Monday, March 5, 2012

Why We Should Replace All Federal Taxes with a Carbon Tax

I am actually writing my research paper for writing class on this topic, so please message me any comments/concerns.

Global warming may be the arching problem of the next few generations.  No, it will not bring about the end of human civilization.  However, there will be devastating tragedies, some of which we are already experiencing.  There is a legitimate choice that we need to make.  Humanity is going to pay for climate change whether we like it or not.  I am not going to harp on about the consequences, but if we want to minimize the effects, we need to drastically reduce pollution.  Now, even if the United States eliminates all of its pollution, there is still going to be a major problem if developing nations like China, India, Indonesia, and South Africa industrialize through coal and oil. 

Although some hope (and even believe) that we can simply innovate our way out of the problem with technology, the prospect of this is dangerously unfeasible.  It is going to require a complete transformation of the world economy.  It is going to take a whole lot more than buying compact fluorescent light bulbs, buying a hybrid car, going to the farmer's market, and getting energy efficient appliances.  Energy efficiency is great, but only if it actually leads to a decrease in energy consumption.  I am going to be blunt: it will cost us a lot of luxury to reduce our carbon dioxide emissions to tolerable levels.  It may not even be possible.  So why should we even try?

The basis of economics is the study of scarce resources.  And like it or not, the primary energy sources (coal, oil, natural gas) for today's society are limited.  Perhaps they will last a few hundred more years, but the cost is ever-rising.  We have already reached a peak of cheap oil, turning to tar sands and high sulfur crude.  Once again, we will have to pay eventually.  The only question is how to limit the damage, how to seamlessly transition for a high-pollution, fossil fuel-based economy.  It will not be as simple as replacing the grid with the elusive "too cheap to charge for" nuclear fission or pie-in-the-sky fusion.  And you are living in a fantasy land if you think that we can even come close to maintaining our current levels of consumption.  No, we are going to have to employ the scorned upon notion of conservation.  We have to cut back.  We have to drive less, bike more, travel less, eat more sustainable foods, move to cities, and use less electricity.  It does not have to destroy our quality of life.  But the path to such a society matters.  

The idea behind a pollution tax is simple: pollution is bad, so we should discourage it.  Arthur Pigou was one of the first economists to popularize the concept of taxing negative externalities.  In an ideal situation, the damage to society of a good is equal to its price.  In a free market, there is no value on the “external” costs of a product, such as the negative health effects of pollution.  Therefore, the price of “bad” products should be raised to the true societal cost.  Unfortunately, it is difficult to measure the true cost of global warming.  The necessary price of carbon dioxide to provide a sufficient revenue stream might well be higher than the harm that global warming will cause.  However, the increased chance of a completely devastating natural disaster may render action necessary at all costs.  Either way, taxing carbon dioxide will lead to lower overall emissions, which benefits society even at low levels of output.

The basic premise of a consumption tax is actually quite conservative.  One argument is the simplicity of a tax on the purchase of goods as opposed to taxing wages.  Income is difficult to measure and to keep track of, and the tax code is rife with loopholes and deductions.  Simplifying the code to a basic tax on the sale of products is going to reduce noncompliance.  Another criticism of the income tax is that it penalizes labor: taxing wages causes people to work less.  A consumption tax rewards investment and saving by raising the price of immediate consumption.  The combination of these effects leads to greater economic efficiency.  A carbon tax is basically a targeted tax on consumption. 

The magnitude of a carbon tax to replace federal revenues is hard to comprehend.   Imagine gas prices at $15 per gallon, electricity prices at $1 per kilowatt-hour, airplane tickets costing three times as much.  A carbon tax would effectively act as a national sales tax.  But therein lays the beauty of it.  Conservatives have already proposed replacing the income tax with a national sales tax.  If global warming were not such a politically contentious issue, then Republicans would enthusiastically embrace such a proposal.  Alas, this is not the case.  Al Gore's suggestion that payroll taxes get replaced by a revenue-neutral carbon tax was wrongly tossed aside.  I embrace his proposal and would like to take it significantly further.

A large carbon tax is not without its own set of complications.  Let us start by examining the liberal objection: any sort of a consumption tax is going to severely target the poor.  Yes, lower income people consume a far higher percentage of their earnings.  In addition, a carbon tax would even target people who have zero income.  This is concerning, but it would be far too complicated and simply unnecessary to leave the poor out of it.  After all, the planet does not discriminate as far as emissions are concerned.  However, there are still ways to make sure that the tax structure remains progressive.  One way is a lump-sum rebate: give everyone a bundle of money back.  This would necessitate a higher rate, but because the poor consume carbon disproportionately to their income, they would benefit more.  Another proposal is to only give money back to people making below a certain percentage of income.  The rebate system could be set up so that the overall tax progressivity is similar to today's structure.  A low-pollution, climate change-free world offers additional benefits for the less fortunate.  Climate change is likely to have a significantly greater effect on the poor, since they are less mobile and less able to adapt.  They cannot afford to move out of high-risk areas (like New Orleans) when the time comes.  A carbon tax is certainly not socialism, but it is not going to exacerbate income inequality more than simply allowing climate change to happen.

So what about regulations?  Why can't we simply mandate a reduction in emissions?  Why don't we require alternative fuels or renewable energy?  Why can't we provide rebates for "green technology" instead of raising taxes?  Well, we are already employing all of these tools.  The EPA has the authority to regulate greenhouse gases, but it is not easy to do.  And many states have adopted renewable fuel standards.  However, without economic incentives, these are impossible to meet.  The cost of renewables (and nuclear power for that matter) is simply too high for a large-scale transformation.  Mandatory emissions-reduction programs are not usually successful.  Even the enviable European countries are having trouble meeting their Kyoto targets.  Canada has pulled out of Kyoto in lieu of paying fines for failing to sufficiently reduce pollution.  CAFE standards require new cars to get 50 mpg by 2020.  This will help some, but it does nothing about the millions of cars that will remain on the road.  An increase in the usage of solar energy is not going to do anything to reduce pollution, only a decrease in fossil fuel use will.  Tax credits are simply not an efficient way to subsidize green technology.  They are too targeted and are highly regressive.  You aren't going to see families making under $50,000 a year buy a Tesla, solar panels, or even a new washing machine.  Tax breaks are also often wrongly targeted.  For example, corn ethanol is subsidized nearly $2.00 a gallon (including tariffs) when it provides little to no pollution benefits.  Simply raising the cost of pollution is a far simpler, far more effective method of encouraging new technologies.  Unlike with direct subsidies, technology is subsidized by its actual effectiveness in reducing pollution rather than the political clout of interest groups.  A carbon tax is also an extremely helpful motivator for conservation.  Sometimes, the best technology to use is no technology at all.  Drive less, use fewer lights, and hang up your clothes.  An extremely high price of energy would force middle class Americans to think twice before moving to the suburbs.  It would be a boon for urbanization and for public transportation.  These are all results that a simple sales tax, without regard to the harmfulness or benefits of the goods that are sold, cannot achieve.

The other market-based proposal that has garnered some more political support has been cap-and-trade.  This would also set a price on carbon, one that would specifically target a certain level of emission-reduction.  Carbon credits would be exchanged between companies.  A company that reduces its carbon footprint can sell its credits to a higher polluter. Such a system worked in the 1990s to dramatically reduced sulfur emissions.  It would certainly be at least as effective in achieving its pollution goals as a carbon tax if executed properly.  However, cap-and-trade is difficult to regulate.  It is easier to levy the final tax on the consumer than to worry about how many credits manufacturers get and the specifics of selling pollution permits.  Cap-and-trade is going to raise prices just as a tax would, but none of the money would go to the government.  With a direct tax, the government gets more revenue, which can be used to offset the complicated and inefficient tax code.  A carbon tax is the simplest and most effective method of combatting global warming.

So can a carbon tax actually work at significantly reducing pollution?  On the technology side, the impact seems obvious.  Increasing the price of fossil fuels is implicitly a huge subsidy for renewable energy.  Tripling the cost of coal would make solar energy close to cost-competitive with current technology.  The idea that it would change people's behavior is less certain.  We learned in introductory economics that the price elasticity of gasoline is less than 0.01.  This means that raising gas prices by 100% even will result in only a 1% decrease in demand.  However, the long-term price elasticity is estimated to be closer to -0.5, although it is going to be lower in the face of large price increases.  Still, the response is significant.  Of course, a large decrease in emissions creates its own problems.

How are we going to collect enough taxes to fund the government if a carbon tax actually works?  Of course, if the pollution is reduced enough, the government may no longer have significant funds to run.  It does not make sense to further raise the tax rate beyond this point, as there will be little, if any, increase in revenue.  If pollution is low enough, it is not even causing significant harm.  In this scenario, I would favor a progressive consumption tax. It can be gradually phased in as revenues would otherwise decline.  It would maintain the current progressive nature of the tax code while providing conservatives with their ideal, simplified tax system.  A consumption tax still discourages the excess purchase of disposable goods, so there is still some environmental benefit.  We can only hope that this situation arises.

The real question that is going to decide the merit of a carbon tax is the value of time.  If this generation is all that matters, it is probably not worth it to reduce fossil fuel usage or significantly cut pollution.  If we are serious in our efforts, it is not going to be easy.  The idea of actually using less energy is not easy to tolerate for most Americans, especially the middle class.  The likely mass urbanization might forever end the suburbs, and will all but eliminate rural towns.  Hundreds of thousands of Americans might be permanently out of a job as coal and oil companies scale back on mining and refining.  New, disposable goods are going to be too expensive for most people to consider buying.  Given the limited supply of natural resources, the transformation to a more sustainable, less disposable economy is inevitable.  I do not think that we should immediately destroy the economy by implementing a full-blown tax now.  However, within the next ten to twenty years, the tax can be gradually phased in.  This will give time for technology to improve and for people to adapt.  Colleges are going to have to shift their major programs, and some people may have to go back to school in order to find a job.  Sure, there will be an influx in “green jobs,” but the job market is going to change forever.  The economic benefits of a shift towards a sustainable, low-pollution society are easy to see: better health, better efficiency, and more diverse and creative energy sources.  However, it is ultimately not the economics, but the social reality that will determine the ultimate policy.  If all you want is to feel good driving your Tesla, eating your veggie burger, and admiring your solar roof, then sit back and relax while the planet does not notice.  A large-scale carbon tax is the least costly, most efficient method of actually combatting global warming.  It will take more than just the United States to solve the problem, but we have to start somewhere.  In the end, the sacrifice will be well worth it.


  1. Posted by 42apples at 4:20 AM <-- lol

    Could a strict carbon tax disadvantage industries in the US as compared to countries with laxer taxes/laws, and would this be significant?

    Good post. You should join the school newspaper or run for office or something.

  2. Yes, although a reduction in other taxes would blunt some of the impact. There is always going to be leakage when countries have different regulations and tax structure. Some people have speculated that California's climate bill (AB 32) is just going to move emissions out of California. Hopefully other countries, including China, will also enact significant carbon taxes. And I guess I should be more clear in that I don't think that it should happen overnight. I think we should start much higher than $30 a ton though, perhaps at $100 a ton. I would tie it in with a progressive consumption tax to collect the rest of the revenues.

    Also, I just had a conversation with someone who's fairly conservative and he said that a carbon tax would be amoral because it's manipulative. I'm not really sure I follow that, since all taxes are in a sense manipulative. Income taxes manipulate wages and employment, consumption taxes manipulate saving, capital gains taxes manipulates investment, etc. A carbon tax simply discourages bad spending more than an income tax or straight consumption tax would.