carbon tax, normal and inferior goods

Policy Application: Carbon Taxes

A group of prominent Republicans have proposed a carbon tax to reduce greenhouse gas emissions.[1] The proposal includes a revenue-neutral[2] carbon tax that would start at $40/ton and then gradually increase over time. The proposal is expected to reduce greenhouse gas emissions by 28% by 2025.[3] All of the funds raised from the carbon tax would be returned to Americans on an “equal and quarterly basis via dividend checks, direct deposits or contributions to their individual retirement accounts.”² A family of four is expected to receive around $2,000 in the first year of the program.

Assume: The proposal is enacted and that each U.S. citizen receives $500 per year. The X-axis on your graph should be “Gallons of fossil fuel consumed per year” and the

Y-axis should be “Money spent on all other goods per year.”

• Do you think gasoline consumption is a normal or inferior good? Explain and keep this in mind when you answer parts (b) and (c).
• Evaluate this proposal using indifference curves and budget constraints for a consumer who doesn’t consume a lot of gasoline (“Prius”). What effect will this proposal likely have on Prius’s gasoline consumption? Prius’s utility?

Assume there are two individuals (“Hummer” and “Prius”) and that they earn the same annual income.

• Evaluate this proposal using indifference curves and budget constraints for a consumer who consumes a lot of gasoline (“Hummer”). What effect will this proposal likely have on Hummer’s gasoline consumption? Hummer’s utility?

[1] Baker, James A. III et al. 2017. The Conservative Case for Carbon Dividends (February). Available at: https://www.clcouncil.org/wp-content/uploads/2017/…

[2] Revenue-neutral means that there is no net increase in taxes.

[3] Hess, Hannah. 2017. A Group of Prominent Republicans Just Launched a Longshot Bid for a Carbon Tax Science (February 8).

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