Step Away From the Cliff

Governments need to raise money from somewhere. As the debts of western governments have ballooned through the prolonged economic crisis, this is especially true today. In addition to providing services to its citizens - be they fans of big government or small - keeping debt levels manageable requires income streams.

Carbon tax proponents have long argued that placing a price on carbon is the most economically and environmentally effective way of reducing greenhouse gas emissions and combatting climate change. Organizations like Sustainable Prosperity have further argued that taxing carbon can be part of a broader movement to shift taxes from good things like labour and income, to bad things like pollution. As countries like the United States are coming to grips with their economic and climate realities, there is a renewed interest in carbon taxation, both as a greenhouse gas reduction tool and a new, more effective form of revenue generation.

This week, a broad spectrum of policy research institutes (the American Enterprise Institute, the Brookings Institution, the International Monetary Fund and Resources for the Future co-sponsored an event in Washington dealing with the economics of carbon taxation. Over the coming weeks, I will be writing about some of the more interesting research and findings that came out of these deliberations.

Bill Gale of the Brookings Institution set the stage for discussions. He laid out, in stark terms, the economic reality that the US government is facing. If the US wants to stop its debt to GDP ratio from rising beyond its current level of just over 100%, it must increase revenues or decrease spending (or, more likely, some combination of the two) by 5% of GDP. This is equivalent to $750 billion. When a carbon tax was modeled, it was found that a very modest carbon tax of $15 per tonne could raise almost 0.5% of this 5% gap. A more aggressive carbon tax of $41 per tonne would raise 1.65% of the needed 5%.

These are significant numbers, and although Gale did not come out and overtly say he favored a carbon tax, he raised a number of facts that build a case for support:

• It is, as economists say, a “first best tax”: it internalizes a negative externality - pollution - and thereby corrects a market failure. Most other taxes distort the market and therefore must be designed to minimize distortion;
• A carbon tax is, relative to other new taxes, very easy to design because it can be built on an energy tax system already in place (as demonstrated in British Columbia, which designed its carbon tax in only a couple of months)
• US citizens realize new taxes are needed; he cited polling showing that 70% of Americans would support a tax increase under certain qualified circumstances.

If a carbon tax is to gain cross partisan appeal in Washington, it has a number of hurdles to cross: distributional impacts and effects on certain industry sectors must be understood and mitigated; and politicians on both sides must recognize that new tax revenues are needed. As well, politicians would have to embrace the simplicity of a carbon tax as compared to a cap and trade regime, and move past the political sensitivity associated with new taxes. This is a big challenge, but the fiscal cliff and economic challenges that will remain in the US for years to come should provide incentives for cooperation and a willingness to debate carbon pricing on its merits, as opposed to just ideology.

This conference and its cross-partisan perspectives was a good start, and I look forward to sharing some of its findings.

Related Materials:

• Event: The Economics of Carbon Taxes