My colleague Alex Brill has continued the widespread practice of economists pretending to be politicians with his short new essay arguing for a “carbon” (greenhouse gas) tax as a “permanent” replacement for existing “carbon-related” regulations. His argument is that such a tax would be “more efficient” than regulatory strategies “developed by bureaucrats in Washington,” and the revenues could finance a “large, pro-growth tax cut.”
Brill’s take: Let’s scrap regulations in favor of a carbon tax
Where to begin? The view is widespread among economists that a (Pigouvian) tax on emissions would be more efficient than the regulatory approach because regulations impose a rough, one-size-fits-all framework for reducing emissions, while a tax allows each emitter to find the least expensive method of achieving its emissions goal. Accordingly, the tax leads the market to achieve a given aggregate reduction in emissions at a total cost lower than that yielded by the regulatory approach, because regulators cannot know the specific conditions characterizing each industrial plant and are likely to have few incentives to discover them.
The central problem with the consensus view is straightforward: The emissions goal is not fixed. Instead, it must be chosen. “Efficiency” requires both an efficient emissions goal that equates the marginal benefits and costs of emissions reductions, and a policy tool to achieve that amount of reductions that minimizes the cost of doing so.
In other words, the conventional view among economists fails to recognize that the political choice among tools affects the emissions goal; the latter is not exogenous. Once government derives revenues from a system of carbon taxes, with ensuing political competition for those revenues, it is not difficult to predict that under a broad range of conditions the emissions reduction goal will be inefficiently stringent. That is, the tax rate will be too high in the sense that the marginal costs of emissions cuts will exceed the marginal benefits.
Regulators too may have incentives to choose emissions goals that are overly stringent, because doing so is consistent with the larger goal of maximizing their budgets (or discretionary budgets), and because such “tough” regulations serve an ideological agenda. But in the case in which Congress must approve or has the power to repeal given regulations, there are strong reasons to believe that a tax approach would prove less efficient overall than the regulatory approach.
It is far from clear that Congress would choose a carbon tax rate reflecting the marginal “uninternalized” social cost of greenhouse gas (GHG) emissions, to be distinguished sharply from the tax rate than maximizes the present value of the revenue stream. This outcome under political competition shaped by democratic institutions depends upon the nature of the majority coalition emerging in Congress; both the group bearing the burden of the carbon tax and the group enjoying the benefits of the new revenues are likely to be concentrated interests.
That is different from the political dynamic under the regulatory approach: The regulated industries and the regulators (i.e., the bureaucracy) are concentrated interests, but to a substantial degree the beneficiaries of reduced emissions are the diffused population writ large.
Credit: Twenty20
Accordingly, even if the tax is more efficient in terms of allowing a cost-minimizing set of actions to reduce emissions, it is very far from clear that that effect would outweigh the possible inefficiency inherent in a system of carbon taxes in which important interests drive a political equilibrium in which the tax rate is chosen to maximize the revenue stream rather than to yield the efficient level of emissions.
There is the further matter that “revenue maximization” means the present value of the revenue stream over some time horizon, that is, at some discount rate. Accordingly, the tax rate that maximizes revenues over a short period is very likely to be higher than that maximizing revenues over the long run, due to the greater ability of market participants to avoid the tax given more time to do so, in particular when the tax rate is higher rather than lower.
Because the marginal members of the congressional majority are likely to be the incumbents in greatest danger of defeat in the next election, it is not difficult to predict that the political equilibrium for a carbon tax will be a rate maximizing revenues over a time period shorter rather than longer, precisely because for those marginal members of the majority, the time horizon is the next election. The near unanimity of economists on the relative efficiency of a tax over regulation is far less meaningful in this broader context than Brill seems to recognize.
With respect to Brill’s argument that the carbon tax be used to finance a reduction in the corporation income tax: What reason is there to believe that the bargaining process in Congress would lead to that outcome? That is: Why should we predict that the interests benefiting from the reduction in the corporation income tax would prove to be the marginal members of whatever congressional coalition imposes the carbon tax? That certainly is possible, but other outcomes seem far more likely.
Some industries and geographic regions will bear disproportionate burdens attendant upon the carbon tax, and their votes will be necessary to enact it, particularly in the US Senate. Will their demands for compensation fall upon deaf ears? Given that “coal country” gave heavy political support to President Trump precisely because of the Obama political assault on their economic interests, it is difficult to believe that they will be satisfied only with a cut in corporate taxes, whatever the equilibrium effect on wages, because the carbon tax would penalize them disproportionately. Investment flows and wages would be affected more in some sectors and geographic regions than in others; would the complex bargaining process shaping legislation simply ignore them? The list of potential supplicants is long indeed, each comprising some combination of constituencies to protect and campaign contributions and votes to offer.
A few final observations are appropriate. Brill calls for a “permanent” end to the GHG regulations in exchange for the carbon tax, but it is far from clear how that covenant would be enforced over time. The industries affected by the carbon tax would have powerful incentives to support a resurrection of the regulatory structure, if there are scale economies in adherence to the regulations, as a means of making entry by smaller new competitors more difficult.
Brill does not delve into the issue of how high the carbon tax ought to be in his “efficiency” framework, but it cannot be trivial if it is to finance a substantial reduction in corporate taxes. This means that the tax shift would engender a sizeable wealth transfer from energy users to owners of physical and human capital, and perhaps others. Is that likely to prove a political equilibrium? If not, some carbon tax revenues will have to be used to compensate the losers, as noted above, and the purported “growth” benefits of the tax shift will come a cropper to a greater or lesser degree.
Brill asserts that “conservative voters . . . are increasingly interested in policies to mitigate the real risk of climate change.” He offers no evidence in support of that assertion, but in any event, it matters only if “conservative voters” as a group are the median (“swing”) voting bloc in the relevant elections. At the presidential level, that is unlikely to be the case; President Trump appears to have won a majority in the Electoral College by attracting large numbers of blue-collar voters in the industrial Midwest who previously supported Barack Obama. It is far from clear that they are “conservative voters,” however defined.
Moreover, the argument that a carbon tax would “mitigate the real risk of climate change” is deeply dubious. If the tax were set at, say, around $40 per ton — approximately the Obama administration estimate of the social cost of carbon — and the market response proved similar to the GHG emissions reductions envisioned in the Obama climate action plan, the effect on temperatures in the year 2100 would be 0.015 degrees Celsius, using the EPA climate model, under a set of assumptions that exaggerate the effectiveness of the regulations. If we assume that the effect would be an order of magnitude greater — 0.15 degrees Celsius — the policy implications would change little or not at all.
That reality suggests that Brill and the other supporters of a carbon tax/corporation tax shift are far more interested in cutting corporate taxes than the environmental “benefits” of the former. After all, why a tax on carbon? Why not on, say, zucchini? Until we hear a convincing answer to that question, the carbon tax shift proposal is not to be taken seriously.