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November 15, 2012

AEI Conference Confirms Dangers of Carbon Tax Swap Deal

November 15, 2012
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Earlier this week there were two contributions to the ongoing debate over a carbon tax and the so-called fiscal cliff. The first was IER’s Tuesday release of my new study outlining the dangers of a carbon tax swap deal. Later that same day, the American Enterprise Institute (AEI) held a conference favorably discussing various issues relating to the implementation of a carbon tax. As the reports following the conference indicate, the participants unwittingly proved my warnings to be accurate.

For those with enough free time, I encourage you to watch the video (hosted at AEI’s site linked above) of the fourth session of the conference, entitled, “Compensation and use of revenues.” The participants were Terry Dinan of the Congressional Budget Office, Donald Marron of the Urban Institute and Urban-Brookings Tax Policy Center, and Richard Morgenstern of Resources for the Future.

For those who don’t have the time, let me summarize two of the major issues that came up during the panel discussion. Terry Dinan explained early in her remarks:

A carbon tax tends to impose a disproportionate burden on low-income households. But, a carbon tax would raise a lot of revenue, and policymakers would have the option of more than offsetting that cost to low-income households if they wished to do so. So what [Dinan’s] paper does is compare several different options for using the revenue to compensate the households… There are often tradeoffs between [compensation] policies. Policies that are best at compensating low-income households typically don’t perform as well in terms of providing a “fiscal dividend.”

Here Ms. Dinan is confirming one of the main points I made in my own study—that carbon taxes harm low-income households. Recall the context: Some conservative academics and policymakers have expressed support for a carbon tax, so long as the revenues are used to provide supply-side (pro-growth) tax cuts elsewhere. Yet I pointed out that it was politically naïve to assume that we would actually get a “revenue-neutral” carbon tax, because this would imply a far more regressive structure.

Think of it this way: Imposing a carbon tax will ultimately raise prices of most goods and services, but in particular it will increase necessities like electricity, natural gas, and gasoline prices. Such price hikes will hit poorer household more heavily than middle- or upper-income households. At the same time, these are the very households who don’t typically have a large federal income tax liability. Therefore, the most “pro-growth” option available—where 100% of the carbon tax receipts are used to offset personal or corporate income tax rates across the board—would mean that the rich receive tax cuts while the poor pay higher energy prices. Does anyone seriously believe the Obama Administration will sign off on such a deal?

Richard Morgenstern, the third panelist, gave a talk (starting around 35:00 on the video) on energy-intensive trade-exposed industries (EITEs). He acknowledged that his presentation was the mirror-image of Terry Dinan’s first presentation: She had talked about ways of compensating poorer households for the impacts of the carbon tax on them, while he (Morgenstern) would be talking about ways of compensating particular industries that would suffer greatly from a carbon tax.

One of the major issues in Morgenstern’s talk was the problem of leakage, in which carbon emissions simply migrate from a high-tax jurisdiction to a low-tax jurisdiction. He said that models showed leakage rates ranged from 5 to 20 percent, with the higher range occurring when single nations unilaterally imposed a carbon tax as opposed to many nations acting in concert. Morgenstern went on to explain the various means by which the U.S. government could try to limit this outcome, which partially defeats the purpose of a carbon tax by punishing U.S. industry while achieving little environmental gain.

This too was an issue of which I warned in my study, where I quoted William Nordhaus’ respected modeling results showing that if only half of the world’s governments (measured by emissions) enact a carbon tax, then the economic costs of achieving a given environmental benefit increase by a whopping 250 percent. I warned that academics who had studied a California state-wide cap on greenhouse gas emissions had shown that further regulations banning the importation of out-of-state electricity could be used to mitigate the problem of leakage.

I drew the lesson that conservatives who support a carbon tax, thinking it is an efficient way to achieve a “market solution” to climate change, are fooling themselves. If a carbon tax were introduced by the US government, academics would soon point out all of the genuine problems of implementation, and demand top-down mandates and other regulations to “solve” the problems.

In conclusion, the AEI conference confirmed the very warnings I had issued in my own paper. The scholars who presented at AEI were quite knowledgeable and were familiar with the ins and outs of tax policy and the economics of climate change. Anyone who thinks a new carbon tax will be used to reduce corporate or personal income tax rates dollar-for-dollar should watch the video of the AEI conference (particularly Session IV) to disabuse himself of that pipe dream.

 


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