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Amplifying Oren Cass on a Carbon Tax, Part 2

Summary:
Even professional economists, take note. Cass makes a great point that I haven’t seen stressed anywhere else. I’ll quote him first, then I’ll quote from my article to elaborate on his insight. CASS: Nor does describing a carbon tax as “revenue neutral” do anything to improve its appeal. Promising to use the revenue for tax cuts or a rebate does not guarantee its best use or a net positive economic impact, nor does it make the policy somehow free. To the contrary, a revenue-neutral tax is guaranteed to be costly precisely because it holds government revenue constant while also increasing costs to private actors by driving them toward higher-cost energy technologies. The effect is most obvious in a world where the tax has driven emissions to zero, and government

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Even professional economists, take note. Cass makes a great point that I haven’t seen stressed anywhere else. I’ll quote him first, then I’ll quote from my article to elaborate on his insight.

CASS: Nor does describing a carbon tax as “revenue neutral” do anything to improve its appeal. Promising to use the revenue for tax cuts or a rebate does not guarantee its best use or a net positive economic impact, nor does it make the policy somehow free. To the contrary, a revenue-neutral tax is guaranteed to be costly precisely because it holds government revenue constant while also increasing costs to private actors by driving them toward higher-cost energy technologies. The effect is most obvious in a world where the tax has driven emissions to zero, and government revenue comes from all of its pre-tax sources, except consumers also find themselves motivated by the tax’s existence to pay the full cost of electric vehicles and solar panels. In this respect, the tax operates much like the minimum wage; it imposes large and plainly government-created costs in the form of “off-budget” spending for which the government is never held accountable. [Bold added.]

And now here’s me, amplifying the above:

Suppose that the U.S. government implemented an outrageously high carbon tax—something like $2,000 per ton—and enforced it vigorously. The price of conventional gasoline would skyrocket some $16 per gallon, while electricity prices would soar because coal- and natural gas-fired power plants would suddenly have outrageous taxes to pay.

In this regime, the amount of U.S. carbon dioxide emissions would fall drastically, so that even with the very high rate of carbon tax, it’s possible that within a decade very little revenue would be coming in. (Remember, total carbon tax receipts per year are annualtons of emissions multiplied by carbon tax per ton.) In this scenario, the tax rates on labor and capital would have to be basically what they were before the new, draconian carbon tax, because of the assumption of “revenue neutrality.” In other words, if the draconian carbon tax isn’t bringing in much revenue since the carbon base gets driven to basically zero, then there isn’t much in the kitty to offset the pre-existing taxes.

So what can we say about the state of the conventional economy? It clearly isn’t benefiting from any “pro-growth” kick emanating from “Pigovian tax reform.” No, in this extreme scenario, the pre-existing distortionary taxes haven’t been cut at all.

However, the situation isn’t simply a wash. Even though it’s not bringing in new revenue, the massive $2,000 per ton carbon tax is definitely forcing Americans to alter their behavior. Nobody would be driving gasoline-powered vehicles, and all coal- and natural gas-fired power plants would be shuttered. Americans’ standard of living would have collapsed, as transportation and energy had become outrageously expensive.

It’s not enough just to observe, “Greenhouse gas emissions are a negative externality while we want to encourage work and saving.” The numbers matter. Even if “taxing bads, not goods” leads to a “win-win” upfront, it’s possible that the numbers move and cause the flipside to occur in a decade or two.

Let me make sure the reader understands the point of my exaggerated example. I picked a ridiculously high carbon tax of $2,000 per ton to make Cass’s point crystal clear. But even at a more moderate level, we still have to take into account the subtle mechanism at work: The more successful a carbon tax is at inducing people to alter their behavior, then the less revenue it raises. The impact of a carbon tax on the conventional economy is not necessarily directly proportional to the amount of revenue it raises, and so in general we can’t rely on catchy slogans like “tax bads, not goods.” To assess the economic cost of complying with a carbon tax—which could be compared to the ostensible benefits of avoided future climate change damages—we need to look at specifics. A very low carbon tax rate won’t raise much revenue, and so won’t allow for much tax reduction elsewhere, but on the other hand a very high carbon tax rate might not raise much revenue either.

Robert Murphy
Robert Patrick Murphy (born 23 May 1976) is an American economist, consultant and author. He is an economist with the Institute for Energy Research (IER) specializing in climate change and a research fellow with the Independent Institute, He was a senior fellow in business and economic studies at the Pacific Research Institute, and he is an associated scholar at the Ludwig von Mises Institute. In addition to economic subjects, Murphy writes about, and has presented an online video class in, anarcho-capitalism on the Mises Institute website. Murphy also has written in support of Intelligent Design theory and expressed skepticism of biological evolution.

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