The Carbon Tax and Fiscal Responsibility

I was ever so briefly at a conference on pricing carbon this weekend at Wesleyan (I was a moderator for a session). The panelists were committed to the same goal (reduced CO2 emissions) so the discussion focused on the issue of regulatory design and policy instruments. Of the competing approaches—cap-and-trade, cap-and-dividend, and a straight carbon tax—the carbon tax, in my opinion, makes the most sense.

By way of background, I find the data on global climate change pretty persuasive even if we accept that there is a fair amount of uncertainty.  Given the benefits of reducing CO2 emissions, reducing dependency of foreign oil, etc., a transition to less carbon-intensive fuels and processes makes sense even if we determine at some point in the future that the environmental risks of climate change were less than we currently believe them to be.

Given the impossibility of establishing property rights over climate stability, the kinds of free-market environmentalist approaches that many find appealing would seem inapplicable. Thus we turn to other kinds of policy interventions.

Cap-and-trade worked quite well for acid rain. There is little question that Title IV of the Clean Air Act Amendments of 1990 created an amazingly cost-beneficial approach to the problem. But CO2 is far more complicated for a number of reasons and it is questionable that caps could function without offsets, which open the door to endless gaming.  The carbon tax, in contrast, is a simple and transparent means of managing a negative externality.

A carbon tax would gradually increase the tax per ton of CO2, thereby making less carbon-intensive forms of fuel and processes more price competitive.  Current proposals require revenue neutrality. Some suggest returning 100% of the revenues on a per capita basis via electronic transfers, thereby limiting the opportunities for transfer seeking and gaming the system (both of which would be ubiquitous in a cap scheme with offsets or any efforts to divert some of the funds to a green industrial policy). Others make the case for “tax shifting” (e.g., using the projected $500 billion in carbon revenues to eliminate those that create disincentives to investment or are overly regressive).  Obviously, one could combine dividends and tax shifting. It would be prudent to combine the carbon tax with the immediate elimination of all subsidies for fossil fuel production. Of course, it would be a major innovation for US government to stop subsidizing the very activities we are trying to regulate….but I digress.

Regardless of how one uses the resources, there is a major hurdle: taxes are taxes (even if we call them “fees”) and in this political environment one might suppose that any proposal for new taxes would be DOA.

But not necessarily.

There is growing recognition of the huge fiscal crisis on the horizon. There is literally no hope of avoiding it through attacks on “waste, fraud and abuse,” earmarks, and domestic discretionary spending.  Yes, any of us could make the intellectual case for massive entitlement cuts or restructuring. But there is little evidence that a majority of either party will ever make the case and endure the political costs associated with substantial revisions in Social Security and Medicare.  So we turn, necessarily, to revenues.  Why not frame a carbon tax as a means of shoring up the unfunded portion of Social Security and Medicare without significant cuts—and thereby avoiding an eminent fiscal collapse.

We know that existing federal trust funds are not a store of wealth. The trick would be to assure that 100% of the revenues were placed in a real trust fund with real assets until the unfunded liabilities were reduced to manageable levels.  At that point—assuming that point ever arrived—decisions could be make to pay down the debt. None of this would preclude future reforms (indeed, they would likely remain necessary given the magnitude of the gap).

As a means of protecting existing entitlements, it might be attractive to the AARP and members of both parties who would like to find some means of avoiding the difficult decisions before us. As a means of reducing CO2 emissions, it would be attractive to environmentalists and younger voters (who would also be attracted by the beneficial impacts on entitlements they may never see under current conditions)?

Could the carbon tax provide a foundation for a potent grey-green coalition committed to fiscal and environmental sustainability?

 

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Cap-and-trade: Will the dead rise again?

Senate Majority Leader Reid has declared cap-and-trade dead (for now). As the Christian Science Monitor notes:

In a bid to win Republican support, Democrats will drop proposed controls on greenhouse gas emissions in favor of more limited measures that have attracted bipartisan support in the past. These include: lifting the liability cap to hold BP accountable for the Gulf oil spill, decreasing dependence on foreign oil, boosting incentives to create up to 400,000 green jobs, and expanding funding for land and water conservation.

If Reid can’t get sufficient support now, one can imagine that it won’t be forthcoming after the mid-term elections (assuming that the GOP doesn’t snatch defeat from the jaws of victory).

But wait!

As Daniel Foster (National Review) and John Fund (WSJ ) suggest, there might be another strategy at work: pass a scaled down energy bill now (loaded up with enough green pork to attract a majority) and postpone the conference report until after the November elections, at which time there will be an opportunity during the lame duck session to  slip cap-and-trade into a conference report.

An interesting question to ponder this weekend: Is cap-and-trade DOA, or will it rise from its  grave in the waning days of the Congress?

The answer may be more complicated than one might suppose. There is an assumption here that Democrats would support cap-and-trade as the preferable response to global climate change. In reality, many on the Left have never been all that happy with cap-and-trade when compared to a carbon tax or more statist alternatives. For many, there is an elemental abhorrence to market mechanisms at the core of cap-and-trade and various plans seem to provide far too many concessions to corporations (e.g., in the distribution of credits, the cost containment components, the definitions of what constitute offsets).

As Jesse Jenkins (Huffington Post) suggest, we should be happy to see cap-and trade die for some of these reasons.  In his words:

the proposed cap and trade bill was riddled with so many loopholes and cost containment mechanisms–most notably the availability of up to 2 billion dubious carbon offsets–that the effective price on carbon was too low to effectively spur clean energy innovation and adoption and the “cap” on carbon was rendered effectively non-binding.

Far preferable for many is a green industrial policy focusing on clean energy.  In Jenkins words: “the most reliably successful driver of new innovation and transformative technology changes has been an active partnership between private-sector entrepreneurs and innovators and a public sector acting as both an initial funder and demanding customer of new, cutting-edge technologies.”

My guess is that some form of cap-and-trade remains the most likely scenario, although less likely than in the early days of the 111^th Congress.

Update: A further complication emerges…Obama would likely veto legislation promoted by coal state Dems limiting the EPA’s authority to promulgate climate rules. (For anyone who is familiar with the politics of acid rain as they evolved in the 1970s and 1980s, this has a familiar feel). http://www.politico.com/news/stories/0710/40174.html

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Greens and Nuclear Power

Environmentalists are coming around to the idea of nuclear power.  This is good news – though we should be just as critical of any rent-seeking by the nuclear power industry as we would of other “green” technology companies and their allies in the government.

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Why Free-Marketeers Should Be Environmentalists (And Vice Versa)

It is no original insight to note that ecologists and economists both derive equilibrium theories from the Darwinian assumption of natural selection of the traits of successful replicators – organisms for ecologists, firms for economists. Like an ecosystem, the economy is an “emergent” or “spontaneous” order, in which the decentralized actions of countless individuals generate a complex system with properties irreducible to those actions. Michael Polanyi and F.A. Hayek distinguish these spontaneous orders from planned orders, in which a system’s operation is guided or designed by a central engineer, and argue that spontaneous economic orders yield greater social welfare over the long run than planned ones.

Similarly, naturalists find that undisturbed ecosystems find their own equilibrium, in which each organism, as if guided by an invisible hand, seems to approach perfect adaptation to its niche relative to all other organisms. Extirpating one species or introducing another risks upsetting the equilibrium and extirpating more species. Since emergent orders are characterized by “tacit knowledge” unavailable to the outsider, we cannot easily replace them with designed orders that function “as if” spontaneous. Thus, the precise consequences of disturbing an ecosystem are as unpredictable as the precise consequences of disturbing a market (Bastiat’s “That Which Is Seen, and That Which Is Not Seen” is relevant here).

The principal difference between economic and ecologic orders is that the former are composed of more-or-less rationally choosing actors, many of whom are consciously considering the ultimate equilibrium that will obtain in a given market, while the latter are composed of nonrational organisms behaving according to evolved instinct. What this means in practice is that we should expect economic orders to approach equilibrium more nearly and more quickly than ecologic orders, which must wait for generations of organisms to survive and reproduce before desirable traits are passed on. Nonrational organisms seem to learn less about assuring their collective survival over their own lifetimes than do humans.

These considerations tell us that human engineering or central planning of an ecosystem is unlikely to work for the benefit of the inhabitants. Attempting to engineer nature to our advantage will have unintended, adverse consequences for the stability of nature. Why should we care about the stability of nature? Because we are part of it. While the ultimate consequences of disturbing nature in any given case are unclear, we know that there will be consequences, more likely adverse than not.

Clearly, maintaining nature in an absolutely pristine state everywhere is not an option. But then, nor is total spontaneous order in the economic sphere (unless one is an anarchist). Moreover, both economies and ecosystems can survive and adapt to ongoing disturbance, although they may not reach peak performance. However, these considerations do indicate, contra Ron Bailey, that some kind of “precautionary principle” might make sense for both ecological and economic planning. We might do well to build into our institutions and way of life a substantial but rebuttable bias against trying to re-engineer nature or the economy.

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Putting a Crisis to Good Use

The leaking underwater oil well in the gulf has attracted much attention, as it should. The effects could be devastating for the already battered economy of Louisiana and other states dependent on tourist dollars. President Obama has announced, quite correctly: “BP is responsible for this leak. BP will be paying the bill.” The President’s response in terms of limiting the immediate damages and stopping the leak seems prudent as well. Read the story on Politico.

However, this is an election year and thus I get more than a little nervous when I read statements like: “every American affected by this spill should know this: Your government will do whatever it takes for as long as it takes to stop this crisis.”

“Whatever it takes” is a big category and one cannot see the word “crisis” without recalling the sage words of Rahm Emanuel: “You never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you think you could not do before.”

Crisis always opens a window of opportunity for policy change.  One could only hope that this and similar crises would lead to a re-evaluation of our energy policy. We have a heavy reliance on petroleum and, as everyone knows, our dependence on imports has increased dramatically in the past few decades. I am certain that the oil spill will lead to new calls for a green industrial policy and heavy investments in solar energy and other green alternatives.

There is an old saying: the first thing you should do when you find yourself in a hole is stop digging. The heavy reliance on petroleum is, in many ways, a product of past policy decisions.

As a recent study by David Victor and the Global Subsidies Initiative notes that governments around the world spend some $500 billion per year in fossil fuel subsidies. In the US, government spent $72 billion on fossil fuel subsidies between 2002 and 2008. These subsidies do not include myriad other forms of taxpayer support for fossil fuel based energy.

As we know, subsidies lead to overconsumption.  They blunt the incentives to invest in alternatives. Before we respond to this new crisis by creating new subsidies for alternative energy or initiating a green industrial policy, it would be advisable to (1) eliminate the subsidies and (2) use a Pigouvian tax to internalize the negative externalities created by fossil fuel consumption. We might discover that this alone could create the incentives for the development of energy sources that do not lead, quite predictably, to the kinds of problems we are witnessing in the gulf coast.

Unfortunately, the probability of this response approaches zero. In Congress, Republicans would gnash their teeth at the idea of an expanded fuel tax and sing the praises of “free” markets while quietly accepting campaign donations to maintain the system of fossil fuel subsidies. Democrats might be more willing to embrace a tax, but they would wither at the thought of allowing markets to create incentives for alternative fuels (oh yes, and they would never refuse the ongoing financial support of the very industries they vilify).

So what can we expect? My best guess: new transfers layered upon existing transfers combined with unsustainable promises made in the heat of an election year.

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The Ethics of the Prisoner’s Dilemma

The Prisoner’s Dilemma is a concept used to model a strategic interaction in which actors choosing their behaviors rationally according to their own self-interest make everyone worse off than they could have been otherwise. This particular “game” is used both to understand failures of cooperation such as arms races and ethnic warfare and to prescribe particular solutions designed to elicit cooperation. The key feature of the game is that, when the game is played only once, no matter what another player does (cooperating with me or trying to exploit me), I am better off trying to exploit the other player – so in the end, every player exploits rather than cooperates, and they are all worse off than they would have been could someone have “forced” them to cooperate. What has been less often analyzed, to my knowledge, is the ethics of the Prisoner’s Dilemma game.

Whether one has a duty to cooperate with others in Prisoner’s Dilemma-like situations is an important question both for policy and for daily life. Take the question of one’s duties toward the environment. The environment is in many aspects a public good subject to Prisoner’s Dilemma problems. Clean air, clean water, and biodiversity are benefits that we all enjoy, and from which non-contributors cannot feasibly be excluded. Therefore, people have an incentive to take less care of the environment than they would could the environment be privatized. Whether other people “do their part” or not, I’m better off not trying to contribute.

So let’s take some examples of things one could do for the benefit of the environment: eating less meat; polluting less by, e.g., driving less; propagating native species and destroying invasive species; reducing, reusing, and recycling; not littering; not spraying pesticides. Assume for the sake of argument that we will all benefit if everyone did these things. Do we then have a duty to do them? Would it be wrong not to do them?

I’ll derive my view from a very simple starting point: One has a duty not to exploit others, but one does not have a duty to allow oneself to be exploited. In the simple Prisoner’s Dilemma game, each player has only two options: cooperate (and be exploited) or defect (and exploit). In real life, however, there are different gradations of action, from, e.g., walking or riding a bicycle everywhere to driving a Hummer. Moreover, cooperation isn’t actually zero, and therefore cooperation doesn’t always entail being exploited. These considerations imply that some degree of cooperation in Prisoner’s Dilemma situations might actually be morally mandatory, but that devoting your life to providing public goods for others would not be.

Now, the latter part of the starting point could be made even stronger. Let’s say that not only does one not have a duty to allow oneself to be exploited, but one does not have a general duty to sacrifice one’s own interests for the benefit of others. Then, the benefits of the existing scheme of mutual cooperation, including your own, must be greater to you, individually, than the costs of your individual contribution, for that contribution to be morally mandatory. To see this, suppose it were otherwise. Suppose that your efforts on behalf of the environment, say, actually made you worse off than you would be if no one did what you did, including yourself. If that were the case, then you would be making yourself worse off for the benefit of others. That would count as a praiseworthy and supererogatory sacrifice, but not a moral requirement.

So here are my tentative conclusions. If your efforts, combined with the really existing efforts of everyone else, make you better off (taking opportunity costs into account) relative to a situation in which no one undertakes effort, then you have a moral duty to make those efforts. To do otherwise would be to free-ride on the efforts of others and thus to exploit them, which is wrong. If this condition is not satisfied, however, you do not have a duty to contribute – but it would still be praiseworthy to do so, unless the effort is clearly hopeless, in which case the impartial observer is more likely to have pity on your madness than praise for it. I actually think this is a rather strong conclusion and implies that we have a duty to undertake some (but not extraordinary) positive action on behalf of the environment, for instance. What remains interesting and unusual about the Prisoner’s Dilemma is that it models a set of cases for which the rightness of one person’s actions apparently depends on what others are doing.

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An Earth Day Wish

The environmental movement has brought some good things.  In particular, policymakers are much more prone (in some cases forced to) think about environmental costs.  Market failures with respect to pollution have been profound in the past and continue to be so.  There is a clear role for government to play in protecting the environment.

My wish for this Earth Day is for one thing: balance.  If I had been asked 50 years ago what the greatest need was with respect to the environment, I would have said (had I been alive) that we need mechanisms to internalize environmental costs.  A lot of those mechanisms are in now in place, though we need a much greater reliance on market-based approaches grounded in property rights, and we are not anywhere near an optimum, I think.

But today, the greatest threat is radicalism among environmentalists.  The radicals are, principally, not those who love the earth, but those who hate capitalism.  They are discredited Marxists taking cover amongst true environmentalists because there is nowhere else for them to go.

So if I were a candle-lighter, I would light a candle for those who are actually trying to advance the cause of humanity (much of which is still—because of lack of economic growth— in a dreadful  state) by promoting the balanced, sustainable development of the earth for all its peoples.

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