social cost of carbon – rbouvier consulting

Is the proposed hybrid/electric vehicle tax a good idea?

By Rachel Bouvier | April 2, 2018 | Comments 0 Comment

In February, Maine’s Governor LePage proposed implementing a fee on the owners of electric and hybrid vehicles.[1] He is not alone – 17 other states have already implemented similar fees[2]). It may seem, at first glance, to be yet another slap in the faces of “liberal-minded environmentalists.” But giving the Governor the benefit of the doubt, it’s actually attempting to solve a problem that’s been seemingly intractable for years: that the state highway trust fund is overextended, at a time when the state’s infrastructure is badly in need of investment.

Maine, of course, is not alone. The Federal Highway Trust fund, which is primarily funded by federal taxes on gasoline, is also underfunded and over-extended. Much like other issues in Congress, though, potential solutions seem to be few and far between, and no politician wants to propose anything as unpalatable as a tax increase.

So, what’s the problem? The highway funds at both the federal and the state level are funded primarily through taxes on gasoline. In Maine, slightly less than 70% of revenues earmarked for the State Highway Fund are from gasoline taxes. Another 27% come from vehicle registrations and fees, leaving the remaining 3% to come from various other sources[3]. In 1991, the first year for which revenue for the highway fund is reported on the legislature’s web site[4] , the highway fund received approximately $197 million (or approximately $363 million in today’s dollars). In 2015, the fund received approximately $308.5 million (or $327 million in today’s dollars). That’s a decrease of about 10% in real terms, despite the fact that the Association of Civil Engineers has given Maine a D on roads, essentially unchanged since 2008.[5]

Moreover, whereas the federal government has supplemented its declining revenues with other sources (with questionable legality), Maine cannot do the same. So how did we get in this mess?

The answer is that the tax is poorly targeted and creates perverse incentives. Let’s start with the targeting question. Taxes are supposed to do several things, from an economic viewpoint: raise revenue and change behavior. In this case, the tax is primarily to raise revenue for the highway system. Some environmentalists would also like to see the gasoline tax used to reduce the demand for and usage of gasoline, as one of the culprits in climate change, but the two objectives are fundamentally at odds, for several reasons.

First, if the revenue from a tax is used to fund a particular program, then the tax should be designed to bring in a sustainable amount of revenue year after year. In this case, the revenue from the gasoline tax has been declining year after year. This decline is due to both technological advances and changes in demand. Average fuel economy for passenger cars has been generally rising since 2000, and the trend has been similar for trucks since about 2004. Average fuel economy for both cars now stands at about double what it was in the 1970s, meaning today’s cars can travel twice the mileage on a tank of gas than they could back in the 70s[6]. That’s great news for the environment, but not great news for those who depend upon the revenue from the gas tax.

Second, even as the Maine population increases, the number of miles driven has not increased. In fact, whereas you normally might expect to see people driving more miles as it becomes cheaper to do so, we aren’t seeing such a trend. In fact, while Mainers drove about 14,925 in 2005, that number actually dropped to 14,838 in 2016[7]. So, the revenue from the gas tax has been hit doubly hard: the average miles per gallon has increased, while the number of miles driven per year has decreased. We could of course increase the gasoline tax (it hasn’t been increased since 2011), but that is likely to further dampen the demand for purchases of gasoline.

So, what to do? We could, of course, follow Governor LePage’s recommendation and impose a surcharge on hybrid and electric vehicles. In one way, that would address the “free rider” problem that some analysts have pointed out: that owners of hybrid and other fuel-efficient vehicles use the highways as much as others, but don’t pay their “fair share” to the highway fund.[8]

Ultimately, though, that would not solve the problem, because the gas tax is poorly targeted in the first place. The wear and tear on our infrastructure is tied to the usage of the highway, which is only imperfectly proxied by gallons of gasoline purchased. A better targeted tax would be to impose a tax on vehicle miles driven, like the one currently being studied by the Colorado Department of Transportation. [9] Of course, such a system would require some method of tracking number of miles driven, either through electronic monitoring such as those already in place on tolled highways, or through some other system.

Such a tax would not, of course, create an incentive for individuals to buy more fuel-efficient vehicles, which is one of the reasons why environmentalists like the gas tax. The gas tax, in their mind, is akin to a cigarette tax, which aims to curb smoking by increasing the price. But if the goal there is to reduce carbon emissions, a tax on the carbon content of fuel, not the gasoline itself, would be a more efficiently targeted tax. But that’s a different blog post, for a different day. (You may view my blog posts on the carbon tax, here and here.)

[1] https://www.epa.gov/fuel-economy-trends/highlights-co2-and-fuel-economy-trends

[2] https://www.fhwa.dot.gov/policyinformation/statistics/2013/hm60.cfm

[3] http://www.thedrive.com/tech/18549/maine-and-colorado-struggle-to-tax-electric-cars-fairly)

[4] https://www.pressherald.com/2018/02/08/legislation-calls-for-new-annual-fee-on-all-electric-hybrid-cars-in-maine/

[5] https://www.greentechmedia.com/articles/read/13-states-now-charge-fees-for-electric-vehicles#gs.y_6lSMM

[6] http://legislature.maine.gov/legis/ofpr/highway_fund/pie_charts/Hfpie1213.pdf

[7] http://legislature.maine.gov/legis/ofpr/highway_fund/rev_exp_history/index.htm

[8] https://www.infrastructurereportcard.org/wp-content/uploads/2016/10/Maine-Report_Card_final_booklet.pdf

[9] https://www.denverpost.com/2017/12/12/colorado-mileage-tax-experiment/

The Social Cost of Carbon: Implications for Maine (Part II)

By Rachel Bouvier | November 2, 2016 | Comments 0 Comment

My most recent blog post, “The Social Cost of Carbon: Implications for Maine (Part I),” went into some of the details behind calculating the social cost of carbon – a number that is used to illustrate the economic damages anticipated by climate change and therefore linked to carbon dioxide emissions.
This blog post will be a bit more policy oriented. Once we arrive at a social cost of carbon, what do we do with it? How can we use it to reduce the amount of carbon that’s emitted into the atmosphere?

Essentially, there are three policy options to reduce climate change. One is what economists like to call “command and control.” This is standard regulation – where each company or industry is given a standard beyond which they are not allowed to pollute. If they are found to have polluted beyond that standard, they are then (typically) fined a certain amount.

The second and third option are what economists call “incentive-based regulation.” Rather than give companies or industries a hard and fast limit, this type of regulation gives the regulated community an incentive to reduce emissions. The incentive could be in the form of a subsidy for each unit of pollution reduced, or, alternatively, a tax system could be put in place. In that case, the firm’s incentive to reduce pollution is the avoided tax on each unit. (From an economic perspective, there is actually no difference between a tax and a subsidy when it comes to determining the “efficient level” of pollution. From a political perspective, of course, there is a huge difference.)

A third option is to implement a trading scheme. The idea is simple: firms are distributed a certain number of permits or “rights” to pollute. (The permits could be initially distributed free of charge, or the permits could be auctioned off.) Firms that could then reduce a unit of pollution more cheaply than the permit price would do so, and sell the unused permit on the market to other firms that have a more difficult time reducing pollution. The firm’s incentive to reduce is the price that they get from selling their permit. Creating a market like this is not without its difficulties, and markets for pollution have met with varying degrees of success. One pollution market close to home is RGGI, the Regional Greenhouse Gas Initiative, which is the topic of one of my earlier blog posts. The revenue gained from auctioning off the permits goes to energy-saving initiatives.

One of the major difficulties in both of these is to set the “right” price – too low, and not enough firms will reduce their emissions; too high, and it can create political dissatisfaction and a drag on the economy. (A side note: unbridled carbon emissions are already creating havoc with Maine’s economy – but that will be the topic of a later blog post.)

A second major difficulty (what I like to call the “liberal’s paradox) is that implementing a carbon price will necessarily be regressive – the burden of the tax will be felt disproportionately among lower-income households. A price on carbon – whether it’s a tax or a permit system – will raise the price of carbon-intensive goods and services, such as fossil fuels and conventionally-generated electricity. Low-income households spend a higher percentage of their income on fuel and electricity than do higher-income households. What to do? It turns out that what you do with the revenue from the tax (“revenue recycling”) can moderate or even negate the regressivity of the tax.

The think tank Resources for the Future (RFF) has published a series of articles addressing this very topic. I’m going to address three possibilities for revenue recycling. Two of them have to do with reducing taxes on other things – shifting the burden from taxing economic “goods” (like income and labor) to taxing economic “bads” (like pollution). (After all, if part of the point of a tax is to alter behavior, why tax good things like income and employment?) The third has to do with returning the revenue directly to the people. So I’m going to focus on three alternatives: tax carbon, but lower the tax on labor income; tax carbon, but lower the tax on capital income; and tax carbon, but return the revenue to the people in the form of a dividend or a lump-sum rebate.

RFF analyzed these three alternatives for their impact on different income groups to see which groups were “better off” after the tax and revenue-recycling scheme, and which were “worse off.” (It’s important to note that RFF did not analyze the effects of reducing carbon emissions – the primary goal of the tax, after all! – on the welfare of each of these groups. It’s well-known that low-income populations are the most sensitive to climate change, and therefore the group most likely to benefit from a reduction in greenhouse gas emissions.)

What they find, summarized, is this: the labor tax recycling scenario found that almost all groups ended up slightly worse off (the groups’ welfare or well-being declined by less than a half of a percent), but that the highest income group ended up with the biggest decline in welfare. The capital tax recycling scheme benefited the highest income group, while generating a reduction in welfare for all other income groups of less than one percent. And the lump sum rebate scheme benefited the lowest income group by more than three percent, while harming the highest income group by almost two percent. From an efficiency perspective, the capital tax recycling scheme is the most efficient (that is, the policy that “distorts” the economy the least).

I’ll replicate RFF’s graphic here:

Source: 2015. Williams, Roberton C., Burtraw, Dallas, and Morgenstern, Richard. “The Impacts of a US Carbon Tax across Income Groups and States.” Washington, DC: Resources for the Future).

Why such differences? Largely, it has to do with where individuals earn their income. Generally speaking, high-income households get a larger percentage of their income from capital (stocks, bonds, and property), while middle-income people rely more heavily on income from labor. Low-income people typically get a larger percentage of their income from transfer payments, which not only include food stamps and unemployment insurance but also Social Security. That explains why lowering the tax on capital would exacerbate the regressiveness of the carbon tax, while lowering the tax on labor would be slightly progressive.

What about here in Maine? I wasn’t able to get data directly for Maine, but only for New England as a whole. As it turns out, all the schemes end up diminishing the welfare of New England residents, but the lump-sum rebate actually performs the worst. Why? The answer mainly has to do with the fact that, overall, New Englanders receive a relatively high percentage of their income from capital as opposed to labor.

How about Maine, though? Is that the case? Looking at the Bureau of Economic Analysis for 2015, I noticed that Mainers as a whole received about 60% of their personal income from wages and salaries. An additional 22.5% comes from personal transfer receipts, which include Social Security benefits, medical benefits, veterans’ benefits, and unemployment insurance benefits. (By far the majority of these personal transfer receipts are retirement income and income from other benefits, excluding unemployment insurance benefits and income maintenance programs such as general assistance.) A little less than 18% comes from capital and property income.

By contrast, Connecticut receives about 66% of its personal income from wages and salaries, 12.8% from transfer payments, and over 21% from capital and property. This implies that lowering the tax on capital would not benefit the average Mainer as much as the average person from Connecticut – but without doing the calculations, I can’t be sure whether the labor tax recycling scheme or the lump sum dividend would be more or less welfare changing.

Of course, the election on November 8 may have made this a moot point. Passing a carbon tax (or fee, as some like to call it) has had a difficult time in the past, and the election of Donald Trump has made that possibility more remote. Any action now is likely to arise at the state level – which is why state level analysis is crucial. Climate change will likely have a disproportionate effect on those who are least able to protect themselves. Any actions to mitigate climate change should not increase the injury.

The Social Cost of Carbon: Implications for Maine (Part I)

By Rachel Bouvier | September 21, 2016 | Comments 1 comment

(This will be the first in a series of blog posts on carbon emissions, their costs and implications for Maine, and existing and proposed policy prescriptions.)

Last week, an article made the rounds entitled “the social cost of carbon“. This is of special interest to me right now, because I recently began teaching Environmental Economics at the University of Southern Maine. (Being a professor used to be my full-time job. Now I’m an economic and sustainability consultant, but teaching that class one day a week keeps me up to date on the most recent articles in my field.)

The concept of “social cost” in economics is nothing new, of course. Economists have long recognized that the production and consumption of certain goods produces negative externalities, or costs imposed on “third parties” who are not directly involved in producing or purchasing that good. Such externalities can be called social costs, and while it’s difficult to measure such social costs, environmental economists do their best (see, for example, my recent blog post on ecosystem services).

So why this new article on the social cost of carbon, and why is it taking on a new importance now? Because the social cost of carbon has now been upheld by a federal appeals court.

The details of the case are not particularly important for our purposes here. Suffice it to say that, every time a federal agency imposes a regulation, they are required to demonstrate that the benefits of the regulation exceeds the costs. This particular case was about improving the efficiency of commercial refrigeration equipment. But if the government (in this case, the Department of Energy) wants to tighten efficiency standards, they need to show that the costs of meeting the new efficiency standards aren’t exceeded by the benefits.

The costs of meeting the proposed standards are relatively easy to calculate. Refrigeration equipment companies might have to use new technologies or inputs, which are presumably more expensive than current methods. But how to calculate the benefits of tighter energy standards? Enter the social cost of carbon.

The social cost of carbon is, according to the EPA, “meant to be a comprehensive estimate of climate change damages and includes, among other things, changes in net agricultural productivity, human health, property damages from increased flood risk and changes in energy system costs.” Yet the EPA admits that the social cost of carbon does not include all damages, because “of a lack of precise information on the nature of damages and because the science incorporated into these models naturally lags behind the most recent research.”

The economic and scientific calculations that went into arriving at the social cost of carbon are mindboggling. The estimates used three well-known (well, well-known in certain circles) integrated assessment models that consider the linkages between climate processes and economic growth. These models translate emissions into atmospheric greenhouse concentrations, from there into changes in temperature, and finally from there into economic damages.

It is an ambitious undertaking, and some would say an impossible one. There are so many uncertainties in any step along that chain. For example, the models are ill-equipped to deal with non-linearities or “tipping points.”. In addition, the damages from an additional unit of CO2 is unlikely to have a linear effect (as a price per ton of carbon would imply), but increase as more carbon is emitted into the atmosphere. Dealing with future costs is difficult as well, as it involves “discounting the future,” a sticky ethical and legal problem as well as an economic one.

I am of the school of thought that “some number is better than no number.” Yes, the social cost of carbon as it stands now is highly imperfect and probably a gross under-estimate of the full social damages caused by a ton of carbon dioxide in the atmosphere. However, it is better than assigning a cost of zero, which would be the implicit price had the social cost of carbon not been considered.

This blog is supposed to focus on the links between the economy and the environment in Maine. So far this blog post hasn’t done that – but be patient!. The next blog post will focus on some of the possible solutions in terms of mitigation of climate change via a tax or a trading scheme (specifically for Maine), and the last will sketch out what’s at stake for the state. Stay tuned!

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