The price of fossil fuel based energy ($ per gallon of gasoline or Kw-hr of electricity) that we have to pay as individuals (or businesses) is basically the immediate cost to produce that energy. There are a few cases where specific taxes are added on, such as the road tax on gasoline. However, in general there is no attempt to include the “externality costs” the use of those fossil fuels imposes on society. For example, burning coal to produce electricity commits us to increased health care costs associated with breathing polluted air, the costs of damage from acid rain, costs of water pollution and land recovery from coal mining, and the costs of climate disruption. Very few economists would argue with the idea that these costs exist and that they are currently not reflected in the price of fuel. In order for all of us to make rational decisions about energy use in our free market economy the total costs of the energy we use needs to be reflected in the price.
The best way to have the price of energy include the external costs is to add taxes to the price of fuel to reflect the external costs. The International Center for Technology Assessment has done a detailed analysis, entitled “The Real Price of Gasoline.” The ICTA calculates several indirect costs, including oil industry tax breaks, oil supply protection costs, oil industry subsidies and health care costs of treating auto exhaust-related respiratory illnesses. The total of these indirect costs is is about $9 per gallon. Add this to the roughly $2.50 current price of gas and you get a total price of $11.50 per gallon. There is plenty of room to argue about what should go into the external costs and how they should be calculated, but this gives some idea of the amount of tax involved. If this tax was generalized to a “carbon tax” that would be applied to all fossil fuels the amount of the tax would be around $3,000 per ton of carbon. This is clearly a big tax and would raise an incredible amount of revenue.
The tax revenue raised from the carbon tax would allow major reductions in other taxes. For example, we could remove federal income tax on all income below some level, say $100,000 per year. Or start a Manhattan Project type effort on non-fossil energy and transportation. We could afford to develop a system of fast electric trains for intercity travel in the US (which would be good because air travel would be rather expensive).
The carbon tax would need to be put into effect incrementally to avoid a big economic shock. We could start with the equivalent of $1 per gallon of gasoline and add another $1 every other year untill we get to the right level. That would get us to where we need to be reasonably quickly without causing a big disruption. After all, we have had changes of that magnitude in gasoline, fuel oil and natural gas during the last year and nothing really bad has happened to the economy.
There is some evidence that the carbon tax needs to be even higher to get fossil fuel use down to the level needed to deal with global climate change, but that is the subject of another post.