Clean Energy Innovation: Making a Carbon Tax More Affordable

Economic theory suggests a tax on carbon emissions is the most efficient way to reduce them. But another important effect of such a tax would be to induce innovation in clean energy technology. The energy industry would raise its clean energy R&D spending and accelerate the introduction of new products and processes, and more companies would enter the industry. Yet, this induced innovation effect is overlooked in most modeling, leading to significant underestimation of the impact of a carbon tax.

On September 18, 2018, ITIF held a Capitol Hill briefing on this important issue. ITIF Senior Fellow Joe Kennedy, author of the recent report “How Induced Innovation Lowers the Cost of a Carbon Tax” (published with generous support from the Alliance for Market Solutions), presented his findings and a panel of experts discussed the policy implications. Kennedy discussed how a moderate carbon tax could have a positive effect on the American economy. Kennedy explained that the federal government has two primary options to reduce carbon emissions: implementing cap and trade programs or a carbon tax. Kennedy argued in favor of the carbon tax because it better feeds into the market economy. He also thinks that a tax leaves room for innovation to prosper through induced innovation. In Kennedy’s view, induced innovation is important because it allows companies to reduce their use of the taxed item. So, a carbon tax will create an incentive for companies to make green tech to reduce taxed carbon emissions. Kennedy explained how the 1980’s oil crisis was a great example of induced innovation at work, since many companies began to research new technologies to replace oil. Finally, Kennedy recommended that Congress increase the alternative simplified credit and allow companies to apply it to non-energy tasks. Second, Congress should create an innovation box to allow companies to develop clean tech. Finally, Congress should allow companies to expense their research costs.

After Kennedy’s opening remarks, moderator David Hart turned the floor over to the panelists. Alex Brill, Resident Fellow at the American Enterprise Institute, talked about the role of the federal government in innovation policy. He explained that there is a natural market failure in innovation because other businesses will create copies of innovations. This outcome is positive for consumers but not for inventors. To fight this, we have patents and other policies in place that the federal government has created and enforced. Brill used these points to argue that there is a role for the federal government in innovation policy. Brill then stated his support for a carbon tax because it creates an incentive for an inventor to take risks to innovate in the energy market. Brill then mentioned that the Federal Government could use the carbon tax revenue to fund other programs like the Child Tax Credit in the Federal Government.

Joseph Majkut, Director of Climate Policy at the Niskanen Center, spoke next. He stated that innovation has reduced carbon by 14% over the past years, but that we need more innovation to eliminate carbon emissions by 2050. He made the point that the innovation process will create a different world than what we live in. For example, gas will not fuel cars anymore, and we will need an increase in electricity production and other areas to meet the innovation process. Majkut stated that a carbon tax will affect multiple industries, which will be a good thing because the tax will reduce carbon emissions throughout the entire economy. Thus, a tax will do a better job of reducing emissions than federal or state regulations because a regulation will likely only effect on a sector of the economy, and a tax will affect multiple sectors of the economy.

Donald Marron, Institute Fellow & Director for Economic Policy Initiatives at the Urban Institute, explained how people respond to incentives. Thus, a large and broad carbon tax will filter through many sectors of the economy. The tax will impact consumers and creators alike. Marron stated that a broad and long-term tax is ideal. Marron stated that a carbon tax is just one lever that you can pull to better the environment; it’s important to realize that the federal government might have to pull other levers like nuclear regulations to create a better environment. Finally, Marron suggested that the carbon tax revenue will hurt some sectors of the economy like coal miners and that tax revenue could help them or other negatively affected sectors.

Ultimately, all the panelists agreed with the concept of implementing a carbon tax, although they had differing viewpoints of what to do with the tax revenue.

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