Topic: Tax and Budget Policy

Nordhaus’s Less-than-optimal Climate Strategy

In “Pointless to rush a carbon emissions plan,” the Toronto Globe and Mail’s Neal Reynolds compares Yale Professor William Nordhaus’s “optimal” approach to controlling greenhouse gases and finds it superior to approaches that would impose deeper controls more rapidly, such as those favored by Stern, various EU leaders, and many in the US.

Under the Nordhaus approach, which is also discussed by Keith Johnson at the Wall Street Journal, costs of control would start at 0.3 per cent of global GDP in 2010 (currently around $60,000 billion), increase to 0.5 per cent in 2015, 0.6 per cent in 2020 and peak at 0.9 per cent in 2065. He estimates the net present value (NPV) of climate change damages absent any controls at $22 trillion. Under this so-called “optimal” approach, the NPV costs of controls would be $2 trillion and climate change damages would be reduced by $5 trillion (i.e., the “optimal” policy would provide net benefits of $3 trillion, but residual damages would be $17 trillion). As he explains, “More of the climate damages are not eliminated because the additional abatement would cost more than the additional reduction in damages.”

He also estimates that proposals that emphasize “excessively early reductions [make] the policies much more expensive… For example, the Gore and Stern proposals have net costs of $17 trillion to $22 trillion relative to no controls; they are more costly than doing nothing today.” By his calculations, his proposal is clearly superior to these other reduction proposals.

However, while Nordhaus’s prescription may indeed be the most “optimal economic approach” to slow global warming, it isn’t the optimal approach to addressing global warming. This is because it ignores adaptation. Some adaptations may reduce climate change damages more efficiently than mitigation. Perhaps all or part of the $2 trillion that Nordhaus would spend on mitigation should, instead, be invested in adaptation. That might reduce damages by more than the $5 trillion. In any case, with adaptation in the mix, $5 trillion may well be the lower bound for the optimal reduction in climate change damages. And, of course, emission reductions that seem to be optimal under 0.9 percent of GDP in 2065 in the absence of adaptation may, once adaptation is thrown into the mix, no longer be optimal.

In fact, a recent Cato Policy Analysis indicates that in the short-to-medium term, adaptation — specifically, reducing vulnerability to climate-sensitive problems that might be exacerbated by climate change — would provide greater benefits than mitigation, and at a much lower cost. Most of those benefits come from the fact that one approach to adaptation is to advance adaptive capacity. Significantly, that can help society cope not only with climate change but, more importantly, to other problems that are more important than climate change now and in the foreseeable future. Thus the ancillary benefits of increasing adaptive capacity are very high, higher than climate change damages in the absence of any controls according to the Cato Policy Analysis.

Notably, Nordhaus acknowledges to having “relatively little confidence in our projections beyond 2050.” To his credit, this skepticism informs his recommended approach, but it would probably have been best to avoid stretching the analysis to 2200.

Sometimes such long-range analyses are justified on the grounds that that’s the best that can be done. But even if that’s so, it misses the real issue, namely, whether even the best available analysis is good enough for making trillion-dollar decisions which, moreover, extend out centuries hence. At these temporal distances, Nostradamus may be just as credible as Nordhaus, or Nicholas Stern, for that matter.

Humility isn’t an offense, and it ought to be acceptable for economists and policy analysts—even those whose stock in trade is climate change—to admit that they haven’t a clue what the world will look like beyond 2050 (if then).

Nordhaus’s numbers indicate that estimates of pre-control damages and post-control residual damages frequently are substantially larger than either the costs or benefits of emission controls. But the treatment of damages (i.e., impacts) of climate change in the Nordhaus analysis is somewhat sketchy. As far as I can determine, none of the damage studies properly account for adaptive capacity, particularly considering that that capacity ought to increase if societies accumulate wealth, human capital and technology at rates implied by all the socioeconomic scenarios used to derive future emissions (and climate change). (See, for example, here.) Thus, both pre-control climate change damages and post- control residual damages could be substantially overestimated.

[Some argue that they disbelieve that economic growth will be as high as assumed, but in that case they should also disbelieve estimates of future climate change and impacts predicated on that growth.]

To summarize, the Nordhaus analysis probably overestimates climate change damages. In any case, the Nordhaus approach could be made more optimal by adding to it an adaptation component that would enhance societies’ adaptive capacities (by reducing present day vulnerabilities to climate-sensitive problems and boosting economic development and human capital in developing countries). In fact, optimal carbon taxes (or cap-and-trade approaches) can only be determined after completion of more comprehensive analyses that include full and equal consideration of adaptation and any ancillary (net) benefits.

Of course that still leaves the problem of relying on analyses over time frames that demand, in Coleridge’s words, “willing suspension of disbelief.” Instead of suspending disbelief and succumbing to gullibility, I would recommend a somewhat different approach (see here, p. 37).

Norway’s Hypocritical Government Launches Attack Against Low-Tax Jurisdictions

The Norwegian government has appointed a one-sided commission to investigate the supposed damage caused by tax havens. A leftist news service reports on this development, and regurgitates a discredited estimate from Oxfam about how low-tax jurisdictions ostensibly deprive politicians in the developing world of tax revenue:

A new commission appointed by Norway will investigate ways of putting a stop to the huge flows of money into tax havens. Tax evasion and corruption are believed to cost poor countries at least 50 billion dollars a year. The commission, launched last week, includes Eva Joly, a special advisor on corruption for the Norwegian development agency Norad… Among the areas that have been labelled as tax havens are Andorra, Monaco, Gibraltar, Jersey, the Cayman Islands, Luxembourg, the Netherlands, as well as some parts of the financial system in London. “I am very proud of this commission and I think it is very important that it has been appointed, because there is quite a high level of confusion surrounding the damaging effects of tax havens,” Joly, who is also part of an anti-corruption working group at the World Bank, told IPS. …According to a 2000 estimate by Oxfam International, tax havens rob developing countries of at least 50 billion dollars a year in revenues.

An amusing aspect of this story is that Norway’s pension fund is a big investor in tax havens:

Finance Minister Kristin Halvorsen and the minister in charge of foreign aid, Erik Solheim, have harshly criticized companies, both Norwegian- and foreign-owned, that avoid taxes by registering themselves in countries with low or non-existent tax obligations. At the same time, however, the state’s massive pension fund that’s fueled by Norway’s oil revenues has been investing billions in companies that are registered in tax havens. This includes companies “based” in places like the Cayman Islands, Bermuda and Cyprus.

The moral of the story, of course, is that politicians are in favor of anything that gives them more money. That enables them to buy votes and provide unearned wealth to their supporters. But taxpayers (the ones who generate the wealth) should not be allowed to protect themselves and their families by utilizing jurisdictions with better tax law.

Up Is Down, Black Is White, and Democracy Is Dictatorship

Europe’s political elitists are not very happy with the unwashed masses. First, French and Dutch voters had the unmitigated gall a couple of years ago to reject the European Union’s proposed constitution. In an effort to sidestep the democratic process, the political elite then made a few cosmetic changes to the document and called it a treaty, hoping this would enable national governments to bypass their voters. Much to their chagrin, however, Irish politicians could not figure out how to sidestep their nation’s referendum requirement, and the people of the Emerald Isle proceeded to reject the statist EU constitution (now officially referred to as the Lisbon Treaty). This led to a frenzy of anti-democratic utterances from the political class, but the prize for the most Orwellian response goes (what a surprise) to a French politician, who just stated that allowing voters to decide is “a tool for dictators.” He also wins a secondary prize for his assertion that the EU constitution, which would have granted even more power to undemocratic bureaucratic institutions in Brussels, is needed “to grant our citizens more power.” The Irish Times reports:

Alain Lamassoure MEP tells Jamie Smyth , European Correspondent, Ireland was wrong to hold a referendum, which is ‘a tool for dictators’. …”We are paralysed by the unanimity rule and we pass legislation through undemocratic procedures … we have a duty to grant our citizens more power,” he said.

Cohn’s Fuzzy-Math Health Care Plan

Over at The Plank, my friend Jonathan Cohn makes a first pass at a Center for American Progress paper on John McCain’s proposed health insurance tax credit.

The main thrust of the CAP paper is that McCain’s tax credit would raise taxes on some people. I can’t really argue with that. If you replace an unlimited tax break with a limited tax break (especially one whose growth is limited), then some people are going to pay higher taxes. The fact that McCain’s tax credit is “refundable” makes the tax-hike problem worse: high-income people must suffer higher tax increases to pay for the new welfare payments. For what it’s worth, I have forwarded a proposal to reform the tax treatment of health insurance that does a much better job of protecting people from tax increases. But that’s not why I’m blogging.

After Cohn finishes with the tax-hiking aspect of McCain’s tax credits, he writes:

But this is where we run smack into the real problem of the McCain plan… This is an incredibly crude and ineffective way of controlling costs. It puts the entire onus on the consumer–basically, it says to everybody “spend less on health care” without doing anything to make sure that people can actually get decent health care at that price. There’s no guarantee of minimum benefits, in terms of services covered or limits on out-of-pocket expenses; nor is there any guarantee of available coverage for people with pre-existing conditions. (Folks with pre-existing conditions could still get coverage through employer policies. But, of course, as the tax deduction goes away, employers will have less incentive to give such coverage in the first place.)

The better way to control costs is with a variety of approaches that starts with a guarantee of coverage to everybody.

That is the Left’s approach to cost-containment – give more health benefits to more people with more ailments, while making everyone pay less – and it is just plain goofy.

More stuff costs more money. Universal coverage equals more stuff. If you’re going to use “universal coverage” and “cost-containment” in the same breath, you’d better tell me where you’re going to cut.

Tax Revenue Tanking? Act Now on Education Tax Credits and Watch Your Savings Grow!

With a sluggish economy and rising costs for everything, state and local governments are facing serious budget problems. It’s clear that there’s a lot of spending that they should simply cut outright. But politicians hate doing that.
But there is one way to save billions of dollars without cutting a single program or budget; broad-based education tax credits.

A fiscal impact analysis of our Public Education Tax Credit from our own Andrew Coulson and economist Anca Cotet was released today that shows the potential savings for 5 states.

Education spending makes up about half of most state budgets and is the biggest item at the local level, so we expected major savings from our broad-based program. But the totals surprised even us.

Here are the pretty stunning highlights:

Illinois saves $5.1 billion in the first 10 years and $1.6 billion every year after the program has been in operation for 15 years.

New York saves $15.1 billion in the first 10 years and $4.8 billion every year after the program has been in operation for 15 years.

South Carolina saves $1.1 billion in the first 10 years and $350 million every year after the program has been in operation for 15 years.

Texas saves $15.9 billion in the first 10 years and $5.4 billion every year after the program has been in operation for 15 years.

Wisconsin saves $9.3 billion in the first 10 years and $3.2 billion every year after the program has been in operation for 15 years.

Americans Overwhelmingly Reject Redistribution

In some heartening news, new poll results from Gallup show that Americans decisively reject redistributionist policies by an 84 percent-13 percent margin. Even Democrats prefer that government focuses on growth rather than redistribution by a margin of 77 percent-19 percent. A blogger for the New Republic claims the question was poorly worded, but that seems like wishful thinking. People were basically asked whether government should focus on making the pie bigger or focus on re-slicing the pie, and the results are very encouraging:

…given a choice about how government should address the numerous economic difficulties facing today’s consumer, Americans overwhelmingly – by 84% to 13% – prefer that the government focus on improving overall economic conditions and the jobs situation in the United States as opposed to taking steps to distribute wealth more evenly among Americans. … Americans’ lack of support for redistributing wealth to fix the economy spans political parties: Republicans (by 90% to 9%) prefer that the government focus on improving the economy, as do independents (by 85% to 13%) and Democrats (by 77% to 19%). This sentiment also extends across income groups: upper-income Americans prefer that the government focus on improving the economy and jobs by 88% to 10%, concurring with middle-income (83% to 16%) and lower-income (78% to 17%) Americans. … In sum, free-market advocates can take considerable solace in Americans’ overwhelming belief that the government should not focus on redistributing income and wealth, but on improving the overall economy. And, to a lesser degree, Americans also believe government continues to do too much – not too little – to solve the nation’s problems.

Justice Department Bureaucrats May Set Risky Precedent with Extra-Territorial Tax Persecution

Bush Administration appointees involved with issues such as the Iraq war and coercive interrogation of suspected terrorists probably don’t spend much time thinking about international tax policy, but they may rue the day that the Justice Department decided to persecute Swiss banks and Swiss bankers for obeying Swiss law and protecting the financial privacy of customers. What’s the connection? By going after Swiss banks and Swiss bankers in hopes of finding a few Americans who might be hiding money from the IRS, the Justice Department is embracing the notion that governments should not be constrained by national boundaries and national laws. Richard Rahn already has an excellent piece explaining why this is an absurd policy, but let’s consider some of the broader implications.

What if John Yoo or Donald Rumsfeld travel to Europe in the near future for business or personal reasons and some European government decides to throw them in jail for violating “international law”? This may sound fanciful, but German authorities already have moved in this direction by asserting universal jurisdiction, and it doesn’t take much imagination to foresee politically ambitious officials from other nations grabbing the baton. The Wall Street Journal report does not cover these broader implications, but it is a good summary of the Justice Department’s fishing expedition:

The Justice Department, in an unprecedented move against a foreign bank, is seeking to force UBS AG to turn over the names of wealthy U.S. clients who allegedly used the giant Swiss bank to avoid taxes. …U.S. authorities have been holding discussions for several weeks with UBS and Swiss banking authorities to identify the U.S. account holders. People familiar with the talks say UBS officials floated the possibility that the U.S. could obtain the names through a request to Swiss regulators. Monday’s federal court filing instead puts the bank in direct conflict with the U.S. government. …The filing is the first against a non-U.S. bank by the Justice Department using what it calls a “John Doe summons,” a maneuver typically used to investigate tax fraud by people whose identities are unknown. The move could spark a major legal battle because the Justice Department is essentially gambling that courts will bless the move when it’s directed at a company with extensive U.S. operations but that isn’t based in the U.S.