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November 13, 2012

IER STUDY: Carbon Tax Scheme Plagued By Theoretical, Practical Problems

November 13, 2012
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More Political Cronyism for Favored ‘Clean Energy’ Sectors, Reduced U.S. Competitiveness in Global Energy Markets May Result from Inefficient Tax Scheme

WASHINGTON D.C. – The Institute for Energy Research released today a new study exposing the fallacies of so-called revenue-neutral carbon tax swaps, an idea that has gained some support among even conservative pundits and politicians despite numerous theoretical and practical problems with the scheme. IER Senior Economist Robert P. Murphy reveals in the study, entitled “Carbon ‘Tax Swap’ Deals: A Review and Critique,” that pro-carbon tax discussions currently underway inside Washington may offer a ‘cure worse than the disease,’ robbing global economies of growth potential and disproportionately affecting the world’s poor.

“In recent years, more and more self-described conservatives, who generally embrace the free market and are suspicious of taxation and government regulation of business, have come out in favor of a carbon tax,” Murphy writes. “Some of today’s conservatives, such as [former Secretary of State] George Shultz, support a carbon tax swap because of national security concerns . . . [while] others – most notably the famous supply-side economist Arthur Laffer – remain officially agnostic on the dangers inherent in anthropogenic global warming.”

“Conservative proponents of the free market, of all analysts, should be wary indeed of any plan to introduce a new carbon tax in the name of promoting economic growth,” Murphy argues. “The dismal record of the U.S. government in implementing efficient climate change policies is hardly evidence in favor of a massive new carbon tax (or cap-and-trade program). On the contrary, it is evidence that such a new program will be abused in the political process, and will not be tailored to the recommendations of climate scientists and environmental economists.”

“Such abuse could take the form of exempting favored constituencies from the scheme, setting the carbon tax rate in line with fiscal needs rather than climate objectives, and/or using carbon tax receipts to fund inefficient yet politically powerful groups, such as producers in ‘clean energy’ sectors who, in principle, should not need federal support in the presence of a well-designed carbon tax.”

Murphy’s analysis offers numerous technical and practical flaws to the conservative case for a revenue-neutral carbon tax swap. Among these are:

  • The best literature on the topic actually argues that a revenue-neutral carbon tax swap would make the tax code more inefficient and would hinder economic growth.  Some estimates suggest that this ‘tax interaction effect’ is so powerful that the theoretical size of a new carbon tax should be cut almost in half, once extra damage to the economy is taken into account.
  • The U.S. Government acting unilaterally cannot significantly slow global carbon dioxide emissions. One respected estimate suggests that if only half of the world’s governments implement the ‘optimal carbon tax,’ then the economic cost of achieving a desired environmental objective will increase by 250 percent.
  • Federal and state governments already have in place many policies that discourage carbon-intensive activities and encourage alternatives, such as gasoline taxes, CAFE standards, and renewable energy mandates. These weaken even the theoretical case for a carbon tax, though advocates rarely include this consideration in their proposals.
  • The promise of ‘revenue neutrality’ is quite hollow, given U.S. history. The federal income tax rate was instituted with a top tax rate of 7 percent in 1913, which was jacked up to 77 percent by 1918. Currently, there are numerous academic and political proposals that want to use carbon tax revenues to fund new programs and ‘reduce the deficit,’ leaving less available for tax relief and meaning the carbon tax would be a net tax increase on Americans. 
  • Any deal using a new carbon tax to offset existing payroll taxes would surely break down quickly, because the two taxes have specific and incompatible purposes.  The textbook theory of a carbon tax argues that it should reflect the social cost of carbon, rising steadily over time with atmospheric concentrations of greenhouse gases. In contrast, to fulfill its own purposes, the payroll tax should reflect the changing demographics of Social Security and other social insurance programs. Whatever relationship initially existed between a new carbon tax and the correspondingly reduced payroll tax would soon break down as these underlying factors evolved.

To read the full study, click here.

ABOUT THE AUTHOR

Robert P. Murphy is an economist with IER specializing in climate change. His research focuses on the proper discount rate to be used in cost-benefit analyses and the implications of structural uncertainty for policy solutions.

Murphy received his Ph.D. in economics from New York University in 2003, where he wrote his dissertation on capital and interest theory. After teaching at Hillsdale College for three years, he moved to the financial sector to work as an analyst for Arthur Laffer (of Laffer Curve fame). In addition to his role at IER, Murphy is a financial consultant, providing forecasts on interest and exchange rates, growth, and inflation.

Murphy has written over 100 articles for the layman on free-market economics and is the author of The Politically Incorrect Guide to Capitalism (Regnery 2007). He has also given numerous radio interviews and public lectures on economic topics.

Besides employing these popular outlets, Murphy has written study guides for the economic treatises of Murray Rothbard and Ludwig von Mises, and designed a Home Study Course in Austrian School economics. He has also published several scholarly articles and notes in peer-reviewed journals, including The Journal of the History of Economic ThoughtThe American Journal of Economics and Sociology, and The Review of Austrian Economics.

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14 Responses to “IER STUDY: Carbon Tax Scheme Plagued By Theoretical, Practical Problems”

  1. Michael Richardson on

    I’d be curious to read this “best literature” when you say “The best literature on the topic actually argues that a revenue-neutral carbon tax swap would make the tax codemore inefficient and would hinder economic growth.” Can this please be cited somehow?”

    Reply

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