Carbon Tax Design and U.S. Industry Performance

Abstract

This paper examines the effects of a U.S. carbon tax on U.S. industries. We consider alternative tax designs that differ according to the tax treatment of internationally traded goods and the use of tax revenues. The effects of these policy options are explored with a dynamic general equilibrium model of the United States that incorporates international trade. In general, the burden of a U.S. carbon tax is fairly highly concentrated among a few industries. For these industries, the magnitude of the burden depends critically on the way the tax is designed. The costs to these industries in terms of profits and output are much lower when the tax is introduced on a destination basis (i.e., based on carbon emissions associated with the consumption or use of fuels) than when it is introduced on an origin basis (i.e., based on emissions associated with the production or supply of fuels). On the other hand, for a given tax rate the economy-wide costa are higher when the tax is destination-based, reflecting the fact that the nation's "emissions consumption" exceeds its "emissions production." There are various degrees to which policy makers could implement the destination principle in a carbon tax. This choice critically influences the extent to which the tax preserves "international competitiveness" as well as the administrative feasibility of the tax. One option is to apply the destination principle selectively, imposing the tax on the limited number of carbon-based products with "significant" carbon content. This gives rise to a partial destination-based tax. Such a tax would avert the most serious potential costs in terms of international competitiveness while avoiding the substantial administrative costs that a full destination-based carbon tax could entail. At the same time, the partial destination-based tax could achieve over 90 percent of the reduction in U.S.-consumption-related emissions that would occur under the full destination-based tax. Using carbon tax revenues to finance cuts in pre-existing distortionary taxes reduces, but does not eliminate, the adverse consequences of the carbon tax policy for industry profits and investment. Aggregate efficiency results suggest that a carbon tax must inevitably generate losses to at least some industries.