The WSJ recently discussed the Niskanen Center, a new libertarian think tank named after economist William Niskanen. What sets the Niskanen Center apart from similar organizations is its advocacy of a carbon “tax swap” deal, hoping to unify Democrats and Republicans with a package that helps the environment and the economy by using the new revenues to reduce corporate taxes. Yet this is a baffling position, because Niskanen was a pioneer in Public Choice theory, which shows that the blackboard models of a carbon tax swap cannot be trusted. Even though Niskanen himself never addressed the specific topic (to my knowledge), the most obvious takeaway from his scholarly work is that a new carbon tax will hardly be “revenue neutral.”
Carbon Tax Swap Barely Works, Even in Theory
I have written previously on how razor-sharp the edge is, to even demonstrate the theoretical possibility of a carbon tax swap deal that also promotes economic growth. A 2013 summary of the peer-reviewed literature concluded that it would be unlikely to achieve this result, and even if it did happen, it would rely on shifting the burden of the tax code away from capitalists and onto workers. (This is because taxing capital imposes a bigger drag on the economy than taxing labor.)
The Niskanen Center’s scholars recognize this theoretical difficulty. In a post from late January. Shi-Ling Hsu writes:
A 2013 paper by Donald Marron and Eric Toder was one of the first to explore this idea [of a carbon tax swap] seriously…Marron and Toder modeled the effects of a carbon tax on five pre-tax income quintiles, unsurprisingly finding that a carbon tax alone was income-regressive. They then layered on top of that a policy distributing all carbon tax proceeds to reduction in corporate income tax rates…
A carbon tax and a lower corporate income tax, Marron and Toder unsurprisingly find, is more regressive than a carbon tax alone. But then, if just one-quarter of the carbon tax proceeds are distributed in a lump-sum household rebate, the burden is shifted to those in the middle three quintiles, with the highest quintiles best off and the lowest at least better off. Marron and Toder close by noting how hard it is to design the “perfect tax swap,” one that is progressive, reduces the distortions caused by high statutory U.S. corporate income tax rates, and taxes carbon. [Bold added.]
But things are worse than Hsu lets on. From the abstract of the Marron and Toder paper we read: “Policymakers may also want to use some carbon revenues for deficit reduction,” and that therefore one option “would be to aim for revenue neutrality over an initial period, after which a widening spread between growing carbon revenues and relatively stable corporate tax cuts would reduce the deficit.” It should go without saying that the projections of a “double dividend” or a “win-win” for the environment and economy do not work if the carbon tax is a net new tax.
Pay Attention to Niskanen’s Lesson
We have seen how even in theory it is difficult to get a “win-win” out of a carbon tax. But when we put aside the textbook and think about actual politics, it should be obvious that political officials will never respect the alleged revenue neutrality used to make a new carbon tax look attractive on paper, as part of a broader package of “tax reform.”
Ironically, one of the best economists to cite for such cynicism is William Niskanen himself. He was a pioneer in so-called “Public Choice” theory, a branch of economics that applies the usual assumptions of self-centered individual maximization to government officials, not just private business owners. In this arena, Niskanen’s famous contribution was a model of bureaucracy that assumed government officials acted to maximize their agency’s budget and power.
Indeed, I dug up my old Public Choice textbook from college—specifically, The Economics of Public Choice by P. A. McNutt (Edward Elgar 1996 Cheltenham, UK)—to see what it had to say about the work of William Niskanen. Here is an interesting excerpt from its discussion:
Niskanen (1971) lists as the goals of the bureaucrat to include the following: “salary, requisites of the office, public reputation, power, patronage output of the bureau, ease of making changes, and ease in managing the bureau”…Mueller (1989) comments that “one gets the impression from Niskanen’s book that the net effect of supplying public output by public bureaus is a substantial expansion of the size of government”…This accords with the view of [Ludwig] von Mises addressed by Niskanen when he commented “that a broader education in economics will reduce the popular support for large government and the consequent pervasive bureaucracy”… (McNutt, p. 135)
Of course, we can’t know for sure what Niskanen would say if he were alive today (he died in 2011), but it seems very naïve from a Public Choice perspective to think a new carbon tax will convince the EPA and DOE to give up their mandates related to climate change, or that the federal government would truly respect the revenue-neutrality of a carbon tax swap deal. It is precisely because of my training in the work of William Niskanen and other Public Choice economists that I am so skeptical about “carbon tax swap” deals.
The new Niskanen Center has made a carbon tax swap deal a major plank in its agenda. Even in theory, it is hard to show a carbon tax helping the economy. In practice, such a hope is clearly fanciful, because political officials consistently try to maximize their revenues and power—as the late William Niskanen taught us.