The Carbon Tax Fails the Public-Choice Test

By Veronique de Rugy

There is an argument now being made, increasingly even by self-described conservatives, that we need a carbon tax (on greenhouse gas [GHG] emissions) to address climate issues. From Democrats to a few scholars at the conservative American Enterprise Institute and more liberal Brookings Institute to the Climate Leadership Council, whose members include energy companies such as Exxon Mobil Corp., Royal Dutch Shell PLC, and BP PLC, to the Alliance for Market Solutions, the number of people rallying behind the carbon tax is noticeable.

So far, only one Republican has actually introduced a carbon-tax bill in the House of Representatives (former Rep. Carlos Cuberlo of Florida, who lost his seat in the midterms). Yet, Rep. Tom Rooney (also of Florida) just co-sponsored another such bill with a bunch of Democrats, including Senator Chris Coon of Connecticut. And it is rumored that Mitt Romney, the senator from Utah, will soon introduce his own bill.

At the heart of the support for a carbon tax (on the conservative side in particular) is the near consensus among economists that a carbon tax is a more efficient way to achieve any given reduction in emissions than is a standard system of command-and-control regulations.

It’s true that environmental amenities are not as easily divvied up into ownership shares and exchanged as are land and shoes and automobile tires. We can all lament this reality. But the difficulty of conventional markets working to efficiently price GHG emissions does not thereby render political markets a reliable means of efficiently pricing such emissions. And yet many economists blithely assume that if markets “fail,” then politicians will succeed.

Apparently, those economists are unaware of the work of both F.A. Hayek and James Buchanan. Certainly, in principle a carbon tax is an “efficient” (less costly) way to control emissions because businesses and others subjected to the tax can find the least costly ways to reduce those emissions, which is not the case with command-and-control regulations. However, for such pricing to work in a way that truly mimics competitive markets, politicians who set this tax must somehow escape the grip of both the knowledge problem and the power problem.

First, how do politicians know the “efficient” level of emissions? That efficient level would equate the marginal benefits and marginal costs of reduced emissions. But while economists can draw diagrams that show such an outcome in the abstract, no one in reality can hope to obtain enough information to discover the “efficient” level. Only the free market — that is, a system of competitive exchanges in which buyers spend their own money and sellers sell their own property — can take advantage of dispersed knowledge and determine what is the efficient price of some good or service. Unlike that standard outcome for market behavior, the carbon-tax “price” reflects the political benefits and costs of the GHG policies, which have no obvious relation to environmental benefits and the economic costs of achieving them.

Accordingly, even if politicians somehow became omniscient, their choices would continue to be driven by political incentives. It is absurd to suppose that people who excel at winning political office would, when setting carbon taxes, disregard special-interest groups and other political considerations.

An “efficient” carbon tax — one that truly solves the so-called “market failure” problem — requires that government officials first divine the optimal rate of emissions and then set the tax at a level that will result in this rate of emissions. But, to repeat, it is utterly unrealistic to suppose that politicians will achieve this outcome. Put differently, while the determination of actual “efficient” prices requires only that each party to each proposed exchange choose whether to make that exchange, using his or her own property, on the proposed terms, determining “optimal taxes” requires that politicians become godlike in their knowledge and saintly in their motivations.

If the “tax” in carbon tax wasn’t enough, this harsh reality should put to rest the idea that a carbon tax is actually a price and that such a proposal is a free market solution, as many conservatives like to claim

In fact, if you want to see how inefficient a carbon tax is likely to be, merely look at the various proposals and the rhetoric around them. As the American Enterprise Institute economist Benjamin Zycher has documented in multiple papers, most carbon-tax proposals have pretty much zero impact on climate. In fact, the most prominent carbon-tax proposals made in the United States set “the price” at approximately $50-$60 per metric ton.  At this level, the temperature effect in 2100 using the EPA climate model would be about 0.015°C, depending on various assumptions. That’s what we call no impact.

Even the most aggressive proposal, as flawed and misleading as it may be, assumes that the midpoint of the taxes on conventional energy required by 2030 to avoid severe climate impacts is $3,156 per metric ton, or more than $29 per gallon of gasoline, taxes that rise rapidly over the course of the century. So in short, even if this report were devoid of large analytic problems — it is not — the increase in taxes suggested there would be a political nonstarter anywhere in the world, regardless of whether it would achieve significant temperature changes.

All of this goes to show that the growing support for the tax doesn’t have much to do with its ability to achieve the climate goals proclaimed by the proponents. Could it have to do with another aspect of the carbon tax — namely, its ability to raise a lot of revenue? Yet, as Zycher notes, “Revenues per se decidedly were not the goal, and many proposals for a Pigouvian carbon tax incorporated reductions in other taxes so as to achieve approximate revenue neutrality.” But this is policy infused with politics, so inevitably, he remarks, “Alas, revenue neutrality is so yesterday.”

Indeed, it is common these days to attend seminars and other events on the carbon tax where the central aspect of the conversation revolves around what political benefits might be received in exchange for the carbon tax, with no or little consideration given to its impact on climate. The uses for which the carbon-tax revenues could be applied include, among others, reductions to the corporate income tax rate, financing of tax credits for workers, or general deficit-reduction goals. Some scholars and politicians would also like to spend this revenue on infrastructure or the earned income tax credit — indeed, on all sorts of non-climate-related programs.

For instance, former Rep. Carlos Curbelo’s carbon-tax bill would have put a $24-per-ton tax on GHG and directed 70 percent of the revenue to the Highway Trust Fund. Senator Coon declared his intent to use the revenue from his upcoming carbon-tax bill to "invest it in infrastructure construction and clean energy [research and development]."

In fact, many of the groups supporting the tax are not even attempting to hide the true purpose of a carbon tax. E&E News, for instance, reported that a conservative-leaning group called Alliance for Market Solutions (here again is that claim about the market) “released a study last year arguing that revenue from a carbon tax could help boost U.S. finances, such as permanently extending the tax cuts passed by Republicans in 2017.” The article went on to quote Alex Flint, the group’s executive director, saying that “it's his belief that a carbon tax ultimately will be the winner because of its ability to address both climate change and the federal government's long-term fiscal health.” Except that, as I note above, most of the levels of carbon taxes proposed so far would have no impact on climate.

In light of all this, it is hard not to conclude that the only and ultimate goal of a carbon tax is really to raise revenue, with the direct consequences to grow the size of government and shrink the size of the economy. 

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Veronique de Rugy

AIER Senior Fellow Veronique de Rugy is also a Senior Research Fellow at the Mercatus Center at George Mason University and a nationally syndicated columnist. Her primary research interests include the US economy, the federal budget, homeland security, taxation, tax competition, and financial privacy.