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Implications of a US Carbon Tax on Agricultural Markets and GHG Emissions from Land-use Change

Jerome Dumortier (jdumorti@iupui.edu) and Amani Elobeid (amani@iastate.edu)

Rising concerns about climate change have led to the introduction of carbon policies around the globe. In January 2019, the Energy Innovation and Carbon Dividend (EICD) Act of 2019 was introduced to the House of Representatives. The act proposes a carbon tax of $15/ton of carbon dioxide equivalent (t-1 CO2-e) starting in calendar year 2019, and covers entities such as refineries, coal mines, and natural gas producers. Adjusted for inflation, the tax increases $10 each year and is subject to adjustments given the under- or over-achievement of annual emission reduction targets. The tax ceases if greenhouse gas (GHG) emissions are at or below 10% of the 2016 GHG emissions.

There are two important provisions of the carbon tax proposal to increase its support among stakeholders. First, the EICD Act of 2019 is designed as a revenue-neutral carbon tax with the creation of a Carbon Dividend Trust Fund. The tax revenue is distributed back to eligible individuals (i.e., US citizens and lawful residents) in the form of a lump-sum payment. Second, there is a carbon border fee adjustment mechanism to adjust the cost of imported fuels and carbon-intensive products covered under the legislation. The purpose of the border adjustment is to avoid carbon leakage by switching to carbon-intensive imports whose production is not subject to a carbon tax. Beyond the lump-sum payments and border adjustments, there are two tax exemptions specifically for agriculture. First, fuels and its derivatives are not taxable if used on-farm for farming purposes. For example, diesel fuel purchased for farm machinery is not subject to the tax. Second, there is no carbon tax on non-fossil fuel emissions from agriculture such as from livestock and fertilizer application—an important exemption because agriculture contributes 9% of total US GHG emissions (EPA 2019).

To assess the impacts of the carbon tax on agricultural producers in the United States and on international commodity markets, we use the CARD Model—a well-established global agricultural outlook model—to evaluate a baseline without a carbon tax and a scenario that includes a carbon tax.1 We can attribute the difference between the baseline and our scenarios in terms of commodity prices, land-use, trade patterns, and GHG emissions to the various levels of the carbon tax. We adjust the cost of production of US agriculture, which we model through the different components of the Producer Price Index (PPI). An increase in the PPI from the carbon tax will affect crop and livestock producers. Adjustments in production quantities (i.e., crop area and livestock herd) allow us to assess the global effects of the carbon tax. We should note that we use a simulation model to evaluate a reasonable pathway as opposed to using historical data in an econometric model; thus, there is inherent uncertainty about the actual evolution of agricultural markets including land-use, prices, and emissions. We only analyze one aspect of the proposed legislation (i.e., agricultural cost of production and trade), and do not include other emission sources such as manufacturing or transportation.

Over the ten-year projection period, the carbon tax ranges from $15 to $105/t-1 CO2-e. We observe the highest increase in production cost at the end of the projection for corn, cotton, and sorghum with increases of 16.4%, 15.5%, and 14.6% above the baseline, respectively; and, the lowest increase in production costs are for wheat (12.5%) and soybeans (11.9%). Oats, rice, sugar beets, barley, and peanuts experience a cost of production increase in a relative narrow band between 13.2% and 13.9%. The magnitude of the cost increase is mostly due to increases in natural gas prices, which is an input in the production of fertilizer.

Figure 1a
Figure 1a. Commodity price changes under the EICD act.
Figure 1b
Figure 1b. Changes in net return under the EICD act.

Although farmers face higher production cost, an increase in commodity prices and a decrease in crop area lessens the effect on crop profitability (i.e., market net return) (see figure 1). Corn, cotton, and sorghum prices increase between 1.0% and 1.6%, but the price increases for other commodities are below 1%. Although we see an increase in the cost of production by up to 16.4% for some commodities, the decreases in net return range from 3.2% (peanuts) to 8.1% (wheat). A crop area that is essentially unchanged from the baseline explains the high decrease in net returns for wheat. Thus, the increase in the production cost translates more directly into a net return decrease compared to other crops.

Under the act, overall crop area in the United States declines by 0.4%. Barley, oats, and sorghum decrease between 2.3% and 2.4%, whereas corn and soybeans decrease by 0.9% and 0.1%, respectively, in the same scenario. The carbon tax mostly impacts fertilizer and, thus, makes using marginal cropland unprofitable. US corn and sorghum exports decrease by 4.9% and 3.4%, respectively. The decrease in soybean exports is smaller than for corn at 0.8%. The largest change in US exports is observed for sunflower seeds with a decrease of 7.5%.

The decrease in US exports for major commodities is in part compensated by an increase in exports from large crop-producing countries. Argentina increases its exports of barley, corn, and sorghum by 0.2%, 1.3%, and 1.0%, respectively. As previously mentioned, we see a slight increase in US wheat production and a 0.5% decrease in wheat exports from Argentina. Brazil also increases its exports of corn and soybeans by 5.2% and 0.6%, respectively.

Dumortier et al. (2012) shows that a tax on US cattle emissions would increase net GHG emissions globally. Thus, the implementation of a carbon tax that affects agriculture in the United States warrants attention to avoid similar effects. Our results show that an increase in carbon emissions triggered by land-use change is negligible and represents less than 0.6% of US emissions in 2017 (EPA 2019). Emissions from land-use change in other countries, especially Brazil, partly offset the reduction in US emissions from land-use change. Focusing on emissions from changes in cropland and pasture (due to changes in livestock inventory), the maximum emissions in the EICD scenario are 35.37 Tg CO2-e. Using minimum and mean carbon coefficients, the emissions are 5.95 and 16.22 Tg CO2-e, respectively.

Given the expected negative effects of climate change on US agriculture in terms of net revenue loss triggered by declining yields, the carbon tax may be a more cost-effective policy. This of course goes back to the discussion on the expected (and highly uncertain) damages associated with climate change and how those future expenditures compare to costs incurred today to avoid rising temperatures. The answer to that question is beyond the scope of our analysis.

References

Dumortier, J., D.J. Hayes, M. Carriquiry, F. Dong, X. Du, A. Elobeid, J.F. Fabiosa, P.A. Martin, and K. Mulik. 2012. “The Effects of Potential Changes in United States Beef Production on Global Grazing Systems and Greenhouse Gas Emissions.” Environmental Research Letters 7:024023.

Environmental Protection Agency (EPA). 2019. Inventory of U.S. Greenhouse Gas Emissions and Sinks 1990-2017. Technical report EPA 430-R-19-001. United States Environmental Protection Agency.

Footnotes

1. Center for Agricultural and Rural Development (CARD) at Iowa State University