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Putting a Price on Carbon

If we are serious about addressing carbon emissions in the United States, we have to put a price on those emissions. It’s a very basic idea. People will do less of something if we make it more expensive. Fortunately, members of Congress are starting to get the point. This past year, they have introduced a number of proposals for carbon cap-and-trade systems and carbon taxes.

Either approach would encourage a shift away from carbon-intensive activities. In a cap-and-trade system, an overall emissions target is set, and companies receive permits that they must surrender with each ton of carbon dioxide they emit. Companies that can cut their emissions cheaply are allowed to sell permits to those companies for which reductions would be more expensive. A carbon tax is a bit simpler: energy sources are taxed according to how much carbon dioxide they release.

Whichever approach we adopt, two things are clear: First, this must be a global effort. And, second, the burden must be equitably distributed across income groups and regions.

Work I’ve done with colleagues at MIT underscores the first point. Unless China, India, and other fast-growing developing countries begin to reduce their carbon emissions, no policy the United States can adopt will prevent concentrations of carbon dioxide from topping 450 parts per million—a level that many scientists think is a tipping point for irreversible and highly damaging climate change. Strong action by the United States is a necessary condition for getting the developing countries to participate in a carbon regime. While there is no guarantee that they will come on board if the United States acts, it is a sure bet that China and India will do nothing if we don’t act.

The good news in our study of cap-and-trade policies is that the developing countries need not act immediately. Since greenhouse gases stay in the atmosphere for decades or centuries, emissions in any given year are less important than cumulative emissions over the next 50 years. If developed countries initiate a carbon policy now, developing countries can join an international regime in 15 to 20 years with aggressive policies that allow them economic growth while avoiding irreversible damage to the global environment.

In the United States, carbon pricing will inevitably raise the price of energy and disproportionately affect low-income households. For that reason, many policy makers are looking at ways to offset those higher energy costs. A study I did for the Brookings Institution illustrates how such a reform could be enacted. A carbon tax would be combined with an “environmental earned income tax credit”—in effect, a rebate of a portion of payroll taxes to offset the higher cost of consumer goods. Such a policy would shift our tax system away from taxing things we like (capital and labor) to things we don’t like (carbon emissions).

Carbon pricing—whether in the form of a cap-and-trade system or a carbon tax—is an efficient way to reduce our greenhouse gas emissions and make a credible statement to developing countries that we take this problem seriously. It is the first step on the long road back to a genuinely international agreement.

GILBERT E. METCALF, a professor of economics at Tufts and a research associate at the National Bureau of Economic Research, is an expert on tax policy and climate change. His  research formed the basis of proposed federal legislation to tax fossil fuels while reducing the payroll tax.

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