Monday, January 5, 2015

Carbon Tax or Carbon Rights?

Larry Summers has a very nice Financial Times oped, "Let this be the year when we put a proper price on carbon" Greg Mankiw has also written extensively and eloquently in favor of a carbon tax, for example here.  Jeff Miron has some interesting skeptical thoughts, recently here.

I agree in principle.  But I have some important qualifications, and some suggestions for framing to broaden the appeal of the proposal substantially. I also think that individual rights may be better than a tax. What matters, really, is a carbon price, and there are different ways to bring that about.

I don't want today to get in to the debate about climate science. How big of a problem is human released carbon and other greenhouse gasses? Are the big computer models accurate? I don't want today to debate the larger economic and policy questions:  How much economic cost is there really? Are there mitigation strategies? Are there more pressing environmental or economic problems? (Species extinction due to habitat loss, old fashioned water and air pollution, etc.)

Too much of the policy discussion focuses on the scientific debate, as if the economic and policy answers follow unequivocably once that is settled. They are not. Let's talk about the second half today.

A Trade

The strongest case for a carbon price is, I think, that if we're going to have anti-carbon policies and energy conservation policies -- and we do, and we are, like it or not -- then a carbon price is a far better way to implement them than direct regulations.

Prices aggregate information. Should you buy a second electric car for short trips? It costs carbon to build a car. Prices tell you. Prices are powerful incentives, which get people to do on their own what they resist by fiat. Prices induce all sorts of creative responses, and regulations induce creative countermeasures. (My daughter, then 8, turned to me one day and said, "Dad, if they make people buy high mileage cars, won't people just move further away from work because it's cheaper to drive?" Proud dad story.) And a uniform price makes sure you spend money efficiently.  If you spend a hundred billion dollars on a high speed train that saves a thimbleful of carbon, that's a hundred billion dollars that could have saved a lot more carbon.

Phrasing the issue my way should help to sell the carbon-price project should to people a bit doubtful about the climate projections. In the extreme, one could argue to the most anti-carbon group, "look, if we're going to waste money, let's minimize the damage."

So I think Larry and the other carbon tax proponents would get further if they were to offer a deal: Let us have a carbon tax, and in exchange we will get rid of all the other horrendously inefficient laws, regulations, tax credits, and other attempts to nag us inefficiently to lower energy consumption and carbon emission.

Accept a carbon tax, and in return, we dismantle gas mileage regulations, electric car lanes, electric car credits (every $100,000 Tesla driving down Sand Hill Road is the beneficiary of $7,500 Federal tax credit), mandates to install recharging stations, ethanol and biofuel mandates, windmill credits, subsidized loans, alternative energy boondoggles, energy efficiency standards on appliances (by which Whirlpool reportedly pays no taxes), solar panel credits, the incandescent light ban, and so on ad infinitum.

A taste from the 2014 tax extenders -- these are only some extenders, not the baseline!
  • the tax credit for residential energy efficiency improvements;
  • the tax credit for second generation biofuel production;
  • the income and excise tax credits for biodiesel and renewable diesel fuel mixtures;
  • the tax credit for producing electricity using Indian coal facilities placed in service before 2009;
  • the tax credit for producing electricity using wind, biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic renewable energy facilities;
  • the tax credit for energy efficient new homes;
  • the special depreciation allowance for second generation biofuel plant property;
  • the tax deduction for energy efficient commercial buildings;
  • tax deferral rules for sales or dispositions of qualified electric utilities; and
  • the excise tax credit for alternative fuels and fuels involving liquefied hydrogen.
If you accept a carbon tax, the proposal should be, we will permanently dismantle all of this. Yes, this means dismantling much of the department of energy and EPA.

(We could also stop subsidizing energy use first, including zoning laws that force a lot of needless driving, housing policies that encourage too-large houses, and so forth.)  

Why are some economists still skeptical about carbon-price proposals? I think that many are rightly wary that the carbon tax will just be added on top of this rot, and worse that the proceeds of the carbon tax will be used to funnel more money to crony energy boondoggles. At a minimum, that is a strong reason to offer a revenue-neutral tax rather than to bundle it with plans to spend the revenues on "infrastructure." Let infrastructure live on cost-benefit analysis not a dedicated stream.

To get a carbon tax, I'd like to hear proponents loudly offer this deal, in a way that skeptics will perceive as enforceable.

A Uniform Tax

Larry touches on an important issue that will pollute the debate:
On the other side of the ledger, there has always been the concern that raising carbon taxes would place an unfair burden on some middle- and low-income consumers. Those who drive long distances to work, say, or who have homes that are expensive to heat would be disproportionately burdened.
Economists understand that a tax like this is all about incentives and substitution, not about transferring income. The public and political system see taxes all about transferring income and tend to forget incentives. This will be a big problem.

The natural political life of any "tax," including the carbon tax, will lard it up with exemptions. People who "need" to "drive long distances to work," and "can't afford" new energy-efficient cars, farmers, small business, people who live in cold climates (we already have a home heating oil subsidy), high energy industries (aluminum, concrete), and so on and so forth will all clamor for exemptions. And will get them.

But this tax, of all taxes, must be uniform at the margin, with no exemptions. Its purpose is incentives, not revenue raising or redistribution. The planet doesn't care how worthy was the carbon emitter.  People who drive a long way to work should move to smaller more expensive houses closer to work. That's the point of a carbon tax. Or shift to smaller cars, or carpool, or make other unpleasant substitutions. That's the point of a carbon tax. Farmers should find less carbon-intensive ways to plow and plant crops. People who live in cold places in the winter or warm places in the summer should move, and use less energy.  Businesses that have to use a lot of carbon should contract. Those on the margin will close. That's the point of the carbon tax. If this pain is not felt, the change in behavior won't happen.

People are hurt. And they can be helped, just not on the margin. People who are hurt can get lump sum checks, or vouchers. If the overall distribution of income is substantially made worse by carbon pricing, let the regular tax system redistribute more.  (If you think about it, that's pretty unlikely. I don't have numbers, but poor people may well use less carbon. Yes, they drive, but they don't fly and especially not in private jets. And getting rid of crony boondoggles in my deal above would help a lot too.)

Larry makes a good and revealing point about the nature of redistribution:
Now these groups have received a windfall from the drop in energy prices so it would be possible to impose substantial carbon taxes without them being burdened relative to where prices stood six months ago. As an example, the price of petrol has fallen by over $1 per gallon. A $25 a tonne tax on carbon that would raise over $1tn during the next decade would lift petrol prices by only about 25 cents.
That is a  very interesting view of just how short-lived this sense of our political system's desire for insurance and redistribution is. If we bring you back to where you were last year, you won't complain.  It's not about the overall distribution of income -- it's about middle income people's right to the gas price they paid last year.

But I'm dubious. Given how long a debate over something this big will take, and how many people will dislike a carbon tax, I'm not persuaded Larry's argument will be enough.  The demand for "transition assistance" and help to pay the carbon tax will likely not be silenced by "well, it just brings gas to what you were paying in 2013."

Furthermore, it's a good bet that the same forces that will undermine my first caveat will be at work on the second one. If I install solar panels on my roof, can't I get a break on the carbon tax?

In sum, I think the carbon tax proposal needs a second deal to be offered. The  carbon tax will be a uniform tax. Everyone pays the same rate on the margin, the tax does not get riddled with loopholes and exemptions.

To get a carbon tax, I'd like to hear proponents loudly offer this deal, in a way that skeptics will perceive as enforceable.

It's not that unrealistic. Gas taxes and tobacco taxes are administered pretty uniformly.

Tax vs. Rights

The economic point is a carbon price. There are lots of ways to implement a carbon price. Instead of a tax, one can have carbon rights.  The cap and trade schemes are the natural alternative, based on the latter idea. They don't seem to be catching on, for reasons that I won't go in to here.

Instead of the current business focus of cap and trade, suppose that every citizen has a right to emit x tons of carbon per year. In order to emit carbon (methane, etc.), or to sell fuel or electricity that emits carbon, a business must purchase those rights.  You can receive your rights with your annual tax filing, and sell them on electronic exchanges. A market will spring up quickly, offering citizens cash for their pollution rights.

It strikes me that this system obviates many of the political problems with carbon taxes.
  • It's by construction revenue neutral, and the flows of money can't go into boondoggles. All the money paid in carbon taxes goes into the pockets of citizens. 
  • It's by construction greatly progressive. Everyone gets the same right. Private-jet fliers and McMansion heaters/coolers will be lining the pockets of poor people who don't travel much and live in small homes. Progressives who bemoan the loss of energy policy at least can console themselves with this grand redistribution. 
  • Environmentalists and those in pursuit of "climate justice" should like it. Everyone gets rights to a clean planet. 
  • If you really don't like carbon, you can choose not to sell. Or buy up other's carbon rights and burn them. (Sorry, compost them.)  
  • Every voter will have a strong incentive not to let anyone off the requirements to buy carbon rights. If favored industries come by and complain how much the carbon rights are costing and want a tax break,  every voter knows that money is coming straight out of their pocket. 
  • Every voter now is an enemy of command and control energy regulation, which lowers the demand for his or her carbon rights.
The last two forces are imperfect, and it will still be important to pair this system with at least a formal promise to use the carbon (methane, etc.) price as the only instrument of energy policy, and with a formal promise to apply the requirement to purchase carbon rights uniformly. But the concentrated interest of voters will help.

This is no panacea, to be sure. Enforcing that businesses buy rights takes much the same bureaucracy as enforcing tax payments.  Whether our political system does a rights scheme better than a tax scheme is a bit of a conjecture.

But take one look at the US tax system. What started in the academic blackboard as the sensible idea "hey, we can all chip in some fraction of our income to pay for the Federal government" has turned in to the monster we see before us. A carbon "tax" also seems nice on the academic blackboard. But I worry that it will suffer the same fate.


  1. FYI, about another recent article by Lawrence Summers:

  2. I can hardly wait for the park ranger to ask for my campfire carbon permit and count how many logs I have. "Hey I see some charring on those s'mores. That'll be another $1.48."

    Seriously, how would you count this stuff? How will they know you bought a bag of charcoal or if you cut down a tree for firewood? How will they know if you used it or not, or passed it along to someone else? Who's going to measure the methane your cow emits? I don't know who "they" are, but you know there will be "them" somewhere - possibly the bureaucrats recently let go from the DOE and EPA.

    I can just see Mike Rowe on "Dirty Jobs". "Tonight's show: cow-methane-measurement guy."

    1. The seller of firewood and campfire permits, or seriously, gasoline, heating oil, propane and so forth has to get the permits.

    2. Of course the carbon accounting of such a system will be hard. The carbon problem is very hard.

      But don't make the mistake of dismissing the idea because of imagined enforcement paranoia.

      The vast majority of carbon emissions on the planet can be accounted to firms (oil, coal producers etc). Carbon fraud on the personal level would be a vanishingly small amount in the scheme of things.

    3. People who are truly concerned with carbon still drive around in cars, or ride in on bikes that have tires, brakes and handles made of petroleum products. I still see treehuggers calling people on cell phones (petroleum product), dressed in clothing (made in factories which are fueled with petroleum and transported in vehicles that burn diesel) and eat out-of-season fruit (year-round pineapples are transported from S America on diesel trucks). It is the responsibility of the consumer to consume less, if they really care.
      Carbon Taxes end up penalizing companies who are producing products demanded by... that's right, consumers. Want to see lay-offs and an economic collapse?... then let's impose a carbon tax. Wait, those employees laid off from the private sector can march over to the gov't for a job b/c it'll employ a slew of gov't workers in order to regulate, monitor and inspect these rules which will cost taxpayers even more money than those subsidies we hate. I agree that price determines choice but it also creates social inequities... and subsidies. I do agree that carbon tax should eliminate needless and pestering legislation and regulation, but there is no silver bullet. I have one question to ask of those interested in this forum... are you certain, beyond a shadow of a doubt, that any of this will change what the future holds?

    4. "It is the responsibility of the consumer to consume less, if they really care."
      People want to be healthy and skinny and yet they continue to eat the garbage McDonalds serves us. We need soft paternalism to push the population in the right direction. CPI will inevitably rise significantly since our modern industries are so carbon reliant, but that is the price we have to pay if we don't want to live in a hell-on-earth.

      "Want to see lay-offs and an economic collapse?... then let's impose a carbon tax. Wait, those employees laid off from the private sector can march over to the gov't for a job b/c it'll employ a slew of gov't workers in order to regulate, monitor and inspect these rules which will cost taxpayers even more money than those subsidies we hate."

      Wouldn't that money be coming from the progressive carbon tax placed on these large corporations? Progressive carbon tax would make it unprofitable for those big companies to ship pineapples and would even the playing field for smaller, local farms (spurring the local economy).

      "I have one question to ask of those interested in this forum... are you certain, beyond a shadow of a doubt, that any of this will change what the future holds?"

      Obviously we cannot change the fact that carbon emissions will eventually make the planet inhabitable but what if we could delay that fate? I'm sure our kids and our kids' kids wouldn't mind...

  3. It seems to me that the carbon tax can be defeated by expanding government generosity.

  4. Love this!

    A small number of years ago I made the mistake of signing a petition for "cap and trade" legislation. Got messages on my answering facility from lawyers promoting the legislation. I wondered why such highly paid people were using their time to call me, but eventually hit upon the answer: Of course, such a law would easily permit of exceptions and create substantial rents!

    Not "cap and trade" but rather, "tax and trade [if there are any worthwhile trades left]"!

    1. "Cap and trade" assumes that the right to emit CO2 belongs to existing emitters - that is why industry likes it. Carbon tax assumes that the right to emit CO2 belongs to the government. Peasants in Africa might feel that the right to emit CO2 into the global atmosphere does not belong to American companies, the American government or individual Americans.

      Calling it a tax is a political non-starter. I personally favor a system where a wholesaler would have to buy at auction from the government carbon permits allowing them to distribute within a three month window products creating, say, one tonne of CO2. The permits would be tradeable on an electronic exchange and the government would be regularly trickling permits into the market. You could control CO2 by setting minimum prices and maximum prices for the permits and the number of permits to be issued between the minimum and the maximum price (below the minimum permits don't get issued and above the maximum there is no limit to the number of permits.)

  5. before deciding on the optimum method of tax for carbon shouldn't the utility of carbon be assessed. The last paragraph and observation of white board theorizing makes the discussion of taxing another reason for disdain. Can a tax system be devised for enthused participants?

  6. My preferred way of thinking about this issue is from the individual rights perspective. Basically, I think it is a moral assumption that the right to pollute should be spread evenly across the population. That just appeals to my sense of fairness--we should all have an equal right to our shared space/planet. I think framing it in this perspective also makes apparent the underlying moral assumption in other proposals. For instance, Greg Mankiw's preferred policy is a carbon tax with off-setting cuts in labor taxes. He likes the benefits of getting rid of distortionary taxes, but I am troubled by the underlying assumption that implicitly high income people have more pollution rights than low income people. The same argument applies to handing out carbon tax or license revenue to congress's preferred green companies. Implicitly, we are assigning this constituency of the pollution rights.

  7. we could get far more bang for the buck just eliminating housing and highway subsidies ... but who wants to think "deeply" about why we use more carbon / capita than other nations.

  8. The only trouble with The Global Warming Crisis is global temperatures have been flat since the turn of the century. So let's rebrand it "Climate Change" and keep hollering for help. How many more years of flat temperatures does it take to cause the Global Warmers to abandon their theory?

    1. Would you say, too, that four consecutive days of down market means that the return on equity is negative?

      We need a model to make such a claim and the model needs to explain the past 50 years of data.

      Luckily there are statistical methods to determine if the time series of a random variable (in this case, ocean temperature) is trending up or down. And those models confirm temperature has been rising over the past couple of decades.

      What's in your model?

    2. In my youth I studied physics and dabbled in scientific computation. It seems to me that the physics, chemistry and math of CO2 build-up should be better understood than they appear to be.

    3. Richard Muller of Berkeley Earth has a wonderful perspective on this arguement. Simply stated he asks if on ascending a staircase you think you've arrived when you reach a landing.

  9. Probably your first article I agree with completely.
    (I assume you don't want to track CO2 emissions at personal level, but at the company level - you don't pay for CO2 emitted when you burn gas to heat your house, gas company pays for CO2 that can be produced from gas they deliver to you, and you pay that much more for that gas.)

    For any form of carbon tax, or price, or whatever, to be truly efficient in reducing CO2 emissions, you need to reach price of at least $40/tCO2. That way you eliminate coal power plants and gas power plants, eliminate coal as industrial and residential energy source and greatly reduce use of gas and oil for any stationary energy use (that is, not for transport). Great benefit: we will be able to stop worrying about the oil availability for the next few centuries (oil is essential for fertilizers and many other chemical products).
    To achieve that and still keep normal way of life, the whole world would need to start building lots of new nuclear power plants, the only energy source capable to replace current coal/gas production. The benefit is: with mass production, following all the safety rules, NPPs would probably be cheap enough not to raise electricity prices.

  10. Hi Prof Cochrane!
    I love reading your blog (even if, or in particular because I don’t always agree with your views).

    Allow me a quick comment on this topic. I think it's unfair (and misleading) to paint tax credits for electric cars, renewable energy etc. as measures designed to reduce carbon emissions NOW. Instead, they function as market incentives for developing alternative forms of energy and transportation that will help us make the leap out of fossil fuels in the future - for strategic as well as environmental reasons.

    We know we will run out of fuel. We know that energy dependency is a threat to national security. And we know we have to develop new technology to reduce dependency on dangerous suppliers, and impact on the environment. But we don’t know which technology will eventually evolve into a viable alternative. And at the individual level (or the corporation level since corporation = people) we don’t feel the need to invest in new technologies because (at the margin) no single individual is responsible for emitting that extra molecule of carbon that will tilt the balance.

    That’s why we have the government distribute funding for research. That’s why a good chunk of the University of Chicago’s budget comes from federal money. To fund a range of technologies that will ultimately produce a solution. Because we need concentration (of power or resources) to get us moving on problems where dilution (of responsibility) would accomplish nothing at all.

    In the end, we can see energy tax incentives as subsidies to solve the problem in the future (through subsidies to R&D) rather than as wrongful incentives to reduce carbon emissions now.

  11. Wonderful idea on individually tradable rights, logistics notwithstanding. If reason translated to policy, this is what it would look like.

    Even if people agreed limiting carbon is good (they don't), there's little room for conciliation here. Liberals love the EPA and you need not look far for cheering of the mileage regs. Conservatives scoff at even better-than-fair policy trade offs as the term "tax" is a verbal component to summon the ghost of Norquist. Industry already enjoys large barriers to entry against competitors so there's incentive to reject a scheme that may turn against them sooner than later. Consumers have been trained to reject anything that may raise gas prices regardless of trade offs.

    No, carbon limits are going nowhere fast. If limiting carbon is important to you, the best hope is found in the projections people like Kurzweil regarding solar. IF the cost/watt keeps dropping at its past 30 year pace it COULD BE competitive with coal (subsidy free) in less than 10 years. The speculative hopes only get more tenuous from there. More likely the problems will become clearer in the next decade & advocacy will move toward spewing other stuff into the atmosphere in the hopes we don't screw things up even more.

  12. Grumpy: I don't know how anyone can separate (1) the scientific debate from (2) the policy solutions. The two have become so muddled since the early 1990s UNFCCC (Rio Convention) at which the organizers declared that "... we should not allow lack of understanding / certainty prevent implementation of policy prescriptions" and "...the precautionary principle should be applied in all cases. The social cost of carbon is used to evaluate the "severity" of the damages caused by manmade causes. The last review (Fifth Assessment Review or AR5) by the IPCC increased to 95% certain the so called likelihood / probability of manmade causes being responsible for global warming. Meanwhile the current administration substantial revised upward the social cost of carbon used in evaluating damages from manmade greenhouse gases in support of executive orders were are now seeing. For example the SCC increased by $33/ton at 2.5% discount rate and $85/ton at 3% discount rate AND 95% likelihood / certainty. The science is badly politicized but there are more "balanced and sane" heads in the room that understand the uncertainty monster and how this is being used and abused.

    1. I also meant to add that the IPCC 95% likelihood is not a statistical or probability measure but is the judgment of the lead authors, like a polling of hands or some such, so it is not based on science or statistical analysis.

  13. John, here are a few thoughts: "Towards a productive libertarian approach on climate, energy and environmental issues"

    Fwiw, Jerry Taylor says, "That's a great post, Tom":


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.