November 12, 2008 4:10PM

The “Fairly Impeccable” Case for (Revenue Neutral) Carbon Taxes

In the course of making his argument that Cato frequently makes counterproductive alliances of convenience (from a strict libertarian perspective, anyway) with corporate special interests, Matthew Yglesias writes at Cato Unbound:

The free‐​market case for a revenue‐​neutral carbon pricing scheme seems fairly impeccable to me. But instead of organizing its climate change efforts around seeking to ensure that any future carbon pricing plan be as close to revenue neutral as possible, Cato prefers to steadfastly defend the rights of industry to unload air pollution unimpeded.

I’m not sure how one might define a “free market case” for a revenue‐​neutral carbon pricing scheme, but the economic case for it would require evidence that (1) the benefits of the tax shift would exceed the costs, and (2) that the proposed tax shift is a less expensive means of addressing climate change harms than other possible remedies.

Regarding (1), the argument is intuitively plausible but is, in fact, quite problematic. And you don’t need to be a Cato libertarian to come to this conclusion. You will find great skepticism about the claim that a tax shift would on balance prove economically positive from economist Lawrence Goulder (a supporter of carbon taxes, by the way). This seminal piece from economists A. Lans Bovenberg and Ruud de Mooij is also good. As energy economist Stephen Smith observes after surveying the relevant economic literature on eco‐​tax shifts:

Ecotaxes are likely to involve distortionary costs at least as high as those involved in raising equivalent revenues through existing taxes. If the question is posed whether we would choose to use energy taxes, in preference for existing taxes on labour and other bases, in the absence of any environmental benefits, then the answer is almost certainly that we would not. Energy taxes would be likely to involve just as much distortion of the labour market as income taxes, and at the same time distort the commodity market. Only if there are expected to be environmental gains can the use of environmental taxes be justified, and the case for ecotax reform must be made primarily on the basis of the environmental gains that would result.

Read that last sentence again.

So, are the benefits that might flow from a carbon tax (defined at the monetarized value of the temperature reductions that might follow) greater than the costs of the same? Energy economist Richard Tol’s review of the published economic literature suggests that the monetarized damages that follow from a ton of carbon emissions at the margin (if mean estimates of future climate change from the IPCC are to be believed) likely works out to about $2. Hence, if a carbon tax is set above $2 dollars, it will may very well deliver more social costs than benefits.

Regarding (2), Indur Goklany makes a strong case that adapting to climate change and applying targeted public policy initiatives to directly address subsequent harms is much cheaper – and much more effective – than a policy of reducing greenhouse gas emissions. Moreover, Goklany points out that this conclusion holds even if we accept the worse‐​case scenarios spun‐​out in the Stern Review on the economics of climate change.

Of course, Matthew Yglesias is free to disagree with the above. But the case for a revenue‐​neutral carbon pricing scheme is not “fairly impeccable” … from an economic perspective, anyway. There are ample grounds for disagreement … and that’s true even if we ignore the debate about the underlying science.