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A Carbon Tax for Reducing Emissions in the Electricity Sector

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.

By Deborah A. Carroll
September 14, 2021

From the first day President Joe Biden took office, his administration has been confronted with the kind of extremely divisive political environment that ensures it will be simultaneously lauded and vilified for its policies and actions on most things. Those related to climate change are no exception.

Some observers maintain that President Biden cannot be a leader on climate change while maintaining a dedication to the use of fossil fuels. For example, Politico recently noted that, “President Joe Biden is pushing ambitious plans for tackling climate change by weaning the United States off fossil fuels—but he’s also taking short-term actions that would make it cheaper and more convenient for Americans to keep driving their gasoline-powered cars.”

The administration contends that it can reduce fuel prices, invest in highway infrastructure and accelerate drilling on leased federal land, while simultaneously committing to achieving net-zero greenhouse gas emissions in the United States by 2050, including carbon-free electricity by 2035.

Perhaps he can indeed do both.

A recent report I wrote in collaboration with Dr. Kelly A. Stevens for the Alliance for Market Solutions evaluates the short-term impact of instituting a carbon tax in the electricity sector, an approach that can help the administration achieve its dual goals.

According to the Energy Information Administration (EIA), 76% of greenhouse gas emissions in the United States result from burning fossil fuels, with approximately 34% of these emissions from electricity generation. The main source of carbon emissions in the electricity sector comes from burning fossil fuels, including coal and natural gas, to generate electricity. However, natural gas produces about half the carbon emissions as coal does, rendering power plants that run on natural gas environmentally preferable to coal-fired plants.

To reduce emissions, some climate regulations promote greater use of natural gas-fired combined cycle generators (NGCC) to offset coal generation. This is possible because the lower pollutant content and high thermal conversion efficiency of NGCC translates into 60% less CO2 emissions than traditional coal generators. However, on average, these plants are running only 54% of the time, leaving potential for further NGCC generation from existing sources. So, we set out to analyze whether a properly designed and implemented carbon tax could be a more efficient means for increasing NGCC utilization than has been seen from other approaches such as utilization targets or emissions caps.

A carbon tax would influence the economics that system operators consider when determining how to run a power plant. In pursing research into this topic, we first used a fixed-effects regression model of monthly NGCC capacity factors–measured as actual electricity output (i.e., generation) divided by total potential output (i.e., capacity multiplied by available time)–from 2003-2017 to estimate the relationship between natural gas and coal resource prices on NGCC utilization. Assuming all increases in NGCC generation directly offset coal generation at a rate of 100%, we then used those estimates in a counterfactual model with different carbon tax prices to evaluate the impact of different carbon tax price points on NGCC utilization and CO2 emissions in the short-run from 2018-2026. Finally, we estimated carbon emissions and related tax revenues from the electricity sector and evaluated how this revenue could be offset for neutrality.

Among our findings: NGCC utilization is highest around a coal-to-natural gas price ratio of 0.75, which represents a low natural gas price of approximately $3.36 per MMBtu (Metric Million British Thermal Unit). In addition, the greatest increase in NGCC utilization occurs when the price ratio is between 0.4 and 0.6, which is roughly a natural gas price between $4.20 and $6.30.

We also found that the highest marginal increase in NGCC utilization happens with a low carbon tax priced at $1-$50 per ton. Assuming no changes in natural gas capacity, a $50 carbon tax would reduce carbon emissions by at least 159 million metric tons, or by 9% of total electricity sector carbon emissions a year through increased utilization alone.

Further, with additional NGCC capacity as estimated by the EIA, carbon emissions could decrease as much as 211 million metric tons a year. With a tax base of all CO2 emissions resulting from electricity generation, this low carbon tax price of $50 per ton would generate approximately $339 billion dollars in net carbon tax revenue in the short-term by 2026, which could be offset in the form of a reduction in the payroll tax paid by employees to achieve revenue neutrality and reduce regressivity.

In order to see a rapid increase in NGCC utilization, especially in the short-term, even a small carbon tax would have a significant impact on replacing coal. Increasing output from existing NGCC plants is a low-cost solution that focuses on short-term operation decisions. Yet, a carbon tax would also have the long-term benefit of encouraging investment in low- to zero-emitting technologies such as nuclear generation and renewables.

Author: Deborah A. Carroll is the director of the Government Finance Research Center at the University of Illinois Chicago.

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