Pollution Taxes or Carbon Taxes As A Substitute for Other Taxes

In the 1980s and 1990s several state regulatory commissions quantified the environmental costs of electricity generation for use in comparing power plant costs. Their estimates varied widely, but all agreed that there is a substantial environmental cost not included in the price customers pay for electric power. These "external" costs are borne by society as a whole in the form of environmental degradation and through medical costs as a result of pollution from power plants.

These external costs can be internalized by imposing a pollution tax on electricity. Pollution taxes and environmental tax shifting have been discussed for many years. The argument behind them is unassailable. Today we tend to tax those things we would like to encourage, like work and property and income while we undertax or don't tax at all, those things we would like to discourage, like pollution and waste. Why not change the dynamic by increasing taxes on waste and decreasing taxes on work?

This argument, while persuasive, has not resulted in environmental tax shifting in the United States. One reason is that in an era of tax cutting it is virtually impossible to generate serious discussion about imposing a new tax, even if the result is revenue neutral(i.e. the amount of revenue generated from the new tax would be offset by an equal reduction in an existing tax).

The restructuring debate offers a window of opportunity for tax shift advocates. Today utility taxes make up a significant source of revenue for communities that host power plants. In a monopoly system these taxes are easily passed through by utilities to customers. But when a customer can choose an out-of-state supplier, then a local tax on electricity could become a competitive burden. Thus, virtually all states that are moving toward utility restructuring are embracing a "tax shift" in this area, substituting one tax for another. Illinois, for example, has replaced its utility taxes with a ten-tiered tax based on electricity use. New Jersey has eliminated most of its taxes on electricity and substituted a flat 6 percent sales tax on electricity.

Nationwide more than $15 billion a year is generated from electricity-related fees and taxes. That comes to about 0.4 cents per kWh. To raise the same amount of revenue would require a nationwide carbon tax of $75 per ton. Interestingly, this would raise the price of coal-fired electricity by almost 2 cents per kWh, surpassing the existing federal tax credit to renewable electricity producers.

An electricity-related environmental tax-shift strategy must be state specific. Convincing coal-rich Illinois or West Virginia to impose a carbon tax might be difficult but the tax imposed per unit of carbon emitted would be very small because of the large amount of carbon emitted. Convincing the Pacific Northwest to adopt a tax shift might be easy politically, but because 85 percent or so of its electricity comes from hydropower, the tax per unit of carbon would have to be extremely high.

This type of pollution tax can be structured to be revenue neutral; that is, the same amount of revenue is generated after the tax as before the tax. However, it is also possible to raise the pollution tax to pay for public benefits programs that also protect the environment and safeguard low-income households. If these programs were included, the total tax might rise by 25 percent.

More Information:

• Archive of ILSR's Materials Related to a $1 Billion Minnesota Tax Shift Proposal - A variety of factsheets, studies and analysis of a state level tax shift proposal that was debated extensively in Minnesota during the 1990's