Debate: The pros and cons of carbon taxes
Philip Booth, the IEA’s Senior Academic Fellow, says YES
Almost every economics undergraduate is taught that if the marginal social cost of an economic activity exceeds the marginal private cost there should be a Pigouvian tax imposed. The market, after considering the tax, will maximise welfare.
Unfortunately, the world is not that simple. In practice, we need market exchange to determine the social cost of said activity. If we did know the value people placed on goods and services, central planning would work – but it is a catastrophe. So why would we know the ‘right’ value of the Pigouvian tax?
Secondly, there are issues of justice. Granted, a Pigouvian tax might move the market towards a better position from an economic welfare perspective, but will the people who have the social costs imposed on them benefit from the tax? Economists tend to assume away this problem and put it in a separate box, but we cannot easily do so. Of course, those affected will benefit from having less of the damaging activity, but it is unlikely they will be compensated.
Despite this, I would support a carbon tax – with strong conditions. The impact of carbon emissions is such that we cannot imagine a market dealing with the problem and their effects so dispersed that the transactions costs of market bargaining are simply impossible. This is not like my next-door neighbour building a factory and making a noise at 5am. My carbon emissions may be harming people in Bangladesh in 30 years’ time.
The problems caused by carbon emissions are potentially so great that if we have to choose between the binaries of no tax or some kind of carbon tax (however imperfect), I would choose the latter. True, a carbon tax could be set at the wrong level, might not work properly because it is not internationalised, might come with heaps of institutional baggage and so on, but faced with a binary choice between two sets of risks, I would rather choose to be exposed to the institutional risks of getting things wrong in the hope that it will reduce the impact of climate change.
But my conditions would be strict. It obviously should not apply to industries to which cap-and-trade already applies. Secondly, it should be proposed in a single bill which abolishes a range of other expensive (often counter-productive) interventions and reduces existing taxes. One advantage of a carbon tax would be higher emission reductions than from other policies at the same price. A carbon tax might lead me to insulate my home or refrain from heating under-occupied rooms, thus reducing emissions at a lower cost than by using expensive electricity generated from green sources.
The bill would also remove deliberate interventions designed to increase energy use and carbon emissions such as the reduced rate VAT on domestic energy. Domestic energy consumption is implicitly subsidised to the tune of almost 15 per cent. This is very bad economics even if you are not concerned about climate change.
Finally, we should consider exercising influence through international institutions and other channels to reduce the huge level of energy subsidy that exists elsewhere in the world. The total value of fossil fuel subsidies in the world is estimated at $300bn (and rising).
This fact alone demonstrates why some of us are so sceptical of government intervention. In response to perhaps the world’s most pressing public policy issue, appallingly-designed policies pull in opposite directions. I don’t hold out that much hope that things will improve. However, perhaps by putting everything in one big bill there might be a fighting chance.
NO, argues the IEA’s Director of Research Dr Jamie Whyte
The emission of greenhouse gases – CO2 from burning fossil fuels and methane from flatulent livestock – is warming the global climate. Let’s not quibble about this scientific consensus, even if there are grounds for scepticism. The question for economists is the proper policy response.
The standard view is that greenhouse emissions are a classic negative externality, and that a Pigouvian tax should be applied. For example, farmers should pay a “fart tax” for each cow they own. This would internalise the external cost of the farts, and cows would be farmed only when the total benefits of doing so exceeded the total cost.
This is preferable to a cap-and-trade system, because the cap is arbitrary. If the price of emitting CO2 under such a scheme were to exceed the external cost (the Pigouvian tax), then too little CO2 would be emitted.
Ronald Coase’s insights about managing external costs through private bargaining are irrelevant here because no one owns the climate and, even if such rights were assigned, the owners would be so numerous and dispersed that the costs of bargaining would be prohibitive.
But does anthropogenic global warming warrant a Pigouvian tax on the emission of greenhouse gases?
The first difficulty is estimating the external cost of greenhouse gas emissions and, hence, the size of the tax. Begin by noting that global warming will have benefits. Increased CO2 emissions have caused a great greening of the planet over the last 20 years. If the climate warms as predicted, vast tracts of land in Russia and Canada, now too cold for agriculture, will become arable. We should expect food to become more abundant and cheaper. More generally, the costs created by cold weather – heating, delays in construction work, etc – should decline. Many people like warm weather. They pay good money to travel to it. I would willingly pay £2,000 a year to make London five degrees warmer.
Of course, there will be costs too. Sea levels may rise, swamping some now inhabited areas. Some places may become too hot for comfortable habitation or agriculture (though these are sure to be smaller than the cold areas made usable). The number of storms may increase, destroying property and interrupting economic activity.
So what is the net cost? No one knows. They don’t even know if it is negative or positive. So they don’t know if greenhouse gas emissions should be taxed or subsidised.
This not an anti-science position. Scientists can predict physical outcomes (with varying degrees of certainty, which, in the case of climate science, is low). But they cannot predict economic outcomes. They cannot tell you the value of those physical outcomes. Global warming will have many effects – some positive, some negative – on a vast number of people with very different environmental circumstances, incomes and preferences. Anyone who claims to know the net aggregate value of global warming displays amazing overconfidence.
Some will say that ignorance itself gives us reason to impose the Pigouvian tax (at some arbitrarily chosen level, as is unavoidable given our ignorance). We should think of it as an insurance policy. The dire warnings may be true and, just in case they are, we should take measures to reduce emissions. Think of the tax as an insurance premium paid against the risk of global warming being net negative.
Yet this logic fails by simply reversing the argument. Global warming might benefit mankind. It would be a tragedy if we didn’t take the opportunity this presents. To avoid this risk, we should tax people to subsidise greenhouse gas emissions. Think of the tax as an insurance premium paid against the risk of missing out on global warming.
This ignorance argument against taxing or subsidising greenhouse gas emissions applies to many things with spill-over effects. Revealing clothes, for example. They affect people besides those who choose to wear them. Are these external effects positive or negative? The answer differs from beholder to beholder and context to context.
There is also a political problem to applying Pigouvian taxes to greenhouse gas emissions – namely, that it is likely to simply relocate emissions rather than cut them. A carbon tax applied in the US will shift (marginal) industrial production to places that don’t apply it. Carbon taxes are one of those cases where there is no point doing something unless (almost) everyone else does it too. Those who advocate applying one in their own country are implicitly committed to the idea that all other relevant countries will also apply one. But that is implausible. The gains from breaking ranks are too great.
Given our ignorance and the implausibility of a globally enforced Pigouvian tax, we should just wait and see. We can adapt to the ill-effects of global warming – relocating activities if need be or building sea defences – while taking advantage of the gains. And we can do this without incurring any immediate cost. Let future people, who will be richer than us, pay for the costs that may arise.