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September 12, 2016

Responding To: The Challenge of Climate Change

Why We Should Stop Calling Carbon Taxes “Regressive”

Arik Levinson, Grady Killeen

For nearly 100 years, economists have been touting pollution taxes as the cost-effective solution to environmental problems. Wikipedia even has a page listing economists and politicians who support the idea. The key notion—“cost-effectiveness”—just means pollution taxes achieve the most environmental cleanup at least cost. But in the nearly 100 years since Pigou wrote The Economics of Welfare, there have been almost no examples of pollution taxes. Here in the U.S., instead of carbon taxes to address climate change, our main tactic has been energy efficiency standards—regulations requiring cars, appliances, and buildings to use less energy.

Pollution taxes should have broad appeal. Environmentalists worried about climate change should embrace their cost-effectiveness. Why wouldn’t we want to reduce carbon pollution as much as possible per dollar spent? And opponents of taking significant steps now to abate climate change should also embrace pollution taxes as cost-effective. Why wouldn’t we want any steps we do take to cost as little as possible?

A common argument against pollution taxes is that they would disproportionately harm lower-income families. In economics jargon, pollution taxes are “regressive.” Recent articles in Forbes, the Nation, and the National Review all cite the regressive nature of carbon and gasoline taxes. But nobody ever stops to ask whether the policy we use in place of taxes—energy efficiency standards—might be even more regressive.

In a recent paper we pose exactly that question in the context of automobiles, comparing a gas tax and fuel economy standard side-by-side. Figure 1 demonstrates the takeaway point. If we impose a gasoline tax equal to the U.S. government’s official “social cost of carbon,” that would amount to about $0.29 per gallon. That tax would cost the poorest households $71 per year, and the richest households $287 (the middle bars in Figure 1). If instead we raised that same revenue with a proportional income tax, poor households would pay only $17 per year and rich households $397. That proportional tax would be neither regressive nor progressive. Because a gas tax would cost poor families more and rich families less, a gas tax would be considered regressive by conventional definitions.

Now consider the U.S. fuel economy standards, which effectively amount to a tax on inefficient vehicles. The average vehicle in the U.S. in 2009 got about 25 mpg, which means it used 4 gallons per hundred miles (gphm) driven. A tax of $39 per gphm would raise the same total revenue as a $0.29 per gallon gas tax. As Figure 1 shows, that $39 per gphm tax would cost poor households even more than a gas tax—$91—and rich households even less—$259. Fuel economy standards are more regressive than a gas tax, not less. In the U.S. we have avoided a cost-effective but regressive policy (the gas tax) in favor of a less cost-effective and even more regressive alternative (the fuel economy standard).

There’s worse news too. In 2011 the U.S. modified its fuel economy standards to adjust for vehicle sizes. Now carmakers that sell larger cars face less stringent targets. That change favors richer households that tend to buy those larger cars, and so since 2011 the U.S. fuel economy regulations have become even more regressive than the ones modeled in Figure 1. For that detail, read the paper.

There is a silver lining for people worried about both climate change and income inequality. It turns out that the most cost effective policy—a gas tax—would also be the least regressive. Now we just need to implement it.

Figure 1. Comparing Gas Taxes and Fuel Economy Standards

Source: 2009 National Household Travel Survey.

Arik Levinson has been a professor of economics at Georgetown since 2000, with occasional absences to serve as a senior economist at the White House Council of Economic Advisers, as a fellow at Resources for the Future, and as a member of the U.S. EPA Science Advisory Board.

Grady Killeen is writing a thesis about the effect of U.S. automobile regulations on the size of new cars, and hopes to go to graduate school in economics.

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