The Economics of a Carbon Tax
Citizens Climate Lobby (CCL) is constantly touting their revenue neutral carbon tax as a ‘free market’ solution. What does that mean?
Micro Econ 101 Simplified (from Jerry Hinkle, Citizens Climate Lobby member)
What Goods and Services does an economy produce? Either
1) what the Government tells them to or
2) what the market decides.
Here is how the theoretical “free market” decides.
• Producers (firms) only produce goods up to where the cost to the firm is less than (or just equal to) the price they can get for them – to do otherwise would reduce profit as cost > price.
• Consumers (you) only buy if the value is greater than (or just equal to) the price paid. To buy more than that would not be rational, cost > value. E.g., one car would be useful, 10 cars would be too expensive for your use.
• Magic – for all the goods the free market produces, the cost is less than (or equal to) the price, and the value is greater than the price! How cool is that! We have “optimized Social Welfare”, optimized value.
• This reflects the argument that the allocation of resources “should be left to the market”, so that we “should not let governments pick winners” like Solyndra.
The Perfect Market
Producers’ (production, distribution, marketing) Cost <= Price
Consumers Price <= Value
Perfect Market is Cost<= Price <= Value
In instances where a product incurs costs on others outside the market transaction (external to the market – the buyer and the seller), society pays the cost. This is a “social cost”.
If you adhere to the efficacy of the market for allocating resources, you Have A CLEAR Problem! Costs are GREATER than Price and Value! Why? Because the producer does not pay the social costs! They only consider their own private costs! As a result, more than the optimal amount of the product is produced – the magic of the market is destroyed!
1) Smoking – the cigarette producer MUST consider the cost of growing the tobacco, packaging and marketing the cigarettes – the private costs they incur. They DO NOT have to bear the cost of lung cancer! This is a social cost. Cigarettes are Too Cheap as a result! Taxing the ‘bad’ has resulted in reducing the numbers of US smokers from half the population fifty years ago to 20% now.
2) Greenhouse Gas (GHG) Pollution – coal and oil bear the cost of extraction, packaging, transporting and marketing, but do NOT bear the cost of a variety of social costs, including Climate Change! The World Bank former chief economist, Sir Nicholas Stern, said “GHG emissions [are…] the greatest market failure the world has ever seen,” with an estimated cost of $4.4Trillion a Year (about 50B tons of global GHG’s a year X Sterns’ Social Cost of Carbon of $85/ton)!! Do you see that Not Just from a Moral Standpoint, but from the standpoint of the efficiency and effectiveness of the market we use to allocate resources (the private economy), It is Just Wrong to Not Charge for Polluting!!
Pigouvian Solution is Simple – Pigouvian Taxes charge the producer this “social cost”, in this case, the damage from pollution. This is to Internalize (bring into the ‘market’) the External cost, it corrects the market, and the magic is restored. Conservatives, all fans of using the market for allocating resources, KNOW that Charging for Pollution is the right thing to do. The equation is Social cost + cost < price <= value.
From Kristen Walser, CCL member: The carbon tax would be in the category of excise taxes (a tax on goods paid by the producer or retailer, and passed on to the consumer as part of the price of the good or service, a ‘hidden tax’). It would be based on the ‘social cost’ of the particular fossil fuel (the carbon pollution from burning coal is double that of natural gas, while unburned natural gas (methane) leaking from wells and pipes and escaping to the atmosphere is 23 times as damaging as CO2 and if it could be measured, it could be charged as such.)
Subsidies and Credits
With subsidies and credits, you tip the market scale, reducing some producers’ costs, or the buyer’s price, and “distort the market”. While the subsidy might reduce carbon, the cost per ton of abatement is often high, and related to a type of technology, fuel, or government program (“government picking winners and losers”).
A carbon tax, on the other hand, is technology neutral, spreads the costs and benefits using across the board objective criteria of ton of CO2 emitted per unit of energy, and is highly responsive to demand, spurring investment and innovation. Morris noted that 80% of US green house gasses could be taxed at less than 2300 facilities, resulting in less bureaucracy, administrative costs, and high efficiency.
From Adele Morris’ Citizens Climate Lobby January talk:
“For instance, if you subsidize clean energy, you end up subsidizing a lot of stuff that would happen anyway. It’s really hard to incentivize those technologies in a way that’s really efficient. And mandates for other kinds of technologies and efficiency standards can reduce emissions but they tend to be relatively high cost and they don’t tend to produce incentives to create new technologies as much as a market based instrument would.
We also like a carbon tax relative to other ways to raise revenue.
In fact in a poll of  prominent economists, 98% agreed with this statement, 'Given the negative externalities created by carbon dioxide emissions, a federal carbon tax would involve fewer harmful net distortions to the economy than a tax increase that generated the same revenue by raising marginal income tax rates on labor income across the board'.
So every tax carries a cost over and above the revenue it raises. That’s called its excess burden.
So if you think about a toll on a bridge, yes you get the revenue from the toll, but you’re also inducing some people go the long way around to avoid the toll. It’s the cost associated with people avoiding the toll that creates this excess burden.
Some taxes generate more of those distorted incentives than others. So if we can impose a carbon tax and use the revenue to reduce those other burdens on the economy, you might even get a pro –growth tax reform that has benefits without even counting the environmental benefits.
And even if you don’t fully offset the costs of the environmental changes, you still are going to greatly reduce the overall burden on the economy of achieving your environmental goals. And that’s really very robust in all of the economic literature and comes out in our modeling work right and left.”
From Kristen Walser: Said a different way, a carbon tax is the cheapest and most efficient way to reduce carbon pollution.
From Jerry Hinkle again, “The above is a theoretical argument. From an environmentalists’ perspective, there is a strong Practical Argument for using the market.
• USE THE ALL POWERFUL MARKET SO THAT EVERYONE, everyday, has a financial incentive to reduce pollution.
• This is the great WIN-WIN: charging for pollution in the form of a carbon fee really is the Right Thing for BOTH the Economy and Environment!”
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