Back in August, I warned that conservatives shouldn’t trust economist Irwin Stelzer when he pushes a carbon tax, because he was confidently telling them “facts” about the economic case that were simply not true. Stelzer is back at again, this time in a year-end post in National Review. Once again, Stelzer tries to convince conservatives that a carbon tax would make economic sense even putting aside issues of global warming. This is utter nonsense, as I’ll explain in this post.
Stelzer Thinks Everybody Should Love Carbon Taxes
To set the context, let me quote from Stelzer’s opening:
We have a unique opportunity to end the rancorous debate about climate change, a debate that is poisoning the air…and inhibiting progress on two fronts: progress on addressing the possibility that we are on the road to a catastrophic warming of the globe, and progress on reforming our anti-growth tax structure…All we need do is stop pretending that the cost of carbon emissions is certainly zero, and that regulation provides a more efficient solution than the market.
In the course of his article, Stelzer makes two critical assumptions that are simply wrong. Stelzer’s first mistake is his assumption that a revenue-neutral carbon tax would clearly promote economic efficiency. His second mistake is to think that carbon taxes will promote growth even if the standard climate models turn out to be totally wrong.
Carbon Tax “Reform”
Here’s Stelzer speaking matter-of-factly about making the tax code more efficient: “We can make a carbon tax revenue-neutral by providing a simultaneous reduction in payroll taxes, accomplishing two conservative goals: lowering taxes on work and risk-taking while raising them on consumption.”
No, this is wrong, and it’s importantly wrong. A tax on carbon dioxide is not a tax on consumption; it’s a tax on carbon dioxide. Yes, consumption will be made more expensive because of a carbon tax, but the two do not function the same way in standard tax analysis.
In particular, a carbon tax has a much narrower base than a general consumption tax, or a tax on payroll for that matter. That’s why raising (say) $100 billion from a new carbon tax, and reducing payroll taxes dollar-for-dollar, will prima facie be more destructive to conventional economic growth. Adjusting for units, the implicit tax rate applied to “carbon dioxide emissions” will have to be much higher than the tax rate applied to “all payroll earned in the United States,” in order to raise the same dollar amount of revenue. Because taxes distort the economy in proportion to the square of the tax rate applied, this shows how much more of a “deadweight loss” a $100 billion carbon tax would carry, versus a $100 billion payroll tax, if we ignore climate change considerations.
This is well-known in the peer-reviewed literature on the economics of climate change. The phenomenon is called the tax interaction effect and shows that even a revenue-neutral carbon tax might cause net damage to the conventional economy, because it would amplify the distortions caused by the pre-existing taxes (even after their rates were reduced because of the new carbon tax receipts). To give an idea of the size of this effect, two of the pioneers in this field estimated in the 1990s that if carbon dioxide in fact carried a negative externality “social cost” of $25/ton, then the “optimal” carbon tax—taking everything into account—would only be $7/ton if we assume the best-case scenario where the revenues are used to reduce other taxes. However, if instead the government were simply to mail a lump-sum “dividend” back to the citizens fully rebating the carbon tax receipts (while keeping the other taxes at their original levels), that same analysis found that the optimal carbon tax would be ZERO. To repeat, this stipulates for the sake of argument that a ton of carbon dioxide emissions causes $25 in environmental damages. The reason for these low-ball figures on the “optimal” carbon tax is that it is so destructive to the conventional economy. Even in the fantasy land where legislators return every dollar of carbon tax receipts to citizens (either through tax-rate reduction or lump-sum payments), the carbon tax was so destructive that its “optimal” level had to be dialed way below the setting corresponding to climate change damages.
The literature has naturally evolved since these early modeling efforts. Among true experts on this topic, the consensus in the literature is that even though it’s theoretically possible that a dollar-for-dollar carbon tax swap would promote conventional economic growth, in reality this is unlikely to occur. This is the exact opposite of what people like Stelzer keep confidently telling their readers. It would be nice if they would at least read some of the literature on carbon taxes before repeating these claims yet again. The case for a carbon tax is not nearly as open-and-shut as its proponents would have the public believe.
Stelzer’s Second Mistake: Thinking Climate Change Not Relevant
Since Stelzer views a revenue-neutral carbon tax as an obviously beneficial pro-growth tax reform, it’s not surprising that he can be so flippant about the original rationale for a carbon tax. Stelzer writes:
Note that support for a carbon tax does not require signing on to the new religion of global climate change, which supports government intervention in the economy even if (when) the theoretical models yield to recent reality and start to project a new ice age. Such conservative support would depend solely on a desire to get the economy growing faster by shifting the tax burden from good stuff like work to bad stuff like pollutants.
Yet this won’t work at all. In the first place, carbon dioxide is not a “pollutant” if we’re throwing out the global warming argument. Trees breathe it, after all and life on earth couldn’t exist without it; we’re not talking about soot.
And to tie this into our earlier discussion, the standard literature shows that because carbon taxes—even if implemented dollar-for-dollar to reduce other taxes—are so economically harmful that their “optimal” rate should be set to less than what one would think from the environmental damage involved. So if Stelzer is saying we don’t need to take a strong position on the climate models and their projections of large damages, he just destroyed the only leg he had to stand on.
If we could forget about the climate change debate for a moment, the absurdity of Stelzer’s argument would be obvious. For example, imagine someone sent National Review an article calling for a large tax levied on every megabyte of data sent over the internet, labeling this a “consumption tax” and arguing that it would promote economic growth if coupled with comparable payroll tax cuts. I’m hoping National Review’s editors would reject such nonsense, realizing that plenty of businesses send data and that such a tax would have a narrower base than payroll. Absent some compelling reason to specifically target an activity, levying a massive tax on it is hardly “pro-growth.”
The same holds for carbon dioxide emissions. For years, a few vocal writers have been playing footsy with conservatives, telling them that Al Gore & Co. might be full of it, but hey we should embrace a carbon tax because it will help the economy. No, it won’t, even on the standard terms of the mainstream literature. When we more realistically account for the fact that at least some of the new revenue will finance more government spending, it becomes even more obvious that a new carbon tax would hurt the conventional economy. If conservatives throw out the warnings of catastrophic climate change, then they’ve thrown out the case for a big carbon tax, too.