For over a century, economists have advocated taxing goods or services that impose greater costs on society than their price reflects. The idea isn’t to raise revenue, even if that’s a nifty benefit, but to discourage the overuse of things that cause unintended harm.
No bigger example of such unintended harm exists today than the air and climate pollution caused by the burning of fossil fuels. The International Monetary Fund conservatively estimates that the price of such fuels fails to account for $4.2 trillion in air and climate pollution costs each year.
By imposing a fee on fossil fuels to fairly reflect those social costs, on the other hand, we can invoke the power of the market to efficiently limit their use. That’s why more than 3,600 economists call carbon fees “the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary.”
Public support for carbon fees would be stronger if everyone grasped how they work to discourage the production and consumption of goods that cause societal harm. Unfortunately, many people don’t get it.
“The expectation that carbon taxes do not work is one of the main reasons for their rejection by people in surveys and real ballots,” an international scholarly review concluded in 2018. For example, only 39 percent of respondents in one Swedish poll understood that a carbon tax “affects my own and other people’s behavior.”
The same misunderstanding certainly exists in the United States. In 2008, Harvard economist Greg Mankiw, former top economic adviser to President George W. Bush, lamented the “particularly large gap between economists and the public” when it came to understanding the use of taxation to put a price on social costs. His prime example was the contradiction between public support for encouraging the use of alternative fuels and public skepticism toward taxes on fossil energy.
One of the best ways people learn is through analogies. To that end, public understanding of carbon taxes may be facilitated by recalling more familiar taxes on harmful goods, including tobacco and alcohol. All of these taxes enhance public health and well-being without resorting to counterproductive prohibitions. Recounting their proven record of success may open minds to the efficacy and desirability of carbon fees.
Kicking the habit with tobacco taxes
For decades, tobacco industry-funded experts downplayed risks to health from smoking, just as industry-funded climate deniers still do regarding the global risks from the burning of fossil fuels. Today, however, virtually everyone accepts the scientific consensus that smoking causes lung cancer, heart disease, strokes, diabetes, emphysema, and chronic bronchitis.
Experts estimate the economic costs of smoking at close to $400 billion a year in the United States, including medical care and lost productivity. In 2004, Duke University health economists pegged the social cost of smoking to family members and unrelated individuals at $6.88 per pack.
Cigarette taxes only go part way toward reflecting that full social cost. The federal government levies an excise tax of $1.01 per pack, and state cigarette taxes added an average $1.91 per pack in 2018.
Still, those taxes bring enormous public benefits. Despite the highly addictive nature of tobacco, expert studies suggest that a 10 percent increase in prices cut adult cigarette consumption by about 4 percent. High tobacco taxes helped drive smoking rates among U.S. adults from 43 percent in 1965 to 14 percent in 2018.
Based on the evidence from dozens of studies from around the world, the World Health Organization declared in 2021 that increasing tobacco excise taxes is “the most effective and cost-effective measure to reduce tobacco use and save lives.” (Emphasis added.)
Better than Prohibition
The infamous U.S. experiment with banning the production and sale of alcoholic beverages, known as Prohibition, came to an end in 1933, but the problems it sought to address, including cirrhosis, alcoholic psychosis, infant mortality, depression, and violence, are still with us.
The Centers for Disease Control reports that
excessive alcohol use led to more than 140,000 deaths and 3.6 million years of potential life lost each year in the United States from 2015 – 2019, shortening the lives of those who died by an average of 26 years. Further, excessive drinking was responsible for 1 in 10 deaths among working-age adults aged 20-64 years. The economic costs of excessive alcohol consumption in 2010 were estimated at $249 billion, or $2.05 a drink.
In lieu of a heavy-handed ban on the sale of alcohol, federal and state governments today tax distilled spirits, beer, and wine at separate rates — with beer and wine generally enjoying a huge preference based on alcohol content. State tax rates vary wildly, from a virtually non-existent 2 cents per gallon of beer in Wyoming to $33.22 per gallon of spirits in Washington.
Clearly these tax rates were not carefully designed by economists to reflect the true social costs of alcohol consumption. One respected team of scholars reported in 2019 that alcohol taxes covered only about a tenth of the total economic costs imposed on society.
Still, dozens of studies confirm that taxes can discourage excessive alcohol drinking and attendant health effects. Investigators typically find that a 10 percent increase in price cuts beer consumption about 5 percent and spirits consumption about 8 percent. As one systematic review concluded, “these results constitute strong evidence that raising alcohol excise taxes is an effective strategy for reducing excessive alcohol consumption and related harms.”
Anyone who has ever thought twice about smoking or binge drinking due to the high cost has at least a basic understanding of the power of taxes to discourage the production and consumption of harmful goods. Carbon taxes, of course, have a far greater economic impact, fall on businesses as well as individuals, and can’t be avoided as easily through abstinence as taxes on liquor or cigarettes. But with every purchase, each of these taxes can help society by making us face the true cost of our decisions to public health and the environment.