Why People Hate Energy Taxes (and why Politicians prefer Trading Schemes)

The French uproar happened because direct taxation of fuels was announced, and the wallet impact was obvious. USC professor Matthew Kahn is a leading microeconomist, meaning he studies behavior of buyers and sellers in market economies. His recent post on the French uprising is The Substitution and Income Effects Induced by Introducing Carbon Taxes. Excerpts in italics with my bolds.

The protests in France over raising gasoline taxes there highlights that middle class people understand that higher carbon taxes have income effects. If you drive 15,000 miles a year and if your vehicle achieves 30 miles per gallon and if the price of gasoline increases from $4 to $4.40 due to a 10% increase in the gas tax, then your disposable income declines each year by (15000/30)*.4 = $200.

Economists celebrate the substitution effects induced by the carbon tax — that people who drive will demand more fuel efficient vehicles and drive them less. On the supply side, the tax will nudge firms such as Tesla to engage in induced innovation to create even more fuel efficient vehicles.

Since voters are smart and do not want to be poorer (as their purchasing power declines due to the tax), economists have pondered how to offset the income effect through policies such as “tax and dividend” or by lowering income taxes and raising carbon taxes (see Gib Metcalf’s 2007 Hamilton Project paper).

A deep issue arises here. Who has the property rights to pollute? If the incumbent polluters have this right, then the designed policy must fully offset the negative income effect I sketched above. Recall that in the 1990 Clean Air Amendments that created the so2 sulfur dioxide market that utilities received free allotments of permits. This meant that they had the property right to pollute and this must have angered some environmental groups. But, the tight cap on total emissions and the incentive effect of being able to sell unused permits created an incentive for these polluters to reduce their emissions.

In my work with Jonathan Eyer, (see our 2017 paper) , we explore how states and local governments have tried to protect their coal interests in the face of increased federal government regulation and market conditions favoring using natural gas for generating electricity. On some level, this is a battle over property rights.

Do fossil fuel consumers and producers have the property rights to engage in this activity? If they do, then those who seek to mitigate the challenge of climate change must compensate them for their income loss associated with carbon pricing. Are progressives willing to identify themselves and pay for this property? If these polluters do not have this property right, then they will suffer an income loss from this new well intended policy and they will use their full arsenal of strategies (including protests) to oppose a change from the status quo.

Given that every American differs with respect to her current production/consumption of fossil fuels, how does a smart public finance economist design a carbon tax and refund policy that induces the substitution effect of carbon pricing without the income effect?

The political economy of climate change mitigation and adaptation has not been fully explored by academic environmental economists who in recent years have focused on creating computable general equilibrium IAM models (see Nordhaus) or on reduced form empirical studies examining the “cause and effect” relationship between climate effects and economic outcomes. Such reduced form “cause and effect” studies should play a key role in determining which voters support carbon taxes. For example, if my home will be flooded because of climate change then I have strong asset protection incentives to vote in favor of a carbon tax. The role of self interest (beyond ideology) in spurring support for carbon taxes should be explored more in new research.

What else do we know about the political support for carbon pricing? Riley Dunlap has been the leader in environmental sociology studying long run trends in support among republicans and democrats.
Michael Greenstone released an optimistic contingent valuation study a few years ago. I tend to be skeptical about such survey evidence. I wish that his survey is right. My results in my 2013 paper on the voting on the Waxman-Markey Carbon Tax bill in Congress and my 2015 paper on California’s voting on introducing carbon pricing tell a different story. High carbon area voters oppose such taxes. This dovetails with this blog post’s main theme.

Soren Anderson has new research on this subject; Here is his preliminary paper. Read the abstract and you will see that his paper’s findings are consistent with this blog post’s main themes and with my past research findings. In studying recent voting on Washington state’s proposed carbon tax he finds;

” Support (for carbon taxes) is weaker in precincts with larger shares of car commuters, bigger homes, and workers in carbon-intensive industries and stronger in precincts with larger shares of young people, racial and ethnic minorities, college educated adults, and voters that are ideologically aligned with the left’s broader policy agenda.”

This is the challenge that we environmental economists face as we try to implement incentives to combat climate change. Let the competition to design a proposal that induces substitution effects without negative income effects begin!

UPDATE; A fundamental question in microeconomics asks; “who is at the margin?” In the case of supporting carbon pricing a given person will support the policy if her expected present discounted value of benefits from the policy exceeds the expected present discounted value of the costs she will incur from the policy.

In an economy where people differ on many attributes such as location, asset ownership, industry, education — it is difficult to quantify these factors and include them in a voting regression. After all, we do not observe how individuals vote on election day; instead we rely on precinct level data and face the ecological regression fallacy.

This is a long winded way of saying that if the costs faced by suburbanites for voting in favor carbon taxes decline then more suburbanites will vote for carbon taxes and support Representatives who vote in favor of these policies. Our 2017 paper explored how the private choice of buying solar panels bundled with electric vehicles could flip some suburban voters toward supporting carbon pricing because the income effect they would face would shrink to zero.

My Comment:

French PM Macron wanted to virtue-signal his leadership regarding the Climate file. But France is powered mostly by emission-free nuclear electricity. So to up the emission reduction ante, Macron went after the transportation sector, i.e. taxes on gasoline and diesel. For everyone outside of the La métropole (Parisians enjoy public transit), this was effectively a tax on personal mobility. And as we are seeing, totally unacceptable in a modern society. Prof. Kahn explains how suburbanites and exurban folks recognize immediately how this policy diminishes them and their lifestyle.  As an environmental economist, Kahn does not question the claim that fossil fuels cause global warming, unfortunately.  So he and his colleagues face the task of convincing the public that raising carbon prices is in their personal interests.

It is why politicians like the EU and Gov. Brown (and Schwarzenegger before him) preferred carbon trading schemes. Such schemes are stealth pricing programs, since they force companies to pay more for energy, who then pass on the cost to consumers when they buy goods or services. But the government’s hand in your pocket is hidden, and the cost of living inflation is spread out by price increases on everything, not just fuel purchases. So the public grumbles about how expensive life is becoming, while the policymakers are shielded by skimming on top of all commercial transactions. And politicians still get money coming into “green funds”, which can be distributed to their friends and supporters in the form of grants and subsidies.



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