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By Maja Schjervheim, Paul Bernstein, Sumner La Croix, Makena Coffman, and Sherilyn Hayashida
For the third year in a row, a carbon tax bill fizzled out at the Hawaiʻi State Legislature. Perhaps it was the difficult timing of introducing a new tax in the wake of a pandemic. Perhaps it was due to qualms regarding the effectiveness, equity, or overall economic impact of such a tax. Economists have long praised carbon pricing as an effective and potentially equitable way to reduce greenhouse gas (GHG) emissions at the federal level. But is a carbon tax a viable option for a small island economy like Hawaiʻi?
There is widespread support for GHG mitigation in Hawaiʻi, evidenced by multiple state goals to reduce emissions and, most recently, legislation to become carbon “net negative” before 2045 (HRS §225P-5). These are critically important, science-based goals. But let’s be real. Ambition itself will not solve the climate crisis. Though the cost of renewable energy has fallen dramatically over the last decade, adoption of low carbon technologies and behaviors remains limited because the market prices for fossil fuels do not reflect their true societal cost. The Intergovernmental Panel on Climate Change (IPCC) projects that the mean net present value of the costs of global damages from warming of 2°C is up to $70 trillion in 2100 (IPCC, 2018). Damage costs include, for example, impacts due to sea level rise, major shifts in agricultural productivity and crop loss, as well as losses related to non-market impacts. If fossil fuel prices reflected the true cost of the fuel’s carbon emissions, renewable energy resources and low carbon transportation options would become much more viable and attractive.
Levying a carbon tax set at the “social cost of carbon” (SCC) aims to do just that by adding the cost of damages associated with releasing one additional metric ton of CO2 into the atmosphere. The Obama Administration convened a multi-agency working group to determine the SCC using global economic and climate models. The group adopted a SCC of $56/MTCO2 Eq. in 2025 and $79/MTCO2 Eq. in 2045 ($2020), with a 3% discount rate. The Biden administration has adopted these estimates as a starting point and also announced it will update them to better incorporate the range of climate damages and uncertainty factors, both of which are expected to significantly raise the SCC (Interagency Working Group on Social Cost of Greenhouse Gases, 2021).
In 2019 the Hawaiʻi State Legislature requested a study to evaluate the economic and environmental implications of a state-level carbon tax in Hawaiʻi and its potential to contribute to the State’s goal of net negative carbon emissions by 2045 (Act 122, 2019). Our team’s report comes to findings that are both encouraging and sobering. As shown in figure 1, a carbon tax set at the level of the federal SCC (“$70/MT CO2 Eq.”) has the potential to reduce statewide emissions by an additional 13% compared to the baseline in 2045. It would take a much higher carbon tax to get near the goal of net negative emissions. A tax that reaches $1,000/MTCO2 Eq. in 2045 reduces emissions by 70% in comparison to the baseline. Emissions reductions come mainly from electricity and transportation sectors.
In general, taxes tend to be a drag on economic activity and the carbon tax is no exception. A carbon tax set at the SCC has a relatively small impact to Hawai‘i’s overall economy while the much higher price pathway comes at much higher cost, as shown in Figure 2. Whereas there is a 0.5% reduction in economic output in 2045 under the SCC-level carbon tax, the higher price would reduce economic output by about 5%. To put that in context, this means that by 2045 the output of the Hawai‘i economy will have grown by 32% from 2025 rather than 39%.
To understand the impact of the tax on a range of households earning different incomes, we divide households into five income groupings. More specifically, by average income quintiles ranging from the lowest 20% of household income groups to the highest 20%. A major finding of our report is that if revenues from a carbon tax set at the SCC are returned to Hawai‘i’s households in equal shares, lower-income households would be proportionately better off and households in every income quintile would experience a welfare improvement. There are two reasons supporting this finding. The first is that higher-income households demand far more GHG-intensive goods and services than lower-income households and therefore generate a larger share of the carbon tax revenue. This means that equal redistribution of revenues across households will disproportionately benefit lower-income households that produce fewer GHGs. The second reason is that visitors would pay the carbon tax while on a Hawai‘i vacation and all of the visitor-generated tax revenues are transferred to Hawai‘i households. [Our study assumes that carbon tax revenues generated from domestic jet fuel are kept for government spending, per the current use of the stateʻs jet fuel tax. Whether a carbon tax of this magnitude on jet fuel would be allowable under the constitution’s commerce clause or federal anti-head tax act is a legal question that merits further inquiry.]
On the other hand, at the higher carbon tax, the decline in Hawai‘i output and income outweighs the positive effects of redistribution of carbon tax revenue and eventually leads to declines in overall welfare across all income groups. Figure 3 shows relative changes in household welfare by income quintile for both the SCC and high carbon tax prices as well as when revenues are redistributed to households (“dividend”) or added to government spending.
Making lower-income households economically better-off in the transition to a low carbon economy is certainly a good outcome and helps to overcome concerns by policy-makers and the general public that a carbon tax would hurt this group. But a carbon tax set at the federal SCC leaves Hawai‘i miles away from achieving the state’s net negative emissions goal, with almost 10 MMTCO2 Eq. left to abate in 2045. left to abate in 2045. Yet the high carbon tax scenario poses serious tradeoffs for resident welfare, which becomes particularly tricky to contextualize because GHGs are a global pollutant – meaning that benefits in GHG mitigation will only be realized if global GHG reduction is achieved. So what do these results mean for Hawai‘i regarding the use of carbon taxation as a GHG reduction tool?
By estimating the cost of GHG abatement for a range of carbon tax rates, there may be a sweet spot for a carbon price in Hawaiʻi. Certainly the SCC estimate falls into that category, but past $300-$400/MTCO2 Eq. there are rapidly increasing costs to GHG abatement. Bottom line, at the right price and if revenues are returned to households, a carbon tax is an effective and equitable way to reduce GHG emissions in Hawaiʻi. Sub-national climate action should be complementary to, rather than a substitute for, national approaches to addressing the climate crisis. However, action by Hawai‘i and other U.S. states can continue to pave the way to a more coherent federal approach.
Interagency Working Group on Social Cost of Greenhouse Gases. (2021). Technical Support Document: Social Cost of Carbon, Methane, (p. 48). United States Government.
IPCC. (2018). Global Warming of 1.5°C. [Masson-Delmotte, V., P. Zhai, H.-O. Pörtner, D. Roberts, J. Skea, P.R. Shukla, A. Pirani, W. Moufouma-Okia, C. Péan, R. Pidcock, S. Connors, J.B.R. Matthews, Y. Chen, X. Zhou, M.I. Gomis, E. Lonnoy, T. Maycock, M. Tignor, and T. Waterfield (eds.)]. (p. 264).
12 thoughts on “Is a Carbon Tax Viable for a Small Island Economy?”
Could you guys do an evaluation of a road metering tax? It seems to me that considerations of congestion costs are far more important than any effect Hawaii could have on global warming through its energy policies (renewable energy subsidies or carbon taxes), and the road tax may also be a good way to reduce carbon emissions.
A carbon tax would also help to reduce traffic congestion as it would raise the price of gasoline substantially. The higher price would give people incentives to reduce the number of trips taken and to ride share. For a recent discussion of using a congestion fee within the downtown-to-Waikiki corridor to control traffic, see a 25 April 2021 policy brief on the UHERO website by Justin Tyndall and Sumner La Croix, Traffic in Honolulu: How to Make Transitory Pandemic Gains Permanent.
Thanks for this – didn’t see it when it came out. In thinking of arguments against a road tax, I am reminded of one of the first applications of welfare economics, when electricity allowed water metering as a practical alternative to additional water supply to New York. A comparison of the alternatives yielded the result that metering was the way to go. Water is a true necessity, so making people pay for it is perhaps a more regressive tax policy than metering roads.
I wonder if the rail would be desirable if metering were properly instituted. (Actually, i wonder if rail is anyway desirable.)
Although it is true that a carbon tax might alleviate congestion, it is a less direct and, in my guess a less effective way to combat congestion.
Hi Don, Here are a few replies to your thoughtful comments.
1. Water is a true necessity, so making people pay for it is perhaps a more regressive tax policy than metering roads.
Our proposal to institute a congestion fee would be a progressive tax as all revenues would be returned in equal shares to households.
2. I wonder if the rail would be desirable if metering were properly instituted. (Actually, i wonder if rail is anyway desirable.)
Good question but way too complex of a topic for a simple answer.
3. Although it is true that a carbon tax might alleviate congestion, it is a less direct and, in my guess a less effective way to combat congestion.
Controlling traffic congestion is a benefit from instituting a carbon tax — it’s a good side effect of such a tax that we rarely consider. Yes, the carbon tax’s main purpose is to control greenhouse gas emissions.
Mahalos for sharing your research here. If you don’t mind, I have some questions:
– Did you consider examining the revenue recycling scenarios through a Public Choice framework in addition to the ideal that’s presented? Or the carbon tax itself through a Coasean framework? If not, would such examinations be on the table in the future?
– Did you also incorporate Goulder’s work on capital/labor distortions via the interaction effect and how that changes the optimal tax amount? Apologies if I just missed a reference; I noticed his citations but didn’t see this particular aspect come through.
– In the Household Impacts section, you state that a dividend transfers wealth from production to consumption, which helps to offset lower productivity. But most theories/models (barring an old Keynesian framework) posit that long term growth is derived from production and TFP, so the offsetting effects are ambiguous at best, no?
Thanks again for sharing and taking the time!
Hi Laron, thanks for the thoughtful comments! Here’s a few selected replies.
– Did you consider examining the revenue recycling scenarios through a Public Choice framework in addition to the ideal that’s presented?
Revenue recycling of ALL revenues in EQUAL shares to ALL households helps to reduce rent-seeking on the tax revenues. It eliminates regulations and adjustments necessary if there is means testing. It gives everyone a stake in the revenues. And it doesn’t give other interests (R&D companies) a foothold from which they would try to expand their share.
Or the carbon tax itself through a Coasean framework? If not, would such examinations be on the table in the future?
Not sure what that would mean in this context. GHG public externalities are the type which are hard to resolve just by establishing property rights. Our team is continuing to do research on the carbon tax but we are focusing on how it compares to an alternative, a renewable portfolio standard for electric utilities.
– In the Household Impacts section, you state that a dividend transfers wealth from production to consumption, which helps to offset lower productivity. But most theories/models (barring an old Keynesian framework) posit that long term growth is derived from production and TFP, so the offsetting effects are ambiguous at best, no?
In our framework, long-term growth is lower. The additional welfare benefits to residents come from redistribution of the taxes paid by tourists.
Hi Laron, thanks for the thoughtful comments! Here’s a few selected replies.
– Did you consider examining the revenue recycling scenarios through a Public Choice framework in addition to the ideal that’s presented?
Revenue recycling of ALL revenues in EQUAL shares to ALL households helps to reduce rent-seeking on the tax revenues. It eliminates regulations and adjustments necessary if there is means testing. It gives everyone a stake in the revenues. And it doesn’t give other interests (R&D companies) a foothold from which they would try to expand their share.
Or the carbon tax itself through a Coasean framework? If not, would such examinations be on the table in the future?
Not sure what that would mean in this context. GHG public externalities are the type which are hard to resolve just by establishing property rights. Our team is continuing to do research on the carbon tax but we are focusing on how it compares to an alternative, a renewable portfolio standard for electric utilities.
– In the Household Impacts section, you state that a dividend transfers wealth from production to consumption, which helps to offset lower productivity. But most theories/models (barring an old Keynesian framework) posit that long term growth is derived from production and TFP, so the offsetting effects are ambiguous at best, no?
In our framework, long-term growth is lower. The additional welfare benefits to residents come from redistribution of the taxes paid by tourists.
Thanks for taking the time Prof Sumner! And please don’t misinterpret me (I have to say this since it’s the internet); my intention isn’t to question your team’s methods or logic. This is all very interesting and I hope you take my questions for what they are: just someone that’s always a student trying to learn more. But I know that can be too much sometimes so please feel free to tell me so.
Re: revenue recycling scenarios, I agree with all of your comment in such an ideal scenario. My question was geared toward whether your team had also considered other implementations given Public Choice intuitions. Off the top of my head, a branch of UH did a survey awhile back about how a hypothetical tourism rebate should be spent. If I remember correctly, about 2/3rds of respondents wanted the funds to go towards infrastructure/environmental/parks projects rather than an individual check or refundable tax credit. I imagine respondents would reply similarly for carbon tax funds, so legislators would be incentivized to act on this sentiment for both personal (“ribbon-cutting” accolades, providing monies/contracts to relevant constituents, etc.) and public reasons (enacting what the people want, building a track record for the next election, etc.). Unfortunately, as you and your team note in this paper and as others have noted elsewhere, such projects increase deadweight loss relative to dispersing funds and often leads to inefficiencies/further distortions that result in negative net welfare. Given scenarios like this that can occur whether projects are financed or money is distributed, I wondered if they were considered in the scope of this project (maybe they just didn’t make it into the final paper)? Or maybe the research request only asked for a best use of funds vs. a variety of uses?
Re: Coase, I was thinking of his work pointing out the reciprocal nature of problems like this and his least cost-avoider idea more than his property rights work. My recollection of this is spotty, but if I remember correctly he emphasized avoiding viewing one party as violating another and to examine the problem as one of scarcity and there being competing uses for the scarce something. So my reading of his advice is to alleviate these problems specifically before jumping to methods that are intuitively (and politically) appealing but that distort economic activity. This came to mind reading your paper because it opens up the question of whether similar emissions reductions could be achieved via the renewable portfolio standard (which you are looking into and that I look forward to reading hopefully), politically or financially subsidizing renewable energy installations (unfortunately also subject to community whims and politicking), or maybe something else entirely. Similar to the revenue recycling question, I was just wondering if any of this was considered. Or maybe the project took the tax as a given, which obviated any alternative avenues?
Re: Household impacts, I still don’t quite understand. Was there an assumption in the model that some (all?) of the additional benefits derived from tourists paying the tax would be saved/invested for capital formation? Or, actually, upon re-reading it and your reply maybe I simply misread it. I took the sentence as stating that the additional benefits were assumed to have been consumed in short order (maybe the same period as receipt of funds) and that this offset lower productivity, which is what I have difficulty squaring. But the paper is referencing productivity in terms of calculated GSP I think… is that a more accurate interpretation?
Again, mahalos for taking the time for a random chat like this.
Hi LaRon, Here’s a few more thoughts on your inquiry. Sumner
Re: revenue recycling scenarios, I agree with all of your comment in such an ideal scenario. My question was geared toward whether your team had also considered other implementations given Public Choice intuitions. Off the top of my head, a branch of UH did a survey awhile back about how a hypothetical tourism rebate should be spent. If I remember correctly, about 2/3rds of respondents wanted the funds to go towards infrastructure/environmental/parks projects rather than an individual check or refundable tax credit. I imagine respondents would reply similarly for carbon tax funds, so legislators would be incentivized to act on this sentiment for both personal (“ribbon-cutting” accolades, providing monies/contracts to relevant constituents, etc.) and public reasons (enacting what the people want, building a track record for the next election, etc.). Unfortunately, as you and your team note in this paper and as others have noted elsewhere, such projects increase deadweight loss relative to dispersing funds and often leads to inefficiencies/further distortions that result in negative net welfare. Given scenarios like this that can occur whether projects are financed or money is distributed, I wondered if they were considered in the scope of this project (maybe they just didn’t make it into the final paper)? Or maybe the research request only asked for a best use of funds vs. a variety of uses?
Reply: Usually models of corrective taxes–taxes used to correct a negative externality–assume lump-sum distribution of the tax revenue to consumers/households. We and several other carbon tax studies no longer ASSUME that tax revenue will be returned, we RECOMMEND it. That’s a real change.
Re: Coase, I was thinking of his work pointing out the reciprocal nature of problems like this and his least cost-avoider idea more than his property rights work. My recollection of this is spotty, but if I remember correctly he emphasized avoiding viewing one party as violating another and to examine the problem as one of scarcity and there being competing uses for the scarce something. So my reading of his advice is to alleviate these problems specifically before jumping to methods that are intuitively (and politically) appealing but that distort economic activity. This came to mind reading your paper because it opens up the question of whether similar emissions reductions could be achieved via the renewable portfolio standard (which you are looking into and that I look forward to reading hopefully), politically or financially subsidizing renewable energy installations (unfortunately also subject to community whims and politicking), or maybe something else entirely. Similar to the revenue recycling question, I was just wondering if any of this was considered. Or maybe the project took the tax as a given, which obviated any alternative avenues?
Reply: Clearly cap and trade could be a viable alternative to a carbon tax, as most studies show that it yields results similar to a carbon tax. It would, however, be hard for a small state to implement cap and trade on its own. Joining with one large state with cap and trade (California) also is problematic. At the national level, cap and trade is a more viable alternative to a carbon tax. Regarding renewable portfolio standards (RPS), Hawaii has an RPS already in place that mandates increasing use of certain renewables in electricity generation. Studies have shown the RPS to be broadly inferior to a carbon tax, primarily because it focuses on GHG emissions from just one sector, it provides no incentives for the electricity sector to optimize emissions from fossil fuels it continues to burn, and it is very regressive in its impact on Hawaii households. Plus RPS involves extensive regulation and is subject to litigation. Bottom line: It’s no surprise that a command-and-control mandate is inferior to a Pigouvian-style tax.
Re: Household impacts, I still don’t quite understand.
Reply: I urge you to take a look at the actual carbon tax report and the technical appendix to the report. Go to: https://energy.hawaii.gov/wp-content/uploads/2021/04/HawaiiCarbonPricingStudy_Final_Apr2021.pdf.
Hi Sumner,
Point taken on the assumption vs. recommendation of the tax funds – big change and that does explain the laser focus on this aspect. If such a tax is implemented, I only hope that the group you presented to was paying attention to minimize distortions/inefficiencies.
Agreed that it’s clear that the c&c approach is inferior to the Pigouvian approach, but I think Coase’s analysis would recommend a broader view ala the radical plant-ukabillion-trees approach. But this still hits Public Choice in that legislators, and the constituents they serve unfortunately, prefer highly visible, feel-good projects over effectiveness. Still, this seems to me to be an under-appreciated aspect of Coase’s work so I ask about/point it out in discussions like this.
Sorry, I actually did read through the full paper and appendices but it was only on my second read that I realized the difference in definitions is likely at play. I really think that’s all it is.
I’ll say it again, mahalos for taking the time!
Hi Sumner, I thought I replied but maybe my comment is pending moderation or something. Either way, if this is a dupe please feel free to disregard.
That is a significant change between assuming and recommending, and it explains the laser focus on this aspect of revenue recycling. If such a tax is implemented, I hope legislators pay attention to take the least-distortionary/most welfare-enhancing path they can.
I agree that c&c is inferior to a Pigouvian tax, but I think Coase’s work would recommend casting a broader net ala the plant-ukabillion-trees approach to achieve the same emissions reductions with greater efficiency and fewer distortions/costs. Specifically here, I think an applicable alternative would be to focus on overcoming political/local opposition to large-scale renewable energy installations or something of that nature (no pun intended).
And sorry I did read the full report and appendices but it was only on my second reading did I realize that I was probably applying different definitions, which likely caused my confusion and question. I really think that’s all this is.
Does this analytical framework still hold for a carbon market? A positive price has the demand-side effects upon which this analysis rides, but what about the supply side? Doesn’t it also send a signal to carbon-sequestering producers to get into the business, with associated output and employment-generating consequences? The problem is that a market is missing, not that a tax is missing, a market for atmospheric greenhouse gas emissions.