Tuesday, August 14, 2012

Tax Carbon, Not Work

Tax This

Not This . . . .

CNN is reporting that several Republicans are calling on Congress to adopt a so-called "carbon tax," coupled with a reduction in taxes on income.  (One might call this plan "Tax and Cut.")  The list of advocates includes former University of Chicago economist and one-time Secretary of State George Shultz, now at the Hoover Institution.  Under the proposal, the national government would levy (additional) taxes on coal, natural gas, and gasoline, presumably calculated to reflect the environmental and health harms resulting from the use of these fuels.    These calls by Schultz and others follow similar proposals by other free market conservatives, including renowned supply-side economist Arthur Laffer, to adopt a revenue-neutral carbon tax.

Proponents of such a carbon tax generally focus on two benefits.

1) First, such taxes force individuals and firms that employ carbon-emitting fuels to take account of or "internalize" the full cost of their activities.  That is, the"carbon tax" functions as a classic "Pigouvian Tax."    While individuals dispute the full extent of these costs, there is no doubt that such costs exists, whether in the form of asthma-inducing smog, global warming, and/or mercury, a byproduct of coal-fired power generation.

2) Second,  the corresponding reduction in income or payroll taxes would ensure that individuals capture a larger share of their individual productivity.   This, in turn, would produce two benefits, one static and one dynamic.  First, knowing that they would retain a larger share of their earnings, individuals would supply more labor to the market, thereby increasing the nation's economic output in the short run.  Second,  individuals would also invest more in improving their own economic productivity, knowing that they would, in the future, capture a greater share of such gains.  The result would be a better-educated and more skilled workforce, more potential output and thus greater economic growth (and a lower price level) in the long run.

These are certainly laudable objectives and, taken together, would by themselves justify the imposition of  a carbon tax coupled with a reduction in tax on labor.   There are, however, two additional benefits that make the case for a carbon tax even stronger. 

3) Third, imposition of such a tax would presumably eliminate the need for much "command and control" environmental regulation.  Such regulation requires firms to employ particular pollution control technologies, even when other technologies would be more cost-effective, thereby reducing economic welfare.   If, however, firms must pay the true cost of their activities, such regulation is redundant and counter-productive; firms will themselves take cost-justified steps to maximize the net social benefits of their activities.  Such steps might include purchasing pollution control equipment, changing the composition of output, and/or inventing new ways to reduce their carbon footprint.  Moreover, firms that produce such equipment would also be free to innovate, producing what they believe to be cost-justified equipment, instead of producing whatever the government happens to mandate.

4)  Fourth, such a tax would eliminate the perceived need (by some) for the national government to encourage the emergence of so-called "green" technologies and industries by distributing state largesse to favored firms or, in extreme cases, bailing out entire industries.   As previously explained on this blog, the national government is poorly suited to predicting which companies and/or technologies will in fact be cost-beneficial and thus a worthy investment of scare capital.  Moreover, once the government takes on this responsibility, private businesses will invest scarce resources in attempting to influence political decision makers, in a rational effort to steer taxpayer largesse their way.  The result will at best be inefficient allocations of scarce capital and at worst outright corruption.  The recent ill-advised bailout of the auto industry provides a classic example of such inefficiency.   As previously explained on this blog, President Obama justified the bailout in part as a means of insuring that General Motors and Chrysler produced more "green" automobiles.  The result has been a heavily-subsidized Chevrolet Volt, with a sticker price over $40,000, that no one wishes to purchase.  By contrast other companies, including Ford, are producing popular high-mileage automobiles in response to market demand.   Society thrives when the decentralized market, not a distant central government, allocates scarce capital.

More than half a century ago F.A. Hayek described the price system as a "marvel" that allows economic actors to rely upon local knowledge and thus coordinates the plans and activities of millions of unrelated individuals, esuring an allocation of economic resources that generates far more economic welfare than any planned society could ever imagine.  However, as Hayek and others would later emphasize, a well-functioning price system and decentralized allocation of resources requires society to create and enforce property rights, thereby ensuring that market prices accurately reflect the  actual costs and benefits of economic activity and thus send appropriate signals to economic actors.  By forcing individuals and firms to internalize the full costs of their actions, and reducing the penalty on labor, a scheme of "Tax and Cut" could harness and improve the already-marvelous price system, improve environmental outcomes and  increase economic welfare for all.