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December 3, 2012

Grist Confirms IER Warnings on Carbon Tax Swap Deal

December 3, 2012
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The Institute for Energy Research (IER) recently released my study on the dangers of a carbon “tax swap” deal. This is the idea, championed even by many conservatives, that a new carbon tax might be economically efficient so long as it is coupled with reductions in other taxes. In my study, I pointed out numerous theoretical and practical flaws with such a naïve recommendation. It’s refreshing to see that a recent Grist blog post confirms my warnings.

The writer, David Roberts, shows that the climate interventionists are not going to be satisfied with an “optimal” carbon tax. Conservatives who think a new carbon tax would end up promoting laissez-faire are fooling themselves; they need to read what the interventionists on the left are actually writing.

Roberts opens his article by admitting “I do not regard [a carbon tax] with the same reverence as many economists and climate hawks,” and declares, “Those who support a carbon tax over cap-and-trade often tout its simplicity, but the fact is, there are plenty of ways to screw up a climate tax too.” Roberts then lists ten reasons for hesitance to embrace a carbon tax. The list is instructive, because it underscores one of the major themes in my own study, albeit from the opposite direction: The climate activists on the left who are championing federal interventions to mitigate climate change will not be satisfied with a theoretically “optimal” carbon tax devised by economists. Therefore, the conservatives who are pushing a carbon tax / income tax cut deal are being hopelessly optimistic when they argue that this would eliminate the need for inefficient top-down regulations, and that it would actually promote economic growth. To see just how naïve this conservative viewpoint is, let’s run through some of Roberts’ reasons for his lack of enthusiasm about a new carbon tax:

1. It’s conservative.

There’s a reason so many conservative (and neoliberal) economists support carbon taxes: They fit comfortably in a worldview that says problems are most effectively solved by markets, with minimal government intervention.

The problems with this worldview are too many to list here, much less to litigate. Economists James Galbraith and Dean Baker argue that free markets are a myth; all markets everywhere are already designed, shaped, and regulated, usually to the benefit of the wealthy. Economist Dani Rodrick argues that industrial policy — “picking winners and losers” — is ubiquitous, a feature of all advanced economies, whether acknowledged or not. Sociologist Fred Block argues that virtually every industrial success story (e.g., fracking) can be traced to government-supported innovation.

…The notion that a problem like climate change, with its century-spanning effects and potentially existential risks, will be solved exclusively or even primarily with “market mechanisms” is a religious doctrine, not a realistic appraisal.

Does it sound like Roberts—who presumably speaks for many environmental activists on the left—is going to endorse a repeal of CAFE standards, renewable portfolio standards, restrictions on drilling on federal lands, and so forth, once a carbon tax is instituted that ostensibly leads firms to “internalize the externality” and restore harmony to the free market? Of course not. All of those regulations will still be applauded by the very people who currently applaud them.

3. “Revenue-neutral” means foregoing any money for climate solutions.

A “revenue neutral” carbon tax is one in which all of the revenue raised is returned automatically to taxpayers. Most of the carbon tax proposals floating around today are revenue neutral, mainly, as far as I can tell, because conservatives demand it. (Conservatives don’t trust government with revenue.) There are three ways to achieve revenue neutrality, which I will list from most to least desirable:

  • dividend system (supported by James Hansen, Bill McKibben, and lots of other greenies) would distribute the carbon revenue to citizens on a flat per-capita basis…
  • A similarly progressive option is to use carbon revenue to reduce payroll taxes, which are paid by around 80 to 90 percent of Americans.
  • regressive option is to use carbon revenue to reduce income taxes, which are paid by between 50 and 60 percent of Americans and are the main source of progressivity in the U.S. tax system (wealthier people pay a higher rate). Replacing a progressive tax with a regressive tax would redistribute wealth upward.

Here Roberts echoes a point that I made explicitly in my own study: Conservatives who think a new carbon tax would have its revenues devoted one-to-one to reducing personal income taxes—let alone corporate income taxes—aren’t seriously thinking through the politics of the situation. What liberal Democrat could possibly vote for legislation that would truly raise the burden on the poor and middle class (through higher energy prices) in exchange for “trillions of dollars in tax cuts for the rich”?

Roberts later on makes another point that I specifically warned about in my study:

6. Carbon tax revenue is supposed to decline.

Remember, the goal of a carbon tax is to decarbonize the economy. As carbon declines, carbon tax revenues will decline, unless the tax is almost continuously ramped up….

But what if carbon taxes have replaced payroll taxes, which fund Social Security? As revenue declines, so will funding for Social Security. Not good. Or what if carbon taxes have replaced income taxes? As revenue declines, individual tax burdens will decline, which will delight conservatives, but should be a source of concern for liberals in favor of active government. The fact that a carbon tax is intended to phase itself out over time cannot have escaped the attention of its conservative supporters.

Roberts is correct to point out that any carbon tax swap deal will break down almost immediately, because of the nature of a carbon tax (which presumably should have the rate reflect the “social cost of carbon”) versus the nature of other taxes, for example payroll taxes that are supposed to reflect the actuarial realities of Social Security and Medicare. Even if, against all odds, there were a “revenue-neutral” deal initially, after a few years it would be hard to even define what the “deal” would entail. Roberts thinks the new deal would leave the government short of cash, whereas I think the deal would mysteriously end up giving the government vast rivers of new revenues.

On the last point, Roberts and I not only agree on the specifics, but also on the overall spirit:

10. All political incentives push toward a poorly designed tax.

It’s true that a carbon tax can be well-designed. For economists, that means using the revenue to reduce distortionary taxes. For clean-energy hawks, it means using the revenue to spark cleantech growth.…

The worst possible thing to do from both perspectives would be to set the tax at a static, low level and use a bunch of the revenue to carve out special deals for various industries. Then you’d get the economic hit from the tax and malign distributional issues.

And yet … that is exactly where all the incentives point.

I couldn’t agree more. When free-market economists tell me how wonderful it would be if the government eliminated top-down climate regulations, and reduced onerous income taxes with a broad-based and textbook optimal carbon tax, it is almost a waste of time to argue such a case on the theoretical merits. (Don’t get me wrong—I do list several theoretical problems with these types of proposals in my study.) The reason such a discussion is pointless is that we aren’t going to get the “optimal” tax reform as designed on the blackboard by economists who are concerned about climate change but understand the problems with inefficient taxes. Recall how large the cap-and-trade legislation swelled, the longer it gestated inside the political process. It is the height of naïvete to think a carbon tax that survived the political process and became law, would look anything like the “efficient” reforms put forth by conservative wonks.

Although he comes at the issue from the opposite side, Grist writer David Roberts ironically confirms many of my study’s warnings to conservative supporters of a carbon tax. There would be many consequences of a new carbon tax, but “pro-growth” reform is not one of them.

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