Designing and Evaluating a U.S. Carbon Tax Adjustment Mechanism to Reduce Emissions Uncertainty

Abstract

There is increasing political interest in the United States in an economy-wide carbon tax. However, many environmental groups see the emissions uncertainty under a carbon tax as a significant shortcoming, leaving them reluctant to support carbon taxes without some assurance about emissions outcomes. This has created an interest in options for reducing a carbon tax’s inherent emissions uncertainty. One leading approach is a tax adjustment mechanism (TAM), which automatically adjusts the carbon tax rate based on the level of actual emissions relative to a legislated target. This article examines the role for TAMs in carbon tax design and the trade-offs of alternative designs. Using two recent TAM proposals (in former U.S. Representative Carlos Curbelo’s [R-FL] MARKET CHOICE Act and for the Climate Leadership Council’s Carbon Dividends Plan), we show that TAMs can substantially reduce emissions uncertainty. We then show how different design choices affect expected costs and emissions outcomes. We show that most design features have clear trade-offs, improving some outcomes while worsening others. Thus the optimal design will depend on the specific goals of the TAM.