Friday, April 10, 2009

Some Thoughts on the Cost of a Carbon Tax

Lately I've been hearing a lot from some people on the Right about potential climate change legislation and why it's going to be horrible. The idea from some of these people seems to be that whether we have an auction-based cap and trade system (which would be relatively imbecilic but seems more or less inevitable) or a carbon tax system, the end result is going to be that we end up paying a whole bunch of money, and we're all going to go straight to the poor house as a result.

Since I think that auction-based cap and trade systems are excruciatingly dumb, I'll focus my comments on a carbon tax system. If this gives anyone an ulcer, I'll be happy to explain how these thoughts can apply to a cap and trade regime, but I'd rather not have to do those gymnastics if no one's ultimately going to care. The subject of this post, then, is whether or not a carbon tax should be expected to force us all into poverty. I will avoid here the question of whether or not such a policy would be advisable in an all-things-considered sense, since that's a question far too big for this post. Suffice it to say that I don't think the necessity of such a policy is as obvious as some people make it out to be. But that's a conversation for elsewhere.

So here's how an effective carbon tax (in the sense of mitigating contributions to climate change) might be expected to work. The government slowly phases in a tax on things like coal, natural gas, and petroleum which are cited as sources of greenhouse gas emissions, as well as other influences on the climate system like agriculture, land clearing, etc. The revenues from the tax are used to finance a tax cut (ideally structured to cancel out some of the potentially worrisome distributive effects of the tax) or to finance some government expenditure that otherwise would have resulted in a tax increase (i.e., paying for the preposterous stimulus programs). The goal of the policy is to increase the price of energy-intensive goods with the tax, and to use the revenues to ensure that people do not lose overall purchasing power. Accordingly, people would have an incentive to shift their consumption away from energy intensive goods and towards non-energy-intensive goods. And while those who purchase disproportionately energy-intensive goods would be expected to suffer, those who purchase disproportionately non-energy-intensive goods would actually be expected to benefit.

Let me illustrate this in action. Let's say we have an economy with two goods: rocks and rubber balls. Producing and using rocks, in our example, does not involve any net impact on the climate system, whereas producing rubber balls involves the use of a substantial amount of fossil fuel. Rocks and rubber balls both cost $5 before the tax. Now let's imagine that every year, Xavier typically buys three rocks for $15, and three rubber balls for $15. And imagine that Cynthia usually purchases five rocks for $25 and only one rubber ball for $5.

Now we implement a carbon tax of $1 on rubber balls, so they now cost $6. The argument from some on the Right says, "Well look; now Xavier's consumption would cost $33 and Cynthia's consumption would cost $31, instead of both costing $30! This is a tragedy!"

But watch: let's say that Xavier and Cynthia don't change their consumption patterns in light of the tax. Xavier ends up paying $3 more in taxes to finance the purchase of the rubber balls, and Cynthia ends up paying $1 more. The government now uses its $4 to finance a $2 tax cut for both Xavier and Cynthia. So now Xavier ends up paying $1 for consuming a disproportionately high amount of rubber balls, and Cynthia actually gets paid $1 for consuming a disproportionately low amount of them.

In such a scenario, we might expect that the parties would see an opportunity to benefit from shifting their consumption away from the more expensive rubber balls. And the extent to which they were doing this before others or to a larger degree, they would benefit. Those who stubbornly insisted on consuming rubber balls, the argument goes, would simply be forced to pay the price for their anti-social behavior.

Things are a little more complicated with real governments who never actually do things like returning all the money, and where there are costs associated with implementing and enforcing the tax. But at least that's the idea. If the tax is revenue neutral, the only people who go to the poor house are the people who have a far greater impact on the climate than everyone else. And when those people go to the poor house, everyone else gets paid for being more responsible. So yes, some people would lose, but it seems like the advocates of this policy would want this sort of thing to be happening. Accordingly, the argument from some on the Right -- which focuses not on how we wouldn't want to trust the government with this policy, and not on how expensive it would be to implement, but only on the fact that it involves an increase in prices -- seems to me to be an utter failure in its current form.

Accordingly, it seems to me that this argument should be abandoned. There are other more plausible arguments that could satisfy the Right's thirst for some reason to oppose climate change legislation. They could question the ethical basis for such a policy, arguing that cost-benefit analysis (by which the policies are typically justified) are not ethically legitimate grounds for the kind of intervention that would be involved in the policy, and that the philosophical groundwork that would be necessary for an alternative analysis has not been satisfactorily settled. They could voice doubts about the government's ability to implement a policy like this in any way that wouldn't be a disaster more morally questionable than letting climate change happen. They could argue that given the amount of restructuring that will be necessary to substantially decrease our contributions to climate change, the resources we use to mitigate climate change could be better used fighting malaria around the world, bringing clean water to those who don't have it, researching cancer and AIDS, or any number of other things. But this overly simplistic argument about costs is misguided, and should be trashed.


Ewt said...

Unfortunately I know my government (The Netherlands) longer then today. They begin with a promise to shift the tax burden but end up with a permantly slowly increasing co2 tax while the promised tax cuts never show. You only have to look at other "consuming taxes" like gasoline or cigarette excise duty's.

In my 24 years I have seen 1 or 2 taxes abolished, but they are always compensated by raising a other tax.

New taxes from 2008 (translated from Dutch)

2008: The CO2 tax;
2008: The general tax credit (tax rebate) is abolished;
1 July, 2008: The flight loads;
1 May, 2008: The package tax;
1 February, 2008: The Big Car tax;
The Labour Discount is reduced;
The combination discount is reduced;
The addition for the lease car is up to 25%.
The cooperating deduction (for self-employed) will be abolished;
The eigenwoningforfait (tax on your home) is up;
The deductibility of health insurance is eliminated;
There is a tax on pension savings of the elderly (aged fee);
The car tax goes up;
There is a new tax on airline tickets (flight fee), scrapped again for 2009.
There is a new tax on amusement parks (Efteling fee);
The groundwater tax rises;
The energy tax goes up;
The gaming tax goes up;
Tobacco tax goes up;
Alcohol taxes will increase;
Diesel tax rises;
LPG tax rises.

Danny said...

Hi Dennis; thanks for stopping by! I definitely agree that we should be wary about any plan that gives government the right to tax us on the condition that we'll get the money back, since governments are notorious for doing the first part and then finding a way around the second part. I hoped to allude to that in my post when I said, "Things are a little more complicated with real governments who never actually do things like returning all the money..." but you're absolutely right to draw attention to this point.

But I think you make an important observation when you note that when one tax is abolished, another tax is increased to make up for the gap. It seems to me that the proponents of a carbon tax aren't seeking to decrease revenue for the government; their point is that this is the kind of tax they'd want to raise, and so now we can look for other taxes that we want to abolish. I am definitely cynical about the possibility that this will be done effectively, rather than the policy being used to open the door to even more government involvement in our lives. But that seems like a very different kind of argument than the one that I addressed in this post.

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