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Would a Carbon Dioxide Tax Be ‘Efficient’?

Thursday, August 30, 2012

Is it reasonable to predict that the adoption of a carbon tax would yield economic improvement relative to current policies?

Carbon taxes are back in the news, supported not only by the usual suspects, but also by a number of prominent conservative economists. The central principle underlying this support for a major tax increase is one that many economic conservatives endorse: Taxes are a relatively efficient policy tool for dealing with environmental externalities. And it is alleged by many that carbon dioxide emissions are responsible for harmful anthropogenic global warming and are thus worthy of taxation.

Let us shunt aside the very real continuing questions of the underlying climate science. Instead, if we assume that carbon dioxide drives harmful climate change, is it reasonable to predict that the adoption of a carbon tax would yield economic improvement relative to current policies?

Consider the direct policy goal of the environmental Left: An 80 percent reduction below 1990 levels of carbon dioxide emissions by 2050. (For the United States, this would result in per capita emissions equivalent to those sometime in the early or mid-19th century.) If such a reduction were to be achieved by the United States alone through any mix of policy tools, the effect on global temperatures 100 years hence would be effectively zero, an outcome about which there is no dispute. Moreover, increasing emissions from other nations, particularly still-developing countries such as China and India, will yield growing concentrations of greenhouse gases. Unilateral U.S. policies would be futile regardless of the assumption made about the underlying climate science.

Therefore, unilateral policies cannot be justified as a corrective to this purported externality. That is why any such policies, in order even theoretically to yield measurable effects, must be adopted by a number of nations sufficient to represent a significant proportion of world economic output.

So: A carbon tax, in order to have an actual effect on the purported carbon dioxide externality, must be imposed by all of the OECD countries at a minimum. In order to avoid adverse competitive effects on international trade flows, any such tax would have to be negotiated, which would represent a textbook creation of an international tax cartel.

Any such policies, in order even theoretically to yield measurable effects, must be adopted by a number of nations sufficient to represent a significant proportion of world economic output.

Consider the implications of such a tax cartel. A nation enacting a carbon tax unilaterally would have incentive to limit it so as to preserve its own competitiveness in international trade. With an international negotiation, on the other hand, a carbon tax would be much more plausible as a revenue tool, and it is no secret that government officials have powerful incentives to maximize revenues. Accordingly: Would such a cartel adopt a carbon tax that is “efficient” in terms of the (purported) carbon dioxide externality? Or would the negotiated tax be substantially higher? There are good reasons to predict the latter, among which are the short time horizons of public officials and demands by interest groups for ever-more subsidies.

Moreover, the higher the tax, the more powerful the incentives to undermine it through competitive behavior; that is the central problem afflicting any collusive agreement. This means that as the tax rises, more nations—China, India, Brazil, etc.—would have increasing incentives not to participate in order to acquire a competitive advantage, and the market incentive to move productive activity to those economies will rise as well.

Because adoption of a common carbon tax would yield winners and losers, and given the powerful incentives of governments to “harmonize” (collude on) their tax and regulatory policies more generally, negotiation of a uniform carbon tax inexorably would lead to collusion on other taxes as well, at least as a means of compensating the losers. Such “harmonization” is likely to result in the creation of an international body charged with the collection and redistribution of carbon tax revenues, a classic “revenue-sharing” cartel in which nations acting collectively are able to impose taxes higher than those that would be observed if the individual countries had to compete for investment capital and the like. The implications of an internationalization of tax and regulatory policies for economic growth (and for our liberty) are not salutary to say the least.

We are left with two alternative justifications: A carbon tax as a tool with which to reduce the net costs of current environmental policy and/or as a revenue-neutral tax instrument with which to improve the efficiency of the tax system.

Under a reasonable set of assumptions, the current Environmental Protection Agency (EPA) regulation of carbon dioxide emissions is the most costly policy approach; that is why the Obama administration threatened such policies in 2009-2010 as a means of inducing Congress to enact a formal cap and trade system and/or tax. With the failure of Congress to enact such legislation, the EPA has begun to implement that regulatory approach.

As the tax rises, more nations would have increasing incentives not to participate in order to acquire a competitive advantage, and the market incentive to move productive activity to those economies will rise as well.

But the newly emerging enthusiasm for a carbon tax has not been conditioned upon a substitution of the tax in place of the current regulatory approach; instead, the tax is to be additive. After all, even as some conservatives have endorsed a carbon tax, what policy concessions have been offered by the environmental Left? Note that the EPA Utility Maximum Achievable Control Technology (UMACT) rule and the Greenhouse Gases (GHG) rule essentially proscribe new coal-fired power plants—both rules impose limits on carbon dioxide emissions from electricity generation—and in reality will impose limits on gas-fired electric generation as well, as the leftist campaign against hydraulic fracturing (cheap natural gas) suggests strongly. And if a carbon tax is enacted also? That would result in a severe constraint on U.S. economic growth, and empty rhetoric about “clean” energy will provide no amelioration. There is nothing “efficient” about such an outcome.

Nor is a carbon tax in isolation likely to be “efficient” as a revenue instrument, even if imposed as part of a “revenue-neutral” tax reform. If various taxes are viewed as implicit prices for public services, reflecting the differing valuations of taxpayer groups for those services, a carbon tax is efficient only if it serves to improve the correlation between perceived value and tax prices. Relative to income or consumption taxes, there is no persuasive reason to believe that. And if a tax overhaul is not “revenue-neutral”? It is hardly obvious that a carbon tax would improve the efficiency of the tax system, particularly if simply added to the existing array of tax instruments—an outcome that is plausible, at a minimum.

In a larger context, it is impossible to separate politics from economics in the realm of environmental policy. Would the process of democratic policy formulation result in a clean substitution of a purportedly efficient carbon tax in place of the current regulatory regime? The answer is far from obvious. Would a tax result in an increase or a decrease in the accountability of government for the effects of its policies, a crucial component of the “efficiency” concept? There are good reasons to suspect the latter, as the direct effects of a tax would be hidden in prices for goods and inputs. Would the wealth transfers (crudely, from red states to blue) created by climate change policies yield more or less “efficiency” over time? After all, it is at least plausible that the losers will have to be compensated directly or indirectly, which means that a carbon tax might have to be accompanied by other spending (and thus taxation); this is not a desirable outcome for those pursuing policy reform.

Benjamin Zycher is a visiting scholar at the American Enterprise Institute.

FURTHER READING: Zycher also writes “Wind and Solar Power, Part I: Uncooperative Reality,” “Wind and Solar Power, Part II: How Persuasive Are the Rationales?,” and “Wind and Solar Power, Part III: Chasing the Green Tail.” Kenneth P. Green coauthors “Presidential Power: Obama vs. Romney on Energy” with Elizabeth DeMeo and contributes “Dissecting the Carbon Tax.” Mark J. Perry says “Carbon Tax Proposal Will Hobble Our Already Challenged Economy, Stall Growth.”

Image by Dianna Ingram / Bergman Group

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