Wednesday, 21 September 2011

Tyler Cowen's Marginal Reservations About a Carbon Tax

A Twitter discussion broke out last week on carbon taxes. The question was, "do all serious economists favor a carbon tax?" Mostly the answer was yes. Tyler Cowen, on his Marginal Revolution blog, also favors a carbon tax, but posted some of his reservations. They are worth addressing (they are covered in my new book).

1. Other countries won’t follow suit and then we are doing something with almost zero effectiveness. 
This is true but perhaps the more relevant questions is, is a carbon worse than the alternatives? It so happens that a carbon tax will have greater pollution reduction co-benefits than the alternatives. Then, a second-order set of questions is, does a carbon tax permit, under international trade rules, sanctions against counties that don't follow suit? The answer is maybe, but a carbon tax is legally a better base form which to take trade actions than alternatives like cap-and-trade.

2. It may push dirty industries to less well regulated countries and make the overall problem somewhat worse. Yes, possibly, see #1, and plus, this may be overstated.... see Leveling the Playing Field, by Trevor Houser and others.

3. There is Jim Manzi’s point that Europe has stiff carbon taxes, and is a large market, but they have not seen a major burst of innovation, just a lot of conservation and some substitution, no game changers.  Denmark remains far more dependent on fossil fuels than most people realize and for all their efforts they’ve done no better than stop the growth of carbon emissions; see Robert Bryce’s Power Hungry, which is in any case a useful contrarian book for considering this topic. I think that reducing greenhouse gas emissions will not require so much game-changers but much smaller, less noticeable increments in conservation and efficiency, most notably in Sweden. Sweden may not have perfected nuclear energy, but it has a much more innovative environment for conservation. Kristianstad, an  80,000-person city has reduced its carbon footprint to virtually zero. Obviously, not every city can do this, but some can, which is better than none.

4. Especially for large segments of the transportation sector, there simply aren’t plausible substitutes for carbon on the horizon. Except conservation. There is a paper by Hammar, Lofgren and Sterner that found that not only do low gas prices beget high consumption, but high consumption begets low gas prices. The explanation is a political economy one -- once people get used to high consumption, and once an infrastructure gets build around low gas prices, people demand low gas prices. But that's not a reason to keep gas prices low. As Herb Stein once told Richard Nixon, "If something can't go on forever, it won't"

5. A tax on energy is a sectoral tax on the relatively productive sector of the economy — making stuff — and it will shift more talent into finance and other less productive sectors. See #2.

6. Oil in particular will become so expensive in any case that a politically plausible tax won’t add much value (careful readers will note that this argument is in tension with some of those listed above). You can't both argue that a carbon tax is harmful and that is won't have any effect.

7. A carbon tax won’t work its magic until significant parts of the energy and alternative energy sector are deregulated.  No more NIMBY!  But in the meantime perhaps we can’t proceed with the tax and expect to get anywhere.  Had we had today’s level of regulation and litigation from the get-go, we never could have built today’s energy infrastructure, which I find a deeply troubling point. Again true, but the point is, is a carbon tax better than the alternatives? At least a carbon tax is the least regulatory of all the options, including cap-and-trade, which still must monitor emissions trading.

8. A somewhat non-economic argument is to point out the regressive nature of a carbon tax. Somewhat true, but generally overstated -- see recent work by Metcalf, Fullerton, and others, which show that for *some* lower-income people, their income is derived from governmental benefits that are indexed to inflation, and would therefore grow with price increases brought on by a carbon tax. Also, work by Sarah West and Rob Williams studied gas prices and substitution, and found that even very modest revenue recycling would remove regressive effects.

9. Jim Hamilton’s work suggests that oil price shocks have nastier economic consequences than many people realize.  But a carbon tax could be big enough to constitute an oil price shock? A $30 per ton CO2 tax amounts to about $0.25 per gallon.

9b. A more prosperous economy may, for political and budgetary reasons, lead to more subsidies for alternative energy, and those subsidies may do more good than would the tax.  Maybe we won’t adopt green energy until it’s really quite cheap, in which case let’s just focus on the subsidies. There a case for limited R&D subsidies because fossil fuel industries already have a much greater market share than renewables, so renewables need some R&D subsidies just to keep up. See work by Acemoglu et al, and by David Popp. But who believes that subsidies are really, on the merits, a great idea? If carbon is what we are worried about, shouldn't we just price carbon instead of trying to lower the price of everything else?

10. The actual application of such a tax will involve lots of rent-seeking, privileges, exemptions, inefficiencies, and regulatory arbitrage. More than subsidies? More than cap-and-trade? The Waxman-Markey bill doled out $378 billion in allowances given away to industries that were at the table. It was virtually co-written with the Edison Electric Institute.

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