NS4054 Fall Term 2015

Views on a Carbon Tax

Overview

• Ed Dolan presents the different perspectives on a carbon tax for the United States – progressive or liberal, conservative, and libertarian

• Ed Dolan, Why Progressives Should Love a Carbon Tax – Although Not all of they Do, EconoMonitor, July 8, 2013

• Main arguments

• Progressives love the environment and believe that carbon emissions cause environmental harm.

• Progressives have no general aversion to taxes

• Logically they should be advocates of carbon taxes if they can accept the power of economic incentives to slow green house gas emissions

2

Progressive Position I

• Main progressive arguments • Center for American Progress

• Argues that climate change, economic growth, and fiscal responsibility are intimately linked

• It follows that a price on carbon should be part of a policy to deal with each of these issues

• Environment Defense Fund

• Makes sense to tax what you want less of

• Green Illusions

• Argues against wishful thinking that solar, wind or other technological fixes will bring a future of cheap, clean and abundant energy

• Subsidies for clean energy bad because they make energy in general cheaper, discouraging conservation

3

Progressive Position II

• Still not all progressives convinced

• Many are skeptical of our capitalist economic system – instinctively distrust market-based environmental policy

• Others fear a carbon tax would disproportionately harm the poor

• Other have ethical objections to the whole idea of bribing people to do things they ought to do voluntarily out of respect for the planet

4

Progressive Position III

Examination of Arguments:

•1. People don’t respond to market incentives

• Many progressives feel government regulation much more effective – commands people to do things in no uncertain terms

• People still smoke despite high cigarette taxes

• Don’t know what tax rate is sufficient to deal with climate problems

•Empirically much evidence that market based incentives produce results

• Studies suggest price elasticity around -0.26 in the short term and -0.58 in the long term – inelastic

• A tax of $1 a gallon would cut use by 10-20%

5

Progressive Position IV

6

Progressive Position V

• Prices having an effect on fuel choice in other industries

• Increased replacement of coal by natural gas in the generation of electricity

• Duke energy is rapidly moving from coal to natural gas in large part because of lower gas prices

• Duke’s CEO is calling for the government to put a price on carbon with either a tax or cap-and-trade system

• Doing so would accelerate a trend away from coal, not only toward gas, but also toward solar and wind power

• In short, preponderance of evidence is that prices work

• Both to promote energy conservation in general and to motivate the choice of cleaner over dirtier sources of energy

7

Progressive Position VI

• 2. A carbon tax would hurt the poor

• Idea that lower income families spend a higher percentage of their budget on transportation, home heating and eclectic utilities than the affluent

• Even if we accept the truth of that claim, it does not constitute a valid objection to a carbon tax

• Policies that keep energy prices low are a poorly targeted way to help the poor

8

Progressive Position VII

• Doing the math

• Families in bottom half of the income distribution spend around 20% of their budgets on energy compared with less than 10% for those in the top half

• Households in the lower half of the income distribution receive only about 20% of all income.

• Comparing 10% of 80% to 20% of 20% makes it clear that lower income families, despite great relative expenditures consume about one third of all energy

• Much smaller number of households that fall below federal poverty line consume about 15% of all energy

• Than would mean that for every dollar by which national consumer energy costs decrease the poor gain only 15 cents.

9

Progressive Position VIII

• There are a number of ways for combining a carbon tax with targeted mechanisms for offsetting its impact on the poor

• Probably the best – refund part of the tax directly to low income households, either through a special rebate or by expanding some existing program like the Low Income Home Emergency Assistance Program

• As long as the rebate came in a lump sum, rather than in proportion to energy use, it would offset the distributional effect of the tax without reducing its incentive to conserve

• We do not as a rule exempt poor people from restrictions on socially harmful behavior – reasonable to expect them to behave responsibly toward the environment

10

Progressive Position IX

• 3. We should protect the planet because we love it

• Idea seems to be that all policies that rely on economic incentives

• pose danger that those who pay a pollution tax, or purchase a carbon offset or trade pollution will absolve them of any further responsibility for climate change

• Better to think that getting several billion of us to behave differently means guiding market forces in the right direction

• Making it in our interest to do the right thing.

11

Conservative Position I

• Ed Dolan, Why Conservatives should Love a carbon tax and Why Some of Them do, EconoMonitor, July 1,2013

• Conservatives like Gregory Mankiw of Harvard cite a number of reasons a carbon tax is desirable

• A Carbon Tax would improve tax efficiency

• Although conservatives don’t like taxes, they reluctantly that the government does need revenue

• Their budget plans have called for a reduction in federal spending to a range of 18 to 20% of GDP

• To fund even that level of spending without large deficits – which they also dislike would require a lot of tax revenue

• Where should it come from?

12

Conservative Position II

• Broad agreement among economists that revenue should:

• Come from broad based taxes that have the lowest possible marginal rates and

• Have the fewest possible exemptions, deductions and preferences.

• Current U.S. system about as far from that ideal as you can get

• As a result it produces maximum distortions of business and consumer decisions while producing a minimum of revenue

• Corporate income tax is exhibit A for these defects.

• Since Japan cut its rate, the U.S. has the world’s highest marginal tax rate on corporate income

13

Conservative Position III

• The U.S. corporate tax has so many exemptions and deductions that many of the largest companies pay no tax at all

• And the tax as a whole produces only a trickle of revenue

• Corporate income tax brings in revenue equal to just 2.7% of GDP down from 6% in the 1950s

• Because other countries have fewer loopholes they get more revenue form their corporate tax even though their rates are lower

• Yet despite raising so little revenue, the corporate income tax distorts business decisions in major ways

• Encourages moving operations offshore, and

• Discourages repatriation of profits

14

Conservative Position IV

• Even companies that pay no tax to government suffer since tax avoidance requires them to use business practices that they would not otherwise choose

• Carbon tax by contrast is much more broadly based since economic activity of every sort depends to some degree on carbon based energy

• Even a low rate of tax would raise a large amount of revenue

• Introducing a carbon tax and using the proceeds to reduce rates on other taxes would maintain revenue neutrality, while reducing tax distortions to business decisions

15

Conservative Position V

• Study at MIT gives some estimates

• Effects of a $20 per ton of CO2 beginning in 2013 and rising at a rate of 4% per year would

• generate enough revenue to cut the corporate tax rate by 2.23% by 2015, and

• would provide net gains to the economy of %2.7 billion when the economic burden of the tax is balanced against the reduced burden of the corporate tax

• Efficiency gains would be nearly as large if the carbon tax revenue were used instead to reduce personal income or payroll taxes

16

Conservative Position VI

• A carbon tax would make the economy more resilient

• Any thoughtful and objective discussion of climate change must acknowledge that many uncertainties remain in climate science

• Not on basic points like the heat trapping properties of CO2 where there is broad scientific consensus but rather on the

• Times,

• Places, and

• Forms

• In which climate risks are likely to manifest themselves – whether as droughts, floods, coastal storms or something completely unanticipated

17

Conservative Position VII

• Those “deep uncertainties” make it impossible to calculate a single optimal response to climate change

• Best response to climate change then is to promote resilience

• through policies that enable our economic and social system to cope with shocks and adapt to unexpected change

• Carbon tax is an ideal way to create resilience because it capitalizes on the inherent flexibility of the market

• Even if we cannot calculate the optimal value of the tax

• Estimates range from a few dollars per to ton to as high as three hundred dollars

• Even a small tax will begin to exert steady pressure for change across a broad front

18

Conservative Position VIII

• A carbon tax would give equal encouragement to development of low-carbon alternative energy sources and to energy conservation

• It would not only spur the search for winners, it would weed out losers before they became politically entrenched (corn based ethanol is a case in point).

• The result would be a more diverse and efficient energy mix.

19

Conservative Position IX

• Other benefits of a carbon tax.• Would make the U.S. economy more resilient to geopolitical

shocks

• Greater energy efficiency and more diverse domestic energy base would make the country less vulnerable than it now is to political events in often unstable areas that supply much of imported energy

• At same time carbon tax would make economy more competitive in international trade

• There is little evidence that low domestic energy prices are either a necessary or sufficient condition for strong export performance

• Germany has among the highest energy prices in the world while many low cost energy countries like Egypt have few exports

20

Conservative Position X

• To be competitive a country has to be ready to react to changes in the global economy

• An efficient tax system with low marginal rates plus a diverse energy mix would enhance the flexibility needed to meet trade challenges.

• A carbon tax is better than the regulatory alternative• In contrast to flexibility and resilience of market based

environmental policies like a carbon tax, command and control regulations are inherently rigid and brittle

• Fuel economy standards for motor vehicles a case in point• Government favored technologies while discouraging the

exploration of innovative ways of achieving fuel efficiency

21

Conservative Position XI

• Worse, they actually provide perverse incentives to waste energy

• Existing fuel economy standards encourage production of fuel efficient cars, but once you own one its lower operating costs give you an incentive to drive more miles.

• Standards also encourage people to delay junking oil cars, since new regulation compliant models cost more.

• In contrast a carbon tax provides an incentive both to buy new fuel efficient cars and to drive existing cars fewer miles

22

Conservative Position XII

• Unfortunately conservative resistance to carbon taxes has unintended consequence of encouraging greater reliance on regulation

• Very much evident in President’s climate plans

• Plan does not contain a word about carbon tax presumably because introducing one would require Congressional action.

• Instead the plan consists entirely of measures that the administration can implement on its own authority.

• Most of the items proposed are subsidies for selected technologies

• Some of the ideas in the plan are good, but those would rise to the top under the market based incentives provided by carbon tax

• The bad ideas in the plan would never see the light of day.

23

Conservative Position XIII

• Bottom line

• Carbon tax is a natural for conservatives

• Conservatives know the tax system is broken

• A carbon tax could be a key element in a comprehensive tax reform that aims to broaden the base an lower marginal rates without increasing the deficit

• A carbon tax would enhance the resilience that the economy needs to respond not just to environmental risks but also geopolitical and trade shocks

24

Libertarian Position I

• Ed Dolan, Why Libertarians Should Support a Carbon Tax• Libertarians don’t like taxes• Believe states should play a role in economic affairs only when

there are problems that can’t be feasibly handled by the private sector

• The polluter should pay has long been part of libertarian theory• Issue then is how to ensure that the polluter pays• For many libertarians the preferred approach is to rely on

private negotiations backed by the right to take legal action for the pollution related nuisance.

• If toxic fumes from a neighboring factory damage your health or property, sue the owners for damage or ask for an injunction requiring them to stop

25

• Unfortunately the tort law approach making the polluter pay works less well as the number of pollution sources and victims grows

• True you with others can very likely get somewhere with a lawsuit against pollution from a factory next door, --easily traced to its source.

• However when there are many sources, some of which are from many distant firms it is difficult to show that pollution from anyone source caused harm to the individual, even if harm is collectively large

• Often the case with air pollution, not only climate change but also urban smog or acid raid

26

Libertarian Position II

• When a large number of sources and remote victims make the tort law approach unworkable have to choose a second-best approach

• Options include:

• Regulations that require specific technologies or

• Impose source-by source emission standards

• Placing a price on pollution by means of a tax or cap and trade mechanism or

• Doing nothing

• Command and control regulations which are both intrusive and inefficient are the least attractive alternative to liberations

• Doing nothing the preferred alternatives in case when the harm was trivial 27

Libertarian Position III

• When harm is not trivial, a policy that puts a price on pollution should be the preferred approach

• Probably pollution taxes are less objectionable to libertarians than cap and trade for three reasons.

• First they are the more economically efficient alternative

• Second they are less complex and less open to political favoritism and corruption

• Third revenue from pollution taxes can be used to reduce marginal rates on other taxes that produce well known distortions of market incentives, such as payroll taxes or corporate profits taxes

28

Libertarian Position IV

• Bottom line

• Climate change is difficult for libertarians

• Creates tension between the principle that pollution is an unjust assault on the persons and prosperity of others and

• The principle that all disputes are best resolved through private negotiations and civil law.

• If unable to do that reasonable for them to support the least intrusive, least inefficient government intervention available to deal with the problem

• In all likelihood the carbon tax

29

Libertarian Position V