The Good Tax: Carbon Fee & Dividend

 Dr. James Hansen

Dr. James Hansen

By David Holmquist

In 2009, climate scientist Dr. James Hansen published his first book, “Storms of My Grandchildren,” on the topic of climate science and his involvement in various governmental efforts over the previous two decades to craft a response to what he described as “the greatest threat civilization faces.” Dr. Hansen is perhaps the world’s most prominent climate scientist. Trained as an atmospheric physicist, he worked at NASA’s Goddard Institute for Space Studies for 45 years, and was its head from 1981 until his retirement in 2013. He is known for his groundbreaking body of work, and for his outspoken warnings regarding the possibility of “tipping points” being reached in the climate system that could lead to runaway global warming.

Dr. Hansen is also known for his climate activism—which has led to his arreston a number of occasions for civil disobedience—and for his advocacy of various public policies aimed at mitigating climate change.

He devoted a chapter in “Storms of My Grandchildren” to an extended argument for one of those policy recommendations, which he dubbed “fee-and-dividend.” The argument begins by establishing the need to immediately begin reducing greenhouse gas emissions (particularly from the burning of coal), and proceeds to describe the political obstacles to achieving effective public policy. He criticizes the predominant policy framework, cap-and-trade, as it was embodied in the Kyoto Protocol and the related “offset” programs designed to create “flexibility” for governments and industries in meeting their emissions caps. “Flexibility” is a code word for avoidance. The underlying problem, he asserts based upon his policy work with governments around the world, is the entrenched political and economic power of the fossil fuel industry.

In the chapter entitled “An Honest, Effective Path,” Hansen calls for “a solution with a clear framework and a strong backbone.” The strong backbone arises from the acceptance of the absolute need to increase the price of fossil-fuel energy. The clear framework is provided by straightforward and transparent policymaking focused on the goal of drastic emissions reductions. Fee-and-dividend, Hansen argues, is such a policy. Its basic operation can be described in just a few sentences:

  • A fee is levied on fossil fuels (coal, oil, and natural gas) at the point of extraction (mine or wellhead) or at the point of entry into the country, at a single rate in dollars per ton of CO2 (or, in the case of other greenhouse gases, their CO2 equivalent) emitted when that fuel is burned.

  • The fee would begin at a relatively low level, but be increased annually at a steady, predictable and significant rate, continuing to increase until emissions reduction targets are met.

  • All of the revenue from the fee would be deposited in a trust fund supervised by the Social Security Administration and distributed on the basis of equal shares to American households.

  • The problem of “leakage,” that is, the flight of energy intensive economic activity (and the associated jobs and emissions) to places without the tax, would be addressed through border tax adjustments. This would create a very strong incentive for other countries to adopt equivalent carbon fees or taxes.

Over the years since Dr. Hansen proposed fee-and-dividend, the idea has been further refined, studied and modeled. It was adopted as the legislative strategy of Citizens’ Climate Lobby (CCL), a non-profit, nationwide, volunteer, climate advocacy group which has conducted over 2,000 meetings with members of Congress or their staffers over the past two years. Dr. Hansen is a member of CCL’s Advisory Board. The policy proposal is now generally known as Carbon Fee & Dividend (CF&D).

The use of the term “fee” as opposed to “tax” is technically correct, because the revenue is not kept by the government. A common objection to the proposal is that the government cannot be trusted to return the money to the people, which might be valid if the dividend were designed to be paid by offsetting other taxes (for instance, payroll taxes). However, if the revenue is directed to a trust fund and paid directly to households through the already existing Social Security payments system, a statutory requirement regarding the use of the revenue can easily be monitored and enforced.

The purpose of returning the revenue to the people is twofold. It cushions the intended effect of the fee, which is to increase the cost of fossil energy both directly, as fuel, and as it is embedded in virtually all of the products we buy. Multiple studies have shown that with equal distribution of the dividend, households in the bottom two-thirds of the income distribution would receive more in dividend payments than they would experience in these increased energy costs. Revenue recycling will also create firm and lasting political support for the fee amongst voters and satisfy the Republican party’s requirement that any new “tax” be revenue-neutral and not increase the size of government.

The key to the effectiveness of Carbon Fee & Dividend is its transparency. As proposed by Citizens’ Climate Lobby, the fee would begin at $15 per ton of CO2 emitted, and increase each year by $10 per ton. We know precisely how much carbon dioxide is emitted by each refined product of each grade of crude oil, by each grade of coal, and by natural gas. Levying the tax is thus a matter of simple arithmetic, with no negotiations required for setting caps and granting emissions permits. The predictable increase in the “carbon price,” which cannot be determined with any accuracy under a cap-and-trade framework, facilitates the planning of investment and spending at all levels of the economy. This will clarify future price differentials between different energy sources and drive the development of clean energy technologies.

Economists across the political spectrum support carbon “taxes” as the most efficient (that is, the least costly) way to discourage emissions and incentivize the transition to a low- or no-carbon economy. A study by the independent forecasting firm Regional Economic Models Inc. (REMI) has shown that Carbon Fee & Dividend (as opposed to a straight carbon tax) will have a modest stimulatory effect on economic growth and job creation nationally. The only exception in this analysis is the oil patch region comprised of Texas, Louisiana and Oklahoma. The Great Lakes Region, including Illinois, is projected to see the greatest positive impact of all the regions in the country.

Carbon Fee & Dividend is not a “silver bullet.” It is not the only measure we need to undertake in order to reduce greenhouse gas emissions and decarbonize the economy, but its revenue stream should be reserved for the payment of dividends to the public. It can co-exist with targeted investments or policies specifically designed to accelerate the development of alternative energy sources. And energy conservation is a crucial part of this effort which will be incentivized by putting an explicit price on carbon—one that begins to reflect the full social cost of the use of fossil fuels.

David Holmquist is the volunteer Illinois State co-Coordinator of Citizens’ Climate Lobby.