Carbon taxes put a price on carbon emissions in order to capture the negative externalities of pollution. Under a carbon tax, the prices of goods along the supply chain would increase and get passed onto consumers to discourage high-carbon production. Economists find that a well-designed revenue recycling method can make a carbon tax pro-growth, and increase its progressivity. In turn, the distributional outcomes of a carbon tax will improve.

However, some carbon tax advocates have come up with a way to “stabilize” prices for consumers under a carbon tax. In a recent op-ed, Kemal Derviş and Sebastian Strauss of the Brookings Institution propose a flexible carbon tax that is tied to oil price. By doing this, they argue, a carbon tax would buffer consumers from oil-price volatility and boosts fiscal revenue. When the oil price increases, the carbon tax would be lowered “but by a smaller amount”and when the oil price decreases, the carbon tax would be “raised by a somewhat larger (but still small) amount.” 

This proposal sacrifices the environmental purpose of a carbon tax. Regardless of the oil price, the negative externalities of carbon emissions do not change, given the same energy source and technology. A carbon price doesn’t depend on the price of oil; rather, it is determined by the democratic system that decides what reducing emissions is worth.

Under this proposal, the price of carbon emissions would go down when there is an incentive to produce more oil. Higher oil prices would result in a greater incentive for firms to produce oil, but would also result in a lower carbon tax. This runs counter to the environmental purpose of a carbon tax to discourage carbon emissions. 

Additionally, this proposal would result in carbon price uncertainty in other sectors. A well-structured carbon tax applies to the oil sector as well as other sectors. Adjusting a carbon tax based on the volatile oil price would impact prices in other sectors, such as agriculture. 

Finally, the proposal would reduce the tax revenue stability. Crude oil prices are highly volatile, and they can be affected by geopolitical and economic events. In the last 20 years, crude oil prices were as low as $24.22/barrel in 2001, and as high as $125.21/barrel in 2008 (in real 2010 dollars). As a result, the revenue recycling program linked to the carbon tax, such as a reduction in other taxes, or a dividend program, would be adversely impacted. The proposal doesn’t provide specific numbers on how the carbon tax would be adjusted. More details would be needed to estimate the actual impact on the tax revenue stability.

A well-designed carbon tax is the most economically efficient way to reduce carbon emissions. However, tying a carbon tax to the oil price would not help us effectively mitigate climate change.

Photo by Zbynek Burival on Unsplash