A carbon tax: how much would be too much?

Even in a debate as heated as the one over global warming, recent proposals by some Republican elders offer hope that cooler heads might one day prevail. They propose a conservative way to address climate risk: harnessing market forces with a carbon tax while refunding dividends to consumers. If such an approach is in the cards, what would it mean for consumers, particularly for buying gasoline without too much pain at the pump?

The University of Michigan Energy Survey asks consumers how much they can afford to pay for energy before the cost becomes so high that they would have to significantly change their lifestyle. The responses are the basis for the affordability indices we publish seasonally, one for home energy and the other for gasoline. Although we don’t ask explicitly about a carbon tax, our data equip us to estimate how many consumers would be pushed outside their comfort zones by a tax of a given magnitude.

Photos of James A. Baker III, Bill McKibben, George P. Shultz and Laurene Powell Jobs

Supporters of a carbon tax include (clockwise from upper right): Bill McKibben, George Shultz, Laurene Powell Jobs and James Baker.

The Climate Leadership Council — whose headliners include former GOP cabinet members James A. Baker III, George P. Shultz and Henry M. Paulson, Jr. — has floated a proposal to tax carbon dioxide (CO2) at $40 per ton. A carbon tax of that level translates to an added 36¢ per gallon at the pump.

Motor fuel is less expensive now than it was three years ago; the national average spanning the period of higher prices through the most recent data is $2.80 per gallon. A $40 per ton carbon tax would bump the price to $3.16 per gallon. Based on our survey responses, that price would still be considered affordable by more than 90% of Americans. It is well below the $5.00 per gallon level typical of the average response to our survey question, which asks:

At what price per gallon would gasoline get so high that it becomes unaffordable to you (and your family)? 

If prompted, our interviewers clarify that “By unaffordable, we mean that you (and your family) would be forced to make significant changes in the way you get around.”

A price of $3.16 per gallon is still 40¢ lower the $3.56 per gallon national average over the year before the large price drop that occurred in the second half of 2014. Economic recovery was then well underway. New car sales — a key indicator of how Americans react to fuel prices — had recovered from their recession slump and where already shifting back toward more fuel consumptive SUVs and other light trucks.

The chart below shows the average survey response in comparison to the national average price of gasoline. Over the nearly four years of data analyzed to date, the average price considered unaffordable has been generally over $5.00 per gallon. Although it trended down as pump prices fell, the price that consumers consider unaffordable has not fallen as much as the price of gasoline itself. So the gap between actual gasoline prices and the average threshold for pain at the pump is quite large. 

In other words, there is a good bit of leeway for a higher gasoline price before most Americans would be seriously pinched. But this good news (at least for carbon tax proponents) is not the whole story. Even at today’s prices, about 2% of consumers already feel constrained. More would feel pinched if a carbon tax were added to existing fuel taxes, and the number of consumers affected depends on household income.

The effect of varying levels of a carbon tax on different income groups is shown in the next chart. In addition to a $40 per ton tax, we examined a lower carbon tax of $10 per ton, which would add 9¢ to the price of a gallon of gasoline, and a high tax of $100 per ton, which would add 89¢ per gallon. All cases are relative to a base gasoline price of $2.80 per gallon.

This analysis grouped consumers into three categories (terciles) according to their self-reported household income. Even without a carbon tax added, 4.5% of low-income consumers feel that, at $2.80 per gallon, gasoline is costly enough that it affects their travel behavior. With a $40 per ton carbon tax, the number of low-income consumers who would feel serious pain at the pump jumps to 14%. That fraction compares to the 7% of middle-income consumers and 4% of high-income consumers that an additional 36¢ per gallon would push outside their comfort zones.

Naturally, these effects vary according to the carbon tax level. As seen in the chart, a $10 per gallon carbon tax does not appreciably change the number of consumers affected in any income group. Ten dollars per ton is similar to the price effect of some current carbon caps, for example. But the number of consumers who would find fuel unaffordable goes up quite a lot for the $100 per ton carbon tax, a level that some economists believe is needed to deeply reduce CO2 emissions in the long run.

Other surveys have found that support for a carbon tax depends on how the proceeds are used. Support rises if tax revenues are rebated back to consumers (as proposed by the Climate Leadership Council, among others). Our data underscore how such an approach would be most helpful for consumers who are less well off, a consideration for policymakers to keep in mind if they want to ease the burden of a carbon tax on those Americans who would be most affected.

For further details on the analysis behind these findings, download our full report on Carbon Taxes and the Affordability of Gasoline.