Economist David R. Henderson Changes His Mind on Carbon Tax

David R. Henderson is a research fellow with the Hoover Institution and was a professor at the Naval Postgraduate School in Monterey, California who taught courses on energy economics. He originally endorsed the standard view among economists that if some physical scientists are right that greenhouse gas emissions will lead to substantial warming, and if the government must “do something,” then the best policy response is a tax on carbon.

However, as Henderson explains in a recent article, he has since changed his mind, and no longer thinks a carbon tax is “a slam dunk.” Even if we stipulate the basic framework of the “market failure” argument, it’s not at all clear that academics and policy wonks should be agitating for a carbon tax. There might be much better solutions available, rather than having the government penalize carbon dioxide emissions.

In the present post I’ll review Henderson’s reasons for his change, and I’ll also address some of the objections that his critics raised against his essay.

Henderson on the Phrase “Price on Carbon”

Before diving into his more substantive points, let me relay Henderson’s discussion of the odd phrase “price on carbon” which you frequently hear in these debates:

Let’s first dispose of…the idea that taxing carbon is the same thing as “pricing carbon.” Carbon is already priced. Natural gas, oil, and coal all have prices and their prices are somewhat related to the amount of carbon they contain. To be sure, adding a tax to carbon would raise the prices of all those fuels, just as adding a tax to alcohol would make your tipple more expensive. But just as setting a tax on alcohol does not “price alcohol,” setting a tax on carbon does not “price carbon.” In my more cynical moments, I wonder if advocates of a carbon tax sometimes call such a tax a price to mislead people into thinking that a carbon tax is a market solution rather than a tax solution.  [Bold added.]

Henderson here hits the nail on the head. Besides just being wrong, to equate a carbon tax with a “price on carbon” would sound ludicrous in the context of any other tax.

Henderson Changes His Mind on a Carbon Tax

After summarizing the textbook case for using a Pigovian (named after A.C. Pigou) tax as the least-cost, decentralized way to correct the “negative externality” of human carbon dioxide emissions—an approach that is endorsed by even conservative/libertarian Republican economists such as Greg Mankiw, George Shultz, and John Cochrane—Henderson explains why he now has serious doubts:

[E]conomists who advocate Pigovian taxes take as given that the most-efficient way to forestall global warming is to reduce the amount of carbon used. But what if their assumption is incorrect?

There are at least three important reasons to conclude that the assumption is wrong. First, cow farts…A far more potent greenhouse gas than carbon dioxide is methane. Methane…warms the planet much more quickly than carbon dioxide before decaying to carbon dioxide…To be sure, the CO₂ lasts much, much longer than methane, but the fact of methane’s huge short-run potency surely suggests that a tax on carbon may not be the cheapest way to forestall global warming.

Second, one important technological development over the last decade has been “geo-engineering.” The idea here is to change other things in the atmosphere that are easier to change than the amount of carbon used…

Is such a technology feasible right now? Maybe not. But if it were, it would be incredibly cheap. Myhrvold’s organization, Intellectual Ventures, estimated that it could be set up in two years for $20 million and an annual operating cost of about $10 million.

…The third low-cost way to rein in global warming is by planting trees. Trees absorb and store CO₂ emissions. You could call the tree-planting strategy geo-engineering, but it would count as such in a very low-tech form. According to a July 4, 2019 article in The Guardian, planting one trillion trees would be much cheaper than a carbon tax and much more effective. At an estimated cost of 30 cents per additional tree, the overall cost would be $300 billion. That’s large, but it’s a one-time cost. [Bold added.]

To summarize, the specific change in Henderson’s thinking is that he has come to realize that even if we thought the government should “do something” about climate change, it’s not obvious that the correct policy is to induce businesses and households to reduce their carbon dioxide emissions. That mentality is usually taken for granted in the Pigovian framing of the climate change debate, but—as Henderson explains—there are several reasons he now thinks that perhaps this assumption is itself wrong. To repeat, even if one stipulates (if only for the sake of argument) that the government should do something to avert the climate change that human activity will cause (if left unchecked), there might be more sensible policies than to tackle carbon dioxide emissions directly.

I have written on some of these themes here at IER, for example when I explained geo-engineering options to college students who wanted humanity to “do something” about the threat of climate change, and when I recently used the new tree-planting study to illustrate Ronald Coase’s famous critique of the entire Pigovian tax framework for fixing ostensible “market failures.” Note too that a huge advantage of planting trees is that they are a “geo-engineering” approach that has few of the downsides of more radical proposals; it would be hard for critics to object that planting trees will hurt the environment in some other, perhaps unpredictable, way.

To help make sense of Henderson’s point about methane, here is a quick chemistry refresher: Carbon dioxide (CO₂) is a molecule consisting of one carbon atom and two oxygen atoms, while a molecule of methane (CH₄) consists of one carbon atom and four hydrogen atoms. Standard estimates conclude that a ton of methane is eighty-four times as potent in “global warming potential” as a ton of carbon dioxide over a 20-year horizon, and that perhaps one-fourth of humanity’s contribution to global warming to date has come from methane emissions.

Rather than restate the arguments that Henderson and I have made, it might illuminate the issues better if I now tackle two of the particular objections that critics raised in the comments section of the popular blog EconLog where Henderson posted his article.

Objection #1: “Tax Carbon Dioxide or Methane: Why Not Both?”

Several critics objected to Henderson’s claim that methane’s global warming potential showed the limits of a tax on carbon dioxide. If methane contributes more to global warming (per ton) than carbon dioxide, said the critics, then let’s slap a big fat tax on methane emissions too. After all, when it comes to saving the planet, why would we let Big Cattle off the hook?

Yet these critics are falling into a familiar trap in the climate change policy debate: they are assuming that political solutions are costless to implement. But in reality, look at how much of mankind’s attention has been devoted to the issue of “taxing carbon” during the last twenty years.

Suppose a “carbon tax” were rammed through, with much gnashing of teeth, and then the technocratic economists had to inform everybody, “Hey folks, even though this was just sold to you as the market solution to climate change, this by itself won’t cut it, since technically it applies only to carbon dioxide from certain large, specified emitters. We need a methane tax too.” That would entail another long process (taking years?) of political fights, with farmers staging protests (this actually happened in 2003 in New Zealand as backlash against a proposed “fart tax”), and the CEOs of veggie burger companies suddenly becoming very concerned about the environment.

When economists and other policy wonks talk about carbon taxes at a theoretical level, they usually are using it as shorthand for carbon dioxide and then add as an afterthought, “Oh and we should include other greenhouse gases too based on their CO₂-equivalent.” But in practice, real-world carbon taxes often don’t explicitly include methane and other greenhouse gases.

For example, British Columbia in 2008 enacted what is considered the textbook example of a carbon tax done right (because of its ostensible 100% refund to taxpayers), and yet famous climate academic and activist David Suzuki ten years later was urging the B.C. government to apply their carbon tax to methane emissions.

This is a serious issue and shows the limits of political “solutions.” If an administration tried to use tax legislation that was explicitly designed to apply to carbon dioxide content, and then broaden it to include methane emissions, that would be a clear overstep of authority. Lawyers for farmers and natural gas companies (which release methane through leaks) would be able to tie up enforcement of such a tax move in the courts, arguing quite correctly that it was a violation of chemistry to apply a tax or fee on “carbon dioxide” to methane emissions.

An interesting example of the problem is Washington State’s (failed) 2018 carbon tax ballot Initiative 1631. An explanatory statement from the Washington State 2018 Voters’ Guide says:

The fee charged would be based on the amount of carbon content in the fossil fuels. In the case of electricity, the fee would be based on the carbon content of the fossil fuels used to generate the electricity. “Carbon content” means the carbon dioxide equivalent released from burning or oxidation of fossil fuels. Carbon dioxide equivalent is a measure used to compare emissions from various greenhouse gases based on their global warming potential. So the carbon content of a fossil fuel is a measure of the carbon dioxide and other greenhouse gases that are released when the fossil fuel is burned or otherwise consumed. For purposes of calculating the fee, the Department of Ecology is responsible for determining the carbon content of fossil fuels or inherent in electricity. [Bold added.]

So this seems to be exactly what the (Pigovian) doctor ordered, right? The “carbon fee” would be assessed according to the global warming potential of the greenhouse gas in question.

Ah but wait, even this bill (which, we recall, failed at the ballot box) wouldn’t have handled Henderson’s concerns, because it applies only to fossil fuel emissions. So even if the government could plausibly argue that methane leaks (which are not really the same as the methane contained in the use of natural gas per se to generate electricity) should be included when assessing the carbon tax, there’s no way Washington State could argue that the voters had cow farts in mind, had they approved this ballot measure. Since about a third of human methane emissions come from agriculture, that’s an important omission.

I don’t want to put words in his mouth, but I think what Henderson is driving at here is that the huge push to “tax carbon” when in practice it means “taxing carbon dioxide” or at best “taxing the carbon content of activities involving fossil fuels” isn’t really tackling the problem correctly. To see that this is a serious concern, here are the opening paragraphs of an FT article from May:

Scientists have sounded the alarm after levels of methane in the atmosphere reached a record high, a development that could cause an unexpected acceleration in global warming and put the world further off course from the goals of the Paris climate deal.

New data from the National Oceanic and Atmospheric Administration of the US showed that concentrations of atmospheric methane surged last year and accounted for about a sixth of the atmosphere’s capacity to trap heat.

“Methane’s unexpected rise is a major challenge to the Paris agreement — and we don’t know why it’s happening,” said Euan Nisbet, earth sciences professor at Royal Holloway University of London. [Bold added.]

If climate activists genuinely believe that the fate of humanity is at stake, it is surprising how much faith they put in political solutions. Currently, even if all nations (including the United States) met their Paris pledges, the standard models project that the Earth would still experience 3 degrees Celsius of warming, blowing way past the 2°C (let alone the more radical 1.5°C) ceiling set by the Paris Agreement.

Especially in light of the backlash against carbon taxes in Australia, France, and even Canada, other economists should consider Henderson’s change of heart on the wisdom (or lack thereof) in embracing a government tax as a solution to the potential problems of climate change.

Objection #2: “So Let’s Subsidize Trees and Tax Carbon!”

Another objection critics raised against Henderson’s essay is that his observation about trees, they claimed, could easily be incorporated into the standard Pigovian framework. If planting trees were an effective way to confer massive social benefits on humanity, then the government ought to subsidize the activity. Why, we could even use the proceeds of a carbon tax to fund the operation!

There are several problems here. First, even if we agreed that government (as opposed to private) payments for tree-planting made sense, it doesn’t at all follow that the revenue should come from a carbon tax. In general, raising a dollar of revenue from a tax on carbon content hurts the economy more than raising a dollar from taxing labor or consumption. (My article on the “tax interaction effect” gives the economic intuition behind this point.) So if the government needs to raise $x billion in order to pay people to plant enough trees to strike a blow against harmful climate change, then there’s no reason to raise that $x billion through a carbon tax. It would be less harmful to the economy to raise that revenue using taxes that fall on a broader base, so that they caused fewer distortions to economic decisions.

Second, the current estimates of the “social cost of carbon,” upon which the dollar amount of carbon taxes is calibrated, would fly out the window if people began a massive tree-planting campaign (or other type of geo-engineering program). If we took the standard computer models and plugged in a scenario where humans plant enough trees (and/or engage in other geo-engineering techniques) to bring the atmospheric concentration of greenhouse gases back to 1980 levels by the year 2080, say, then in the context of that baseline the additional emission of a ton of CO₂ today would have a negligible impact on human welfare.

In other words, if a massive tree-planting campaign or other geo-engineering program worked out the way Henderson hopes, then in the new equilibrium when everybody reacted to the new scenario, the computed “social cost of carbon” would be close to $0/ton. And so at that point, if we had a bunch of statutory carbon taxes on the books penalizing emissions at the rate of (say) $30/ton or higher, that would be totally unjustified and would be causing massive amounts of economic damage for no environmental benefit at all.

Now it’s true, a sophisticated defender of carbon taxes could acknowledge the above reasoning, and nonetheless argue that governments would matter-of-factly revise their carbon tax magnitudes downward in light of the new data, as the proliferation of tree-planting programs (for example) reduced the estimates of the social cost of carbon. Yet this attitude displays the height of naïveté. Once a carbon tax is installed, it will be political forces—from government officials wanting more revenue to spend, to motorists and businesses wanting a lower tax burden—that control its level or repeal. Anybody who thinks climate scientists will control the dial on a carbon tax should ask a bunch of public finance economists what they think of the efficiency of the current tax code.

Conclusion

Economist David R. Henderson used to believe that if the government were going to “do something” about climate change, then a carbon tax seemed to be the obvious policy tool to use. Yet now he has had serious doubts. This isn’t because he’s a “science denier” but rather because he’s thought through some of the limitations of the Pigovian tax framework for dealing with alleged negative externalities. Especially for activists who genuinely believe the world faces catastrophe, they should give serious consideration to Henderson’s reasons for thinking a carbon tax might be a false “solution” to climate change after all.

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