To paraphrase Ronald Reagan paraphrasing Will Rogers,
some people around here never met a tax they didn’t dislike. Others have
met just one: a carbon tax.
A number of the nation’s leading conservative economists, who as a rule do not like taxes, are touting some benefits to a federal carbon tax. That group includes Gregory Mankiw, a former Romney adviser and George W. Bush-era chairman of the Council of Economic Advisors; Douglas Holtz-Eakin, Sen. John McCain’s 2008 chief economic adviser; and Art Laffer, progenitor of Reagan’s treasured Laffer Curve.
Such a tax could raise an estimated $1.5 trillion over 10 years and help wean the country from carbon-intensive fuels. And with Congress set for a season of budget fights and a possible effort to overhaul the tax code, the carbon tax is likely to reenter the conversation about getting America’s fiscal house in order.
So, it’s worth understanding why the economics of a carbon tax might make it appealing to some conservative economists, and why many political arguments about taxes don't apply to it.
A Pigovian Tax
A carbon tax is a special kind of tax called a Pigovian tax, named after 20th-century British economist Arthur Pigou.
Normally, a competitive market produces just the right amount of a good. If there are not enough people selling glue, its price will rise and people will cash in by selling more glue. If too many people are selling glue, the price will go down, and some people will find it’s not worth their while to sell glue anymore. Either way, the market should settle at the point where the cost of producing more glue is equal to the value people place on that additional glue.
But Pigou realized that if a producer wasn’t paying for the full cost of producing a good, they would produce too much of it anyway and everyone else would foot the bill. Imagine that making glue is expensive because it costs a lot to cart away all the horse carcasses used in its production. There’s not going to be a lot of glue because only people who really like glue will be willing to pay to produce it.
Now imagine that instead of carting away the dead horses, glue factories realize they can dump them in nearby rivers for free. All of a sudden, it becomes a lot cheaper to make glue, so the price goes down. At a price like this, you can’t afford not to buy glue, so people consume more of it, and new glue factories pop up.
It all looks like economic growth, until the dead horses start piling up, and people start getting sick. Then they get a bunch of medical bills and the government has to spend money cleaning up the river. The sticky-fingered glue barons don’t mind much, because they can afford to buy the expensive houses upriver, and when the cost of cleanup gets spread to everyone, the cost to them is a pittance compared to their newfound glue fortunes.
Meanwhile, the tape users are fuming. They’re getting sick from glue they don’t even use, and the horse-dredgings are driving up their tax bill. And because a bunch of the former tape-makers have jumped on the glue bandwagon, there’s now a tape shortage. It’s a mess.
When you account for the costs of sickness and cleanup, each tub of glue costs $20 to produce. But the glue factories don’t pay for this, so they can sell glue at a going rate of $12. Glue that’s only worth $12 is being made at a cost of $20, so $8 is being wasted on each new tub of glue.
In this case, Pigou would prescribe an $8 tax on glue. Now, it costs glue factories $20 to produce glue, and only people willing to pay that much for glue will buy it. Less glue is produced, so fewer dead horses end up in the river, and the revenue raised from the tax can be used deal with the problems caused by the ones that do.
How It Works in the Energy Market
The dysfunctional glue market looks a lot like the current energy market.
Carbon, like the dead horses, creates what economists call a negative externality. A negative externality is the cost of an economic transaction that’s not borne by either the buyer or the seller, and is instead pushed onto society. It distorts markets and leads to inefficient outcomes, such as producing $12 worth of glue for $20.
A Pigovian tax corrects for a negative externality by making sure buyers and sellers pay the true cost of a good or service.
In this case, high-carbon fuel looks cheap on paper, because the costs to the producer don’t include the costs of global climate change or dependence on foreign oil. So, too much high-carbon energy is consumed. The producers don’t mind, because the extra costs are spread to everyone, while much of the benefit accrues to them. The people who use the most fossil fuels also benefit from buying lots of underpriced energy. Meanwhile, residents of places like New York and New Orleans, who don’t consume all that much carbon, pay the costs of the uptick in extreme weather that scientists say is linked to carbon emissions.
A tax on carbon would raise the price to include the trust cost of burning it, so that the economy doesn’t end up producing $12 worth of energy at a cost of $20.
By making carbon emissions more expensive, it would cause them to decrease. It would also lead to increased use of low-carbon energies—natural gas, wind, solar— which suffer from society’s de facto subsidy of carbon emissions.
Why It Appeals to Conservative Economists
So, why do some conservative economists who normally oppose new taxation support a carbon tax? Because a carbon tax, like any Pigovian tax, taxes something we want less of. And when you tax something, you get less of it. Even for the remaining cohort of climate-change deniers, Mankiw lists a slew of other downsides to carbon emissions in his Pigovian manifesto.
Taxes on alcohol can also be considered Pigovian taxes, because alcohol consumption can have harmful effects for society because it can contribute to crime and lost productivity at work. Taxes on cigarettes fit the bill, too, because of the public health costs of tobacco use.
But most taxes, especially at the federal level, tax things we want more of: labor, investment, business activity.
Depending on how broadly or narrowly you define economic growth, these taxes either arguably or definitely hurt growth.
But a Pigovian tax creates economic growth by allowing markets to allocate resources more efficiently. Think of all the wasted resources that went into making those jars of glue that cost $20 but were only worth $12. When the market produces the right amount of glue, those resources are freed up for more useful purposes.
Liberal economists tend to like a carbon tax, too, but usually differ with conservative economists over what to do with the revenue. They’re more likely to see the revenue as an opportunity to extend government services, subsidize alternative energy, or, in the current economic environment, pursue some other form of stimulus.
Conservative economists are more likely to advocate using the revenue to lower rates on other taxes, give everyone a tax rebate, or pay down the deficit. It’s these latter uses that are likely to dominate the discussion of a carbon tax in the coming months.
A number of the nation’s leading conservative economists, who as a rule do not like taxes, are touting some benefits to a federal carbon tax. That group includes Gregory Mankiw, a former Romney adviser and George W. Bush-era chairman of the Council of Economic Advisors; Douglas Holtz-Eakin, Sen. John McCain’s 2008 chief economic adviser; and Art Laffer, progenitor of Reagan’s treasured Laffer Curve.
Such a tax could raise an estimated $1.5 trillion over 10 years and help wean the country from carbon-intensive fuels. And with Congress set for a season of budget fights and a possible effort to overhaul the tax code, the carbon tax is likely to reenter the conversation about getting America’s fiscal house in order.
So, it’s worth understanding why the economics of a carbon tax might make it appealing to some conservative economists, and why many political arguments about taxes don't apply to it.
A Pigovian Tax
A carbon tax is a special kind of tax called a Pigovian tax, named after 20th-century British economist Arthur Pigou.
Normally, a competitive market produces just the right amount of a good. If there are not enough people selling glue, its price will rise and people will cash in by selling more glue. If too many people are selling glue, the price will go down, and some people will find it’s not worth their while to sell glue anymore. Either way, the market should settle at the point where the cost of producing more glue is equal to the value people place on that additional glue.
But Pigou realized that if a producer wasn’t paying for the full cost of producing a good, they would produce too much of it anyway and everyone else would foot the bill. Imagine that making glue is expensive because it costs a lot to cart away all the horse carcasses used in its production. There’s not going to be a lot of glue because only people who really like glue will be willing to pay to produce it.
Now imagine that instead of carting away the dead horses, glue factories realize they can dump them in nearby rivers for free. All of a sudden, it becomes a lot cheaper to make glue, so the price goes down. At a price like this, you can’t afford not to buy glue, so people consume more of it, and new glue factories pop up.
It all looks like economic growth, until the dead horses start piling up, and people start getting sick. Then they get a bunch of medical bills and the government has to spend money cleaning up the river. The sticky-fingered glue barons don’t mind much, because they can afford to buy the expensive houses upriver, and when the cost of cleanup gets spread to everyone, the cost to them is a pittance compared to their newfound glue fortunes.
Meanwhile, the tape users are fuming. They’re getting sick from glue they don’t even use, and the horse-dredgings are driving up their tax bill. And because a bunch of the former tape-makers have jumped on the glue bandwagon, there’s now a tape shortage. It’s a mess.
When you account for the costs of sickness and cleanup, each tub of glue costs $20 to produce. But the glue factories don’t pay for this, so they can sell glue at a going rate of $12. Glue that’s only worth $12 is being made at a cost of $20, so $8 is being wasted on each new tub of glue.
In this case, Pigou would prescribe an $8 tax on glue. Now, it costs glue factories $20 to produce glue, and only people willing to pay that much for glue will buy it. Less glue is produced, so fewer dead horses end up in the river, and the revenue raised from the tax can be used deal with the problems caused by the ones that do.
How It Works in the Energy Market
The dysfunctional glue market looks a lot like the current energy market.
Carbon, like the dead horses, creates what economists call a negative externality. A negative externality is the cost of an economic transaction that’s not borne by either the buyer or the seller, and is instead pushed onto society. It distorts markets and leads to inefficient outcomes, such as producing $12 worth of glue for $20.
A Pigovian tax corrects for a negative externality by making sure buyers and sellers pay the true cost of a good or service.
In this case, high-carbon fuel looks cheap on paper, because the costs to the producer don’t include the costs of global climate change or dependence on foreign oil. So, too much high-carbon energy is consumed. The producers don’t mind, because the extra costs are spread to everyone, while much of the benefit accrues to them. The people who use the most fossil fuels also benefit from buying lots of underpriced energy. Meanwhile, residents of places like New York and New Orleans, who don’t consume all that much carbon, pay the costs of the uptick in extreme weather that scientists say is linked to carbon emissions.
A tax on carbon would raise the price to include the trust cost of burning it, so that the economy doesn’t end up producing $12 worth of energy at a cost of $20.
By making carbon emissions more expensive, it would cause them to decrease. It would also lead to increased use of low-carbon energies—natural gas, wind, solar— which suffer from society’s de facto subsidy of carbon emissions.
So, why do some conservative economists who normally oppose new taxation support a carbon tax? Because a carbon tax, like any Pigovian tax, taxes something we want less of. And when you tax something, you get less of it. Even for the remaining cohort of climate-change deniers, Mankiw lists a slew of other downsides to carbon emissions in his Pigovian manifesto.
Taxes on alcohol can also be considered Pigovian taxes, because alcohol consumption can have harmful effects for society because it can contribute to crime and lost productivity at work. Taxes on cigarettes fit the bill, too, because of the public health costs of tobacco use.
But most taxes, especially at the federal level, tax things we want more of: labor, investment, business activity.
Depending on how broadly or narrowly you define economic growth, these taxes either arguably or definitely hurt growth.
But a Pigovian tax creates economic growth by allowing markets to allocate resources more efficiently. Think of all the wasted resources that went into making those jars of glue that cost $20 but were only worth $12. When the market produces the right amount of glue, those resources are freed up for more useful purposes.
Liberal economists tend to like a carbon tax, too, but usually differ with conservative economists over what to do with the revenue. They’re more likely to see the revenue as an opportunity to extend government services, subsidize alternative energy, or, in the current economic environment, pursue some other form of stimulus.
Conservative economists are more likely to advocate using the revenue to lower rates on other taxes, give everyone a tax rebate, or pay down the deficit. It’s these latter uses that are likely to dominate the discussion of a carbon tax in the coming months.
9 comments:
I found this article quite interesting, as it explained very clearly and with a very good example, about Carbon Tax or Pigovian Tax. There are many products being sold in our economy that are absolutely unnecessary and are being produced in a way that is bad for the environment, and I believe that the Pigovian tax is an excellent way of ensuing that the production of that product will decrease, as it will become more expensive to balance out the negative cost. Only people who absolutely need it will buy it, and if a product is not making many sales than it is likely to stop being produced, and will therefore not be harming whatever it was harming in order to be produced.
Georgie Goulding...
I found this article interesting as it clearly presented the idea of a Carbon Tax, and why people/parties are either for or against it. In a world where the global population does not appear to be slowing down anytime soon, Carbon taxes are imperative so as people, companies/ multi-nationals, have to think twice before they dump they're wastes in a river. The article explains why it is important to have a Carbon Tax in place, "By making carbon emissions more expensive, it would cause them to decrease." It would also drive the change towards alternative options that are low in carbon emissions such as wind, solar, natural gas etc. There are many goods and services in our economy that are essentially useless, a Pigovian Tax is a smart way to eliminate useless products that harm the environment, as the cost of production will be too expensive.
The Carbon Tax is a great example of how to improve a wasteful nation. If the population had to pay a carbon tax I can definitely see people being more mindful of the way they pollute and use such energy. Yes, there’s a clean air Acts and other laws that are enforced against big companies, but how much of that law specifically holds every commuter responsible for the carbon they release every day. Although, I’m another tax paying person and I wouldn’t look forward to a new tax, I do want everyone especially those who are wasteful to be held accountable for what they do.
Its quite ironic how society will complain about more and more taxes every year, yet they refuse to dilute their affluent lifestyle. And of course, I am no different, I consume and pollute just like everyone else and I definitely do not want to pay more money towards the government especially since the government does not always spend the money beneficially. Our nation needs to fix the problem we have created and not continually put band aids on the little things. Of course a carbon tax would be a good thing, however only if our money was actually going towards the right problem. These taxes will only continue to pile on more and more over the years until the point where millions of people will not be able to make ends meet and the economic system will crash indefinitely. Hopefully with this new carbon tax, we will put the money to some good use, rather then supporting certain government agencies and organizations that cause major problems to begin with. Instead paying off the deficit or investing in ways to decrease carbon emissions would be more logical.
This article was very informative and described the positive aspects of a carbon tax. I really cannot see the downside to implementing a carbon tax. It would not cause any unnecessary strain on business, and it would force businesses and consumers to choose more environmentally friendly products and services. The analogy about the glue factors that Mankiw used in order to describe the Pigovian tax really helped me fully understand this concept. Since some of the nation’s leading conservative economists support the concept of a carbon tax, there is hope that politicians on both sides of the aisle will endorse this new tax.
The concept of a pigovian tax is very interesting and seems to make sense. If
the producer is able to cut the cost of production by dumping waste into a stream
rather than spending money on disposing the waste in a way that is less harmful to
the environment most of the time they will choose the less expensive way. The same concept applies to carbon. If a carbon tax is not included then producers will find it inexpensive to produce large quantities of products without regard to carbon release in the environment. They will most likely produce more products than needed in the market, since the cost of carbon released to the environment is not applied. A carbon tax will also help reduce social cost. Usually pollutants and externalities harm society and externalities while markets gain benefits.
I dind't know that the Carbon Tax was also called the Pigovian tax. When following Pigou's thinking, it's clear that if people want to purchase an item and find shortcuts like dumping horse carcass into the river instead of disposing of them properly then the affects of the pollution will be transferred to the people. It's a great idea to add tax to the in the amount needed in order to clean up the mess. This is a great analogy to the negative externality of Co2. Because of carbon tax, this will decrease the amount of Co2 that is emitted by factories. This will significantly decrease air pollution which is what this planet needs.
I think this was my favorite article. call me a conservative economist but I like the idea of a Pigovian tax. Sure when we start taxing everything, a society will be up in arms but what about the problems that the article describes? People who are taxed on harmful goods, would know what was coming to them for paying said tax. Sure, it would create more underground black markets but then government would have to force stricter laws on the market. I am trying to stay in the Keynesian viewpoint so obviously the tax would only be focused on things that affect the economy. The Bloomberg administration enforced a tax of large drinks, and in the news recently, it was reported there was a health increase. On the other hand, suppose we did start buying carbon? Our environment will begin to look like China's, who have to wear masks and still has a poor health market. This would fit the scenario of the dead horses in the river, so the tax is something that shouldn't be taken lightly because, it could happen.
A moderate tax and some regulation on carbon emissions would help balance the damage industry can do to general welfare and health, yet I emphasize the word moderate. Keep in mind that as a society Americans are using the products that these industries are producing and if a society expects these industries to internalize these extra costs, society must also live with a shortage of production. It is important not to bite the hand that feeds, so to speak, an attack to these industries would not be appropriate.
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