolved over time?
David Kreutzer: The basic theory of the carbon tax comes from Pigou, an economist who was around 100 years ago. And his argument was that you have these market imperfections, there's something called an externality. And with carbon, we call it the social cost, which is somewhat misleading. And what he said is we can have an offsetting tax that would bring the market back to, in essence, perfection. Where marginal benefits when you include all the benefits equals marginal costs when you include all the costs. And economists have loved this. And there've been a century of dissertations and theses written on finding market imperfections and correcting them with the exact right tax. So, that's the economic theory. There really haven't been many successful uses of these offsetting taxes. There are few, but in the carbon area, none of them have been implemented.
You could say that the BTU tax that Al Gore tried to get through in the 1990s was a sort of carbon tax. It turned out to be very, very unpopular. And right after the Obama administration came in office, there was something called cap and trade, which would have features similar to a carbon tax. And then in 2010, Kerry-Lieberman bill was more explicitly a carbon tax. There are people have been talking about it because the— you can draw such nice economic diagrams to show how wonderful it would be if you knew exactly what the tax level should be. And if the implementation was costless.
Marie Sapirie: So, setting the level of tax for a potential carbon tax is one of the major questions that policymakers would have to confront in designing any new tax. And you've written about the difficulties in performing economic analysis on climate policies. Would you tell us about why that is and how economic analysis should be used to help shape the appropriate policy response?
David Kreutzer: What the policymakers would use as the guide for the level of the carbon tax is something called the social cost of carbon. And there are some economists, one who won a Nobel prize, that have put together models where they try to estimate what the damage is for each ton of CO2 that's emitted now. If you look at the damages over the next several centuries, and sometimes even thousands of years, which in my opinion, is laughable to try to do that. And the way they do that is they use the climate models and they say, "Well, this much additional CO2 will lead to this much warming, which will lead to this much more sea level rise. And perhaps, some higher level of winds and hurricanes." Though, we haven't really seen that yet. Then they translate that into economic damages. And then they discount it to bring it back to the future, saying, "OK, if there's going to be $10,000 worth of damage in 150 years from a ton of CO2 emitted today, how much would we be willing to spend to cut that CO2 today?"
And so, you want to compare it to, well, what if we made another investment that could generate $10,000 worth of benefits in 150 years? All right, how much would we have to invest to get that benefit? And you wouldn't want to spend more than that on the climate benefit. So, in any event that that discount rate is a, is a huge area of controversy, but that's just one of them. Trying to actually figure out where the economy is going, how much damage global warming is going to do is a nearly impossible task
Marie Sapirie: Turning to the existing carbon tax proposals. A critique of them generally is that they will introduce complexity and administrative burdens. They're also potentially regressive and less rebated to lower income taxpayers in some way, and that they are economically disruptive. Could you tell us about the challenges to implementing a carbon tax that need to be considered?
David Kreutzer: Pretty much anything that raises energy costs is going to be regressive because people with lower income spend a higher percentage of their income on energy, on gasoline, on heating, and so on. And carbon tax would be no different than just simply any regulation would do the same thing. And the other complexities are where do you charge the tax? And you could imagine that the carbon tax proposal being similar to the cap and trade proposal, where they looked at oil and petroleum refiners, taxing the refiners, taxing natural gas producers, and taxing coal at the mine mouth. But they're also going to be problems with what you do with people who are doing offsets. Certainly that's going to be part of it because Wall Street wants to have something to trade. And then you get up, well, how much carbon is saved by a farmer that uses no till in Iowa that otherwise was going to use a plow. And all of that introduces scientific complexity, as well as just administrative complexity. And they're also simply administrative costs. Any tax has administrative costs. And you'd want to look at whether those would be significant compared to whatever benefit you're trying to provide. And we may get to this later, the problem of people viewing the carbon tax not as a market efficiency generator, but as a revenue generator.
Marie Sapirie: Are there ways to avoid or to minimize some of the potential problems with the implementation of a carbon tax?
David Kreutzer: I think it's difficult to avoid the ones that I just laid out. Especially, you know, economists have a bad habit of coming up with wonderful ideas that work in the abstract and ignore the politics of actually getting them implemented. And one of my professors, he won a Nobel Prize, doing something called public choice and saying, "You need to look at what are the political incentives that come around with these various tools that you want to implement." And as I mentioned earlier, it's pretty clear that the revenue part, which— of a carbon tax, which I did some modeling with some colleagues when I was at The Heritage Foundation. And even a carbon tax of $25, $30, growing by the rate of interest, generates hundreds of billions of dollars a year in revenue. It also does hundreds of billions of dollars of economic damage to the economy each year. And if the solution to a problem is going to fund your pet project, you're much more likely to believe there is that problem. And so, I think we see that. People on Capitol Hill, they talk about we need to fix the climate problem, but they're really excited about the revenue.
Marie Sapirie: So, recent carbon tax proposals include a border adjustment. An export rebate coupled with an import tax equal to the domestic tax. What are the merits and the potential problems in that approach?
David Kreutzer: Yeah, you know, that maybe is the most compelling sounding part of this thing. But it is I think the most dangerous. It is a constant battle to keep people that want tariffs and other trade restrictions at bay. There are always special interests that want to protect whatever their industry is or whatever their product is. And it's an almost impossible task for economists to keep that as low as possible. This carbon border adjustment would be very, very difficult to set up. I mean, you'd have to know, for instance, if you're bringing in a car from Japan, did they— how much of a carbon tax did they have in Japan? Did they import something from Korea where they had a different carbon tax? Did they use steel from some other country? What's the carbon content that hasn't been taxed and all of these products that are coming in? And there are going to be lobbyists who are going to go out and say, "Our competitors' imports actually have more carbon than they claim." There are going to be lawsuits. There's going to be all sorts of rent-seeking and lobbying going on. And once you get that in place, I think that would be the most difficult thing to unwind. It's very, very difficult to get rid of tariffs because of what we call the special interests effect. The benefits are narrowly focused and the costs are spread out. So, there's not much organized opposition to them. So, I think that the carbon border adjustment tax that that tariff is the scariest of the proposals that they've put out.
Marie Sapirie: To conclude, what are the alternatives to a carbon tax that policymakers should consider?
David Kreutzer: I believe that manmade emissions of greenhouse gases have caused warming of the earth and will continue to do so. I'm also convinced that we're not heading to an existential threat. For instance, even the IPCC knows that we don't have any upward trend in hurricanes, floods, droughts. And NOAA says, looking at the tornadoes, there's no upward trend in tornadoes, after you adjust for the fact that we've been using radar to find them lately. So, I don't think the climate problem is as scary as the solutions they're offering. And even if it were, you can look and see, well, what would happen if we got rid of all CO2 emissions in the U.S. altogether? It has a pretty minor effect on whatever global warming there might be, less than two tenths of a degree, and you can do that for the whole developed world.
And you might get something of four tenths of a degree reduction. That's talking about getting rid of all CO2 emissions, which isn't going to happen. So, what you have to do is impose what I would consider some fairly draconian restrictions on the growth of CO2 from the developing world. People that hardly produce any CO2 at the moment who are desperately poor, who need affordable energy. So, what I'm getting around to saying is, I think what we need to do is promote economic growth, not just in the U.S., but worldwide. The impact of the climate will be something that rich people can adapt to. And the projections for world income per capita world income by the end of this century would be four, five, six times what it is now and the more so for the developing world. So, if we do nothing, we'll still do a lot.
People will still build stronger houses. People will continue to build the sand up on the beaches as they already do. So, we will make adaptation that will happen without any policies. But I think it's a mistake to impose significant economic costs for almost trivial impact on global warming. I also think it's totally disingenuous to call climate change the greatest threat of the 21st century. I think poverty is a bigger threat. I think the potential of crazy world leaders with nuclear weapons on intercontinental ballistic missiles is a huge problem. But whatever problems we're going to come up with, the richer we are, the better we handle them. That's absolutely crystal clear. And you can look at the people that do this research. They say that the problems of climate are not that much for rich countries. Well, if we allow economic growth to continue and to increase, in an absolute sense, all the countries are going to be rich in 150 years.
Marie Sapirie: Thank you, David, for joining us today.
David Kreutzer: Thank you very much for having me on.
David D. Stewart: Now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor-in-Chief Paige Jones. Paige, what will you have for us?
Paige Jones: Thanks, Dave. In Tax Notes Federal, Richard Ray considers the questions that arise when taxpayers sell their farms. Richard Kaplan and Barry Federici delve into pension law. In Tax Notes International, Kartikeya Singh analyzes how the scoping criteria of amount A under the OECD's Pillar 1 proposal would affect U.S. and non-U.S. multinational enterprises. Three tax professionals consider changes to U.S. documentation requirements for previously taxed earnings and profits. In Featured Analysis, Nana Ama Sarfo reviews some coordination concerns reflected in comments from the EU's recent DAC8 consultation. On the Opinions page, Joseph Thorndike writes that Henry David Thoreau’s brief stint in jail was significant in inspiring future civil disobedience. Marie Sapirie examines the tax information reporting on cryptocurrencies that is likely to be required in upcoming infrastructure legislation. Robert Goulder and Joseph J. Thorndike discuss the relationship between taxes and infrastructure. And now, for a closer look at what’s new and noteworthy in our magazines, here is Tax Notes State Editor in Chief Jéanne Rauch-Zender.
Jéanne Rauch-Zender: Thank you, Paige. I'm here with distinguished professor Walter Hellerstein, with the University of Georgia Law School, visiting professor at the Vienna University of Economics and Business, and the chair of the Tax Notes State advisory board. Welcome to the podcast, Wally.
Walter Hellerstein: I'm thrilled to be here. Thank you.
Jéanne Rauch-Zender: I was very excited to publish your recent Tax Notes State article "Platforms: The Postscript." Would you give listeners a summary of the article and explain why you spent so much time and effort including four articles on this topic?
Walter Hellerstein: I'm delighted to do so. I was actually thrilled to write or co-author all four articles. The first article was in December of 2017, maybe the Mesozoic era from a tax standpoint, because it was six months before the Wayfair decision. And what was interesting about the first article was four states had platform legislation, again, designed to somehow induce taxpayers, or really more appropriately tax facilitators, like platforms to collect the tax, because it was easier than complying with the information reporting requirements. Then comes Wayfair. Well, quickly, the states woke up. Oh my goodness. Right? So, suddenly as of a little over a year later, January of 2019, 10 states had enacted platform legislation, instead of just four. They had woken up. Obviously they knew they could do this. And most importantly, it was no longer just making life so hard to report on the information associated with the sale, but actually to say, you must collect.
And if you exceed a certain threshold, namely the threshold that had been identified in the Wayfair case, the $100,000 or 200 transactions, you must collect. OK. Let's fast forward, one year later, or about a year later. From January 7, 2019 to January 6, 2020. And those are the dates of the Tax Notes State, I think it went from State Tax Notes to Tax Notes State at some point. 38 states. So in one year, in one year, 28 states adopted platform legislation. Now, I've lived a long time, too long probably, but I've never in my life ever, ever seen the kind of legislative response that has been so rapid. But Amazon and all the websites that are defined as tax collectors now, they have their hands on the money. So imagine it 28 states in one year enacted platform legislation. And that's when we thought, I said, "OK, we know that over the next few years, in the near future, states will enact the platform legislation."
So, we said that was the finale that was— the finale was supposed to be in 2020. And then we thought, well, of course, when all of the states, the remaining seven states, the last one was Missouri, enacted platform legislation. We got to the point where 45 of the 45 states that have sales taxes have platform legislation. So, we thought we'd put a postscript saying, "Well, let's have a complete review and analysis of all the legislation." We've come a long way, baby, in a very, very short time. And I think right now we're still just getting started.
Jéanne Rauch-Zender: That was very insightful. It was an excellent review, Wally, thank you. Now, in your article, you note the parallels between the international and U.S. subnational platform developments, writing, "It is important to recognize that marketplace platforms are emerging as an equally significant development in the international cross-border consumption tax context." Will you discuss the analogous issues that you raised?
Walter Hellerstein: Well yeah, the issues they're basically the same. And again, they're driven by the same problem, that is at least in an international context. When you think about it, the same, what I would call, and actually the OECD has used this term too in dealing with these issues, define substantive jurisdiction as being having the taxing rights over something, whether the taxing rights over a good or service you purchase, consumption, or in the income tax context, having income fairly attributed to the jurisdiction. Those are the taxing rights. That's substantive jurisdiction. The other problem is, OK, you've got the taxing rights, how do you enforce those taxing rights? So, in the subnational context, at least prior to Wayfair, and even after Wayfair, the question is, what do you do when you have a taxing rights in the jurisdiction because consumption occurs there, but the seller is not there? All you have is the consumer who owes the tax. Well, that problem that we have some nationally is that precisely the same problem that we have internationally.
Jéanne Rauch-Zender: Thank you, Wally. I'm grateful for the articles and your continued support. And thank you so much for coming on the podcast. It's been a real pleasure. Before we let you go, where can people find you online?
Walter Hellerstein: Well, you can find me at wallyh@uga.edu.
Jéanne Rauch-Zender: You can find Wally's article at taxnotes.com. And be sure to subscribe to our YouTube channel Tax Analysts for more in-depth discussions on what's new and noteworthy in Tax Notes. Again, that's Tax Analysts with an S. Back to you, Dave.
David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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