Blog April 7, 2017

Where CO2 Policy Goes from Here

President Donald Trump has recently signed an executive order to dismantle the Clean Power Plan and proposed cuts to Environmental Protection Agency programs on climate research. To some, these actions suggest that climate-related policy innovation has stalled.

However, away from the federal government, states are increasingly exploring legislation to price carbon emissions. An approach that exists in Canada known as “fee-and-rebate” has support in several states. Depending on the design, fee-and-rebate schemes could impact credit fundamentals for certain types of municipal bonds and issuers.

Today, the price of carbon shows up indirectly in narrowly defined tax advantages for employing renewable energy and efficiencies. These advantages can seem arbitrary and, as they are often short-term, they can complicate utility investing. The essence of fee-and-rebate policies is to tax carbon (put a “fee” on it) and return it (“rebate” the proceeds of the tax) to businesses and households. Typically, fee-and-rebate policies are designed to be revenue neutral, but they don’t have to be.

No state has yet passed a comprehensive fee-and-rebate law, but two have inched closer in recent years: Washington and Massachusetts. If fee-and-rebate moves forward in these states, it could impact their economic growth and the composition of their revenues. We are closely following carbon tax legislation in states like Washington and Massachusetts because we expect more states to consider, and perhaps enact, such legislation.

  • Washington - In November, Washington voters considered a revenue-neutral ballot initiative that would have imposed a tax of $15 per ton of carbon emissions in exchange for reducing the state sales tax by 1 percent, among other changes. The initiative failed by 59-41 percent vote.1 Much of the pushback came from interest groups that preferred no rebate or from environmentalists pushing other alternatives. But pricing carbon emissions remains popular in Washington.
  • Massachusetts - Two bills have been introduced in the Massachusetts legislature this year that would put a price on carbon emissions. A Senate bill is revenue-neutral while a House bill is revenue-positive. The latter bill would rebate 80 percent of carbon tax proceeds, while the remaining 20 percent would be used to fund green infrastructure investments.2

For investors, the proposals in Washington and Massachusetts raise several long-term questions. The most obvious relates to the fee. What is the economic cost of imposing a price on carbon emissions? In the case of Washington, we believe the impact of the initiative that was defeated would have been benign. The $15 per ton tax roughly equates to only 15 cents at the pump.3 Additionally, Washington relies only modestly on fossil fuels for its electricity. In our view, imposing a price on carbon emissions would be more burdensome in states with greater production of fossil fuels.

Another question is how many states are likely to consider carbon taxes in the future? Our best guess is that at least half the states in the U.S. are likely to debate carbon tax legislation at some point in the next 5-10 years. Few states are overly reliant on fossil fuels for generating economic growth, which makes taxing carbon less burdensome. As the graph below illustrates, while the top 13 states derive an average of 10 percent of their gross state product from mining, the remaining 37 each fall under 2 percent. (Figure 1).


In addition to the effects of the carbon tax (fee), the rebate also raises questions. For instance, Washington’s proposal to roll back its sales tax by 1 percent would have been offset by an equal amount of carbon fees. The swap would alter 5 percent of the state’s general fund revenue mix. That’s a sizeable figure given that carbon pollution taxes might decrease as the activities that generate carbon pollution decline.

Finally, what of bonds backed by motor fuel taxes? If a carbon tax incents less driving or use of more electric vehicles, bonds backed by motor fuels tax revenue might weaken in credit quality.

We will continue to look at the possible effects of a carbon fee. The price signal it would send could reduce the effect of arbitrary, and short-lived, policy upon utility and energy investments, but it may also have an impact on bread-and-butter municipal issuers.


[1] Lewis Kamb, “Washington voters reject initiative to impose carbon tax on fossil fuels.” The Seattle Times, November 8, 2016.
[2] Mary Dixon, “With two new bills, Massachusetts moves on carbon pricing,”, February 8, 2017. Accessed April 6, 2017.
[3] Note: The tax is expected to rise slowly over time.  


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