Economists Mislead on Carbon Tax

We live in strange times indeed when an environmental reporter for the New York Times writes that we should stop pushing for a carbon tax, just a few weeks before dozens of distinguished economists sign a letter to the Wall Street Journal calling for a carbon tax. Yet despite the prestige behind the impressive list of signers, the economists mislead the American public on several key points.

Specifically, there is quite open hostility on the progressive Left to merely a carbon tax—for example as is spelled out in the “Green New Deal” that has attracted so much attention. It is thus very dangerous for these economists to tell the public that a carbon tax would promote economic growth by eliminating unnecessary regulation. Furthermore, there is no discussion of just how severely economic growth would be limited, even if the carbon tax receipts were refunded dollar-for-dollar (which of course they won’t be). The talk about average families receiving more back in dividends than they pay out in higher energy prices is extremely misleading, and could only be true if the scheme fails in its ostensible goal of drastically cutting emissions. Finally, the attempt to maintain American competitiveness with a “border adjustment” would simply ensure that the program was symbolic and did little to slow global carbon dioxide emissions.

No, a Revenue-Neutral Carbon Tax Deal to Replace Regulations Is Not Going to Happen

The letter is composed of five separate principles upon which the distinguished economists agree. Here are two of them:

II.  A carbon tax should increase every year until emissions reductions goals are met and be revenue neutral to avoid debates over the size of government. A consistently rising carbon price will encourage technological innovation and large-scale infrastructure development. It will also accelerate the diffusion of carbon-efficient goods and services.

III. A sufficiently robust and gradually rising carbon tax will replace the need for various carbon regulations that are less efficient. Substituting a price signal for cumbersome regulations will promote economic growth and provide the regulatory certainty companies need for long- term investment in clean-energy alternatives.

Yes, it is certainly true that if the federal government institutes a carbon tax, then it would be better to keep it revenue neutral, and to also scrap the existing regulations on the energy and transportation sectors that are ostensibly in place to limit greenhouse gas emissions.

However, those observations don’t prove that it’s a good idea to go down this route in the first place, or that these “if, then” statements have any practical relevance. It is extremely naïve for these economists—many of whom are quite familiar with the Public Choice school, and are usually quite skeptical of “government solutions” to social problems—to lead the public to believe that either of these outcomes will occur. Does anyone really believe that in this political climate, with a massive federal debt that is projected to grow by more than a trillion dollars next year, that the federal government will install a gigantic new tax and not touch any of the incoming receipts? (Keep in mind, even if the government didn’t engage in any new spending, but instead used just some of the new carbon tax receipts to partially offset the budget deficit, then that would still constitute a net tax increase, and would not be revenue neutral.)

Regarding the regulations, such as the Renewable Fuel Standard (RFS), CAFE mandates requiring ever higher fuel efficiency in our vehicles, and the so-called “Clean Power Plan” which punishes coal-fired power plants: Yes, I agree wholeheartedly that these are absurdly inefficient regulations, even if we stipulate the basic climate change externality framework. But these economists should ask themselves: If these regulations are so inefficient, then why do they exist in the first place? The answer, of course, is that they are there for politicalreasons, not because they passed a legitimate cost-benefit test.

My concerns aren’t merely hypothetical. We have popular progressive outlets like Vox saying for years that a carbon tax won’t be enough, and the draft text calling for a “Green New Deal” is quite explicit that it will take a carbon tax plus regulation and plus massive “green” federal investment programs in order to cope with climate change.

Furthermore, voters in Washington State have twice rejected carbon tax ballot proposals, with the version in 2016 being a carbon-fee-and-rebate plan that was explicitly designed by an environmental economist. In Australia the carbon tax has been a political football. Even in “civilized” Canada, the carbon tax is a very contentious issue, with certain provinces rejecting the idea and the federal government foisting it upon them. Finally, the last time I saw Paris, it was reeling from grassroots opposition to a carbon tax affecting fuel prices.

Indeed, in contrast to the economists in the Wall Street Journal’s claim that “bipartisan support” exists for the carbon tax, here is what Paul Krugman (who is alsoa Nobel laureate) said recently in the New York Times: “[C]laims that a carbon tax high enough to make a meaningful difference would attract significant bipartisan support are a fantasy at best, a fossil-fuel-industry ploy to avoid major action at worst.”

A U.S. Carbon Tax (With Border Adjustments) Will Not Solve the Problem

As usual, proponents of a carbon tax engage in a “shell game” as Oren Cass called it. In this case, the WSJ letter tries to save the planet while sparing U.S. jobs:

IV.  To prevent carbon leakage and to protect U.S. competitiveness, a border carbon adjustment system should be established. This system would enhance the competitiveness of American firms that are more energy-efficient than their global competitors. It would also create an incentive for other nations to adopt similar carbon pricing.

Here’s what’s going on in principle IV, quoted above: If the U.S. government enacts a stiff (and rising) carbon tax on American industry, it will raise the prices of American-made goods. If foreign imports from countries without a carbon tax were allowed in, they would undercut American products. Not only would this hurt American-based firms, but it would perversely shift production to other countries where emissions are higher (per unit of output) than they are in the U.S., even before the implementation of a carbon tax. (This is the problem of “leakage.”)

In order to stop leakage and maintain U.S. competitiveness, therefore, the WSJ letter calls for a border adjustment, where a special tax is added to any imports coming from countries that lack a carbon tax, and where U.S. exports entitle the American producers to a refund, so that they can still compete in the global market without being hobbled by a unilateral U.S. carbon tax.

A border tax adjustment can indeed partially cushion the blow from a U.S. carbon tax, but it does so by limiting its applicability. In particular, U.S. firms are still allowed to produce and sell to foreigners without taking account of the greenhouse gas emissions involved. Furthermore, most (perhaps all) of the economists signing the WSJ letter are fierce critics of President Trump’s moves on international trade. It seems odd then that they would so cheerfully embrace a proposal that would involve massive new taxes to be levied at the border on imports, especially when there could be all sorts of “regulatory arbitrage” in which multinational corporations rearranged their production chains in order to exploit imperfections in the border adjustment rules.

No, American Families Won’t Benefit Financially From Getting Some of Their Money Back

One of the most misleading claims in the WSJ letter is the final plank:

V.  To maximize the fairness and political viability of a rising carbon tax, all the revenue should be returned directly to U.S. citizens through equal lump-sum rebates. The majority of American families, including the most vulnerable, will benefit financially by receiving more in “carbon dividends” than they pay in increased energy prices.

On this one, it’s hard to know where to begin. First, let’s assume for the sake of argument that the WSJ letter is accurately describing the situation. It is telling Americans that only a small segment of the population—“the rich”—have above-average emissions, and so they will be the ones to pay out on net, once we take into account the “carbon dividends” funded by the new tax.

Even on these terms, it is odd to see so many economists—several of whom are considered politically conservative—embrace the claim that a new tax is “fair” if it redistributes hundreds of billions of dollars from a small segment of the population to everybody else. Suppose instead the government levied a one-time surtax of 50% on everybody’s checking account balances, and then sent the money raised in equal lump-sum installments to every citizen. Under that scenario, the “majority of American families” would “benefit financially” too, but how many of these Nobel-winning economists call it fair?

In any event, the claim is extremely misleading. Remember, the whole point of doing this—so we are told—is to drastically cut U.S. emissions of carbon dioxide. If households and businesses completely revamp their operations in order to reduce their carbon footprint, then they won’t be paying taxes on those avoided emissions. The government can’t send out lump-sum checks with money it hasn’t collected.

I have written on this issue before, with different types of examples to explain the situation to the reader. For our purposes here, let me try this approach: Suppose the economy consists of 90 poor people and 10 rich people. Originally, each poor person emits 10 tons of carbon dioxide per year, while each rich person emits 20. The government institutes a stiff new carbon tax of $100 per ton, leading everybody to cut emissions in half.

When the dust settles, each poor person emits 5 tons of CO₂, on which he or she pays 5 x $100 = $500 in annual carbon tax. Similarly, now that the stiff tax is in place, each rich person emits only 10 tons, on which he or she pays 10 x $100 = $1,000. Put the money from the 90 poor people and the 10 rich people into one giant pot, and you have (90 x $500) + (10 x $1,000) = $55,000 in total carbon tax receipts. The government thus mails out lump sum checks of ($55,000 / 100) = $550 to each person in this hypothetical community.

Now in this setting, the rich people are clearly hurt: Each one faces much higher prices on goods and services, and must explicitly pay out $450 in net carbon taxes. (Each rich person pays in $1,000 and gets a rebate of $550). The poor people, on the other hand, might seem to be ahead: Each one only explicitly paid out $500 in carbon taxes, while receiving a lump-sum rebate of $550. What’s happening is that the explicit losses of $450 per rich person adds up to $4,500 (because there are ten total rich people in this example), which is then used to send a net $50 to each of the 90 poor people. Because there are more poor people than rich people, the explicit losses of the rich group are spread out and diluted when they’re redistributed among the whole society.

However, simply following the dollars around is not the full pain caused by our hypothetical carbon tax. Everybody suffers from a lower standard of living. For example, with a $100 per ton carbon tax, according to this online calculator, gasoline prices rise 44 percent, natural gas prices rise 124 percent, and home heating fuel rises 56 percent. And if we consider coal prices, they would rise a whopping 660 percent—which would of course completely knock out coal as a viable energy source, even though it currently provides almost 30 percent of U.S. electricity.

And these obvious jumps in fuel prices (which are calculated based on the chemistry of their carbon content) would spill over into everything you buy. Imagine how much more it will cost to have goods shipped via Amazon, or how much more fruit in the store would cost, when gas and diesel prices rise so much.

This is the way to think about the much-ballyhooed “dividends” that our WSJ letter writers are promising to American households. Right now, would you, the reader, agree to a deal that raised prices by the percentages I outlined above, even if you got an extra annual check for $550 to help compensate you? In this framework, would the extra $50 per year you’re effectively skimming off the rich guy down the street really make you whole?

To repeat, part of what’s going on in the numerical example is that the stiff carbon tax is causing people to reduce their use of carbon-intensive goods and services. To the extent that it is successful, a carbon tax causes people to avoid paying the carbon tax. When economists discuss the society-wide burden or compliance cost of a tax, the issue is not the flow of dollars into the Treasury, but rather it comes from changing patterns of behavior that are less efficient than the status quo.

Now of course, the economists who signed the Wall Street Journalletter would reply that these large economic compliance costs would be more than matched by the environmental benefits of reduced emissions. But if they want to tell Americans that the carbon tax will reduce their material lifestyle, in exchange for less climate change, then they should do so openly.

Before leaving this section, let me try one last attempt to get the reader to see the sleight-of-hand that these economists are pulling here. Suppose that President Trump had his protectionist economic adviser, Peter Navarro (who has a PhD in economics from Harvard, by the way), announce a new tariff of 100% on all Chinese imports, but that the proceeds from this new tax would be sent lump-sum to every American citizen. Would the economists who signed the WSJ letter then agree that “most American families” would benefit financially from the tariff? I mean after all, rich people tend to spend more dollars (in absolute terms) on imported goods than poor people do, so the statement would be correct. And yet, of course none of the WSJ letter signers would endorse such a plan. They would (rightly) warn Americans that such a large tariff would disrupt production decisions and lower just about everybody’s standard of living. The fact that these economists are adopting a completely novel talking point to sell a carbon tax should make Americans quite suspicious.

Conclusion

Dozens of heavy-hitting economists have sent a letter to the WSJ, praising a bipartisan revenue-neutral carbon tax that halts climate change, eliminates inefficient government regulations, and makes most families richer. It would be more fitting for Nobel laureates in literature to pen such a plea, because it’s based entirely in fiction.

As many of these same economists recognize in their other work, there are institutional reasons that government wastes money and produces counterproductive regulations. The only way the “border adjustments” and rebate checks will actually limit the economic fallout from a new carbon tax, is if the scheme fails in its ostensible purpose of sharply curtailing emissions. The simple fact is that rapidly reducing U.S. emissions through a massive new tax is going to have huge economic consequences. If some economists think that this cost is worth it, they should make the case plainly to the public and policymakers, rather than engaging in misleading talk about dividend checks.

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