On August 1, 2023, Fitch Ratings downgraded the United States’ long-term rating from AAA to AA+. “The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA’ rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions.” The Council on Foreign Relations noted that “The last downgrade of this sort, by S&P, came in 2011 in the wake of the Global Financial Crisis and another fractious debt ceiling showdown.” It further noted that “There is also no doubt that the overall fiscal picture is now more challenging than in 2011.”

The downgrade explicitly noted the exceptionally high debt-to-GDP of the United States at 112.9%, compared to the median AAA of 39.3%. Ten countries have AAA ratings including the European Union and the Scandinavian countries of Denmark, Norway, and Sweden. Thanks to this ballooning debt burden, the non-partisan Congressional Budget Office (CBO) in its report “Budget and Economic Outlook 2023-2033” notes that by 2028 net interest payments will be higher than discretionary defense spending. We are in a time where we should be spending more on defense, not less.

Clearly the U.S. must reduce its debt burden by some combination of cutting spending and raising taxes. In the highly polarized political environment this will be no mean feat. Republicans, as was vividly illustrated in their internal battles which resulted in the ouster of House Speaker Kevin McCarthy, want to cut spending. Democrats, on the other hand, prefer increased taxes in order to preserve a wide range of social programs.

Benefits of a Carbon Tax

Rather counterintuitively, the current circumstances are most propitious for finally implementing a carbon tax, an idea that’s been around for a long time but a politically sensitive one. On April 24, 2008 the CBO wrote that “Market-oriented approaches to reducing carbon emissions (such as a cap-and-trade program or a carbon tax) are much more efficient than command-and-control approaches (such as regulations that require across-the-board reductions by all firms). The reason is that the market-oriented approaches create incentives and flexibility for emissions reductions to occur where and how they are least expensive to accomplish.”

It elaborated on this argument in a report published in May 2013 and observed that “The effects of a carbon tax on the U.S. economy would depend on how the revenues from the tax were used. Options include using the revenues to reduce budget deficits, to decrease existing marginal tax rates (the rates on an additional dollar of income), or to offset the costs that a carbon tax would impose on certain groups of people.”

Another benefit of a carbon tax is that it will create incentives for U.S. companies to be more carbon efficient. Those which reduce their carbon footprint in economically sensible ways will lower their costs and raise their profits. Market forces will spur competition to become more energy efficient since an increasing number of customers are using a firm’s carbon footprint in making sourcing decisions. It will also enable U.S. firms to be more competitive in other markets where a carbon border adjustment mechanism (CBAM), such as in the EU, is being put in place. The CBAM penalizes firms whose carbon footprint is higher than a European competitor. Finally, a carbon tax can contribute to America’s energy security since we will need less oil and gas from foreign sources as discussed in a recent Brookings report “Carbon Taxes as Part of the Fiscal Solution” by William G. Gale, Samuel Brown, and Fernando Saltiel. It points out the grim fiscal outlook in the U.S. and the inevitable need to cut spending and raise revenues and makes the case for a carbon tax.

The ability of a carbon tax to reduce emissions can be very significant. Resources for the Future (RFF), an independent, non-profit research institution in Washington, D.C.,  has a Carbon Pricing Calculator. It is an interactive tool that “helps users visualize the environmental and economic effects of different carbon pricing policy designs.” It compares various scenarios, such as proposed Congressional acts, to the business as usual baseline which shows 4.83 billion metric tons of energy-related CO₂  emissions in 2035. In the scenarios they analyze, the most dramatic reductions come from the Climate Action Rebate Act which cuts them by more than half to 1.93 billion metric tons by 2035.

Of course, a carbon tax has its critics, most typically from conservatives. In an April 10, 2023 working paper for the National Bureau of Economic Research (revised June 28, 2023),“Five Myths About Carbon Pricing,” Professor Gilbert E. Metcalf argues that none of these criticisms are true: “1) that a carbon price will hurt economic growth; 2) that carbon pricing will kill jobs; 3) that a carbon tax and cap and trade program have the same economic impacts; 4) that we can’t achieve carbon reduction targets with a carbon tax; and 5) that carbon pricing is regressive.”

Source link for this article