The drumbeat for carbon taxes has begun in earnest, and if we don’t pay attention we may wake up one morning a year from now and find the issue has been settled and a rare opportunity has been lost.
Mankiw has a piece in today’s New York Times that says the intellectual battles are over, and now it’s time for a grand coalition to put a tax on carbon. He gives these arguments:
1. Carbon taxes use a tried-and-true method for curtailing something we don’t like, in this case pumping carbon into the atmosphere.
2. We can use the revenue to cut other taxes, like the income tax. The taxes we cut have harmful effects on the economy, so we reap a double bonus: less bad stuff (carbon emissions), more good stuff (economic growth).
3. The only alternative to taxes is cap-and-trade. This opens the door to giving away carbon permits (bad), and if we somehow manage to auction them the result is identical to a carbon tax.
4. Each nation can set its own carbon tax, so we don’t have to worry about coordination. A global permit system would enable polluters in the US to buy carbon offsets in China.
In each case Mankiw is wrong, in some a little, in others a lot. It all adds up to a questionable sell job.
1. Yes, putting taxes on things we want to discourage is an old, time-tested idea. (Incidentally, it long predates Pigou. Do you remember a harbor fracas just before the American Revolution?) But so is issuing permits. We have permits for hunting and fishing, also for marriage. (One to a customer.) Neither involves reinventing the wheel.
2. Mankiw makes this argument because he believes that income, corporate profit and other taxes prevent the economy from reaching the free-market bliss it could otherwise attain, He knows government has to raise money, but he thinks it causes wicked distortions when it siphons off some of the earnings stream. This is faith-based economics, however. There is no systematic evidence that the income tax leads people to work less, and even if it did, it may just be the case that many of us should work less. If Mankiw’s travels take him to Cornell, he should have a Frank discussion on this topic.
But relying on carbon taxes is also a terrible way to finance the government. We are talking about half a trillion dollars or so in revenue, so the percentage of financing would be quite large. Income fluctuates, and that is a problem, but the spending on a particular set of items, like fossil fuels, has the potential to fluctuate even more. Example: suppose we really are facing an oil production peak, and scarcity causes the price to spike? Every 10% rise in oil prices will tend to cause something like a 5% reduction in long run demand (I’m rounding here – and thanks to Gar Lipow for his valuable work in collating the evidence), but this also means less carbon tax revenue, potentially a lot less. This is a serious problem, one that the green taxers have not really confronted.
3. Cap-and-trade and cap-and-auction are two entirely different animals. The first gives away the permits to historic polluters, the second asserts the public’s ownership of the commons and charges a price for its use. It is true that the dominance of wealth over our political system often leads to giveaways like cap-and-trade, but that’s a fight we can’t avoid in any case.
The real wonder here is that Mankiw could make such an elementary economics error as to suggest that taxes and cap-and-auction are “effectively” the same. In an uncertain world this is false. From a conventional benefit-cost perspective, Weitzman showed long ago that there were important differences depending on the slope of the marginal benefit and cost functions. Translated into common English, if we are uncertain about the long run relationship between the price of carbon emissions and the amount of emission – and we very much are – and if the risk of allowing too much climate change is greater than the risk of economic indigestion from trying to be too green – which seems pretty clear to me – then permits are the right choice. By controlling the number of permits we control our most important impact on the earth’s carbon budget, but allow prices to wander. By setting a tax we control the price but allow the amount of pollution to wander. That’s a big difference: you might say, given the gravity of what is at stake, that it’s the difference between ecological responsibility and irresponsibility.
4. Both taxes and permits create the same problem. If one country takes stringent action of either sort and another doesn’t, producers in the less-green country get a competitive advantage. If you have a permit system, they don’t have to pay for the permits; if you have a tax system, they don’t have to pay the tax. What to do? There have been mumblings from Europe about a green tariff to offset these differences, which makes sense to me. This is a discussion we need to have no matter what system we put into place.
Mankiw doesn’t seem to have paid attention to the global debate about climate equity. In the long run, there is no defensible argument against allotting each of the planet’s residents the same carbon “space”. In the short run, the rich countries start out with more because they can’t cut back to the sustainable level immediately without causing themselves and everyone else grave harm. But they also have an obligation to take action first and more aggressively since it is the accumulation of carbon in the atmosphere that causes the problem, and us industrialized types have been adding to this accumulation for a hundred years or more. Kyoto was a bumbling attempt to implement this ethical framework; hopefully we will do it better in the future.
The reason we need global action is that it is a global problem. Countries that fail to act free ride off of those that do. This points to the need for a stronger climate treaty, but no such treaty would try to tell countries what methods they should use, only what results they should be held to. So Mankiw’s discussion of taxes vs permits in the global context is confused and, in the end, irrelevant.
Bottom lines: (1) Although we still have (soon to be extinct) dinosaurs blocking the path, there is now a general consensus behind aggressive action to forestall the most extreme climate change. If Mankiw had published this article five years ago I would have welcomed it. Today, however, the question is what to do about the problem, and I would strongly encourage those who put ecological responsibility and social justice first to stick to their guns. We should have permits because they put the planet first, and we should auction them and distribute the revenues on a per capita basis because it is fair and economically sound. (2) It is a mistake to get drawn into a debate over how high to set carbon taxes. No one wants to pay taxes. The result will be a half-hearted effort riddled with safety-valves and loopholes. Perhaps this is why the big money is behind a tax approach: they know they will be let off the hook. When we talk about how many permits to issue, on the other hand, the debate is over how much carbon accumulation, and therefore how large a risk of catastrophic climate change, we are willing to accept. That’s the conversation we need to have.