I've finally been provoked into writing this post. Though actually it is going to be about something slightly different, or at least I'm going to go through a long rambling diversion, inspired by Idiocy on carbon permits by Timmy.
But since I'm also rather conscious that many of my posts are (when looked back over the period of a couple of years) utterly incomprehensible due to lack of context, I'm going to do some context.
If you look at the problem of Global Warming from an Economics point of view, then it is a perfectly standard problem, that of uncosted Externalities. Which is to say, emitting CO2 is free, but has a cost in terms of climate change. The standard Economics answer is to tax it (in some way) to Internalise this cost.
It is worth pointing out (another parenthesis, I'll escape to my main point eventually) that we don't apply this approach to all things. For example, in the UK, exceeding the speed limit (and getting caught) is penalised by a fine, which deters the poor people, and by having points docked off your license, which deters everyone, since 4 speedings is enough to lose your license for a while. Which is to say, is isn't Discouraged, it is Forbidden. Another example is killing people: killing people is Bad, but we don't deter that by imposing massive fines, we lock you up. So even rich folk can't do it. My sense, from reading various bits of Green literature, is that they think emitting CO2 should be of this "forbidden" nature, and shouldn't merely be something that you pay to do in order to pay for the externalities. That is a point of view, certainly, but for the purposes of this post, I'm going to ignore it and consider the std.Economics approach. End of parenthesis 1.
So, if we're going to "tax" CO2 (note that I'm carefully putting quotes around tax, because we might want to do carbon permits) then we need to decide how to sting people, and how much we should charge them. How much to sting them is quite a difficult problem, because it depends on a variety of things which we know moderately well (climate sensitivity, for example), things we're less sure of (what the airborne fraction will be in the future), and things we're even less sure of (how much ecosystem damage might occur, and how much it should be costed at. Even attempting to cost ecosystem damage winds some people up, and there is a helpful example from the Grauniad just now. That is representative of the "ecosystem damage should be forbidden, not penalised" school of thought, which as I've said I'm going to ignore for this post. If that winds you up, complain, and we can have another post on that) and then there are the things that we know extremely well, but different people disagree on what the value is that we know (discount rate, where we have Lord Stern versus the world). There are a couple of solutions to this difficult problem: the one I'd favour is to not worry about it too much. Set your costs at a reasonable best-guess level; or even start by setting them deliberately low, and then ramp them up as clarity arrives, or it becomes clear that people can tolerate them.
Another diversion: carbon costs can in principle be largely revenue neutral, in that you can (and should) offset them by reducing other taxes (there is still an effect because you're shifting taxes around the economy and penalising high-CO2-use, but I'll ignore that for now). People dislike carbon "tax" because it has the word tax in, and they don't trust the government to do this in a revenue-neutral way. So, a good way to start is at a low level, and establish trust that other taxes will indeed be cut. Ends.
OK, so just for now I'm not very interested in how much to charge people, but the question of how to charge them is interesting. And the two principle candidates are carbon permits and carbon taxes. Carbon taxes are easy: you just tax carbon emissions, probably by taxing fuel and 'lectric and stuff. Carbon permits are where you make a rule that in order to emit CO2 you need a permit, and you force people to buy permits (or, in the less reputable schemes, you give away a set number of permits) and then people can trade them.
Carbon permits are complex, permit a parasitic trading class, and allow pointless political interference. Carbon taxes are simple and provide little opportunities for parasites. So naturally our political class prefers... yes, you've guessed it, the bad system. However, I don't really want to rant about that either, I want to finally get to my main point, which (to give credit where it is due, came from Timmy, though I think he would say that from his point of view, it is merely the bleedin' obvious). And that point is...
There is a fundamental difference between carbon taxes and permits. For the permits, you do your science ahead of time and you work out how much CO2 you want to emit, and you issue permits to this level. Anyone wanting to emit CO2 (well, I say anyone, I mean anyone covered by the scheme) then needs a permit to do so. That means you know the maximum amount of CO2 that can be emitted. The idea is that companies that still need to emit CO2 are forced to buy permits, which they will do from people, presumably, who have managed to reduce their own emissions at a cost less than that of the permit they are selling; or who for some other reason have excess permits (like, for example, our idiot EU-wide governments handed out permits like confetti). But never mind: what it means to the bureaucracy that manages the permits is that the price of the permits has become irrelevant. Which is why the Grauniad is silly. When you've set the number of permits, you've done your job. If you find yourself saying "the price of carbon permits is too low" then you've failed to understand the permit system. Of course, to decide how much CO2 should be emitted is tricky. I don't even know what levels the current EU permit system is designed to produce, and quite possibly they don't either.
To make a carbon tax work, on the other hand, you need to decide how much damage the CO2 is going to cause, and you then penalise emitters at this rate. This too is tricky, but is does allow the normal market conditions to operate, rather than requiring explicit government intervention, which I think is a good thing. In theory, it is what the Stern report has allowed us to work out. You still need to do pretty well the same science as you needed to do to set permit levels, but what you don't have to do is the complex step of deciding what CO2 levels the government wants to see. It provides a softer (you can start with an under-estimate of the cost, to ease people in, for example; and it still works), but more continuous pressure. With permits, if you accidentally set the limits too tight for any one year, then (if anyone takes the limits seriously) you risk some of your industry grinding to a halt, unable to find any free permits. Or, conversely, if there is an economic slowdown, suddenly permits become effectively valueless, because there are excess permits no-one wants to burn, and the Grauniad becomes sad.
Conclusion: carbon tax good. Carbon permits bad.
[Note: this post got updated, overwritten, and originally published with the wrong date, thereby pushing it below the visible level. Now pushed to the top again]
[Update: there is another interesting example, again courtesy of Timmy, or what happens when you try to set your limits by another process: just deciding on limits, and then sort of giving various institutions quotas. First off, those targets aren't very important to the institutions, so they ignore them. And secondly you encourage a whole pile of clip-board tickers to go around measuring them. Compare that to a simple carbon tax: in that case, fuel prices just go up, so your institutions actually care, and no external pressure is needed.]
[Update: and another thing: with carbon taxes, you don't have to wait for international agreement. You can just do it, in a manner revenue neutral within your own economy. CF points out in the comments that you may need to pay attention to imports, though]
* Timmy, Chasing Rainbows - credit where it is due, Timmy is the source for my understanding of the central point of this post
* Hansen on cap-n-trade vs carbon tax - Me in 2009
* Atmoz joins the campaign.
* A carbon tax is meant to hurt a little, but we have a choice: we can change - New Anthropocene.
* Australia's carbon tax
* Timmy in El Rego
* Hot Topic: the case for a carbon tax "There is no policy instrument that is more transparent and administratively simple than a carbon tax." Unfortunately its overtness tells against it politically because voters, politicians and emitting industries see the price very clearly and can calculate what they think it might cost them. But in Shi-Ling Hsu's view environmental measures that purport to be painless are either misleading or set to accomplish nothing."
* November 08, 2011: Australia Carbon Tax is Passed
* Larry Summers Calls For A Carbon Tax Now That Oil Prices Have Fallen - Timmy, Jan 2015.
* How Not to Pass a Carbon Tax - GREG MANKIW, August 2015.
Petrol and diesel in the UK have a very high rate of tax. This is effectively a super carbon tax. i.e. Set at a higher rate than would likely ever be considered for a carbon tax called by that name.
However, fuel duty notoriously doesn't discourage many people from driving. Is there any evidence a carbon tax on other sources of energy would be any more effective at reducing consumption? As opposed to raising revenue, of course, which it would be very good at.
[I'm aware of the petrol tax "problem". However: if your belief is that fairly (or even over-) taxing energy use (sufficient to pay for the costs of the associated GW) will lead people to pay for the costs of the damage rather than reducing the use, there is no problem, if you adopt a Stern-type view -W]
Secondly, a revenue neutral carbon tax would have no effect on an average user and would reduce overall taxation for low energy users. Would the expected reduction in consumption from the less well-off, high energy users be enough to achieve its ends?
[The less well off aren't high energy users. How can they be, they don't have enough money? Do you mean, "high as a proportion of spending"? -W]
"or even start by setting them deliberately low, and then ramp them up as clarity arrives,"
That is essentially the Nordhaus proposal. Start low now and ramp up to $250 a tonne CO2 in 30 years. He suggests this partly because of what you say, partly because we've a huge amount already spent, invested, in the current way of doing things. Other things being equal it will be cheaper to make sure that replacements for the curent way of doing things are low carbon rather than destroying things that work today and building low carbon things to replace them. Go with the tehnological and capital cycle in other words.
And, of course, there is always Eli Rabett's Simple Plan to Save the World (actually there is an economics litereature on this for Timmy's sake). It takes care of China and India for starters
There seems to have been a huge improvement in fuel efficiency in new cars in the UK over the last few years (including a move for more models to be diesel rather than petrol), that I guess has been driven by the increase in fuel price
Looking at the new Ford Focus (mass market, european medium size car, just been released) it has combined cycle (mixture of urban, extra urban) mpg (miles per gallon) of up to 67 mpg. Even the lowest combined cycle mpg is 47.1mpg with a 0-62 time of 8.6 seconds.
Well, yes Eli.
"Imagine a world wide EAL system controlled by the early adapters market denominated in yen or euro. The effect will advantage them their currencies in the same was as the oil market being denominated in $ has benefitted the dollar. "
Although thinking that oil being priced in $ benefits anyone other than foreign exchange dealers means your economic thinking could do with a bit of polishing.
They're all just fiat currencies, the idea that oil is priced in $ "benefits" it is, umm, odd.
Tim, you are an economist? Having a commodity priced in your currency insulates it from exchange variations. Moreover your oil companies don't have exchange costs (however small they are) when you buy the stuff.
I've wanted carbon taxes in the U.S. for almost 40 years now. Instead, we institute fleet fuel efficiency standards - unbelievable!
If such taxes had been implemented long ago as I and my friends desired, the entire landscape would look different over here. We subsidized an unsustainable sprawl and profligate agriculture instead.
(Thankyou for not insulting us with "colonial cousins" BS this time.)
[Oops, sorry, I won't forget next time :-) -W]
There's one big problem with using taxation to control "bad" behaviour.
Taxation is parasitic, and the last thing any government wants is for that particular parasite to kill its host.
This is one huge conflict of interest. If governments tax in order to reduce consumption, success means a reduction in collected revenues. And so it follows that, in the land of political expediency in which our politicians reside, any taxation scheme ostensibly designed to reduce consumption cannot be allowed to become too successful.
There's a huge incentive to encourage continued or increased consumption, regardless of the platitudes uttered.
With this in mind, I'm going to predict that any "carbon tax" will be too small to make any significant difference, and that governments' real motivations for carbon taxes will be to increase (or collect) revenues and not to reduce fossil fuel consumption.
[We already have fairly hefty taxes on petrol, which exceed the Stern-level carbon taxation required -W]
> less well off aren't high energy users
This might be worth documenting. The poor may use much less but there are so many of them it may add up.
I'd suggest example that energy wasted by low-income renters heating uninsulated buildings, while it's being paid for by the poor out of their low income, ought to be 'charged to' the landlords for carbon tax purposes, as it's a needless waste.
Many good ideas were proposed in the 1970s and most were defeated; the few that became law and regulation paid off enormously well; many are documented here:
One more thing to think about with a carbon tax is how to deal with the tricky issue of trade. The harms of carbon dioxide are not confined within national borders, unlike, say, harms from traditional pollution, or harms to exploited labourers. Countries with carbon taxes (or a cap-n-trade thing) may wish to impose tariffs on the CO2 output included in goods imported from countries without carbon taxes. Calculating the tariff in a carbon tax regime is mathematically simple, however, in a cap-n-trade regime it is extremely complicated (since the imported goods would not likely participate in the carbon permit auction: yet if they did, they would strongly affect the price of permits).
The legality of carbon tariffs in the context of current trade agreements is controversial. Jeff Frankel has written about these details.
Carbon pricing schemes have deal with trade, as ignoring the issue will be a deal killer with the public, who are anxious about jobs disappearing to low wage, low regulation, countries.
crf see eli rabett's simple plan. It has mechanisms to handle that assuming that it is adopted by major economies.
Of course a tax will not be revenue neutral. There is a cost in administering the tax which must be payed for somewhere.
[No, because the costs of administering whatever you drop in exchange will drop. Indeed, if you use it to increase income tax thresholds, for example, you could simplify the tax lives of many people -W]
And because most of us correctly believe that a new tax cannot be revenue neutral and we don't want to personally have to pay such a tax, a cap and trade where the corporations where the direct cost is much more appealing. Of course cap and trade has a larger administration cost as it is more complicated, and the costs will be passed on to the general public one way or another....
[Err, not sure how to interpret that. I didn't make sense, I presume that was deliberate: you're just saying that CnT may be more popular because it appears that someone else is paying? That is just all-too-common stupidity, which is hard to fix -W]
I prefer calling it an FCOAD fee.
Yes, the second point is about common stupidity and the appearance of someone else paying. And I made a typo, should be 'a cap and trade where the corporations wear the direct cost is much more appealing'. Although of course that doesn't make much sense because a carbon tax is payed by the corporations.....
The first point I've thought of a bit more and I'm a bit undecided on that point. I don't think its too likely that you can just introduce the carbon tax and drop another tax that has equal complexity and everything come out revenue neutral. And it would be a good thing if the govt simplified the tax system, but this could be done regardless of carbon tax or not, so I'm sticking to the belief that there will be an administration cost. Of course it could be too small to care about. And putting a tax on carbon may encourage easy energy saving practices such as insulation etc which may save more money than the cost of administering the tax.
Personally I am 100% in favour of carbon tax.
And from an economical point of view I would think tax makes the most sense if you see the damage of Carbon as progressively increasing as emissions go up. Whatever the level of emissions there will be the same economic pressure to reduce emissions. In contrast a cap and trade picks a target. If the economy is heading over this target then prices will have to blow out in order to meet this target. If the economy is heading under this target prices will reduce and allow emissions to increase to the target level. A cap and trade would make most sense if there is a level that causes abrupt damage, and minimal damage below this level, and we can identify this level and control our economy accordingly.
I don't think I've understood your criticism of permits. I've always been attracted by their simplicity and the lack of possibility for Government interference. The level of emissions is set and that's it.
[You're missing a whole set of problems. Firstly, the level of emissions set: well, we currently have permits, what level of emissions *is* set? Is it transparent? Not obviously -W]
They are then traded.
[Second: you've skipped over a whole block of stuff here. How have the various companies acquired their permits? Have they been given them? (argh: terrible problem: huge polluters get huge numbers of valuable permits) Have they bought them? (who from? For how much? Who sets the price? How?). Where do they trade them?
Third: are you allowed to offset? If you can get some dodgy certificate from somewhere else of carbon reduction, can you use that as a permit? -W]
Everyone can understand what's going on. I once saw a TV documentary where it was suggested everyone in the UK was given a carbon credit. Most would be sold to business and little old ladies, who neither drove nor went on foreign trips, would enjoy a very comfortable old age. Why mess around with taxes and incentives, subsidising windmills and other nonsense? Just decide how much carbon will be emitted and leave it to the market to decide how and by whom.
[OK, you're addressing part of the problem: you're going to divide up the emissions per capita, and allow reselling. That certainly isn't how the current system works (though arguably it is better than the current one, where permits are given away like confetti). One might ask, "who could complain about little old ladies enjoying a *very* comfortable old age?" But in that case, you're proposing a huge xfer of wealth to the little old folk, which I sense could well be controversial.
And, why did you slip in the word "incentives"? I didn't use it, taxes don't require it, there is no subsidising of windmills or anything else -W]
"Tim, you are an economist?"
No, just an interested amateur.
"Having a commodity priced in your currency insulates it from exchange variations."
Eh? No. If the dollar declines then the price of oil as expressed in dollars will increase. Because, while we may quote the price in $ we're actually just converting into $ the price that results from all the people waving all the Â£,â¬, Yen etc in the world wanting to use oil. Demand doesn't change just because the $ is worth less Â£, so if the $ is worth less against the Â£ then the $ price of oil will rise.
"Moreover your oil companies don't have exchange costs "
True but trivial.
Carbon permits could be a simple and transparent system, just like income taxation could be a simple and transparent system. The fact that neither are simple and transparent in reality (at least here in the US/California) suggests it's a political process problem that will only be marginally affected by the choice of tools.
I agree with crf, and I have pointed out on several occasions the issues with ERs simple plan. A carbon tax is effective for reducing the emissions in a country or region that can't be exported. For emissions that can be exported like manufacturing it will simply cause that to happen. If you try to tax imports you have to figure out the carbon content, and there is no practical way to do that. China will tell us that everything they are exporting to us is produced with power from clean sources, and that nasty coal based power is only used for things that they directly consume. They will also not tell the truth about how much CO2 they emit etc. (I don't mean the Chinese are particularly bad about this, it is just how the world works.)
So if there was a world government that could impose a global carbon tax then I completely agree that this would likely be the best way to go.
But fundamentally the problem is getting global agreements, and otherwise you are just moving the deck chairs around.
Exchange markets are neither instantaneous nor perfect so price does not adjust automatically.
Brian, I just noticed your comment. How in the world could income taxation be simple and transparent? The word income is almost impossible to define, especially for businesses. And if you tell me that GAAP defines it, I can assure you that there are many cases where you would not consider it the least bit simple or transparent.
Nicolas Nierenberg, I believe that most workers in the US are paid on a single W-2 form. Without itemized deductions, etc., the IRS could fill out their tax forms themselves by looking up things on a chart. Is this not simple and transparent?
Sure if there income is exclusively from work, and they have very limited investment income and nothing else like spousal support, retirement earnings etc. then they can fill out the 1040EZ which takes about five minutes and can be filed electronically. The vast majority of people in that situation pay no U.S. Federal Income tax.
However most of the people who actually pay income tax have increasingly more complicated income sources and expenses related to those. So even forgetting about the various tax credits etc. it is by definition a complex issue.
> are you allowed to offset? If you can get some
> dodgy certificate from somewhere else of carbon reduction
Still working on that. I've got 50 acres of wildland, some in big trees, but most of it recently started on a 200-year restoration, slowly recovering its topsoil.
A while back a certification organization offered me $30,000 for the 'offset' value of the timberland for a hundred years -- they'd then sell that to some one who wanted an offset.
I asked to document it as already "used" -- toward offsetting my own lifetime fossil fuel use -- nope, they don't do that. If it's not for sale, it doesn't exist.
Hank, amazing lack of creativity on their part. They should have purchased and sold it back to you for a small fee.
From the OP:
Which is why the Grauniad is silly. When you've set the number of permits, you've done your job.
Yes, but there's an added wrinkle. The linked article was primarily about a collapse in the international carbon market connected with the Clean Development Mechanism, in which developed countries or their businesses gain extra permits outside their own carbon cap, from funding alleged carbon reductions in countries that do not have a cap.
"Exchange markets are neither instantaneous nor perfect so price does not adjust automatically."
True but boring. For FX and oil are probably the two most liquid markets in the world, meaning that prices adjust there more quickly than anywhere else.
Nicolas Nierenberg, I'm not particularly convinced -- it's quite easy to imagine a simpler system with regards to those sorts of income, as well. (Interest income reported by the interest-payer; dividend income reported by the dividend-payer; investment income counted at time of sale on the difference between purchase and sale price; etc.) Only a small number of taxpayers have more than a few standard kinds of income (wages, interest, mutual funds, dividends, perhaps a few others), and many of that group (e.g., people who own their own businesses, billionaires) probably need an accountant for other reasons, anyhow. The point (which we're wandering away from) is it's extremely easy to imagine ways to make the income tax anywhere from "simpler" to "actually simple" for almost everyone, and likewise it's easy to imagine a carbon tax as "simpler than permits" or even "actually simple", but that the ability to imagine this doesn't necessarily correspond to the reality of how a carbon tax would turn out in practice.
Incidentally, I am not deeply interested in the question of tax vs. permit; in particular, I'm not trying to convince you that a permit system is better or simpler. I just think you're being a bit willfully obtuse on a fairly simple and tangential point.
It would be nice to have some examples of products currently sold for which externalities are already taxed or otherwise included in the price.
[Petrol, in the UK -W]
There is no equitable or efficient way to achieve revenue neutrality. Carbon pricing is logarithmically regressive because increases in the cost of fuel and electricity spread throughout the economy.
[That is a very odd thing to say. Is it true just because you say it, or is there some underlying reasoning that you are omitting? -W]
Revenue neutrality is an attempt to make the tax politically palatable. It is counter productive as a mitigation strategy. Neutrality removes the intended incentive of the tax.
[No, it doesn't. Neutrality is only true across the economy as a whole, not for individuals -W]
and we have to take it on trust that the overall tax burden on the economy will adjust to take into account that so much is being raised at "carbon source". I would not have trusted Brown/Balls....and nor do I trust Osborne.
[Indeed, I think that many people would not trust. Which is why I explicitly addressed this point: by setting the start point low (hence, less important) a reputation for trustworthiness in this area can be established. Or broken, if it doesn't work out -W]
But there are infrastructure questions as well. Should I turn down a job that means I might have to drive 100 miles per day?
[I certainly would -W]
If the telecomms infrastructure were good, then I could tele-work for some days - the advantages of working and interacting with real people are still great but I would not have to embrace the clammy M25 everyday. But the last govt milked telecomms dry with the 3G licence auction and we are still suffering.
[The 3G license auction was open and entirely fair. That the 3G companies got hopelessly overenthusiastic isn't the governments fault. Plus, that has almost nothing to do with telecommuting, since you'd wouldn't do that over 3G anyway, usually -W]
I am sorry if you consider me willfully obtuse. Accounting for income is an incredibly complex topic. Really take a look at GAAP to find out. This is, IMO, actually on topic as people try to act like these topics are simple when they aren't.
If forced to choose between a carbon tax or cap/trade, Iâd choose a carbon tax. I donât think it is an effective approach, even less so if it is revenue neutral. Of course, carbon taxes already exist. In the US, there are in place taxes on all forms of carbon and power generation. Most of these taxes are imposed to generate revenue rather than account for externalities. If the petrol tax is similar to US gasoline tax, then the externalities road construction and repair are included as revenue raised for that specific purpose.
A carbon tax is regressive. Because all taxes and fees are passed on to the consumer, the effects of the tax are especially burdensome on those least able to afford it. An extra $100 a month doesnât mean much to the well off, but it is equivalent to a two week layoff to a working guy. I say logarithmic because a carbon tax adds cost not just to our personal and commercial use of power and fuels, but also to almost everything else we buy. Everything in the store costs a penny more.
["An extra $100 a month doesnât mean much to the well off, but it is equivalent to a two week layoff to a working guy"!?! How many people do you know who work for $200 a month? As for the regressive aspect: tough. Taxes on consumption are good, taxes on income, bad. If you (as in, the populace and political system as a whole) want to de-regress them, then feel free to do stuff like raising the income tax threshold, using the carbon tax income perhaps. Then not only do people get more income, and more incentive to work, they also get their lives simplified -W]
I have read your article William and I have enjoyed reading the many comments you have generated. I do not believe the answer is taxation, people are totally sick of it and most don't understand the wider issues of what it would be set up to acheive. The majority of consumers use energy, mostly to a minimum comfort level, to which they have been accustomed.
The answer here is forcing people to use less energy. If everyone who replaced a tungsten light purchased a low enery lamp energy consumption would reduce from day one. Banning inefficient light sources would be a great start.
I am sure many of us could cite other ways of reducing energy consumption but would it really help without legislation.
I would be happy with taxation in the form of surcharging for excessive energy use, especially in the home. That tax could be levied and collected by the energy suppliers.
This should all be about educating people and setting reasonable targets.
Here's the math on the two week layoff equivalence. Someone taking home $600/week - decent pay around here - would, at an extra cost of $100/month, over the course of a year lose an amount equal to 2 weeks pay.
As for the regressive aspect: tough. Sounds like the Tory line. De-regress them...do stuff like raising the income tax threshold, using the carbon tax income perhaps. That would bring neutrality back to individuals rather than true across the economy as a whole. Maybe it's a distinction that doesn't matter.
It is hard to assess whether a carbon tax will provide effective incentives for the desired behavior without knowing the actual form and rate of the tax or the neutrality mechanism. If the desired result is reduced C02 emissions, the desired behavior must be energy transformation.
I think you are missing the point a bit. I'm no expert on this but, there is no 'desired behaviour' as such.
There is a market failure because the cost of fossil fuels does not include the externalities (the damage caused)
You work out your best estimate of how much this damage costs (including low probability, high impact scenarios) and then add this cost into the price of carbon (ideally at the minehead / port of entry)
You can do what you like with this, distribute it to everybody on a per capita basis (Hansen), do something to 'de-regress' the taxes, whatever.
The point is the fossil fuels are now the 'correct' price because they include the externalities.
Where there are realistic alternatives (Power generation ?) the alternatives will take over. Where there is no realistic alternative (aviation?) fossil fuels will continue to be used but the price is correct as it includes the cost of the damage caused.
You will end up with the economically 'optimal' amount of global warming, in the areas where it is cheaper to use an alternative, the alternatives will take over. In the areas where we continue to use fossil fuels, we are paying for the damage they cause. You don't need politicians 'picking winners', competition will sort it all out. As the science becomes clearer you can adjust the carbon level to more accurately reflect the damage caused.
On the contrary, desired behavior is the sole purpose of a revenue neutral carbon tax. It raises no new government revenue, which is the most common purpose for a tax. If the purpose of the tax were to account for the now and future external costs of mitigation and adaptation, then there should not be neutrality.
[You're not reading what is written. Until you do that, its hard to have a conversation. Go back and actually read the post. The point of the carbon tax is to internalise the externalities. This isn't about behaviour -W]
From Tim Worstall's comments
I fear youâre missing the point of Pigou taxes. Theyâre not to compensate. Nor to enable the government to compensate.
There are times when the market does not properly process prices. Because there are things which are not included in the market. These are known as âexternalitiesâ. Pollution is one of these. There are also positive externalities: basic science perhaps.
There are certain costs and or benefits that are not used in calculating prices in a market. Thus the market price will not be optimal. Weâll get too much of the bads, to little of the goods.
The solution is to adjust the market prices to account for those things not included in the calculation of what market prices are. The point is not to raise revenue, not to raise funds to compensate for the bads. Itâs entirely and purely to correct market pricing.
Thus what we do with the money, who is compensated how, have nothing at all to do with it. We could burn the money raised and a Pigou tax would still do what we want it to: correct those market prices.
Sadly itâs possible for people to take almost anything to be an externality (Iâve seen it said that inequality is one such) but the basic idea is indeed entirely sound.
I think that you've been reading too much of Tim's free market rhetoric.
Any system of relying on a carbon price (either carbon trading and carbon tax) suffers from 2 overwhelming problems:
1. For the price to be high enough to get the changes you want in one area, you will have to put up with unacceptable things in other areas.
[But I think that you are trying to make "your desired changes" through the tax - remember, it is supposed to internalise the externalities of the carbon. For example, if you count the petrol taxes as carbon taxes, then they are higher than they need to be. You might well say "but there is still too much congestion and too many yucky cars and people don't use public transport" which is fair enough, as an expression of your opinion. But its not the point -W]
In reality, this will lead to the price always being set very low. It is like trying to open a locked door by pushing against the whole door â not the best way to do it if you donât want to break the door. And if you don't want to break the door, you won't dare put enough pressure on. But it is the wrong approach - you want to target your intervention to the lock.
2. The market will always tend to preference the changes which are the cheapest in the short term, which will be the ones which do not require major infrastructure change. This is very different from the changes that will make bigger cuts more possible in the longer term. Not all carbon cuts are created equal. Some (like making an expensive efficiency improvement to a coal fired power station) actually make it harder to cut more in the future.
[The market will (if not broken by government intervention) choose the cheapest change. Full stop. Short or long term. But the market knows about discount rate and investment costs. If the market knows that there will be a carbon tax of X, rising to Y over N years, those costs will be factored in -W]
I know that social democratic ideas like these are unfashionable, but it seems very obvious to me that any serious attempt at making big cuts in GHGs will require targeted government intervention - both regulations and investment. Carbon pricing will never be the major player in the story.
E.g. Nordhaus et al have it about right. Government investment in clean tech is what is most urgently required, not carbon prices.
[For all I know you might be correct, but so far you haven't made a convincing case. Why exactly should the government be better at innovation than private industry? The UK is certainly littered with examples of the government doing it badly: British Leyland for example. I'm all for social justice and so on: I just can't see why that requires government intervention in an area where an effective method (carbon taxes) is known -W]
"The point of the carbon tax is to internalise the externalities. This isn't about behaviour."
We may be, as Mark Twain said, separated by a common language. Internalising the externalities is the effect of the tax. The expectation is that correct pricing will alter market activity in its broadest sense for the better. Is behavior the wrong word to describe that activity?
[It depends what you mean by "better". If you mean a moral judgement, then no. If you mean, so that costs and benefits more closely match, then yes. You could describe that as changing behaviour, if you like. But if you get to thinking that way, which is what I rather sense you are trying to do, you'll go wrong -W]
For the tax, "better" means market activity that results in emissions reduction. Not a matter of morality, regressive vs progressive taxes depends on one's view of the theory of the diminishing value of each additional dollar.
The opportunity to substitute a carbon tax (or is it a CO2 tax?) for some current tax is intriguing. If the new tax will generate x amount of revenue, how do you determine which tax it will replace?
[I think there are two answers there. The first is, that isn't up to the people proposing the carbon tax, its just part of the political process. This I think is ultimately the correct answer - it is just part of balancing of the tax take from different sources against spending. But inevitably people will ask, and so we need an answer; since most people who know the word think CO2 taxes are regressive, probably the best answer is to increase income tax thresholds, since everyone hates income tax -W]
âI think that you are trying to make "your desired changes" through the tax...â
No, Iâm thinking only about what changes are necessary to move in a realistic way towards a low carbon economy. If your climate policies require you to cripple crucial industries, or take on particularly difficult political or social issues, they just wonât happen. They will be politically and economically unfeasible.
Focussed policies allow you to deal with this problem because if any one particular area is difficult for economic, social or political reasons, you can leave it alone and focus on the others. An across the board carbon price does not allow you to do this. Therefore, inevitably, policy makers give up and keep the price low so as to not cause trouble in the troublesome areas. That isnât an ideological argument, itâs a realistic one.
More generally, I think that it is pretty bizarre and troublesome to characterise the problem as the need to internalise an externality, for several reasons. The main one is this:
If you have a locked in technological system with a lot of sunk costs, the problem is not that right now, the carbon price is too low. The problem is about something that happened in the past, the residue of which is the technological and/ or social system that you have been left with. I understand that you scientists call it âhysteresisâ. If the past was different, the present carbon price could be exactly as it is now, and yet there would be no problem.
[Of course. But changing the carbon price now, and saying it will go up in the future, will influence investment decisions taken now and affect long-term infrastructure. This is another argument for starting now, with a lowish price, and ramping it up -W]
Now one way that you could deal with that problem is to âinternalise the externalityâ in the present. But by doing that, you may well be leaving the underlying problem â the reason for the externality existing - untouched.
[Those are words that fit into sentences but they don't actually make sense. The externality exists because there are uncaptured costs of actions like burning fossil fuels. That *is* the underlying problem, from the economics viewpoint -W]
Internalising the externality may provide incentives that lead to the changing of the underlying problem, but it also may not, and whether it does or not is extraneous to whether you have âinternalised the externalityâ. Internalising externalities is quite different from finding ways to avoid externalities occurring in the first place.
By characterising it as the problem of an externality that needs to be internalised, I think that you are going to encourage answers that are going to be focussed on immediate cuts, which may not be the best in the longer term.
That isnât brilliantly expressed, but you may get the idea.
Your other point on industry Iâll write a reply to later.
apologise for referencing Tim again
Thereâs also the William Nordhaus idea, start with a low tax and (credibly) commit to raising it. Perhaps $5 or $10 a tonne now, rising to $250 or so around 2040. This allows both the development of new technologies and also works with the grain of the capital cycle.
The Nordhaus solution is almost certainly better for those places (yes, USA, we are looking at you) which do not at present have anything like the required carbon taxes. Whacking $80 a tonne on right now would cause huge dislocation: better to let the economy adapt more gently.....
>Taxation is parasitic...
I think that Jim Hansen has the right idea in regard to this - you don't want the carbon tax to replace other taxes, because otherwise it does end up a "government income" with all that entails. His idea of rebating the carbon tax to the population directly is appealing because it avoids that moral hazard. Furthermore, it clearly identifies that the impost (charging users for the externalities of their carbon consumption) is a cost that is borne by all individuals (equally).
[I am opposed to this. Firstly, because accepting the nonsensical "taxation is parasitic" stuff falls into the hands of the wacko wing of the libertarian groups. Secondly, because expecting the government to collect and then redistribute the money without touching it is unrealistic. Even if it started that way it would creep (e.g. lottery funding in the UK). Its a tax. Don't be afraid of the word or the concept -W]
Conservative American climate skeptic also advocates a revenue neutral carbon tax. He differs in initially taxing only gasoline. He would reduce the payroll tax that funds medicare, a regressive tax for a regressive tax. His reasons have little to do with climate or CO2.
[Did you mean to include a link? I don't know who you mean, or what his reasons are. Are they are of any interest? -W]
Charles Krauthhammer in a post at dotearth.
Are they are of any interest?
Not any more than any of the other reasons to favor a tax. Neither his reasons nor yours need to come up in a conversation between the two of you. The talk would be about how to get the tax politically or if there are other ways to reduce consumption with minimal government intrusion. His reason to offset the tax rather than use it to increase funds is similar to yours.