Sunday, September 16, 2007

Mankiw on Carbon Taxes

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.

22 comments: said...


Very well put. I am curious about your remark that the "big money" is behind a tax approach. It does seem that somehow the buzz is on for it. I was at a seminar this past week at the University of Maryland. I heard someone who is involved with global climate policy at the World Bank going on about various alternatives. This individual made the remark that "cap and trade is passe," or something like that. I do not know what the basis of that was/is, but pretty clearly if such talk is floating around the World Bank, the buzz is out pushing for a tax. I also heard that Stiglitz is very much for a carbon tax.

One reason I can think of, besides your theory that the big money is foreseeing that a push for a tax will prove to be a political flop, is that Kyoto has essentially involved a cap and trade system, if one that has not been well implemented. And, well, obviously Kyoto has had a lot of problems, with the US and China and India and Australia staying out, quite aside from the apparent mismanagement of the carbon trading system in Europe. So, lots of people are unhappy and looking for an alternative. And, as you note, the bottom line does not seem to offer much serious other choices than taxes or cap and trade.

Peter Dorman said...

At the moment all I have to go on are rumors. As we all know, there was a big PR commitment for many years to climate skepticism. That strategy has served its purpose, but now it is time for the next phase. The rumors pertain to who is funding what, but I don't think any of it is ready for such dignity as a blog post can confer.

As you say, however, all the ducks are lining up and saying approximately the same thing: only a tax will do. I can see the political economy of this pretty clearly, I think. When all is said and done, taxes cap the cost of a climate policy. They provide a predictable price environment for investors. Cap-and-auction caps carbon. It provides a measure of certainty to a social commitment to minimize climate risk. It's a question of priorities.

Econoclast said...

Peter writes: >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.<

It's good to pay attention, but _what does it matter_ what we think? We marginal economists (not marginalist ones) have no influence on policy as far as I can tell. If we have no power, what opportunity are we losing?

Sure we can get more power. But if it can be achieved at all, it can be done with more general slogan like "fight global warming." The distinction between taxing carbon and the other "solutions" seems a bit too academic.

Peter Dorman said...

To be honest, Jim, the "we" at the beginning of the post is not heterodox economists, who, as you rightly point out, are invisible, but the activist community working on climate change policy. As a group, they are potentially a force to be reckoned with -- at least I hope so.

And the distinction between taxes and permit auctions is not academic nit-picking, IMO. The level of commitment to really bringing carbon emissions under control is quite different, and, if revenues are distributed on a per capita basis, you would have possibly the biggest and most progressive redistributive program in US history.

Anonymous said...

"Cap and trade" suffers from the following: it starts with bargaining how high the cap should be, and if succesful, the bargainers get more than they need and their trading rights are useless. By the same token, the schema achieves rather little. This happened in Poland. Some obsolete industries gobbling untold oodles of coal-based energy crumbled for "unrelated reasons" and the country has too many permits.

Things may improve because the coalition government forgot to send minister of industry to relevant UE negotiations for the next round of bestowing caps, and only minister of environment represented the country.

As we know, making steel, cement etc. did not vanish into some black hole but moved to countries with cheaper labor and, accidentally, not subjected to caps. Thus cap-and-trade can cause these industries to peregrinate, perhaps lifting the development levels of the countries they pass through.

I think that every schema suffers from similar effects. Carbon tax would probably end up riddled with assorted loopholes, starting from farmers, then more depressed regions or whatever. Probably a better way would be to increase the tax gradually and without loopholes and use the proceeds for assorted schemas helping people and industries to switch to alternative energy sources.

If the revenues are used in this fashion, then even total elimination of carbon burning from the economy will be budget neutral.

Probably some minority of carbon revenue could be devoted to causes unrelated to switching to energy alternatives, like highway maintenance, and it would be OK.

What I do not believe is that the government can impose a schema like cap-and-trade or carbon tax and just wait for salubrious consequences.

Anonymous said...

piotr berman said: As we know, making steel, cement etc. did not vanish into some black hole but moved to countries with cheaper labor and, accidentally, not subjected to caps.

How about carbon import duties for those products that got out-sourced to said countries? If the WTO objects on the grounds that said duties are ``barriers to trade'', tell them that when it comes to measures necessary to save the world, they can go perform a cranio-rectal inversion.

Bruce Webb said...

When I hear 'carbon tax' or even see the word 'Pigov' I want to reach for my pistol.

Because once the policy discussion moves from the theoretical to the practical the plan details always show a burden shift from capital to wage workers.

Mankiw's plan is typical. When asked how he would offset the regressivity he would use payroll tax. Which is to say tax all future workers to pay off past excesses of capital.

The burden shift takes many shapes and forms but it is always there.

"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”."

I doubt the word 'equity' is in Mankiw's vocabulary except for its use to mean 'common stock'. Still less that he would see equitable solutions to be something to target. He probably realizes full well there is "no densible argument", which explains why he doesn't advance one to start with.

Anonymous said...


I missed the "reduce payrol tax" part of the argument.

my god, are we just looking at another way to kill Social Security?

Anonymous said...


i am not sure i understand any of this, but if your plan is to

"if revenues are distributed on a per capita basis, you would have possibly the biggest and most progressive redistributive program in US history."

you might as well give it up and go back to reading good books.

these people are reluctant to stop selling SUV's. they are not going to embrace a scheme to redistribute "revenues." said...

Pretty much any program that has any concern about global equity will have what some might label "loopholes." After all, this was what Kyoto did regarding China and India, lettiing them off the hook for the time being. Given that China appears to have surpassed the US and is doing so well economically, it looks to me like the time has come for them to be more active, even if India might still be given some string.

I would remind one and all that back in the mid-90s, the US Senate passed the Byrd-Hagel amendment by 95-0, which said that the Senate would not ratify any agreement that did not demand sacrifices by developing countries (that is, let them have "loopholes"). Even if Gore had won in 2000, he would still have been up against this unpleasant fact in regard to ratifying Kyoto. For all his faults, in some sense Bush did everybody a favor by simply withdrawing the US completely from the treaty, given the hopelessness of ratifying it, although of course the way he did it and the assinine things he was saying and doing in connection with this put the focus on him rather than the Senate and the interests behind that more broadly supported amendment that basically told poorer countries to go stuff it.

Bruce Webb said...

Barkley. Examine China on a per capita basis compared to the United States. The could be three times as Green as the US and still have more active tonnage of emissions.

Asking them to match smaller population countries ton for ton is in fact an unfair handicap and would put serious obstacles in the way of bringing broader prosperity to the countryside.

Whether or not Kyoto struck the right balance (and considering that everyone but four countries signed on suggests they were at least close), simple formulas that don't weight for population or prior industrial base (China being much more reliant on coal than the US) seems more an excuse for US inaction than anything.

Bruce Webb said...

Coberly, from Mankiw's article

"But Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged. He proposes a tax of $15 per metric ton of carbon dioxide, together with a rebate of the federal payroll tax on the first $3,660 of earnings for each worker".

It is their answer for everything. Raise minimum wage? No increase EITC and pass the bill to the income tax, oh btw after reducing all taxes on dividends and corporate profits. And eliminating the estate tax. The policy goal is always the same, increase the return on capital and the expense of anything else. If they can achieve a social good along the way then fine, but it never quite seems to be the goal of the plan. Instead it is the sales pitch.

Anonymous said...


I am not allowed to mention the t*x word on this site (unlike "cap" , which i guess is not a t*x), but my alarm about "reduce the payroll t*x" is that it would be such an easy sell... and would turn Social Security into welfare. and we know what happens to welfare.

even if we wanted handouts from the swells.

Anonymous said...

as far as china and greenhouse gasses go, given that they start at a lower per capita than we do, that should not be a reason to "give" them a whole lot more slack.

they can start right from the beginning developing carbon-efficient ways of doing everything.

they don't have detroit to feed. they don't yet expect mc-mansions and suburban sprawl,

and i think they might find tiny little plug in electric cars for city use quite sexy.

besides they are already choking in their own smog. said...


I did not ask China to match. I know the population numbers and the history. I just said that they should do something. It is a hard political fact that the US will do nothing if China does nothing, although I fully agree that the US should do a lot more than China, still.

hapa said...

(((hello! me and some people were talking this over over there and i wrote this comment. i'm reposting it here, verbatim, so as to let you see how incredibly dumb i am. thx.)))

We can use the revenue to cut other taxes, like the income tax. The taxes we cut have harmful effects on the economy

the neolib democrats are walking right into this, consciously or not, by pairing up tax-carbon-not-employment and invest-only-what-you-raise-by-sin-tax so strongly. hello, a dog could smell the problem with that logic, from a negotiation point of view.

job training? turbulence smoothing? subsidies for facilities renovation? anything at all but buying useless shit from homeland ecosecurity contractors at a million dollars a leaf? only europeans care about how much it costs the public to offset a molecule. snort.

the only thing worse for the economy than taxes is failing to act to standardize the masses. says the strawman.

there is now a general consensus behind aggressive action to forestall the most extreme climate change

ouch. qualifiers.

no one wants to pay taxes

hmm. it's much more pleasant to hire thugs to rough up your suppliers than to do it yourself. with enough abstraction, you can even march against the violence while gaining from it.

i'm not seeing the systemic thing hitting people. shifting how water is gathered and distributed. shifting how goods are produced and distributed. the need for long-term money plans for these things, at all levels, and the invalidation of current contracts that this implies. people are acting like CO2 is a pesticide.

Bruce Webb said...

Barkley you can't cheat an honest man.

There is a certain segment of the Republican Party that is not honest at all, they are using China and India's resistance to gross tons to argue that the US doesn't need to accept per capita figures. In effect they are using "China needs to do more" to cover the position "The US doesn't need to do anything".That this a distortion of your position should go without saying, the problem is that they are more than willing to twist your words to support something you don't believe at all.

Anonymous said...

I think Peter Dornan is flat-out wrong on this, and I don't know why he keeps insisting on it.

You have to be pretty naive about political economy if you think cap and trade or permits will truly give you "emissions certainty". Industry will always say that the permit level imposes costs that are too high, and lobby first for easing permit limits and then for offsets. The offset industry will turn into a swamp of corruption. Don't take my word for this, look at the EU system.

Carbon taxes by contrast are much more transparent and easier to implement than permits. They can be done through current administrative systems. It is harder to get exemptions made because the system is more transparent.

Furthermore, in cases where the cost of abatement has been overestimated, carbon taxes can easily lead to *greater* greenhouse gas reductions than permit systems. There is no a priori reason to say that carbon taxes will give you less emissions reduction. said...


Why has the EU system gone bad? I don't think it is because of offsets. Near as I can tell, they just set too low a quantity. Do you know better?

Regarding exemptions, nobody gets exemptions with cap and trade. They buy their exemptions, if they don't already have them.

That we are not able to predict for sure which system will cut more is because we do not konw all the reaction functions, and have no way of finding out without attempting to implement them. However, Peter's (really Weitzman's) is basically correct. Assuming that either system is enforced, cap and trade gives you a definite quantity amount, whereas taxes give you an upper limit on the cost per emitter.

Bruce Webb,

Well, as of now, except for some action beginning to happen in some states and cities in the US, there is no action going on with regard to CO2 in India, China, or the US (or Australia either, that I have heard of).

Anonymous said...


On the EU system, I said business will--

lobby first for easing permit limits and then for offsets.

Both were in evidence in the EU system. First, they got a lot of permits by overestimating how expensive emissions reductions were going to be, then they allowed offsets to be purchased in all kinds of countries and the influx of offsets increased permit limits still further (to higher than planned levels). Unfortunately, I had a hard drive crash that robbed me of my saved sources on this, but the most accessible stuff might be the Economist articles from early this year. Sorry I don't have anything at my fingertips -- I'm doing a different policy area now.

On definite quantity vs. assured costs -- my point is again that assured cost can perfectly well end up bringing you more reductions than definite quantity.

I urge you guys to think hard about the political economy of this. Cap and trade is a fairly new administrative / regulatory form that is much less transparent than taxation, and admits of even more ways to circumvent it.

Anonymous said...

To continue -- there are multiple sources of possible leakage in actual cap and trade systems. Not just offsets, but banking and borrowing, and just outright exemptions when emissions demand spikes and the political system cannot handle the high costs this would impose on business (this happened in RECLAIM the southern California). Overallocation has been a persistent startup issue with programs, and very few have managed to auction a large share of permits. It's all very well to wave your hands and say your perfect cap and trade program won't have these issues, but how certain can you be of this?

I'm not saying cap and trade can't work, of course it can and has worked to reduce emissions. But why bother with the extra complexity and the vulnerability to lobbying? What are the big advantages over taxes that it brings? Carbon is a particularly good pollutant for a tax...a stock pollutant, plenty of time to figure out the reaction function in adjusting the annual flows, very flat curve for short-term marginal benefit of reduction, while the marginal cost of abatement must turn very steep at some point.

Bruce Webb said...

Barkley at the political level the argument is that Kyoto is unfair to America by putting different standards by nation on India than the United States. That this makes little sense on either a comparative development level or per capita and still less in combination is simply being ignored.