Taxing Carbon is Bad Economics

At Institute of Economic Affairs, IEA’s Director of Research Dr Jamie Whyte explains (here) why taxing carbon is a bad economic idea. Excerpts in italics with my bolds.

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.

 

Climate change is a stool standing only if all three assertions are true. This post is addressing the last one.

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.