Pricing Carbon: How Would It Affect the Poor?

Putting a price on carbon – whether through a trading system, a carbon tax, or otherwise – will increase energy costs.  These increases are regressive because the poor spend a larger portion of their budgets on gasoline, heating and power.  But determining the ultimate distributive impacts of pricing carbon is not straightforward.  Pricing carbon has a host of indirect effects that may affect wages and return on capital, which themselves will impact income distribution even apart from the direct effects of the tax. Economists use complicated models to try to trace these effects.

A key issue is: if we put a price on carbon, who ends up with the money? If the government gives away allowance in a cap-and-trade system, the value of allowances is captured by energy firms but then partly recaptured by the government in taxes on the increased profits. If the government collects the revenue from auctioning allowances, it can either spend the funds or reduce other taxes. This choice, too, will impact demand for energy by the recipients of the benefits, and hence energy prices and availability.

Untangling these effects is no simple matter, but it does seem likely that the overall effect is to burden poorer households more than richer ones.  A 2002 analysis shows that, if the government gives allowances away and uses the increase in taxes on firm revenues to reduce the corporate taxes, the burden on lower-income households could reach as much as six percent of their income, whereas wealthy households actually see an increase in income. The study also found that international trading of allowance improved the situation of lower-income households compared with that of the wealthier by lowering the overall cost of carbon reductions.

The regressive effects of pricing carbon can be countered by changes in the income tax, or by using the proceeds to benefit lower-income groups in other ways. One recent study indicates that the distributional impacts are small if government revenues are returned in the form of a taxable “dividend” and can even be progressive if the revenues are used to improve the tax treatment of lower-income individuals.

Despite all the complexities, there seem to be three lessons from the economic studies.

  1. Putting a price on carbon is likely to have a regressive effect, considered by itself.
  2. This direct effect can be amplified or countered depending on how the allowances are distributed and what is done with government revenue.
  3. We need to put a price on carbon, but there is no reason why we should do so in a way that harms the poor.

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Reader Comments

2 Replies to “Pricing Carbon: How Would It Affect the Poor?”

  1. Oy….given what share of carbon emissions come from transportation choices and general household energy consumption, I just cannot see a coherent argument for cap and dividend. If we’re serious about carbon pricing, lets be serious about carbon pricing. Essentially, downstream price signals – have to- hurt as a condition of making them work. If you simply backfill energy price increases with lower 1/3 tax dividends, you have a redistributive tax policy that doesn’t actually decrease energy consumption unless you believe the poor will suddenly start buying the energy efficient cars, appliances and homes they can’t afford to begin with.

    You have to remember that a free allowance carbon trading system, where emissions sectors are each their own self contained market (i.e. power not competing with industrial, not competing with trans fuels) would not produce windfalls. It’d merely be a system where like competitors, with like BACT, would settle on a price equilibrium between allowance and compliance costs. It’s only when you open the system up and begin auctioning allowances that you start talking about the government acquiring revenues beyond simply that necessary to administer the scheme.

    If you’re going to extract revenues, IMHO, the only legitimate use is to use such revenues to directly fund alternative energy projects that would, in the long run, have the effect of reducing the cost of alternative energy. Spurning innovation is productive, whereas redistributing money to counteract price signals is a closed loop cycle of waste.

  2. Why is the problem of regressivity framed as a problem unique to carbon pricing? Any form of carbon regulation — whether by pricing or otherwise — could disproportionately affect the poor. So could regulation of other criteria pollutants. To the extent that food safety regulations affect food prices, they also could disproportionately affect low-income consumers, and the same might be true of vehicle safety regulation or any other type of regulatory program.

    Carbon regulation is only one factor, and probably a comparatively minor factor, that affects energy prices. We need regulatory policies to protect the welfare of low-income consumers with or without carbon pricing; that is a problem that is distinct and separate from carbon regulation.

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About Dan

Dan Farber has written and taught on environmental and constitutional law as well as about contracts, jurisprudence and legislation. Currently at Berkeley Law, he has al…

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About Dan

Dan Farber has written and taught on environmental and constitutional law as well as about contracts, jurisprudence and legislation. Currently at Berkeley Law, he has al…

READ more