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?


10 thoughts on “The Carbon Tax and Fiscal Responsibility

  1. Mark, I find myself agreeing with pretty 100% of what you are saying. Does that scare you?

    My only difference is that I would probably use some carbon tax revenues to subsidize green technologies, but I’m intrigued by the green-gray coalition.

    1. I have little reason to suppose that subsidies for green technologies would be anything more than corporate welfare payments that would be used for political purposes. Perhaps I am wrong on this one.

      1. Quite possibly. What about relatively straightforward subsidies, such as consumer subsidies for high m.p.g. autos.

  2. Marc,

    While I too favor a carbon tax, I do so only as an alternative to other more negatively distortionary taxes. I could also be sold on it if packaged with spending cuts so that other tax rates could be cut and the overall rate of taxes would stay the same.

    But I don’t see how it is a greater condition of justice – even in the world we can have vice one we cannot – for taxes to grow absolutely or as a percentage of GDP.

    Aren’t we taxed enough or even too much (the latter is my view)? – and so adding this tax to pay for certain programs will only allow the government to avoid trade-offs that it must confront in the absence of new revenue sources?

    Isn’t the carbon tax a la Eisner and Wilson simply rationalizing big government at a moment in which realities are going to mug us into economic conservatism?

    As a positive prediction, I could see your plan flying – which makes it so dangerous, not worthy of praise!

    1. I would strongly support shrinking the state. I would love to eliminate all tax expenditures and means test Social Security and Medicare. Believe me, when I did the exercise at the NYT I had no problem creating a surplus. But in reality, the large entitlements are here to stay and thus the huge unfunded liabilities. I would love to see the carbon tax be used for tax shifting purposes after we covered our unfunded liabilities and brought our debt down to acceptable levels. If that could be hastened by programmatic changes, all the better. But I don’t see these kinds of changes on the horizon. Yes, is a handful of responsible legislators but the vast majority of legislators understand that any significant reduction in entitlements would result in electoral defeat. Vote maximization drives everything. If I am correct in this assumption, then we can either try to find a funding mechanism or wait for everything to collapse. I would pursue the former approach while appreciating the fact that we simultaneously brought significant change to our energy policy.

  3. I would favor doing nothing about CO2 emissions and instead deal with whatever negative/positive externalities happen to occur whenever they happen to occur.

  4. America is fiscally bankrupt. The fiat currency system is unsustainable. The welfare/warfare state is unsustainable. Socialism always bankrupts itself and destroys a nations economy. The political class in America is too big and too entrenched. The only answer is a gradual,say over 30 years or one generation, dismantlement of the American welfare state. Unless this is done America will degenerate into a police state in which not only our standard of living will be destroyed,but our Constitutional liberties will be trashed forever. As of today,we are well on our way towards this abyss of a new dark age. Tinkering with the tax systems will not change anything, America is too far gone. Only a complete about face and change of direction can save whats left of the American Republic. Whether America has the political will to go down this path is highly unlikely. We are doomed to the trash heap of historically failed Republics. As Rome went,so will America.

  5. CO2/climate research hasn’t graduated from infancy, science takes more than one generation to arrive at accurate predictive models. We should no more change government policy for that than we should have let phrenologist present evidence of criminal propensity, or given the nobel prize to Egas Moniz for introducing the lobotomy as treatment for schizophrenia. Theories have a voice at policy discussion, but let’s not shush political, economic, religious, liberal, arguments in deference to bombastic experts; the baby voice of climate science should be ignored.

    Until a few months ago, the evidence was conclusive, and the expert consensus firm, that homo sapiens did not breed with neanderthals, and that’s been studied longer and by more people than integrated “climate science”. Now its dead wrong.

  6. I’m really buying the argument for more government intervention here. I mean, we’ve demonstrated there IS a problem. We’ve proven that the data has NOT been fudged and that the “scientists” working on it are not pushing a political agenda. And, since the government has been so effective at replacing the free market in the past, why not give it a whirl with our entire energy industry on the line? Fuel prices aren’t that high, right? And besides, it’s a small price to pay considering that we’d be saving the world, according to some obscure british climatologist’s model. Except that human co2 emissions comprise an almost insignificant minority of alleged “greenhouse gases”, and this policy of “cap and tax” will effectively ENCOURAGE maintaining the current levels of emissions, which, even according to the most deluded climate alarmists, will not solve anything.

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