The case against the Carbon tax

We should be making energy less expensive, not more expensive.

Feb 26, 2024

On the Center-Left and Center-Right a carbon tax is a popular alternative to Green energy subsidies and mandates. Probably for this reason, I have gotten many comments asking about what I think about a carbon tax. Because of these repeated questions, I decided to finally write an article on the topic.

What should be the goal of energy policy?

First, we must establish what the goal of energy policy should be. I have made clear that my goals are to promote:

Long-term widely-shared economic growth. As this pertains to energy policy, this means abundant, affordable, and secure energy.
Mitigate the negative side effects of our energy on the natural environment and human health.

Let me be clear that I believe that the first goal is much more important than the second. If there were a zero-sum trade-off between the two, I would not hesitate to choose the first goal. Fortunately, there are ways of achieving both goals, as long as we always favor economic growth.

Second, I want to make clear that carbon dioxide emissions are only one negative side effect on the natural environment and human health. Air pollution, water pollution, destruction of wild habitats, extinction of species, and hazards to human health are also important negative side effects.

The goal of Carbon taxes

Carbon taxes are designed to capture the negative externality of carbon dioxide emissions that are not fully captured in the price of energy. Many supporters of carbon tax like it because it is perceived as an alternative to a command economy. The carbon tax essentially assigns a price to energy that is more aligned with its overall cost to society.

Carbon taxes give an incentive to:

Consumers to ration their energy usage, particularly those energy sources that emit high amounts of carbon per unit of energy.
Companies to shift their investments and equipment from carbon-intensive energy sources to less carbon-intensive energy sources.

For these reasons, a carbon tax is typically viewed as a market-based alternative to Green energy subsidies and mandates. Keep in mind though that the goal of a carbon tax is very different from my stated goals. There is at most a 20% alignment between a carbon tax and my goal.

So we are already off to a rocky start for carbon taxes.

Problems with Carbon taxes

In addition to having what I believe are incorrect goals, carbon taxes have very serious problems that its supporters often do not recognize. I will list them out here and then describe some in greater detail in the following sections.

A carbon tax:

Makes energy more expensive (so it violates what should be the primary goal of energy policy)
Does not deal with most of the negative side effects of energy
Amount will be set by politics, not science
Is Regressive
Is unlikely to be implemented
Disincentivizes natural gas
(in some cases) Will tax the wrong energy producers.

Carbon taxes make energy more expensive

A key goal of a Progress-based energy policy should be that energy is abundant, affordable, and secure. This needs to be true both for wealthy nations as well as developing nations. It must apply to nations in all geographies.

Carbon taxes make energy more expensive. That is the opposite of affordable. As far as I am concerned, that makes the carbon tax bad from the start. We should not be trying to raise the cost of energy.

To be clear, I am also generally opposed to making energy less expensive than its market price through subsidies. Market prices are essential for a society to make wise use of its resources. Distortions in those prices should only be implemented when there is a powerful argument in favor of it.

Carbon taxes only deal with carbon

This is pretty obvious and I guess that this argument will not impress supporters of carbon taxes. I understand that supporters of carbon taxes are laser-focused on mitigating climate change, but I am not. Once you get past all the rhetoric of impending climate doom, we can see that carbon emissions are only one of many negative side effects of energy on the natural environment and human health.

Carbon taxes do nothing to address the vast majority of those negative side effects. Most likely supporters of carbon prices would respond that additional government interventions would be possible. Though now their proposal is getting pretty complex.

Externalities are extremely hard to calculate

The strongest argument that supporters of the carbon tax have is that carbon taxes will “internalize” the external costs of carbon to society. In theory, they are correct, but not in practice.

Almost every advocate for carbon taxes does one of two things:

Goes through sophisticated mathematical calculations to identify the “correct” price that accounts for the negative externalities of carbon on society. Unfortunately, they arrive at widely different amounts that are primarily determined by the untested assumptions made before the calculations were even made. Given that these assumptions cannot be easily tested, it is not clear what the “correct” carbon prices should be.
Start with “assume a carbon price of $100/ton” or some other amount. Interestingly, they are typically nice round numbers that suggest that the actual externalities of carbon are not really considered.

So while supporters of the carbon tax use the concept of externalities to market their proposal, they do not actually use those externalities to determine its amount. This is a bit of a bait-and-switch.

Ironically, the process that supporters use for determining carbon prices is exactly the process that command economies use to calculate the correct price for goods. So while supporters of carbon taxes say they are against “command economies,” they use exactly the same methods to determine the “correct” price. So a carbon tax is really a command economy in disguise.

Externalities are constantly changing

Just like prices in a market economy, externalities are constantly changing. Most things in life have diminishing returns. The negative effects on society per ton for high carbon emissions are likely to be very different from medium levels of carbon emissions. It seems likely that the true cost of carbon to society diminishes as actual global carbon emissions decline. At some point, it seems likely that the negative externalities approach zero, while the negative effects of the tax on economic growth remain.

So calculating the proper level of taxes will need to be ongoing. That sounds an awful lot like a command economy to me.

Carbon taxes will not be set by externalities

Given all the above complexities, the reality is that the amount carbon tax will be set by politics, not by externalities. Parties on the Left will try to set the carbon tax as high as possible, while parties on the Right will try to set the carbon tax as low as possible. And corporate interest groups will lobby for exemptions that undermine the entire point of carbon taxes. We see this political tension every time a nation tries to implement a carbon tax.

I believe that the only way for the carbon tax to greatly reduce carbon emissions is for it to be set so high:

As to be politically infeasible
As to have a very negative effect on economic growth (both in the short-term and the long-term)

Major overhauls of taxes are among the most difficult types of legislation to pass. This is because many people will end up paying higher taxes, and so they will fight hard against legislation. So they must be given financial incentives to lessen their opposition.

So realistically, the only kind of carbon tax that can be implemented are likely to have minimal changes on global carbon dioxide emissions.

Carbon taxes ignore positive externalities

Those who argue for carbon taxes focus almost exclusively on negative externalities of carbon emissions to the climate, but they ignore positive externalities to the economy.

As I have argued in other posts and my book, From Poverty to Progress, the widespread use of fossil fuels is one of the Five Keys to Progress. Now, of course, I do not claim that fossil fuels will be necessary for human material progress forever. I am very confident that a better energy source will be invented, but I am equally confident that it does not yet exist.

If I am correct, fossil fuels have hidden positive externalities that are likely in the range of tens of trillions of dollars. The wealthiest pre-industrial society was the Dutch Republic which peaked at an estimated $2100 per capita GDP just before 1700. Today, numbers over $50,000 per capita GDP are common in industrialized societies. In 2023 the world economy is about $100 trillion.

A simple calculation shows that if the current world’s population of 8.1 billion were at the per capita GDP of the Dutch Republic, the global economy would be roughly $17 billion. And that is assuming that developing nations would be able to reach the same level of economic development as wealthy nations, which is a big assumption.

Now obviously fossil fuels are not the only cause of modern economic growth, but it seems reasonable to assume that they have been an essential precondition up until now. So fossil fuels gave something like a positive externality of roughly $80 trillion per year.

If one takes the externalities argument seriously, then it looks like the government should be subsidizing fossil fuels, not trying to tax them. To be clear, I am not proposing such a subsidy, but I wonder why those who care about externalities are not doing so.

Carbon taxes do not do anything directly

Most supporters of the carbon tax lean heavily on carbon taxes for creating incentives for corporations to invest heavily in alternate low-carbon practices and technologies. That seems reasonable until you realize that carbon taxes do not do that directly. Corporations still have to invest in alternate low-carbon practices and technologies. This leads to a “double payment” which I explain in the next section.

Of course, carbon taxes encourage end consumers to use less energy. At the margins, this is probably a good thing. I am a strong supporter of energy efficiency, and we can definitely do better in this area. Many products seem cheap but are not so cheap when one factor in the energy needed to use them over time. But energy efficiency and carbon emissions are not the same thing. If energy efficiency were the goal, then you should support a feebate rather than a carbon tax.

So paying increased carbon taxes does not accomplish anything positive in itself except to incentivize consumers to ration their energy usage. There is certainly plenty of energy that is wasted, but it is hard to believe that lowering energy usage substantially will not result in a lower material standard of living. That is the opposite of the goal we should try to achieve.

Unfortunately, this is exactly what is happening in Europe. The governments have deliberately driven up energy prices with gasoline taxes, carbon prices, and other government interventions. This has led to de facto Energy Austerity rather than an Energy Transition.

By that I mean, the Europeans have primarily driven down carbon emissions by driving up energy prices, not by substituting Green energy sources for fossil fuels. This is very bad for economic growth and does much to explain why their economies have stagnated since 2007.

Carbon taxes lead to double payment

Let me explain what I mean by “double payment.” The carbon taxes will raise revenue. That is the first payment. But it still has not accomplished anything other than depressing energy use.

The second payment is the actual investment that corporations need to make to bring alternate low-carbon practices and technologies online. Corporations will have little choice but to add this cost into their price structure.

Most likely, this will take a few years from the decision to invest to the time when it is fully deployed and working. If one looks at the entire economy, this could easily be decades. Energy investments are extremely expensive and with less capital (due to carbon taxes), corporations will need to spread those investments over many years or even decades.

So consumers will have to pay twice:

Higher prices due to the carbon taxes
Higher prices to pay for corporate investments

This is the opposite of affordable.

Carbon taxes are regressive

Another major problem is that carbon taxes are regressive. By that, I mean that the wealthier a person is, the lower the percentage of their spending they will pay in carbon taxes.

In addition to a growing economy, the poor and working-class need affordable prices above all else. Affordable energy is the basis of affordable prices for all other goods. Expensive energy drives up the cost of manufacturing, transportation, education, health care, housing, and virtually every other good or service.

Lower-income households spend a significantly larger share of their income on energy than middle- or upper-income households. On average low-income households spend 8.1% of their income on energy, compared to only 2.3% for the rest of the nation. A full 40% of those households spend more than 10% of their income on energy. High energy prices function as a regressive tax that punishes the poor and the working class far more than the professional class (Drehohl).

This is a major problem for me, as I passionately support progressive tax rates (within reason). Those who contribute more to our society deserve to keep the majority of their earnings, but they can afford to pay a higher tax rate than poorer citizens.

Many supporters of carbon taxes try to make up for this by:

Phasing in a carbon tax while phasing out a mildly regressive tax like payroll taxes or more regressive sales taxes. But payroll taxes are nowhere near as regressive as carbon taxes, so it is not a fair trade. In the United States sales taxes are collected on the state level, so it is not clear how this swap would work. In Europe swapping VAT for carbon taxes, however, seems like a reasonable trade.
Creating a rebate that gives back all or some of the revenue in a flat amount (for example $2000 to each family or $1000 for each adult)

I appreciate the attempt of the supporters of a carbon tax to make their overall policy less regressive. If we had to have a carbon tax, I could only support it with these add-ons.

Carbon taxes do not tax system costs of wind and solar

I am going to write a separate article on this issue, but for now, I will say that zero-carbon energy producers often force increased carbon emissions in the energy system. System costs are when one energy producer forces up the costs for other energy producers in the same system. This is particularly common for intermittent power sources, such as wind and solar. It is not clear to me that carbon taxes can factor those system costs into their tax.

Intermittent solar and wind create additional demand for natural gas to function as “peakers” to load the balance between electricity production and consumer demand. This is particularly true at night (when there is no sun) and winter in Temperate latitudes (when days are shorter and the sun is at a lower angle). Unfortunately, peaker gas plants are far less energy-efficient and emit more carbon than other types of plants. So to reduce carbon with zero-carbon renewables, the actual result is to make up most of the savings with increased carbon emissions from using less efficient types of natural gas plants.

Yes, in the long run, batteries are an option, but this is a very expensive alternative to natural gas. Batteries might lead to lower carbon emissions by the system, but significantly higher costs.

Worse, the peaker natural gas plants will have to pay the carbon taxes that were made necessary by wind and solar plants. It is far more cost-effective to run very energy-efficient CCGT plants 24/7, but the carbon tax makes this less likely because solar and wind appear to be lower carbon.

Zero-carbon solar and wind cannot replace fossil fuels

Carbon taxes incentivize zero-carbon wind and solar. Many Greens and supporters of carbon taxes believe that we can easily substitute fossil fuels with increased wind, solar, and other zero-carbon renewables. This is simply not true today (except for geothermal which is uncommon), and it does not seem likely in the foreseeable future. Any biomass and biofuels often emit more carbon than fossil fuels.

The reason is simple. Solar and wind cannot replace:

Coal-burning power plants, though they might be able to defer the need for additional coal plants in the future.
Direct coal or natural gas combustion for manufacturing
Crude oil in most transportation modes
Petrochemicals used as the feedstock for thousands of products
Natural gas plants

Only natural gas can replace the first four in anything like a cost-effective manner.

If you are skeptical, I have already written articles on how solar and wind cannot replace coal in the United States or Asia. Solar are wind are overwhelmingly in addition to coal, not instead of coal. And this generally applies to other fossil fuels as well.

Quite frankly, once coal has been replaced, there is not much point in additional solar and wind, except in certain unique geographies. And nothing in my plan undermines their ability to do so.

Carbon taxes disincentive natural gas

If you start with the observation that natural gas is the only viable replacement for high-carbon coal, then one can see a real problem with a carbon tax. New CCGT plants emit about 2/3 less carbon than existing coal plants, but they still emit some carbon. And we will all have to pay additional taxes to reduce carbon. This is the opposite of what we should be trying to accomplish.

Carbon taxes are designed to give companies an incentive to shift to carbon-free energy sources. The problem is that carbon taxes disincentivize natural gas and crude oil, which currently have no viable alternatives in many sectors. In particular, since natural gas is the most cost-effective means in the United States to reduce carbon emissions while maintaining a stable and affordable energy system, carbon taxes create very bad incentives.

Under a carbon tax, an electrical grid or industrial company that is seeking to transition from coal to natural gas will have to:

Pay the carbon tax for the carbon that is emitted by coal during the transition.
Pay for the installation costs of installing natural gas plants.
Pay for the carbon emissions of the natural gas plants for the foreseeable future, even though the roughly 2/3 reduction in carbon makes the external costs of the carbon very low.

Only the second cost is essential. The first and the third are exclusively because of the carbon tax. This seems like a very inefficient means to shift from coal to natural gas, as I advocate.

Carbon taxes also tax crude oil, which currently does not have a viable alternative for most types of transportation. We should not be fooled by the existence of electric cars to miss the extraordinary complexity of electrifying transportation. The vast majority of transportation devices can only realistically be powered by crude oil.

Airplanes, cargo ships, military vehicles, tractors, and long-haul trucking are just a few modes of transportation where electricity is not viable in a cost-effective way for the foreseeable future. It is one thing to tax a high-carbon means of transportation when there is a viable alternative already in existence. It is quite another to do so when a viable alternative does not exist.

Electric cars are still in their infancy, and they will remain so if the electrical grid is powered largely by solar and wind. Once the electrical grid of wealthy nations is powered largely by natural gas, nuclear power, and hydroelectric dams, then and only then is the electrification of transportation at scale viable. A carbon tax will slow down that transition.

There are better alternatives

Rather than trying to drive up the cost of energy, we should focus on making cost-effective transitions away from the highest carbon-producing energy sources. I know climate activists will hate me for saying this, but we do not need to achieve global Net Zero by 2050. This goal has nothing to do with science. It is an ideologically driven goal (notice the nice round number; science does not work that way).

Nor do we need to eliminate fossil fuels. We just need to shift the trend from increasing global carbon emissions to a long slow decline.

Let me give a more concrete example of the difference.

The simplest means to do so is to substitute coal combustion with the only viable alternatives for on-demand or base-load energy. I advocate for a transition from coal to a blend of natural gas, nuclear, and hydroelectric energy. The exact blend of the three will be determined by geography and local cost structure. For North America, natural gas is far superior and could easily lead to a virtual elimination of coal use in only 5 years. Since a new CCGT plant emits roughly 2/3 reduction of the carbon emissions of an existing coal plant, this will lead to very low levels of North American carbon emissions.

This would lead to a far greater decline in carbon emissions than has so far been achieved by Green energy policies and at far lower costs. In my book, I estimate that such a goal would cost a maximum of $148 billion in the United States. This is less than 30% of the cost of the recent Inflation Reduction Act of 2022.

There is also no reason to believe that American manufacturing firms will have a problem rapidly scaling up the production of CCGT plants. In 2002 and 2003 the United States installed almost 40 GW of CCGT plants annually. At that rate, we could replace every coal plant with energy-efficient CCGT plants in just over 5 years.

The same goes for the European Union. Coal-burning power plants in the EU currently generate just under 107 GW of electricity. This means that we could replace every single coal plant in the EU for only $73 billion. This is a tiny fraction of what has been spent thus far on Green energy in Germany alone.

In another article, I explain how American LNG can help make this transition easier and how we can expand the transition into Asia

Meanwhile, global Green energy spending is roughly $1 trillion per year, and global carbon emissions are still going up.

The Final Verdict

The carbon tax:

Undermines long-term economic growth
Drive up energy prices, particularly for the poor and working-class
Does not actually capture externalities
Disincentivizes natural gas, the only viable low-carbon technology to replace coal, the highest carbon emitter

And just as important, there are far better alternatives. Perhaps a low carbon tax is better than current Green energy policies that mandate and subsidize wind and solar, but the policy has too many negative side effects for me to support.

From Poverty to Progress