Mechanisms to Reduce Emissions Uncertainty under a Carbon Tax

Carbon taxes produce uncertain emissions levels, which can be a particular problem for certain constituencies and when international agreements are based around quantity targets. Many studies examine ways to reduce price uncertainty under cap-and-trade, but very few look at reducing emissions uncertainty under a carbon tax. We build a new reduced-form model of US carbon dioxide emissions (calibrated based on a sophisticated dynamic general equilibrium model), with trend and cyclical uncertainty in both GDP and emissions intensity, and uncertainty in the elasticity of emissions intensity with respect to the carbon price. We then introduce hybrid carbon tax policies that combine an initial price path with automatic tax adjustment mechanisms (TAMs) and evaluate how much these mechanisms can reduce emissions uncertainty. Our results show that the magnitude of the effects on emissions and costs varies widely based on how the TAM is designed.