Carbon Tax: Universal or Select Applicability?
By Corbin Lubianski
In the United States, there has been significant political pressure to adopt a universal carbon tax to reduce carbon dioxide emissions. In essence, a carbon tax is a tax instituted upon goods and services that use large amounts of carbon dioxide and other greenhouse gases to discourage consumption for specific industries. However, there is little consensus on whether a carbon tax should be adopted universally throughout the economy or only to select industries.
In the study of microeconomics, a carbon tax is referred to as a “Pigouvian tax” where a tax is adopted to an economic activity that is causing negative side-effects to the economy. When adopted, they shift the equilibrium price and quantity supplied to the social equilibrium. An example would be consumption taxes on cigarettes because they increase the risk of lung disease and inevitably cause large costs for hospitalizations.
However, not all goods and services have the same relationship between price and demand changes, or demand elasticity. For example, the average price change for gasoline has the reduction of demand by 2.6% for every 10% increase in prices, according to Molly Espey at the University of Nevada, Department of Economics and Statistics. Essentially, a price increase will lead to a decrease in demand because people are less sensitive to gasoline price changes than to a nonessential good like soccer balls.
A Pigouvian tax’s effectiveness depends on the demand elasticity, such that reducing consumption for a good is difficult by increasing the price. It would be unwise to assume that all carbon-production industries have the same demand elasticity because consumers respond to different price changes of goods and services.
Carbon taxes try to reduce the demand for goods and services that produce large quantities of greenhouse gases by increasing the supply costs. Let’s use an example of the airplane industry. A single round-trip business class ticket from Boston to London costs about $8,000 and produces around 4 tons of carbon dioxide. We want to adopt a carbon tax on airplane flights to reduce carbon emissions by placing a $50/ton on plane tickets, as to place the tax directly onto the consumer. This would increase a single round-trip business class ticket from Boston to London to about $8200, or a 2.5% increase in price. Assuming that the elasticity of demand is 0.5 (5% demand reduction for every 10% price increase), the change in quantity demanded would be 1.25% by multiplying the percent change in prices to the price elasticity of demand.
Most estimates recommending a $50/ton carbon tax argue that electricity generation would be reduced roughly 70% after 20 years. A percentage reduction of 1.25% in quantity demanded round-trip business class tickets from Boston to London is vastly different from the 70% reduction in electricity generation. The difference of efficiencies should be inferred that efficiency differences are expected. Therefore, we should not explicitly target certain activities because the activities’ quantity demanded would drastically decrease. The goal is a reduction in carbon emissions and not reducing the quantity demanded. We need to reduce emissions while not significantly harming economic activity.
A reason for the source of the differences in efficiency would be the substitutes for long-distance travel in comparison to substitutes for electricity generation methods. For long-distance travel, say from Boston to London, the most viable method would be to either fly or take a boat. Because taking a ship is rather expensive and time-consuming in comparison to flying, taking a plane for long distances will remain the best option for traveling for the foreseeable future.
Let’s try to reduce carbon emissions caused by air travel by 70% and continue to use the example using a single round-trip business class ticket from Boston to London that costs about $8,000 and produces around 4 tons of carbon dioxide. We can find the new price of the plane ticket that would cause a 70% reduction in demand assuming a demand elasticity of 0.5. By dividing the demand reduction by the demand elasticity, we get a price change of 140% or a plane ticket that costs $19,200.
The efficiency of electricity generation to airline tickets is difficult to justify concerning the high costs. Assuming that the question means that the average residential house produces about 10 tons of CO2 from electricity and heating per year, it would be hard to justify reducing the carbon reduction efficiency of electricity generation to compensate for the low reduction percentage of airline tickets.
As a result, this policy would likely be very ineffective because of how expensive it is to reduce carbon emissions from business class travel. Better efforts should be made to reduce emissions from electricity generation because a higher percentage of emissions is reduced. In conclusion, we should advocate for a carbon tax on industries that would not bring drastic harm to our economy.