If carbon taxes are so great…

A good question on Friday from a student at Westminster College:

If revenue-neutral carbon taxes are such a great idea, why has only British Columbia adopted this policy?

I gave what I thought was a decent answer in class, but wanted to put some more thoughts down in writing:

1) People prefer the devil they know to the devil they don’t.

More specifically, people seem to prefer whatever tax system they have now, however lousy it may be, to possible alternatives. A good example here concerns Washington and Oregon, which both instituted income taxes in the 1930s. Washington’s income tax was found to be in violation of the state constitution, so the state adopted a sales tax instead. To this day Washington has a sales tax but no income tax, and voters would almost certainly reject an effort to replace the sales tax with an income tax. Across the state line, Oregon has an income tax but no sales tax, and voters there would almost certainly reject an effort to replace the income tax with a sales tax. Go figure.

I think that one part of the explanation here is that tax reform proposals seem to automatically engage people’s cynicism and mistrust of government, so they’re inclined to think the worst. In the case of revenue-neutral carbon taxes (i.e., raising taxes on fossil fuels but lowering existing taxes on income, sales, etc) the worst-case thinking is “You’re going to raise tax fossil fuel taxes but you’re NOT going to lower existing taxes.” This is a very difficult argument to counter, although B.C. has tried, e.g., by stipulating that the finance minister loses her salary if the tax is not revenue-neutral.

2) People don’t (yet) accept that climate change is a serious problem.

Tax reform is a big deal, and you’ve got to have a good reason to get behind it. Many people don’t feel that urgency right now.

When my older brother and I were kids, one of our household chores was hanging up the laundry. So we would go to the laundry room in our apartment building and proceed to snap towels at each other and otherwise goof around. And then eventually my brother would announce that it was “No f***ing around time”, at which point we would get down to business. The analogy, of course, is that Americans are still goofing around when it comes to climate change. At some point they may recognize that it is “No f***ing around time”, at which point they’ll be more willing to consider significant changes like environmental tax reform.

Put points #1 and #2 together and you see that people are inclined to stick with the status quo in part because they think we can just keep doing what we’ve been doing. But we can’t. The real choice is between changing our tax system and changing our climate. The status quo is not an option.

3) Economists think about the world differently than “normal people”.

When economists think about taxes, they mostly focus on efficiency and things like deadweight loss, or what was once described as plucking the goose to get the greatest amount of feathers with the least amount of hissing. When “normal people” think about taxes, they mostly focus on equity and fairness. And, as above, cynicism and mistrust of government play a major role.

Similarly, when economists think about environmental issues, they naturally think about using market-based instruments like carbon taxes or cap-and-trade systems. When “normal people” think about environmental issues, they mostly think about regulatory policies (like fuel-economy standards) or government-funded R&D into clean energy.

Finally, when economists think about policy, they often focus on pragmatic consequences and use a cost/benefit framework. In contrast, “normal people” often focus on left-versus-right ideology. (This contrast is the basis for one of my jokes, namely that economists are the kind of people who are against the death penalty because it’s too expensive.) Unfortunately, environmental tax reform exists in a kind of ideological no-man’s-land: when I make the case for using capitalism to tackle climate change, the stereotypical responses from the left and right, respectively, are “Capitalism? We don’t believe in capitalism!” and “Climate change? We don’t believe in climate change!”

4) There will be winners and losers.

Environmental tax reform will generate gains that are bigger than the losses, but there will be losses and they will disproportionately affect certain people and certain economic sectors. This was addressed in the equity part of #3 above, but it’s worth emphasizing that some people will lose their jobs and some industries will shrink. Those changes are inevitable if we want to tackle climate change, and in the big picture they will be offset by new jobs and growing industries in other economic sectors. There are ways to try to minimize these losses, e.g., by providing offsets for low-income households (as in B.C.) or by targeting certain tax reductions for energy-intensive industries (as in our proposal for Washington State). But in the end the theoretical ideal—a policy that makes everyone better off and makes nobody worse off—is unattainable; in the real world there will be winners and losers.

Of course, it’s worth remembering that climate change will produce winners and losers, too, and the odds are that the losses will outweigh the gains. This takes us back to #2 above, that people don’t (yet) acknowledge that climate change is a serious problem. If and when they do, perhaps they will be willing to take the difficult steps that will be necessary to deal with it.

PS. A fisheries analogy

A similar Tragedy of the Commons situation often exists with overfishing (e.g., with cod in New England), and the political challenges are often even more stark. The obvious solution to overfishing is to limit fishing and allow stocks to recover, and economists would recommend use economic instruments like a tax on fishing or a cap-and-trade system (which is known in the fisheries world as an ITQ system of Individual Tradable Quotas). But these policy recommendations almost always encounter resistance from the fishing community itself, the complaint being that you’re taking a struggling industry and kicking it while it’s down. The four issues identified above can be clearly seen: People are skeptical of changing the system they currently have (it’s worked for generations!), they don’t always believe that the problem is serious (maybe the fish are just having a bad year and will be back next year!), they think differently than economists (you’re kicking us when we’re down, and that’s not fair!), and there are winners and losers (what about the older skippers who just want to fish for another year or two and then retire?).

3 responses to “If carbon taxes are so great…”

  1. Yoram

    A very interesting post. I think you are absolutely right in pointing out the limited political constituency that supports a carbon tax (basically economists – not much of a constituency really!).

    But this is what it is. Accordingly, when it comes to the climate change policy debate, economists are frequently missing in action. They are running around on a desert island, as in that classic 1970s economist joke, shouting “imagine a can opener”.

    As a result, I think they should get more involved in pushing second best alternatives (they can always add a footnote saying that in the best of all possible worlds a carbon tax is the way forward but in the meantime….). To me this means advocating renewable subsidies, which lead to a larger installed renewable base that provides public goods as opposed to fossil fuel public bads. Getting renewables down their cost curves through economies of scale and learning by doing seems eminently sensible policy-wise.

  2. Renewables subsidies, though, are becoming more and more difficult to justify. It was never really the intent of the industry to become lifetime subsidy recipients, and carbon taxes are a fair way to balance the amount of damage that thermal power gets to do for free.

    But yes, carbon taxes are a ‘new devil’, and most people don’t even think of the external cost of carbon-based power as being an implicit subsidy. Explicit subsidies – like the much meddled-with US PTC – are much higher in the scrutiny list.

  3. Scruss: Why are renewable subsidies becoming more difficult to justify? Governments have a history of subsidising public goods: think education and defence.

    Yes, carbon taxes would be better. But they are not happening. They are the proverbial fictitious can opener. Let’s move on and do what we can do. Renewables provide lots of home grown jobs, so indirectly bolster effective demand at a time when we have large output gaps, they reduce balance of payments imbalances, provide geopolitical security – I could go on.

    Remember fracking was born out of government financed R&D, tax credits and subsidies. The free market only kicked in to scale the technology when sufficient risk had been removed. See here:

    http://thebreakthrough.org/blog/Where_the_Shale_Gas_Revolution_Came_From.pdf

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