The Optimal Carbon Tax: A Fatal Conceit?

by Will Wilkinson on April 30, 2008

Jim Manzi graciously answers Josh Patashnik’s reply at the TNR Environment and Energy blog to my optimal carbon tax post. I find Jim extremely convincing. Is he missing something?

Viewing 10 Comments

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    In response to his first point about compliance costs, a revenue-neutral carbon tax could involve taking some other tax off the books at all. That's just what has happened in British Columbia, with the elimination of the (very inefficient) corporate capital tax.

    His second point seems to be that other forms of energy have negative externalities too. But that only counts against a carbon tax if the carbon tax exceeds the cost of GHG net of the external costs of substitute energy forms. Also, Manzi ignores the fact that if carbon is priced better, there will be all kinds of substitution effects, including accomplishing stuff with less energy use.

    His last point is that a carbon tax only makes sense if global warming is an emergency, which is just wrong. It makes sense if the benefits exceed the costs.
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    There's also some public-choice handwaving libertarians always seem to turn to when their arguments don't make sense. Since you've conceded that a politically plausible carbon tax will probably be less than the optimal amount, you can't take the public choice argument seriously.
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    The public choice argument is a sound one, I think. Basically, there is some extra cost to setting up a new tax, because you have to placate some pissed off people with bribes.

    Although, the government bribes companies everyday, for campaign contributions etc. It's not too clear that the level of bribery has to increase just because the government is pissing them off with a new tax.
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    Jim Manzi is an accomplished businessman, who he's not an economist, and his arguments aren't very convincing to anyone who is. He claims that a carbon tax is more efficient than a cap-and-trade system, while economists generally see them as identical in efficiency terms, preferring cap-and-trade because it allows policy-makers to precisely set the amount of carbon emitted, its ease of use in international treaties, and to a lesser extent, political feasibility.

    Manzi's point 2 claims the social utility created by lower gas prices as an externality, but it is not, since it's captured in the profits of the producer. There is economic incentive to produce cheaper energy, while there is not economic incentive to produce cleaner energy. A carbon tax, or a cap-and-trade system, transfers the social costs of pollution onto producers, such that there is an incentive to produce cleaner energy.

    Economists believe there's a certain type of market failure caused by products that have positive or negative externalities, and that government can effectively correct these inefficienies through excise taxes, subsidies, and other policies. Economists see fossil fuels as a product with negative externalities. None of Manzi's arguments counter these points. The fact that marginal costs of emission are hard to calculate should lead to calls for greater study, and a certain degree of care in implementing policy correctly. They don't support a policy of doing nothing.
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    Thanks to everybody for the very insightful comments. Here are a few quick thoughts.

    Pithlord:

    1. Yes, in theory we could eliminate an entire class of taxation and make that permament, but what is being proposed (as far as I know) is a recution in income tax rates at lower incomes, not a elimnation of the income tax system. (Obviously, this is all asimplification, as we would need really to look at the probability distribution of likely total compliance costs given the fixed and variable compliance costs of various tax schemes under the odds-weighted set of future tax scenarios with and without the introduction of this new class of taxation today. I think that such a question is not realistically analyzable, but it seems to me to be a clear prudential estimate that if we introduce a new class of taxation today, we increase the expected vale of future compliance costs.

    2. My point here was not that this is false in theory, but that we have no reliable way to measure these values.

    3. My point here was that the way around the "unmeasurability" argument is to argue that most such effects are unmenasurable, but that AGW costs (or, really, NPV of expected costs) is so high that it is practically measuable. This is, I think, an untanable psoition, and referenced a set of posts which in turn reference a set of articles that describe in detail why I think this is true.

    4. That's not exactly what I argued (or, at least, was trying to argue). I don't know what the theoretically optimal carbon tax would be (and I don;t think anybody else does either). What I was trying to say is that under any risk-adjusted forecast for AGW impacts, it is probably low vs. the inefficiency costs that it would, in practice, create. It is only in a "black swan" (ie, outside the currently-estimated risk PDF) event that we would be in the kind of emergency that would have, in retrospect, justified a large carbon tax. But planning as if that case is known is not wise. Ive gone into a lot of detail on why I think this in some of the artiles and posts that are linked to this one.


    Ben:

    1. You say that "He claims that a carbon tax is more efficient than a cap-and-trade system, while economists generally see them as identical in efficiency terms, preferring cap-and-trade because it allows policy-makers to precisely set the amount of carbon emitted, its ease of use in international treaties, and to a lesser extent, political feasibility."

    Here are some well-known economists with relevant expertise that I can think of off the top of my head who are on the public record as favoring a carbon tax over cap-and-trade: Greg Mankiw, Paul Krugman, Alan Greenspan, Bill Nordhaus, Ken Rogoff, Martin Feldstein, Gary Becker, and Nicholas Stern. A majority of economists surveyed by the Wall Street Journal support a carbon tax over cap-and-trade (or any other alternative): http://online.wsj.com/article/SB117086898234001...

    2. Once again, my point here was not that such an external cost does not exist, but that we can'r reliably measure it.

    3. You say that "The fact that marginal costs of emission are hard to calculate should lead to calls for greater study, and a certain degree of care in implementing policy correctly. They don’t support a policy of doing nothing."


    How is this different than saying that "The fact that marginal costs of steel are hard to calculate should lead to calls for greater study, and a certain degree of care in implementing our national policy of having the federal government set the price of steel correctly. It doesn't support a policy of doing nothing."?

    I can think of two pssible classes of arguments for how they are different: (1) arguments that resolve to the idea that one is easier to other measure than the other, or (2) arguments that resolve to AGW is an emergency. I've tried to address both.
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    Jim,

    Thanks for the timely and civil response. I don't follow your analogy between governments setting carbon taxes and governments setting steel prices. The correct analogy would be to compare setting taxes to setting taxes or setting prices to setting prices. If carbon emissions have a negative externality, placing a tax on them makes economic sense. If steel has a negative externality, placing a tax on it makes sense. In order to support a carbon tax while opposing a steel tax, you only need to argue that carbon emissions have large negative externalities while steel does not.

    Reserach shows evidence that carbon emissions definitely have a large negative externality, though the size of the externality varies between studies. No such research exists with regard to steel. The uncertainty created by the variance within the stuides does not negate the evidence they jointly present. Policy-makers should seek to reduce uncertainty by evaluating completed studies and/or implementing new ones, but the lack of precision as to the marginal cost of carbon emission does not support a policy of doing nothing.
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    Jim,

    All I can say is that in British Columbia, a right-of-centre government has been able to use the introduction of a carbon tax as an opportunity to get rid of some pretty stupid taxes on business activity. It has been subject to some populist criticism from the left, but the left is a bit immobilized by the political correctness of what the government is doing.

    I suspect that in most OECD countries, there are some low-hanging fruit of taxes that are, by any estimation, more wealth damaging than a carbon tax.

    I don't claim to have any real idea how high the NPV of the cost of the marginal tonne of GHG emissions is, and I doubt that anyone else does either. Who knows? To figure it out, you'd have to resolve insoluble questions in dozens of disciplines. However, it is surely positive, and could be quite high. The left's public-choice intuition is that it is higher than any politically-feasible carbon tax, and that makes sense to me.

    In each of a cap-and-trade system and a Pigovian tax, the government sets one side of the equation and the market the other. In cap-and-trade, the government sets the volume of emissions and the market determines the cost of a unit of emissions. In a Pigovian tax, the government sets the cost and the market determines the volume. Which one is more efficient depends on whether the planning failure in determing the optimal volume is greater or less than the planning failure in determining the external cost of a unit of emission. In the global warming case, my guess is that the uncertainties are so great in both cases that political feasibility is the more important consideration. Cap-and-trade is more feasible because less transparent, though, and that's a bit troubling, but not as troubling (I think) as bad as not doing anything.
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    Cap-and-trade is more feasible because less transparent

    Let me translate that into plain English: the difference between cap-and-trade and tax is that under cap-and-trade the past polluters get the (limited) right to pollute, which they can then sell, while under a tax, they have to pay.

    They are (assuming perfect planning) Pareto equivalent, but differ by a very big transfer of money. A very quiet transfer.
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    the difference between cap-and-trade and tax is that under cap-and-trade the past polluters get the (limited) right to pollute, which they can then sell, while under a tax, they have to pay.

    Nah, it depends on the mechanism for apportioning pollution credits. If these are auctioned, then everyone has to pay for the right to pollute, just like in a carbon tax.

    If they are handed out to some companies for free, then yes, some companies will be net sellers and make money off the deal.
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    Ciekawa strona, trafilem tu przypadkowo, ale od dzis bede wpadal czesciej, pozdro

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