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Benjamin Zycher: Against a Carbon Tax

The common economic arguments for taxing greenhouse gases aren't persuasive. Proposals for carbon pricing and a border-adjustment tax on imports and credits on exports — the central ancillary policy needed to preserve the competitiveness of U.S. companies given the implementation of a tax on carbon — are back in the news. Various observers, public officials, and many economists endorse it as the most efficient way of addressing the purported adverse effects of increasing atmospheric concentrations of greenhouse gases (GHG).

Before addressing the analytics of a carbon tax on conventional energy and a broad swath of productive activities (e.g., agricultural operations and cement production), in pursuit of a solution to the climate crisis — the effects of increasing GHG concentrations are detectable, but there is no evidence of a crisis — let us recognize that the terms carbon or carbon emissions or carbon pollution are propaganda, the obvious purpose of which is to cut off debate before it begins by assuming that GHG emissions must be reduced as a policy imperative.

Carbon dioxide is not carbon, and it is not a pollutant, as a certain minimum atmospheric concentration of it is necessary for life itself. By far the most important GHG in terms of the radiative properties of the troposphere is water vapor, never classified as a pollutant by anyone. But why not? Is it because ocean evaporation is a natural process? So are volcanic eruptions, but the massive amounts of particulates, aerosols, and toxins emitted by volcanoes are pollutants by any definition. Unlike carbon, the term GHG has the virtue of scientific accuracy without assuming the answer to the fundamental policy question.

The arguments in favor of a tax on GHG are long-standing and fundamentally unsound.

  • GHG emissions create [climate change] problems for the rest of the economy – negative externalities – but market prices fail to reflect those adverse impacts, yielding important inefficiencies in resource allocation and indeed that potential climate crisis.
  • A GHG tax would be more efficient than a command-and-control regulatory approach because it would allow emitters of GHG to reduce their emissions at the lowest costs, that is, in ways reflecting their respective individual circumstances.
  • A GHG tax would be more efficient because it would preserve neutrality across technologies; that is, it would not be afflicted by policymakers' politicized favoritism among technologies, sectors, industries, and geographic regions.
  • A GHG tax would generate revenue, which could be used to finance a reduction of the more economically harmful taxation of capital and incomes, as well as cash transfer payments to deal with the adverse effects upon lower-income households.

Let's consider each of these in turn.

The Externality Argument

The almost-universal assumption in the public debate is that the uninternalized impacts of GHG emissions upon third parties are negative, but that premise is vastly weaker than commonly asserted because increased GHG concentrations yield benefits as well. Among those are planetary greening, increased agricultural productivity, a substantial reduction in net mortality from cold and heat, and increased water use efficiency by plants. There also are adverse effects from increasing GHG concentrations, but that analysis is complicated by the fact that both natural and anthropogenic factors are driving such phenomena as sea-level change. (Example: The sharp warming from 1910 to 1945 cannot have been anthropogenic.) Disentangling those factors is an analytical task far more difficult than the Intergovernmental Panel on Climate Change and the international industry of climate alarmists would have us believe.

The dire predictions so often heard in the media are projections generated by climate models under specific sets of assumptions about future GHG concentrations and their effects that are far from universally accepted. The central problem is that, when back-tested, those models fail to predict the past or the present; on average, they have overstated the tropospheric temperature record during the satellite era by a factor of more than two.

Accordingly, the magnitude of any negative GHG externality (even if we ignore offsetting beneficial impacts of increasing GHG concentrations) is far from clear. Even on the basis of the current integrated climate-economy models, that externality — the social cost of carbon (SCC) — falls to a number close to zero or even negative merely as a result of incorporating a discount rate fully supported by standard economic analysis.

The Relative Efficiency of a GHG Tax

The efficiency of a GHG tax (a Pigouvian tax in economic jargon) depends on how the tax rate (per ton of GHG emissions) compares with an honest evaluation of the net impacts of those emissions. The tax can be too low or too high: Are those responsible for the net cost of any negative externality being asked to pay too little or too much? If policy-makers have political incentives to choose a GHG-tax rate essentially unrelated to the magnitude of any negative GHG externality — in particular, one that is too high — then the tax loses the efficiency that is its asserted rationale. Essentially, the efficiency argument starts with the assumption that there is a need to reduce GHG emissions, and that a tax is a more efficient way of reaching that goal than command-and-control regulation.

Many economists endorse that argument, which may sound reasonable, but it ignores the incentives that drive government behavior in practice. Once government derives revenues from a GHG tax, with ensuing political competition for new spending (and the interest groups that will look to benefit from it), it is not difficult to predict that the emissions reduction goal will be inefficiently stringent; the tax rate will be too high. It might be the case that regulators as well have incentives to choose emissions goals that are too stringent, because doing so is consistent with the larger goal of maximizing their budgets. But other political factors held constant (the adverse political impacts of requirements for reductions in GHG emissions) the revenues generated by a GHG tax would move political incentives toward emissions cuts sharper than in the regulatory case.

I note in passing that the ideological opposition to fossil fuels among Democratic lawmakers, many progressive activists, and the bureaucracy would reinforce the political incentives to enact a GHG tax rate higher rather than lower. Can anyone believe that the Biden administration's current interagency exercise to estimate the SCC will produce a number lower than the earlier Obama effort?

Technological Neutrality

Congress is highly skilled at carve-outs, special tax provisions, sector-specific favoritism, and on and on. That is the very nature of the process of building a coalition in Congress. Accordingly, it is not plausible that a GHG tax would be applied in a uniform, neutral fashion across industries and geographic regions as it emerges from the congressional bargaining process.

Tax Reductions and Cash Transfers

The proponents of a GHG tax argue that a package deal to impose new costs across most of the economy, with all the adverse employment and wage impacts and higher energy costs that would result from that, in exchange for cuts in capital and income taxes disproportionately benefiting higher-income households, would be politically viable. Seriously? It is easy to envision the political ads on TV: The cost of filling Joe Sixpack's fuel tank has gone up by X dollars while the individual tax bills of the Elon Musks of America will go down by $Y million.

To be sure, there is a second element in the compensatory part of the package, which is that some of the revenue should be used to offset adverse effects upon lower-income households. This is unconvincing. In reality, the revenues will be allocated to the interest groups able to form a majority coalition in Congress.

Some industries and geographic regions will bear a disproportionate share of the GHG-tax burden, and their votes will be necessary for enactment, particularly in the Senate. They will have to be compensated; the list of potential supplicants is long indeed, each comprising some combination of constituencies to protect, and campaign contributions and votes to offer. In short, the cash-transfer and tax-reduction arguments advanced in support of the GHG tax are so unlikely to be enacted that it is difficult to believe that the proponents actually expect any such policy outcomes. This suggests that they are far more interested in the tax part of their proposal than in the transfer or tax-cut dimensions, and that the tug-of-war for the revenues will be of little concern.

Because the GHG tax would reduce the international competitiveness of many U.S. industries, there would have to be a border-adjustment tax. This would involve imposing fees upon imports from nations without comparable policies, and paying rebates to exporters for sales into nations without such policies. Apart from the huge problem of estimating the tax equivalents of other nations' GHG policies — can anyone believe that such a process would not be politicized? — the larger problem is created by international supply chains.

Goods imported from a given nation are likely to contain components and other inputs from several other nations in differing proportions, and those nations' policies on GHG emissions almost certainly will vary considerably. The border adjustment would have to estimate transfer prices — always a subjective and problematic calculation — and the effects of shifting exchange rates, changing input proportions, and a host of other complexities in order to arrive at a border-adjustment fee or rebate for a given economy. This means that a huge new bureaucracy will have to be assembled to do a vast amount of work, and efficiency is the last outcome that anyone should expect.

The GHG tax supposedly is a climate policy. But the proponents of GHG policies never tell us what impacts on the consequences of climate change are to be expected from implementation of GHG taxes, subsidies, and regulations. If we apply the Environmental Protection Agency climate model, and if we incorporate assumptions that exaggerate the future climate effects of reductions in GHG emissions, the Biden net-zero policy would yield a reduction in global temperatures of 0.173 degrees Celsius by 2100. The proposed GHG tax would yield only a portion of that trivial number. International efforts to reduce GHG emissions similarly would have very small effects. In short, a GHG tax, like almost all seemingly plausible climate policies, would be all costs and no benefits.

Watchful waiting and adaptation over time are the only climate policies that make sense scientifically, economically, politically, and in terms of the preservation of freedom.

Benjamin Zycher is a resident scholar at the American Enterprise Institute.

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Posted: June 16, 2022 Thursday 06:30 AM