The Nuts and Bolts of a Carbon Tax

This post was suggested by commenter Almost Iowa yesterday.

On November 29, on the eve of the Paris COP 21 event, an open letter in praise of a carbon tax was released:

“Taxing carbon pollution will spur everyone ― businesses, consumers and policymakers ― to reduce climate-damaging emissions, invest in efficient energy systems and develop low-carbon energy sources.

This single policy change — explicitly using prices within existing markets to shift investment and behavior across all sectors — offers greater potential to combat global warming than any other policy, with minimal regulatory and enforcement costs.

We urge negotiators at the upcoming UN Climate Conference in Paris to pursue widespread implementation of national taxes on climate-damaging emissions.

We endorse these four principles for taxing carbon to fight climate change without undermining economic prosperity:

1. Carbon emissions should be taxed across fossil fuels in proportion to carbon content, with the tax imposed “upstream” in the distribution chain.

2. Carbon taxes should start low so individuals and institutions have time to adjust, but then rise substantially and briskly on a pre-set trajectory that imparts stable expectations to investors, consumers and governments.

3. Some carbon tax revenue should be used to offset unfair burdens to lower-income households.

4. Subsidies that reward extraction and use of carbon-intensive energy sources should be eliminated.”

A carbon tax is advocated by libertarians such as Tim Worstall, who writes, “And the point that everyone is making here is that carbon emissions are currently an unpriced externality.

The joy is that we know how to deal with those. The proof might have started with Arthur Cecil Pigou (the guy who first hired Keynes into an economics department) and his discussion of the effects of a superfluity of rabbits in one field on the crops of the farmer next door but the proof is still true. If you’ve unpriced externalities then markets won’t work to deal with this problem. For the entire point of designating them as unpriced is that markets do not take them into account thus given that markets ignore them they can’t solve any problems associated with them.

Given this we do know what to do: we intervene in the market to price those externalities. We could have a cap and trade system, it could be a carbon tax. The general view of the economists working on this is that the carbon tax is better. Sure, there’s a certain disagreement about how large that tax should be: Nordhaus says perhaps $10 a tonne now and $250 a tonne in 30 years’ time.

…”this idea of a carbon tax to deal with climate change is simply the mainstream, scientific consensus one, about how to do that dealing. There’s amazingly little disagreement among the economists who study the point. Hell, even Exxon now applies a $60 a tonne tax to emissions in their internal modelling. There’s also nothing new about this point, it’s the same thing all those economists have been saying for the past decade. It’s also nothing new for me to be saying it, I even wrote a book on the point three years back.

Yes, climate change is a problem we should do something about and that something is a carbon tax. What a very mainstream conclusion. But as I say, there’s a sadness in the fact that just about everyone, from Republican politicians insisting upon no new taxes to green activists insisting that we need the destruction of globalised capitalism to deal with it refuses to actually listen to, or apply, that solution that really is the mainstream scientific opinion on what we ought to be doing about it all.”

But those who mistrust government as a matter of course are reluctant to give them a new revenue stream. Even I, a progressive liberal, see plenty of ways that a carbon tax could be misused.

So, unlike the open letter above, I advocate making the carbon tax 100% revenue neutral. In the U.S., I suggest that all revenues go towards lowering Social Security taxes on employees and employers. Perhaps in the UK it could be spent on their island’s jewel, the National Health Service.

A hypothecated tax is a tax where the money obtained, or part of the money obtained, is used for a particular purpose, rather than spent on a number of things. This is normally used to benefit the cause of the hypothecation. An example is the U.S. gasoline tax, which is spent on highway improvements. For our purposes, the hypothecation would enable transparency as well as benefiting the beneficiary.

As per Wikipedia, “the U.S.gasoline tax is not perfectly hypothecated–about 60% of federal gas taxes are used for highway and bridge construction. The remaining 40% goes to earmarked programs.[6] However, revenues from other taxes are also used in federal transportation programs.”

Gas tax

Structuring a carbon tax to fit in with or mimic the U.S. gas tax would not be a horrible idea, either–the country’s transportation infrastructure badly needs an overhaul.

But these two possible beneficiaries also benefit from one other factor that is important in discussions of a carbon tax–if it works, the revenue will decrease over time. As both Social Security and the U.S. transportation system have other sources of substantial revenue, this could be planned for.

They key is that it would not need to fund a new bureaucracy and would help build no-one’s empire. This is the cornerstone of crafting a palatable carbon tax.

There are many other details to consider–how to stop large scale carbon emissions from emigrating to places with friendlier tax regimes being among them. This would require perhaps tariffs, perhaps treaties, perhaps a combination.

But it could be done. And I think it should be. As part of a program that includes Fast Mitigation and Pre-Adaptation, a carbon tax would give us less of what we don’t want–CO2 and other pollution–and more of what we do want–perhaps Social Security, perhaps transportation infrastructure, perhaps more health care.

Kind of a no-brainer, really.

26 responses to “The Nuts and Bolts of a Carbon Tax

  1. Out here in the sticks, people smoke, people drink, people drive a long way to their low income jobs.

    Cigarettes cost $80/carton, half of that is tax. People still smoke a pack a day. Gasoline costs about $2,00/gallon, a quarter of that is tax and people still drive F150 V8’s thirty miles each way to a $13/hr job. From what I can see, taxes do not influence consumer behavior.

    However, what I also see is energy programs like wind serve as a means of transferring wealth from the poorest of the poor, to richest of the rich.

    Consumption taxes are by nature regressive. Smart disciplined people with low-incomes can avoid cigarette, gasoline and alcohol taxes by avoiding the consumption of these thing. How do you as a consumer, avoid carbon taxes when it is a tax on almost everything you purchase?

    • Yeah, but even in the sticks people are influenced by the sort of ‘nudges’ a carbon tax would provide. Think of how many cigarettes they’d smoke if they cost a buck a carton! When I was in the Navy they were selling cartons of Pall Mall Reds for twenty-five cents. I switched brands and lived with a cigarette in my mouth for months…

      • “Yeah, but even in the sticks people are influenced by the sort of ‘nudges’ a carbon tax would provide.”

        Sales of pickup trucks fall as the price of gas rises and sales go up as the price of gas falls. We know that. But we also know those figures are for “sales”. One could also infer that money spent on gas competes directly with the truck payment in the family budget. When the price goes down, more money is available for the vehicle. From first hand experience, I do not see a correlation between the price of gas and the number of Priuses on gravel roads.

        I would argue that culture is far more important than price pressure. We have a saying around here, “there is always money for cigarettes, beer, gas and tattoos”. I quit smoking during the running craze of the 70’s. Back then there was always money for tennis shoes. The point being, we are more driven by social rewards than marginal cost.

        IMHO, things like prohibitions and vice taxes are the result of a serious disconnect in society. They occur when the elites lose their ability to influence the greater culture and resort to force out of frustration.

        The success of the green movement was that it changed the culture of young hip people. The failure of the green movement is that alienated everyone else.

  2. Tom,
    What you call fast mitigation could be implemented without a carbon tax.
    Develop, out of the massive river of monies flowing to, for instance “communicate” climate change, and put that money to actual use of building cleaner coal, better utility grids for developing countries, better nuclear power plant technology, etc.
    Pre-adaptation is called “infrastructure improvements” in normal times.
    Why is that so hard now that it requires an extra carbon tax?
    I urge you to review “Chemist in Langley” on the realities of neutral carbon tax and at least comment on why your version is going to work.

  3. “Kind of a no-brainer, really.”

    When I see a complicated solution to a complicated problem described as a “no-brainer” I tend to think of it as a solution designed to appeal to people without brains.

    I was long inclined to think that a carbon tax would be a good idea, but the more I think about it, the less I am so inclined.

    Giving the government a new revenue stream is only a good idea if you like the idea of ever-expanding government. Making it revenue neutral does not solve the problem since you can’t really do that except at one instant in time. Earmarking the funds does not really help since that is just an invitation to play budgeting games. And once you have a dependence on the revenues, then there is a powerful incentive to maintain the revenues. That means maintaining lots of fossil fuel consumption.

    One possibility might be to directly return all revenues to the citizens. But that creates a large constituency for a revenue maximizing tax that has nothing to do with any other policy goals.

    Then there is the problem that a carbon tax drives up the prices of domestically produced goods vs. foreign goods. So now you need a bureaucracy to administer a complex system of credits for exporters and a complex system of tariffs on imports. Bye-bye free trade.

    And finally there is the question of where to set the price of the externality. Lacking a rational means to do so, as with carbon, that becomes an exercise in raw political power. Bad idea.

    • Well, maybe my brain has quit functioning. (I’ve been spending a lot of time over at Only In It For The Gold–my only excuse.)

      Keep thinking about it. I don’t want to give government a new stream of revenue so much as I want to replace one stream of cash with another one, one-for-one. And as a carbon tax would produce decreasing revenues over time if it works, it seems like less of a threat.

  4. Tom,

    Thank you for an enlightening article. Until about 15 minutes ago, I was in favor of a carefully crafted carbon tax, but with reservations. I am now opposed to any such tax. What crystallized my thinking was the following:
    “there’s a certain disagreement about how large that tax should be: Nordhaus says perhaps $10 a tonne now and $250 a tonne in 30 years’ time.”
    Which led me to realize the final point in my previous comment: Setting the tax will be an exercise in raw political power. Or, as one of my favorite Billy Holiday songs says:
    Yes, the strong gets more
    While the weak ones fade

  5. So if a Social Security rebate is the way to make it revenue neutral, when what of people who don’t work?
    Will you extend it to those who receive Social Security as well?
    And is this rebate equal in dollar amount for each recipient, or is it a lower percentage rate on the SS tax?

  6. The Canadian province of British Columbia has already enacted a revenue-neutral carbon tax (set at $30 per ton). http://www.fin.gov.bc.ca/tbs/tp/climate/carbon_tax.htm

    Income tax rates in the province are now among the lowest in the country.

    This was a meaningful factor in my decision to move west from Ontario, since I’m proportionally a much bigger payer of income tax than consumer of fossil fuels. (I earn approximately double the top tax bracket, and drive a Fiat 500.)

    • Thanks for posting here.

    • Russ R.,

      Thanks for the link. This will be an interesting experiment to see how long the tax remains unambiguously revenue neutral and to see what effect it has.

      But BC may not be a good model for other jurisdictions. Electricity production is almost entirely hydro. Does BC have much in the way of energy intensive industry? If almost all emissions are from local consumption (cars, space heating), then many of the complications go away.

      • BC’s industry has been highly resource driven (forest products and fossil fuels accounted for 62% of exports a decade ago), but both have suffered systemic declines. Today most of the economy seems to be driven by residential real estate speculation.

        One item that was intentionally exempt from the carbon tax was aviation fuel. Leakage would have been an obvious problem there.

    • So is it possible that lower income people in British Columbia pay a higher percentage of their income in taxes than the wealthy?

      • Unlikely because part of the revenue is directed to a refundable tax credit targeted at low income individuals.

      • In other words, the tax takes money from actual people and returns it to a class of people. I would think a wise policy would return money to whom it was taken from. Even my VISA card tells me how much I spent on gas.

      • Almost Iowa wrote: ” I would think a wise policy would return money to whom it was taken from. Even my VISA card tells me how much I spent on gas.”

        It sounds like you are saying that each person should get back exactly what they paid in tax. That would make this the most pointless government action in history, which would be quite an achievement.

      • Mike, not quite. Trying to mitigate the regressive nature of a consumption tax by punting a rebate in the general direction of a class of low income people is not effective policy because it invariably rewards the wrong people. Allowing an actual rebate of taxes paid to low income consumers is far more effective and fair.

  7. I wish I’d waited a couple of days before posting–I’m really busy now and the post isn’t as good as I want it to be. Plus I’m too busy to respond to comments now.

    Sigh.

  8. Entirely and fully agree that the best offset of the carbon tax is to lower FICA. I’ve suggested as much in other pieces. Apologies, but I never do quite manage to get absolutely everything into one single piece on the subject…..

    Re Almost Iowa and gas taxes. Short term demand is highly inelastic. In the long term it’s pretty elastic. Europe has had much higher gas taxes than the US for 30 years or so. We all drive cars with smaller engines, commute shorter distances, live closer to where we work and so on. It takes many years for these sort of taxes to make much difference. But that’s fine, this is a many decades problem too.

    • Tom, interesting insights
      Your conclusion, that CO2 is a multidecade problem, begs the question of is it, and if so is it one of subjective or objective reality? If it is an objective problem, is it one of any significance to justify the extremist policy demands and hysteria? Tom, I hope you’re busy in a good way.

    • Tim,

      If you use a carbon tax to replace FICA, then you must make sure that lots of fossil fuels continue to be used; otherwise Social Security will collapse. Gee, maybe that is a way to get the ideological far right in the U.S. to sign on to a carbon tax.

      Re gas taxes, I think you have confused cause and effect. Europeans tolerate higher gas taxes because you drive smaller cars and live in more compact cities. Aren’t the population densities of most European metropolitan areas decreasing?

  9. Tim, fossil fuel demand is only elastic within limits; demonstrated by tens of thousands of deaths due to cold in during recent UK winters. At some point we need to escape the limits of the argument defined in the media and acknowledge that the people who created the AGW-scam are the people who control the fossil-fuel market, and that decreasing its supply through funding environmental activism, they’re creating an inelastic market that benefits them not only in terms of ROI, but also in advancing their depopulation agenda. The Committee of 300 (Olympians) is a group that acquired a lot of its wealth through the opium trade; they’re the descendants of the owners of the British East India Company, and their agenda is anti-humanism.

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