Innovation in Taxes: using carbon pricing to grow economic value

Source:  Jimmy Jia, CEO, Distributed Energy Management and Board Member, CleanTech Alliance,

Carbon is considered a major source of long-term risk to the environment. Yet carbon consumption via fuel inputs, is critical to our modern-day society, economy, and quality of life. This creates a public benefit gap: how to effectively provide for communities today while mitigating long-term risk.

This course will examine the role of taxation as it applies to carbon, energy, and economic frameworks. Attendees will explore multiple industry sectors that are affected by carbon and identify levers for change. We will study and apply lessons learned from managing carbon and other negative externalities to the design, evaluate, and implement carbon policy proposals. Attendees will learn how to apply these decision frameworks to increase the public benefit and economic value.


Carbon, energy and the economy are inextricably linked. The Washington Business Alliance has been convening stakeholders for the past few months in helping solicit and craft a carbon pricing policy that takes into account business interests and concerns.

This writeup is a review of a carbon taxes seminar developed for George Washington University. It begins with a short discussion of energy, carbon and taxation and how they can be linked together to reach policy goals. The second part is a set of best practices that Washington State should be considered when designing a carbon tax.

Fundamentals: Energy, Carbon and Taxes

Energy is consumed to do work. An energy balance has three components. Energy In describes the fuels (electric, petrol, natural gas, thermal, etc.). Wasted Energy Out is energy not put towards productive uses. This can be due to equipment inefficiency or consuming energy when it’s not necessary, such as leaving the lights on when no one is in the room. Useful Energy Out is why we consume energy in the first place. It produces the value propositions of light, warmth, comfort, convenience, security that we seek in our society.

Energy in always equals energy out as per this equation:

Energy in = useful energy out + wasted energy out.

Efficiency is the ratio between Wasted Energy Out and Useful Energy Out.

Carbon, a shorthand for “Carbon Dioxide” is a pollutant released by certain forms of energy. Within the energy balance, it is a component of the Wasted Energy Out. There are a few different forms of carbon. Geologic Carbon comes from underground in the form of coal, natural gas, petroleum and other fossil fuels. Biological Carbon exists in the trees, animals, soil and atmosphere. Carbon Equivalents refer to other pollutants, such as methane, that have similar effects on the climate. Unfortunately, many of these carbon equivalents have a much worse impact than carbon dioxide itself.

It is important to differentiate between biological carbon and geological carbon. It is true that biological carbon is a key component to life on earth. However, the world currently releases 5.5 GigaTons of Geological Carbon per year into the atmosphere while only 0.2 is absorbed from the atmosphere into our geological formations. This means we are releasing over 27 times what our earth can absorb[1]. This excess in carbon, accumulated over a century, is causing changes in our weather, our climate and is already having a noticeable impact in our supply chain and economy. This continued accumulation of carbon is considered highly unsustainable.

Taxes are a mechanism for governments to raise revenue, incentivize society’s behavior, and invest in public spending priorities. Taxes generally need to be fair, transparent, convenient and not arbitrary. Additionally, taxes should have minimal administrative costs and be a low burden on compliance and fraud activities[2].

Broad-Based Taxes, such as sales, income, and property taxes are part of a general fund for government priorities, such as schools, police, fire, and prisons. Excise taxes are levied at production. Some excise taxes, such as Tobacco and Alcohol Taxes, are used to raise the price of the product to reduce demand. Portions of the revenue are nominally set aside for public health programs on avoidance and cessation, although politicians frequently divert the funds to the general coffers. The Fuel Tax is an excise tax that funds roads and transportation. Cap and Trade are policies that cap the maximum amount a business can pollute and creates a tradable credit for businesses that don’t reach their limit. These programs don’t contribute to a government fund as the dollars are kept within the marketplace. In the USA, Sulphur oxides (SOx) and nitrogen oxides (NOx) are managed via a cap and trade mechanism.


  • ENERGY is always in balance. What we do on one side will always affect the other.
  • CARBON is a pollutant of our conventional energy system that can be mitigated from the supply-side or demand-side.
  • TAXES can be used to mitigate bad behavior, encourage positive behavior, and drive investments for innovation.
  • An energy balance diagram can be used to show the relationship of energy, of different tax programs, and how each relate to managing pollution.

Figure 1 Carbon and Taxes Organized into an Energy Balance

Lessons Learned through a Review of Taxes

Carbon taxes are relatively new and there is a small and growing data about their effectiveness. One major challenge that carbon faces is its pervasiveness across the entire economy.  To better understand how tax policies can be applied to carbon, we review a variety of taxes for their strengths, effectiveness and challenges they face. Based on this comparison, here are 5 attributes for strong taxation programs that Washington State should consider when developing a carbon tax.

  • Successful taxation programs support a strong policy goal.
  • Minimize administration concerns by taxing at production.
  • Maximize effects by incentivizing consumption.
  • Maintain Transparency.
  • Enable the ability to adjust and update the tax as needed.

1) Successful taxation programs support a strong policy goal.

A strong policy goal is a prerequisite for a strong taxation program. It demonstrates to the public that the money is being put to good use and it helps converge various revenue options, expenditure decisions, and drive innovations in zoning, water, transportation, and other governmental activities.

George HW Bush created the Acid Rain Program under Title IV of the 1990 Clean Air Act Amendments to reduce acid rain and improve public health. The cap and trade mechanism for SOx and NOx was a market-based approach to achieve that goal. Since 1990, emissions have reduced by as much as 40%. This program is estimated to have resulted in over $70 billion of annual health benefit for $1-2B in annual government costs[3]. The program has been hailed as probably the most successful program related to human health in the past 10 years.

The fuel tax was created in Oregon in 1919 and was appropriately dubbed “Get Oregon Out of the Mud”. It promised to use the revenue to improve the quality of the roads due to the popularity and widespread adoption of the horseless carriage. The tax was hugely popular with the citizens as people could see their tax dollars improving their livelihood as roadways improved the ease of transportation. Within 10 years, every state in the union had a fuel tax that went to construct and maintain the highway and roadway system.

Recommendation for WA State: Committing to a deep decarbonization strategy of 80% reduction is a strong goal commitment. Given the broad nature of carbon in the economy, a goal-driven approach will help focus the efforts towards a worthwhile goal.

2) Minimize administration concerns by taxing at production.

An important factor in taxation is the level of effort to administer it. A complicated administration creates challenges for certifying compliance and increases the likelihood for fraud. Therefore, creating a simple administrative infrastructure should be encouraged.

In the acid rain cap-and-trade program, there were a discrete number of polluters. Phase 1 focused on the top 110 power plant polluters and phase 2 dealt with the rest. In total, there was a mere 3,500 polluters. Collection and compliance is relatively simple – one knows exactly how many to tax. The fuel tax is a production excise tax that is paid by the producer. It is collected from the individuals at the pump. This simplifies the collection of the tax to only a few entities – the gas companies.

Carbon suffers from the challenges that nearly every consumer emits it. Because it is so pervasive, the production tax is probably the best place to levy it. Levying the tax on consumption would be nearly impossible to administer, certify and check for fraud. That was one reason why British Columbia’s carbon tax is a production tax.

There are two objections to carbon as a production tax. First, to a consumer a production tax is merely included in price and the consumer may feel at a loss as to how to change their behavior to avoid it. Second, if the carbon tax is taxed at production, then isn’t it just another version of the fuel tax? Both of these objections can be alleviated by how one designs tax consumer incentives, addressed in the next section.

Recommendation for WA State: The WA carbon tax should be a production tax to simplify administration and collection. Behavior changes should be tackled with consumer incentives and investment decisions.

3) Maximize effects by incentivizing consumption.

Investing the funds within the system to reach policy goals leverages the effectiveness of the funds. It also demonstrates to the citizens that the government values the purpose of the revenue. These practices can be very effective in changing consumer behavior.

Denmark has both a carbon tax and an energy tax. The energy tax is a broad-based tax that is used to fund government priorities. The carbon tax is invested in infrastructure that reduces the carbon footprint of the country. Thus, a carbon tax can be differentiated from a fuel tax if the expenditures is dedicated towards achieving the deep decarbonization goals.

The deposit-refund model of plastic and aluminum bottles were designed to reduce littering. Consumers pay a deposit per bottle at time of purchase, a convenient time to collect the fees. The deposit is refunded when the bottle is returned to a recycling station, reinforcing a behavior that is difficult to legislate. Since the refund can be collected by anyone, not just the purchaser, it also creates financial value to someone in the market, even if the purchaser isn’t motivated to collect on the deposit. To date, 10 states have a bottle bill[4] and in those states, recycling rates for bottles can be as high as 90%. Meanwhile, the USA as a whole has a bottle recycling rate of 31%, demonstrating the effectiveness of incentivizing consumer behavior[5].

Tobacco control has a similar story, utilizing a tax revenue on cigarettes and other tobacco products to fund prevention and cessation programs. During the years of 1989 to 2008, the California program cost the state $2.4 billion and led to health benefit savings of $134 billion[6]. An important lesson is that as little as 10-20% of the tax revenue, when invested in these sorts of activities, can have an amplified economic benefit to society at large. Imagine the societal benefit if 100% of the tax revenue was invested in prevention programs.

Recommendation for WA State: Dedicate the carbon tax revenue to investing in infrastructure that reduces the carbon requirement of the economy. This would include electrification of the grid, renewable power, energy storage technologies, thermal and district heating, etc. This also differentiates the carbon tax from other taxes – it is funding an energy resilient economy.

4) Maintain Transparency

Citizens and businesses need transparency to be able to make sound business decisions. For a citizen, having access to data assuages concerns that their tax dollars are put to good work. For a business, transparent data creates certainty about their progress towards a policy goal.

In the acid rain cap and trade program, transparency was key in making it work properly. First, the program was phased in over the course of many years so that companies could prepare for their adoption and plan their investments around those targets. Second, the EPA publishes the latest information on the air markets on their website[7]. One can look up the emissions of individual power plants[8]. Using air quality monitors, one can see a map of how emissions have evolved over the past 20 years[9]. This level of transparency and data access makes it simple for citizens to see the positive effects of the Cap and Trade program.

Figure 2 Source: EPA

Recommendation for WA State: For a carbon tax to succeed, there must be simplicity and transparency in what is being taxed, and clear information on the investment of the revenue. This creates a pathway for accountability on the progress towards policy goals.

5) Enable the ability to adjust and update the tax as needed

Perhaps the biggest challenge is that any result of a decarbonization policy will take decades to become apparent with their effects lasting far longer than the regular political cycles. Furthermore, technology, political pressures and priorities will change. To have a carbon policy etched in stone in the 2017 present may not serve the 2050 future. Therefore, the system needs to guide us to the end goal of deep de-carbonization while responding to current-day challenges.

A cautionary tale is the fuel tax, which when created, was not inflation adjusted. Legislatures have the onerous task of raising the rate every few years – a huge political lift. As a result, most only get updated every decade or so, resulting in a chronically underfunded transportation infrastructure. On the other hand, utility rates are determined by a regulatory commission that has jurisdiction over the setting of rates that are fair, just, reasonable, and prudent[10]. The commission, appointed by the Governor, takes input from the utilities, the Attorney General, and the general public to approve or disapprove of any increases to the rates that serve the public’s interest.

Recommendation for WA State: Create a system with political oversight that can make data-driven and transparent adjustment to the revenue and investments. This may be in the form of a commission of experts to decide how to best invest carbon tax revenues in meeting state policy goals. This could be in infrastructure (electrification of mobility, reducing wasted heat, biological sequestration, etc.), to fund research, or to incentivize companies to purchase energy efficiency options for their operations.

Case Study: Denmark

The Danish carbon tax system has attributes of these 5 best practices. In 1991, they adopted a policy to reduce carbon levels by 20% before 2005. To achieve that, they levied a carbon tax on top of their energy tax to fund the initiative. They used their carbon tax revenue to invest in infrastructure (co-generation, district heating, renewable energy, and energy efficiency). They gave tax breaks to companies who agreed to invest in their own energy efficiency initiatives. The Danish Energy Agency, jointly with Statistics Denmark, publish an annual report on the economic progress towards the carbon goals. As the country reach their carbon reduction goals, they shift their spending priorities to continue to drive down their carbon footprint. These strategies, in conjunction and collaboration with the industry, has reduced carbon by over 50% in 30 years. This is even more impressive considering that energy consumption increased a mere 10% and the GDP grew by 60% during that same period[11]. Denmark not only reduced their carbon risks and exposure, they also created a new industry that now exports their expertise, making them more competitive on the world stage.

Figure 3 Source: Eurostat

In Summary

  • Taxes should support a policy goal. Therefore, adopting a goal of 80% deep decarbonization would send a clear signal of the state’s commitment to combat climate change.
  • Carbon is pervasive and released by every consumer of energy. To ease the burden of administration, the tax should be levied at the producers.
  • To maximize the effect of reaching the policy goal, the tax revenue should be invested in incentivizing low-carbon behaviors, not to fund general government programs.
  • Giving companies a tax break if they invest in energy efficient technologies not only is aligned with the state’s goals, it also enables companies to be innovative with their solutions. These decisions can be incremental and will accumulate over time.
  • Government should invest their carbon tax revenues in infrastructure that uses less carbon. These may include batteries, electrification of roads, thermal and co-generation facilities. Since infrastructure decisions last for about 100-200 years, these decisions should be *best in class* rather than incremental decisions.
  • Create a transparent system that makes annual reports on the state’s progress. This system should also have ability to update the adjust technologies, revenue and investments over time to continuously meet state policies.

[1] Carbon Cycle Diagram from NASA. University Corporation of Atmospheric Research. Last Accessed 10/26/2017

[2] James Mirrlees et. al. Tax by Design Oxford UP 2011

[3] Cap and Trade: Acid Rain Program Results, Clean Air Markets Program, US EPA


[5] 2015 United States National Postconsumer Plastic Bottle Recycling Report. American Chemistry Council 2015

[6] Centers for Disease Control and Prevention. Best Practices for Comprehensive Tobacco Control Programs — 2014.




[10] PSE General Rate Case, Docket UE-0-0904, Final Order, Order 11 (April 2, 2010).

[11] Successful environmental taxes in Denmark: European expert platform on environmental taxation and green fiscal reform Danish Ecological Council