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February 2, 2011

Blinder Understates the Cost of a Carbon Tax

February 2, 2011
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Alan Blinder, Professor of Economics at Princeton University

In a recent article (“The Carbon Tax Miracle Cure,” Jan. 31) Alan Blinder listed numerous alleged benefits of a phased-in carbon tax. His main argument is that it would stimulate job creation in new technologies and techniques. Out of his entire column, he devoted a single sentence to the possible downside of his plan when he wrote, “No one likes to pay higher taxes.” A more balanced assessment shows that a carbon tax presents very real dangers, even if we rely on the same economic analysis that so enthralled Blinder.

To see the fallacy in Blinder’s argument for job creation, consider his list of the “few nice side effects” that would result from a carbon tax: “reducing our trade deficit, making our economy more efficient, ameliorating global warming…” Since he puts global warming at third in the list, we see that the so-called negative externalities of carbon emissions aren’t playing a role in his main argument.

No, Blinder is making the simple observation that if the government imposes artificial costs on the current way businesses operate, then the market will respond to the new handicap and end up generating new products and techniques along the way.

This analysis is true, as far it goes. But the same could be said for any new government policy that made it illegal for businesses to continue operating in the ways that they currently find the most efficient. For example, if the government promised to impose stiff taxes on nails and screws over the next few decades, that would certainly cause entrepreneurs to see “lucrative opportunities” in developing do-it-yourself furniture that used only wooden pegs and glue. But obviously consumers would be worse off because of the less convenient and/or more expensive products.

This is basic economics: you don’t make the country richer by taxing it, or by taking options away from industry. If investors pour money into carbon-reducing technologies under the threat of a future carbon tax, there is correspondingly less investment available for other technologies.

Advocates of a carbon tax claim that there is a special reason to penalize carbon emissions, as opposed to nails and screws. They argue that because emissions of carbon dioxide (and other greenhouse gases) may eventually lead to significant damages from climate change, entrepreneurs currently are not taking all of the costs of their actions into account.

Even if we concede this framing of the issue, it still does not follow that economists should favor a new carbon tax. Ironically, we can use the same researcher—William Nordhaus—upon whom Blinder based his own case.

It is true that Nordhaus himself favors a carbon tax. In the 2007 calibration of his “DICE” model of the global economy and climate system, Nordhaus estimated that the theoretically optimal carbon tax regime would reduce (the present value of) climate damages by about $5 trillion, at the cost of about $2 trillion in lost economic output. This is why Nordhaus favors such a policy—its theoretical benefits exceed the costs by up to $3 trillion.

However, this figure assumes all governments around the world implement the tax. If some governments cheat, then the alleged benefits shrink, as some of the emissions simply migrate from the high-tax to the low-tax areas.

Nordhaus’ calculation also assumes that governments implement the economically optimal carbon tax. If the tax is set too high, however, Nordhaus’ results demonstrate that the cure can be much worse than the disease. For example, when Nordhaus simulated the impact of limiting atmospheric concentrations of CO2 to 1.5 times their preindustrial level, he found that it would make the world more than $14 trillion poorer than if governments did absolutely nothing to regulate emissions. This is because the simulated $13 trillion in benefits from avoided climate damage were swamped by $27 trillion in reduced economic output.[i]

The proponents of a carbon tax (or cap-and-trade) continuously point out that there is a “consensus” on the natural science linking human activity to rising global temperatures. But the economic arguments, needed to show that the benefits of a carbon tax outweigh its costs, are far less conclusive.

For example, in the spring of 2009, Richard Tol published a survey of comprehensive studies of the global “welfare impacts” of climate change.[ii] These impacts included not just direct economic harms, but also tried to value (in dollar terms) intangibles such as human health and mortality. Of the thirteen studies Tol surveyed, the best-guess estimate of global GDP impacts ranged from a loss of 4.8 percent to a gain of 2.5 percent. Most of these impacts were calibrated for temperature increases of 2.5 to 3.0 degrees Celsius, which are not expected to occur until the second half of the 21st century. (Currently the globe is about 0.8 degrees Celsius warmer than the preindustrial benchmark.)

Tol found that of the eleven studies that had been published since the year 1995, the worst estimate was a global GDP loss of 1.9 percent. To put that number in context, in a 2009 report the Congressional Budget Office estimated that an 83 percent cut in emissions—the long-run cap proposed under the Kerry-Boxer bill—would reduce U.S. GDP in 2050 from 1.1 to 3.4 percent.[iii]

To repeat, the damages in Tol’s survey were calibrated for a particular range of temperature increases, and in reality it’s always possible that global warming could be worse by, say, 2085. Yet using reasonable projections of what is likely to occur, the economic case for a carbon tax is not nearly the slam dunk that Blinder implied in his article.

Blinder is right that this country could use a burst of entrepreneurship and investment. But there are much more productive policies to stimulate investment, than to threaten tax hikes on affordable energy.



[i] See Table 5-1 on page 82 here: http://nordhaus.econ.yale.edu/Balance_2nd_proofs.pdf .

[ii] Tol’s paper is not available for free, but it is summarized by Jerry Taylor here: http://www.masterresource.org/2009/11/the-economics-of-climate-change-essential-knowledge/

[iii] See Table 1 on page 13: http://www.cbo.gov/ftpdocs/105xx/doc10573/09-17-Greenhouse-Gas.pdf


View Comments
  • Anonymous

    Dear Mr Blinder: Please take Your blinders off, sorry just couldn’t resist, to get serious about Climate change lets start by making the new Power Plants first before We take Coal Plants off line! We could collect all the Emissions from Coal Plants and put them in under ground storage, then take by rail tanker cars to Utah, Colorado, and Wyoming to pump out of the ground the 2 Trillion barrels of Shale Oil! Then We could build Methane Power Plants on top of Land fills to burn up all the stinky Methane leaking out of the ground. Next We can grow Algae for Fuel instead of Ethanol, if You do the math on how many gallons per acre each one makes it’s simple logic, Algae makes 10,000 gal. per acre, Ethanol 250 gal. per acre, no contest! This Carbon Tax will necessarily sky rocket all Americans utility bills, does this sound familiar hmmn, spoken by Barack Husein Obama during the 2008 Election! I hope You guys don’t think You can pull the wool over Our eyes on this, because Your sadly mistaken! Restart Off Shore drilling now not 10 years from now, lets also build 21st Century Nuclear Power Plants that only take a couple of years to come on line, the last Nuke Plant built was in Byron IL. in 1981, I know this cause I walked hru it right before it went online.

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