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By James Mak and Erik Haites
Hawaii’s constitution requires a Tax Review Commission (TRC) be appointed every five years to review the state’s tax/revenue system. Commissioners comprise of tax experts in the state and serve without compensation. In its final report to the Legislature, the 2020-2022 Tax Review Commission’s top recommendation is a carbon tax for Hawaii. [1] If enacted, it would help to meet the State’s goal, established in 2018, of sequestering more greenhouse gases (GHG) annually than amounts emitted no later than 2045.
A carbon tax is a tax on each metric ton of greenhouse gas (GHG) emitted. The intent of a carbon tax is to encourage people to use less fossil fuel by switching to renewable energy sources. GHG emission reductions are achieved by gradually raising the tax over time. The tax can generate substantial tax revenue, even though raising revenue is not its primary purpose. In jurisdictions that have a carbon tax, typically most of the revenue collected is distributed to residents to build public support for the policy (e.g. When Canada introduced its carbon tax, it sent out rebates to households shortly before the tax came into effect.) and to help people affected with adjustment costs (e.g. buying an EV). If the tax is effective in reducing use of fossil fuel, the revenue declines (ultimately to zero), adjustments to a carbon free economy are made and rebates stop.
If Hawaii adopts a carbon tax, it would be the first state in the nation to do so. (The first carbon taxes date back to 1990 in Denmark and Finland). As of April 2022, there were 37 jurisdictions around the world with carbon taxes. Congress has not enacted a carbon tax for the U.S. In 2022, Congress passed the largest piece of federal legislation ever to address climate change in the U.S.—the Inflation Reduction Act of 2022 (IRA). Under the Act, the U.S. will invest $391 billion in energy security and climate change of which $270 billion will be in the form of tax incentives/subsidies. The subsidies approach won’t work for Hawaii because it requires deep pockets. The U.S. government can run budget deficits to fund subsidies. The State of Hawaii cannot. This essay assesses TRC’s recommendation of a carbon tax for Hawaii.
The TRC is asking state lawmakers to “Enact a carbon tax that reflects the social cost of carbon. Return 80 percent of the proceeds, other than proceeds from aviation fuel, to households.” (The social cost of carbon is an estimate of the global economic damage caused by a ton of greenhouse gas emissions.) The remaining 20 percent of the revenues collected should go to mitigate the effects of climate change. Twenty percent “will not be sufficient but can be a significant start.” It amounts to between $90 million and $100 million per year for the first five years.
The TRC’s recommendations rely on studies conducted by a team of University of Hawaii Economic Research Organization (UHERO) researchers that computed the potential economic impacts of a carbon tax. The analyses are based on a carbon tax set at the federal government’s estimate of the social cost of carbon (SCC) starting at $56 per metric ton of CO2 equivalent (MtCO2e) in 2025 and gradually rising to $79 per metric ton (in 2020 dollars) in 2045. The researchers find that Hawaii’s “cumulative emissions would decline by 10% over twenty years, over and above reductions from other policies already in place.” They further find that rebating 80% of the carbon tax revenues (excluding revenues from aviation fuel [2]) in “equal shares” to households divided into five income groups will make the average household in each of the quintiles economically better off after paying the tax, in part because tourists contribute to carbon tax revenues but don’t qualify for rebates. [3] Visitors’ share of carbon tax revenues is projected to rise from 27% in 2025 to 36% in 2045. Further, the carbon tax with rebates benefits lower-income households more than upper-income households because lower income households on average consume less energy-intensive goods and services than higher income households but receive the same rebate; thus the combined effect is progressive. So far the findings are supportive of a carbon tax. But there are caveats.
The analyses of households focus on the average household in each income group. Within each quintile, some households gain after receiving the rebate and some are net losers as there can be wide variations in energy use among households within each income group. While there are likely more winners than losers, the studies don’t provide information on who stands to lose.
A carbon tax creates a risk that exports are more costly leading to lower export volumes due to reduced competitiveness. (In practice, virtually all jurisdictions with a carbon tax minimize this risk by rebates or exemptions for most or all of the emissions associated with export goods.) In Hawaii the carbon tax would negatively affect tourism, the state’s largest export industry, by raising the cost of visiting the state relative to the costs of visiting competing destinations. The reduced tourist volume results in a lower level of GDP compared to an economy with no carbon tax. It would also reduce the demand for non-tourism exports. Returning 80% of the tax revenue generated by the carbon tax to households in the form of rebates restores some of the household spending and thus dampens some—though not all—of the negative effects of the tax. There will still be a “small” contraction of the Hawaii economy.
As for the TRC’s recommendation to set the tax rate at the social cost of carbon, it bears noting that the most recent estimate of the social cost of carbon is $185 per metric ton, or more than triple the federal estimate. As of April 2022, no jurisdiction with a carbon tax even comes close to having a tax rate of $185 per metric ton. Switzerland, Liechtenstein and Sweden ($130) and Uruguay ($137) are closest. Most jurisdictions with a carbon tax have rates that are much lower than $56 per metric ton. As a carbon tax will increase the price of just about everything in Hawaii, it is highly unlikely that Hawaii state lawmakers would approve a carbon tax that’s as steep as $185, or even $56, per metric ton of GHG emitted. For example, a carbon tax of $56 per metric ton would increase the after-tax price of gasoline by about 50 cents per gallon if the tax is fully passed on.
UHERO’s researchers conclude that “… deep decarbonization is unlikely to be realized solely by the imposition of a carbon tax at the federal social cost of carbon by a state government.” If so, why bother?
There is a straight-forward answer. Fighting climate change requires GHG emitters to pay for the true (social) cost of their emissions. Since each and every one of us contributes to climate change, we should all be part of the solution even though the result at the state level may be modest. Economists call it internalizing the externality.
Whether to enact a carbon tax now is not a simple decision. There is built-in incentive to be a free rider—i.e. let some other jurisdictions carry the burden while Hawaii reaps the benefits from lower damaging climate change impacts due to mitigation actions taken by the rest of the world. If Hawaii were to go it alone, the state can expect higher prices generally and slower economic growth. Even with rebates to households, some Hawaii residents will be economically worse off than before. But the news is not all bad; switching from fossil fuels to renewable energy sources enhances Hawaii’s energy security. And many Hawaii residents will be happier with fewer visitors.
Hawaii is currently experiencing high inflation and anemic economic growth. With that sobering scenario, state lawmakers have an excuse to delay enactment of a carbon tax (or implement with a lower tax rate) in the upcoming legislative session. However, the rationale for a carbon tax remains sound.
Acknowledgement: We thank Sumner LaCroix and Robert D. Ebel for helpful comments on an earlier version of this essay.
1 The alternative to a carbon tax is an emissions trading system (ETS). Under such a system, the government places a cap on total state carbon emissions which would be lowered over time and sell pollution “allowances” up to the limit of the cap. California was the first state to implement such a system in 2013. Currently, at least a dozen states have a carbon pricing program using the ETS system.
2 Federal regulations restrict how revenues from state taxation of aviation fuels can be used. Also, in the studies, GHG emissions by the military are not taxed because the federal government has immunity from state taxation.
3 There are various options on how the rebates can be distributed. For example, the TRC deferred to lawmakers to decide whether rebates should be given to households in all five income groups ($744 per household in Year 1) or only to those in the bottom four quintiles ($948 per qualifying household). To make it simple, this essay assumes every household gets a rebate. The TRC also deferred to lawmakers to decide whether rebates should be adjusted to reflect household size; larger households generate more emissions.
Erik Haites is President of Margaree Consultants, Inc. Canada and has over 30 years of experience related to climate change policy. He is an expert on carbon pricing around the world.
James Mak is a Research Fellow at UHERO and Professor Emeritus of Economics at UH-Manoa.