Taxing Carbon is Like Taxing Diamonds

To reduce carbon emissions, we must tax fossil fuels—but, say the pundits, we can’t do so because the tax would be regressive, clobbering the poor. In general, sales taxes are indeed regressive; moreover, as I recently argued, sales taxes are partly “passed back” onto suppliers, hitting small businesses hardest.

But wait… Imagine that we impose a sales tax on diamonds. Would we worry about the burden on middle class purchasers of one-fourth-caret engagement rings? What about the part of the tax “passed back” onto the DeBeers Group? Not much sympathy for global monopolists either.

Surprisingly, a carbon tax would operate much like a diamond tax, for reasons both of demand and supply.

Demand: The wealthy actually consume a disproportionate amount of carbon. Discussions of a carbon tax usually focus on the price of gasoline. One gallon of gas produces about 17 pounds of CO2. One metric ton is 2204 pounds. So a $100 tax on a ton of CO2 comes to $0.77 per gallon—a significant cost to low-income commuters and small truckers. But the very poor don’t drive or travel or occupy much space; the rich fly planes, including private jets; drive to low-density suburbs; occupy and heat multiple houses and hotels; and buy lots of stuff. Clearly the rich consume much more carbon per capita than the poor.

Supply: Sellers and buyers of goods differ in their sensitivity to price changes; the greater the sensitivity, the more they can avoid a tax by selling or buying less. Economists call this sensitivity elasticity of supply or demand; they measure it as the percent change in quantity sold or bought in response to a one percent change in price. Demand elasticity for oil is low, about 0.5; so a 1% increase in oil price would cause a 0.5% decrease in consumption. That makes sense, since in the short run, it’s hard for people to cut energy consumption, especially if they must drive to work. But, though numbers are hard to come by, elasticity of supply is much, much lower, for two reasons. First, oil production takes decades and billions in capital investment; producers cannot quickly increase or decrease supply. Second, oil producers form an international cartel, an organized mega-monopoly, which holds down production to drive up prices. Since they’re already charging what the traffic will bear, they can’t much raise prices to cover a tax.

As economists long ago figured out, buyers and sellers share a tax in inverse proportion to elasticity. Therefore, if supply elasticity of carbon is, say, 0.1, while demand elasticity is 0.5, the suppliers will pay five times as much of the tax as consumers. That reduces that $0.77 per gallon gas tax to only $0.13. Moreover, precisely because most of the tax falls on suppliers, it will generate plenty of revenue to help those unfortunate long-distance commuters and small truckers, to build more public transportation, to invest in renewable energy, and even to cut super-regressive taxes like the payroll tax.

Who owns the suppliers, anyway? According to Edward Wolff, in 2007, the top 1% in the US owned 43% of non-home wealth, mostly securities, including of course energy company stocks and bonds. The top 10% of wealth holders owned 83%. The same folks who own DeBeers also own Exxon, Shell, and BP.

A May 2013 federal study of the Social Cost of Carbon estimated costs of additional CO2 emissions for 2010 to 2050 ranging from $27 to $221 per metric ton in 2050, depending on assumptions. I think these numbers are low; in any case they tell us how much consumers and producers would have to compensate society for damage—not how much a tax of that size would reduce emissions. Given the low elasticity of supply and demand, it might take a pretty whopping tax to keep our grandchildren medium rare.

So we have good news and bad news. Good news: the cost of reducing carbon emissions will fall hardest on the 1%, who consume the most energy and own the energy companies. Bad news: ditto. Expect a fight!

Comments are closed.