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The perfect carbon tax
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The purpose of a carbon tax should be to promote the development of renewable energy as a replacement for our current dependence on fossil fuels. Imposing a tax on something generally results in less of that something being produced or consumed. A credit does the opposite, promoting production and consumption of what is given a credit.
I do not believe that a carbon tax should be used as a major new revenue source for the spenders in Washington. A carbon tax should also not be a large burden on the businesses or people who currently consume a large amount of fossil fuel energy. It should also promote the development of renewable energy.
In my previous article I suggested a carbon tax rate of one cent ($0.01) on the carbon equivalent in one gallon of gasoline. This amount of tax would provide all of the money needed ($7 billion per year) to fund the renewable energy tax credits. The renewable energy tax credits are very important to jump-start our renewable energy infrastructure.
The tax credits are working. An article from Barron’s discusses the huge increase in production capacity by solar cell manufacturers. Barron's noted that these companies might be at risk because of reductions in the amount of tax credits. The large expansion of capacity will have the effect of pushing down prices (and margins) for these companies as they expand capacity. This is just what we want!
The US Congress has not yet renewed these credits beyond the end of 2008 and credits have been slightly reduced in some European countries. My own belief is that the volume of solar cell production is so small compared to the total demand for new electric power that solar cell manufacturers will have plenty of room to expand capacity for the next several years.
The goal of the tax credit is to generate enough demand so that eventually technical innovation and economies of scale will create an industry that will be able to compete with fossil fuel power sources without the need for continued subsidies. To reinforce this trend, the perfect carbon tax should have a way of changing future behavior without imposing large costs on current consumers. One way to accomplish this is to set up a tax with an automatic escalation feature that would double the tax every four years. This can change current behavior, especially where it concerns long term investment horizons.
If you were planning to build a coal-fired power plant with a 40 year expected life span, the current one cent tax would not be a huge detriment to your investment plans. But over the 40 year time horizon, this tax will grow slowly at first and then more rapidly (exponentially) so that at the end of 40 years, the tax would be the equivalent of $10.24 per gallon of gasoline carbon equivalent. Starts to make wind and solar investments now look much better. The tax is aboput affecting expectations, without the burden of a large current tax cost. (This is the opposite of the Bush tax cuts which many people expect to expire in 2010. They generate little revenue now, but discourage long-term investment because investors will factor in the future tax hikes when determining their return on investment. Another reason congress has only a 20% approval rating.)
There is so much that we could do as a country to promote the development of renewable energy, more efficient transportation, and a stronger growing economy, if we could only recognize our problems and develop some practical solutions to solving them.
