– December 31, 2019
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In a previous piece, I showed that economists usually invoke considerations of externalities to justify government involvement in otherwise well-functioning markets. For this, the externalities associated with the emission of carbon dioxide are a prime candidate. The theoretical case is pretty clear: the atmospheric emissions from using fossil fuels cause changes to the planet and material harm to people around the world. Mitigating the damage and ensuring that we reorient our economies to correct for that is the problem for which taxes on carbon emissions are offered as a solution.

Even so, there are daunting operational and informational difficulties; carbon does not go entirely unpriced (we do pay market prices for fuel, in addition to excise taxes on fuel as part of general revenue-raising measures), so corrective measures — insofar as they can be justified — must be that much smaller. Causing distortionary and wealth-reducing harm in order to protect against far-off and only gradually damaging climate events — the most apocalyptic scenarios are rejected by science and serious supporters alike — seems like a worse deal than the problem a carbon tax intends to solve. This is particularly so for the poorest and most vulnerable, for whom getting richer is (even according to activists themselves) the main way to protect against adverse climate events. 

The foundational premise for eco-justice is the principle that poverty is vulnerability and that wealth protects. Even if benefits and vulnerabilities to a changing climate are distributed unevenly across the globe, a richer world creates the very resources that allow us to protect others; maximizing wealth creation and then redistributing as needed might be a better path than intentionally slowing down our economic progress. 

I see three major problems with advocating a carbon tax: first, we need to put the ecological damage into the right economic perspectives, since in the long run economic growth swamps even the most outrageous estimates of climate damages; second, the strange beast that is externalities (and the other potential candidates for corrective Pigouvian taxes); and lastly, the need for realism over utopianism in the political process — we can’t just wave our wands and put flawlessly working policies into action.

1) Perspective

In his recent book Stubborn Attachments, Tyler Cowen incessantly pushed the case for economic growth. Uncommonly for a libertarian, he made the case for a 0 percent social discount rate — that is, the premium we ought to place on the present over future generations. Normally, economists support positive (or market-generated) discount rates as problems materially exist in the present rather than the future — prioritizing the conditions of those not yet born over those currently suffering strikes me as particularly cruel. 

Cowen’s argument, like that of Nobel laureate Robert Lucas, is that over long time periods, economic growth swamps all other distributional or justice concerns, and so we ought to maximally take future generations’ material standards of living into account. No amount of regulatory tinkering, large-scale redistribution of wealth, or taxes levied on externalities could have generated today’s wealth from our sprawling ancestors a few centuries past. 

The most urgent calls for invasive climate policies today stem from research that applies very low rates of discount, as that maximizes the present value of the future harm — but Cowen persuasively shows that this also applies to the economic welfare of future generations. 

Interestingly, as a low discount rate maximizes the emphasis we put on climate damage in the future, it does the same thing for our descendents’ incomes. All else equal, writes fellow AIER writer and economics professor Vincent Geloso, “richer individuals are less vulnerable to environmental shocks than poorer individuals.” The conclusion ought to follow that making the poorest people of our societies rich (as well as enriching the poorest countries on the planet) would be the most environmentally conscious path — true eco-justice. 

More concretely, consensus estimates of the global cost of climate change report numbers like 8 percent of GDP by the year 2100. You may even double them, allowing for the most extreme tipping points and disasters, and Cowen’s point about economic growth still holds: over time, economic growth dwarfs everything. The projections of the World Bank and the UN say that the world in 2100 is likely to be richer than ours by orders of magnitude, somewhere around 300–500 percent richer than we are today: simple back-of-the-envelope calculations of 3 percent annual growth (1.03^80-1 = 960 percent richer) or 2 percent annual growth (1.02^80-1 = 380 percent richer) suggest that those numbers are in the right ballpark. 

Climate costs of 8 percent, 10 percent, or even 15 percent of global GDP are absolutely astronomical amounts (7-13 trillion dollars) that we should consider doing something about. But we should keep them in perspective and not cripple the economic growth that will allow future generations to pay for even such outrageously large expenses with comparative ease. 

In most fields, “This time is different” arguments are habitually mistaken: why, to paraphrase the British historian Lord Macaulay, with nothing but improvements behind us ought we to project nothing but misery ahead?

Over time, economic growth swamps everything else — even damages from climate change. 


2) Conceptually, externalities are quite odd

Yes, the theoretical argument for correcting externalities is straightforward, and in their introductory environmental economics class, economists eagerly draw diverging social and private cost curves. 

In reality, they are much harder to come by. Bryan Caplan argues that while

the concept of externalities is not very controversial in economics, its application is. Defenders of free markets usually argue that externalities are manageably small; critics of free markets see externalities as widespread, even ubiquitous. (emphasis added)

Caplan also shows that the negative externality of a bad thing and the positive externality of a good thing are analytically identical; corrections for negative externalities (like carbon taxes) call for similar corrections to positive externalities. 

In the recent conversation between Sam Harris and Andrew McAfee, titled “The Great Uncoupling,” the latter follows the discussion about carbon taxes with a dreamy endorsement for the “undervalued” societal benefits that come from caring for young or elderly family members. Following his Pigouvian framework, that kind of positive externality ought to be subsidized, such as through a universal basic income (UBI). Interestingly, both McAfee and Harris instantly discard UBI proposals because their negative incentive and distortive drawbacks far outweigh their positive benefits. Even though the policy does some good, it is not worth addressing. 

The dissonance with the previous carbon tax debate is bizarre. Nothing could better illustrate the striking tendencies for progressives to get the economic principle but apply it only selectively

Perhaps, Harris thoughtfully interjected, one alternative is to pay UBI only at a low enough level so as not to cancel the impetus to work. That is, he openly admits that policies to correct for negative externalities should not destroy the positive fundamental benefit that the underlying process generates. Exactly!

If McAfee and Harris re-ran the same thoughtful and balanced argument they had over UBI on carbon taxes, they’d grasp much of the intellectually honest hostility toward them. And no, Trump didn’t pay us to say that.

To keep beating this dead horse a little more: if the externality principle is held consistently rather than selectively, there are many other externalities that — perhaps more urgently — demand our attention. Many of them plague the 21st century and demonstrably cause much more present ill and many more deaths than even inflated climate damage simulations ever could:

  • obesity and the diabetes epidemic, the care for and the inefficiency losses stemming from their existence acting as an effective drag on the rest of us;
  • Deaths of Despair, the alienation and loss of community that has contributed to the opiate crisis and single-handedly reversed the long-time trend of rising life expectancy in the U.S., entailing a serious loss of production and extended division of labor — not to mention the human suffering by the people involved;  
  • the societal disaster that is homelessness and again the social, personal, and economic loss our societies suffer from an evident inability to meet those very basic needs.

If the externality principle is followed fully, the causes of these ills are prime candidates for targeted taxes. And as the harm and literal deaths from these sources far exceed the hypothetical (and mostly far-off) deaths from climate change, they would seem to be much more urgent candidates for Pigouvian taxes to correct. 

We can make externality examples even more mundane and trivial, including the nuisance from crying babies in public or the — annoyingly American — tendency for questionable fashion choices. Fully accepting the externality principle in terms of a wedge between the marginal social cost and the marginal private benefit implores us to similarly levy a fashion tax, a sugar tax, and a parenting tax. 

While absurd, these suggestions should rationally temper the conviction with which we support carbon taxes. Coupled with the fact that we’re not about to die in the immediate future (and no, Greta’s fears of a Sixth Mass Extinction are pretty far from reality), we should be less keen on implementing them. We are not about to be  inundated by rising sea levels or other scenarios of alarmist natural catastrophe; climate-related deaths have plunged over the last century, in no small part thanks to fossil fuels, by the way; and costs of climate-related disasters are not exponentially increasing (if anything, they are below historical averages when stripping out our morbid desires to build homes in more environmentally dangerous areas). 

Granted, particularly bad outcomes from climate change may reverse these trends, but it seems like those calling for strict climate policies and carbon taxes have not yet shouldered that burden of proof.

3) Realism over utopia

Markets work, if you let them. They don’t, contra utopian libertarians, fix every conceivable problem or social ill. That, as Steven Pinker likes to say, wouldn’t be progress — that would be a miracle. The point market fundamentalists raise in response to additional taxation or regulation is that markets are the best we have; comparing ideal governments with flawed markets, as Jason Brennan famously argued, is the entirely wrong comparison to make. 

In a recent review of John Quiggin’s celebrated Economics in Two Lessons: Why Markets Work So Well, and Why They Can Fail So Badly — a work that McAfee explicitly paraphrased in the interview with Sam Harris — Peter Boettke persuasively reiterates this argument: The advance of economic thinking in the last few decades isn’t that markets solve everything, but that government attempts to correct undesirable market outcomes fall way short of their imagined goals — oftentimes amounting to cures that are noticeably worse than the diseases they address (tariffs, agricultural subsidies, antitrust enforcement, and combating financial crises come to mind). 

In principle, perhaps benign rulers and omniscient scientists could navigate the many political pitfalls and optimally design a carbon tax — but among despots and ludicrous leaders left and right, is it likely?

In contrast, decarbonization, the process of getting more economic bang for our emission bucks that McAfee deserves praise for popularizing, is taking place almost regardless of what climate policies we enact. This argument, while naturally distrusting of governments’ abilities to implement policies well, gets at a more fundamental point that environmental economists endlessly quibble over: what’s the correct carbon tax rate? 

We might reiterate the economist’s tired slogan that there are no free lunches; the cost of a carbon tax can be negligible to society only if the rate at which it is levied is low enough — i.e., if it does not bite and the efficiency losses (see “tax-interaction effects”) are thus kept at a minimum. Conversely, a high carbon tax could quite possibly stem CO2 emissions but come at the expense of, particularly, the poorest. Pick your poison. 

This illustrates that carbon taxes are not a panacea. Leakage matters. Exemptions and already-existing energy subsidies matter, and the interactions of a newly levied carbon tax with the existing tax system may spoil the erudite environmental economist’s neatly laid plans. And that’s ignoring the many public choice obstacles that prevent the passing of an effective, broad-based carbon tax legislation in the first place, one that is not filled with loopholes or catered to special interests.  

Carbon taxes do alleviate some negative externalities that we might want to counter — but they come with a nasty drawback (and getting them in place requires an inefficient and opaque political process) that no caring person would want to impose on the poorest of us, namely that basic necessities become more expensive. While few shed tears for the billionaires’ more expensive vacations or the fuel costs of millionaires’ gas-guzzling car bills, we do lament energy costs for those living paycheck to paycheck. 

As a solution, some observers have argued that offsetting the higher cost of necessities for the poorest through a revenue-neutral carbon tax might solve the problem. Rebating the proceeds among the population makes the tax progressive and offsets some of the damage to the poorest in society. This might sound like a wash, but revenue-neutral taxes still have emission-reducing impacts as they change the relative price of carbon in the direction activists want. 

While it is generally unwise to rebate carbon tax revenue if the main purpose is to reduce consumption and reorient an economy — economists would rather have you do one thing well than two things half-heartedly — it might be the only way to politically get the policy passed. Economists’ second-best option might be lawmakers’ first-best option. 

Canada’s recently implemented experiment might serve as an example here. While the price of CAD $20 (rising to $50 over the next few years) is much lower than most observers think adequate, the Canadian legislature realized that people generally don’t appreciate making items for everyday use more expensive — especially for the poorest. So they decided to rebate the revenue evenly, administered through standard tax filings once a year. 

That might not be enough. A Brookings Institution report from a few years ago concluded that because of the time delay in receiving the rebated carbon tax revenue, the funds simply wouldn’t arrive fast enough for those most vulnerable segments of society; a $50 or $100 rebate at the end of the year is of little use to a family struggling to pay for gas right now. The problem, pointed out again and again, is one of liquidity rather than solvency.

What About China?

Developing countries are increasing their emissions as they grow rapidly; developed countries are reforesting and reducing their emissions as they can afford to spend on the environment. Almost all Western countries have reduced their emissions in recent years (even when accounting for consumption of items produced abroad), and given enough time and economic development, large countries like India and China will curb — decouple — their emissions too. All of this was obtained with very little assistance of carbon taxes

Sure, some countries have had a strong public-awareness emphasis on reducing their climate footprint. For all I would quibble with the histrionics of Greta Thunberg, the unofficial spokesperson of my native Sweden, she has fueled a movement of flight shaming and cutting individual emissions wherever possible. Notice how that has come about not through government regulations or taxing carbon, but through people changing their evaluations of the consequences of the choices they are making, and innovations and competitive capitalism allowing them the tools to do so. In other words, it is people and markets going about their business as usual. 

Raving about carbon taxes places thus-far unimpressive hope in having an ineffective sector of society apply an underutilized tool in order to address a problem that we are already solving. It strikes me as an unnecessary Hail Mary rather than a slam dunk, if I may mix my sports metaphors. 

Instead, countries could keep sliding down the far side of their Kuznets curves — the observed tendency for countries’ emissions to rise when they grow, but then stagnate and fall after they’ve reached a comfortable standard of living. 

In Sum: Little Gain or Mostly Pain

A carbon tax, far from a solution to rally around, may at best be a minor tool in an overall strategy, insofar as we want to speed up our transition, willingly shouldering the burden that places on the poorest — or cleverly reimbursing them for it. 

Implementing a carbon tax is far from the no-brainer Harris and McAfee seem to believe, and its impact is unlikely to do more than marginally accelerate a process that capitalist markets are already fueling. Political “solutions” to climate change are, as every activist monitoring the COP negotiations should know by now, largely ineffective.

There are legitimate concerns that serious Pigouvians must consider. The benefits of carbon taxes are theoretically plausible but practically either naïve or exaggerated. Where, how much, and in what way carbon taxes may be implemented are open questions over which serious people may quibble. Believing the fairytale that carbon taxes are slam dunks is both mistaken and intellectually vacuous. 

Hopefully, this overview may remove some of the ideological blinders that Harris and McAfee displayed in their otherwise informative conversation. On the topic of carbon taxes, much dispelling of wishful thinking is needed. 

Joakim Book

joakim-book
Joakim Book is a writer, researcher and editor on all things money, finance and financial history. He holds a masters degree from the University of Oxford and has been a visiting scholar at the American Institute for Economic Research in 2018 and 2019. His writings have been featured on RealClearMarkets, ZeroHedge, FT Alphaville, WallStreetWindow and Capitalism Magazine, and he is a frequent writer at Notes On Liberty. His works can be found at www.joakimbook.com and on the blog Life of an Econ Student;
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