Further thoughts on the carbon tax.

This post is in response to feedback from my previous post on this topic.


There are no panaceas.

But as abstract ideas go, pollution taxes are pretty appealing. Holding constant lots of things that we can’t really hold constant, it means replacing the inefficiency resulting from poorly defined/enforced property rights with a world where prices more accurately reflect the costs of one’s decisions.

Let me come back to the things we’re “holding” constant in a bit. Why do I want to throw my weight behind shifting public perceptions in favor of pollution taxes?

I think they’re underrated by the median voter. Climate change is just a subsidy paid in the form of worse conditions. But most people (including people who should know better) don’t have a good understanding of the problems caused by subsidies.

Which is not to say a carbon tax isn’t overrated by the median policy wonk. There are a ton of important caveats, but on balance, as a policy for use in the next 50 years, I think they’re a useful tool to enhance efficiency or replace worse tools.

Again, there are no panaceas. I’m also not a huge fan of the “Economists’ Statement on Carbon Dividends” as written (for reasons I’ve hopefully mostly addressed). I suspect the best case scenario for my preferred carbon tax policy would be a modest improvement. I think the bulk of the gain would be a cultural shift away from “let’s regulate our problems!” to “let’s leverage incentives to address our problems!” Not Earth shattering, but a step in the right direction.

So let me state my position, then we can dig into criticisms and caveats.

Let’s make marginal shifts away from taxing investment and towards taxing negative externalities. As we go, let’s spend a lot of effort trying to study the impacts and adjust accordingly. Let’s heavily agument that with abatement policies rather than trying to return to some pre-industrial climate target.

Okay, let’s dig into criticisms and caveats.

  1. Public choice considerations
  2. Geoengineering and other alternatives
  3. Cost
  4. Coordination
  5. Uncertainty

1-Public choice considerations

A Green New Deal will be a rent-seeking bonanza. Pollution taxes will face the same sorts of problems that plague the tax code in general. There will be intentional loop-holes and accidental screw ups.

We have to continue to push for reducing the complexity of tax codes in general. But I can’t deny that a carbon tax would be a step back on this margin.

Minus a hundred points for my position.

2-What about geoengineering?

Geoengineering sounds like a possible panacea. Maybe it is. But I’m not willing to flip a switch and find out the hard way all at once.

First off, geoengineering is scary. The climate is a complex system and complex systems are difficult-impossible to manage well. And that’s especially concerning if it means that anyone with a few million bucks can try to fiddle with Earth’s thermostat.

But it seems like a plausible tool that might be used to address climate change. Similar to my take on a carbon tax, I think the way to go is baby-steps plus research.

What about subsidizing “green _____”

Personally, I’m skeptical. Solar sounds appealing, and I (personally) think windmills are beautiful. But I don’t think the government will do a good job of picking winners and losers. Pollution taxes are appealing to me because they don’t require bureaucrats to choose. Again, I think the way to go is to use pollution taxes to offset other taxes–while continuing to advocate for reduced size/scope of government and a return to federalism.

Plus five points for my position.

3-Cost

We should also remember that GDP is an imperfect measure of well being. The current figures aren’t directly comparable to the figures we’d get in a post-carbon-tax world. A one-time fall in GDP doesn’t (necessarily) mean we’ve screwed things up.

A tax big enough to halt climate change would be incredibly costly. Too big a tax yields a negative net benefit.

Still, it’s worth remembering that a) we can go too far with a carbon tax, and b) we don’t have access to a silver-bullet solution. So let’s start small and gradually increase carbon taxes till we get close to (our best estimate of) the optimal level.

Plus epsilon points for my position.

4-Coordination

The basic idea of a carbon tax is that we’re dealing with a global-scale externality problem. But small scale taxes are unlikely to do much beyond shifting where pollution happens. A fully effective tax would require multi-lateral coordination. And, as a country, we aren’t very good at that.

Trying to create a tax on imported carbon-intensive goods that didn’t face a tax at home seems a) sensible at first blush, and b) a massive opportunity for public choice problems.

On the other hand, we could justify a tax commensurate with the local impacts (something like 10% of the global impact). This fits nicely with my idea of starting small and adjusting at the margin.

But even within the U.S. there are coordination issues. Long Island will likely face net costs from climate change, but other areas will benefit from a longer growing season.

Plus 10 points for my position, but also minus 10 points.

5-Uncertainty

Uncertainty cuts both ways: we’re currently accidentally manipulating the climate and that could turn out to be catastrophic. Trying to intentionally manipulate it in the other direction is also dangerous. Again, the appropriate focus is on marginal tinkering [much as it clashes with my non-interventionist priors] rather than ambitious global engineering [which grabs my priors by the lapels and knees them in the groin].

When I teach externalities, I draw a graph like this:

Negative externalities when we magically know their magnitude.

In this market, we end up with an equilibrium quantity defined by the point where Marginal Private Cost equals Marginal Social Benefit (MPC = MSB). But the Marginal Social Cost (MSC) is greater, so we get a deadweight loss equal to the triangle I’ve shaded in red and purple.

It’s important to note: we don’t actually know where the MSC curve is. It’s somewhere above MPC, but we’re basically in the position of trying to eliminate a subsidy we don’t know the size of.

The relevant models–climate models and economic models–are filled with uncertainty that we simply cannot resolve without real life experience.

What does the economic way of thinking tell us? Act on the margin. Setting a tax that pushes supply (MPC) up to the green line doesn’t fully address the problem (as I’ve assumed it to be in this graph), but it’s an improvement.

Even better, it’s an improvement where the biggest returns are experienced up front. This modest tax fails to get rid of the red deadweight loss (DWL) area, but it eliminated 3/4 of the total DWL.

Plus X points for my position where X is a random variable with an unknown distribution, positive first derivative, and negative second derivative.

tl;dr:

At my friend’s behest I’ve been looking at Bob Murphy’s critique of carbon taxes. I find it’s shifted the magnitude of my prior opinion, but not the direction. I still think carbon/pollution taxes are a good idea, but I no longer think they’re a great idea. My take away from Murphy’s work is that the optimal carbon tax is fairly modest. My response is to advocate for getting a very modest carbon tax on the books, then gradually shift tax policy in that direction.

For climate change (and any other problem) we ought to be pluralists. A mix of approaches is ideal. Part of the appeal of Pigouvian taxes is that they allow and encourage a wide range of responses. The best pollution abatement scheme isn’t something we can look up in a binder. We have to discover it, and crowdsourcing is the appropriate way to do that.

But carbon taxes are only one part. We should also advocate for changes that will ameliorate harm. I am more bullish on these policies than I am on a carbon tax:

  • Make it easier for the world’s poorest people to move to rich countries that will be better able to cope with climate change.
  • Quit subsidizing flood insurance.
  • Quit subsidizing polluting industries (and other industries).

Even though geoengineering scares me, we should try to learn more. Ditto for any other possible tools that come along.

RE: Economists’ Statement on Carbon Dividends

I just got an email asking me to sign on to an open letter arguing for some carbon tax policies. I’m seeing some push back from (smart, economically literate) Facebook friends, but I think it’s a viable step in the right direction.

Here’s the statement paraphrased:

We think global warming is an important and urgent issue and we recommend these five things:

1. A carbon tax is the best, most cost-efficient way to do as much about carbon as needs to be done. [For a given level of carbon reduction, I agree. How much carbon reduction should happen (and how much at government behest) I am deeply agnostic about.]

2. We think this should be phased in over time and should be revenue neutral. [Yes on both points, but the rest of the statement makes it seem like they’re talking about a pretty short time horizon. I’m not sure how fast is too fast, but I’m sure there’s such thing.]

3. A carbon tax is more efficient than a set of specific regulations. [Certainly!] It’s also less likely to be subject to changing political winds. [Is it though?]

4. We should also apply a carbon tax to imported goods. This would reward energy-efficient American firms and prod other countries to follow suit. [Hmmmm… I can’t really disagree with the general principle, but this sounds like it will require bureaucratic oversight that will be subject to regulatory capture. On the other hand, we’ve already got that.]

5. We should give the revenue collected back to U.S. citizens, to offset increases in energy prices. [Okay, but if it’s going to be revenue neutral and come with a transfer scheme, that’s going to take some detangling!]

I buy into the notion that carbon emissions create large scale externalities that will probably be more bad than good on balance. Not universally bad, mind you. And not something that humanity won’t ultimately adapt to. But I think the people who will face the brunt of the bad outcomes will be the world’s poor (who we should help migrate to better climates!).

I don’t think we can just impose “the right” carbon tax and have everything come out just right. Even though I routinely draw out the case with a supply and demand graph in class, the truth is that nobody has access to those curves in real life. But a small tax can serve to reduce the inefficiency of pollution even if we don’t get it exactly right.

The revenue neutral part is important–we’re currently taxing lots of things we actually want more of (like investment). So if we can cut those taxes by taxing things we want less of (pollution), we’re reducing two sources of inefficiency in the current setup. Of course you and I have bolder views about what policy should look like in 100 years, but restricted to a 10 year window, a revenue neutral carbon tax looks pretty good to me.

The letter dramatically over-simplifies things. Climate change is probably a problem, but probably not as big a problem as proffered by proponents of proposals to prepare for apocalypse. It’s not clear to me that we have a good idea of a) all of the effects (good and bad), b) how people will adapt, and c) how people will adapt to a changing policy regimen.

Figuring out how to handle the tax on imports will be difficult and rife with rent seeking. Unmentioned is the impact on exports. If all our trading partners follow a similar policy, there’s no problem, but in the mean time there’s a tension that will probably be resolved with some unfortunate bit of rent seeking.

I’m sure most reasonable people would agree that instantaneous change would probably be unduly costly, but it’s not clear what the right speed of implementation is.

There are some miscellaneous rhetorical points I have issue with, but I suspect those are in there to throw a bone to people who aren’t me.

I hope that 10 years from now this open letter looks a bit silly. But I also hope that 10 years from now pollution taxes start to replace more inefficient taxes. On balance, I’m happy to see the letter prodding us in that direction.

Is Australia’s Carbon Tax Repeal Really Market Enhancing?

Some libertarians cheer whenever there is any tax repeal. However, we need to distinguish taxes in form versus taxes in substance. Taxes in substance have no relation to a benefit or penalty attached to the payment. Taxes in form, but not in substance, pay funds to the government, but are tied to some benefit or compensation for damages.

It is standard economic theory that the best way to prevent pollution, as with other negative The effects, is to make the polluter, hence also the buyer of its products, pay the social cost of the pollution. The economist Arthur Cecil Pigou provided a thorough explanation in his 1920 book The Economics of Welfare. A tax on pollution has since then been called “Pigovian.”

One of the most discussed Pigovian taxes has been on the use of carbon-based fuels such as coal, natural gas, and oil. A “carbon tax” can be on the fuel inputs or on the emission outputs. The most effective Pigovian levy is on the emissions, as that provides an incentive to reduce pollution such as by capturing the carbon before it gets spewed out. If the polluter does not compensate society for dumping on the commons, then in effect it gets subsidized, as it sells its output at less than the total social cost of production.

Many countries have been confronting pollution with inefficient policies such as regulations, credits for offsetting pollution with purchases of forest lands, and permits that can be traded. Australia enacted what was called a “carbon tax” with the Clean Energy Act of 2011, implemented in July 2012. But this was not a Pigovian tax. The Act created a “carbon price mechanism,” a cap-and-trade emissions trading scheme that at first set a price per ton of emissions. This mandated price had the effect of a ‘carbon tax’. But after 2015, the mechanism would have transitioned to a trading scheme.

However, in 2013 the newly elected prime minister sought a repeal of the “carbon tax” emissions trading scheme. In 2014, parliament passed the repeal.

The opponents of emissions taxes claim that this increases costs to business and households. This is narrowly true, but policy should consider the total costs to society. The pollution imposes a social cost on Australia and the rest of the world. This is not a cost paid in explicit money, but costs in the form of illness, a less productive environment, and possible effects on the climate.

The opponents of emission levies overlook that the absence of compensation for the pollution costs is in effect a subsidy to the polluters and their customers. A pollution charge is not a tax in substance, but rather the prevention of this subsidy, and compensation for dumping toxic materials on other people’s property.

The repeal did not provide a replacement, and this creates uncertainty for business about any future anti-pollution policy. This policy uncertainty reduces investment and growth.

The best way to implement a pollution tax is as a replacement of other taxes. Taxes in income, sales, and value added impose the excess burden of higher costs and less output and employment. If politicians are concerned with tax costs, why are they not repealing these taxes? When a pollution tax replaces such market-hampering taxes, the total costs paid by consumers does not increase, but rather shifts in favor of less- polluting products.

Actually, the revenue obtained from Australia’s brief carbon tax was used to compensate taxpayers and affected companies. But the most effective policy would have been to have an explicit tax on pollution instead of a trading scheme, and to lower other tax rates, along with a transitional compensation to those with net losses.

Some opponents claim that Pigovian charges would be good if applied globally, but in a single country, would put its industries at a disadvantage. But that would not happen with a “green tax shift,” the replacement of inefficient taxes with a “green tax” on pollution. A green tax shift would reduce the environmental cost of pollution while not increasing the total tax costs for the country’s economy.

What Would You Do?

I picked up a five things to-do list from Grover Cleveland over at Pileus Blog if he were supreme ruler of the land. He in turn got his 5 from a prompt by Angus over at Kids Prefer Cheese. If readers have any more Top 5 lists they’ve come across let me know and I’ll link them accordingly.

Anyway, here are Angus’s Top 5: Continue reading