The Carbon Tax — And Reasons to Oppose It

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The National Climate Assessment is the latest in a series of reports that has thrust climate change into the public spotlight — and added to the intensity of calls for a carbon tax. This brief article will illustrate first the arguments put forth by advocates for the carbon tax and then explain a couple of reasons among the many for which my organization, the Institute for Energy Research (IER), steadfastly opposes such calls.

The Case for a Carbon Tax

The argument for a carbon tax is fairly straightforward if one understands the framework most commonly employed by advocates. The framework operates from these basic foundations:

1. Emissions of carbon dioxide cause global warming;

2. Global warming will impose costs on human society writ large; and

3. A government can discourage carbon dioxide emissions, and thus avoid the costs of global warming, by placing a tax on carbon-based fuels while reducing taxes elsewhere to improve economic efficiency.

The first foundation, that emissions cause global warming, is the predominant position within climate science and — while all scientific findings should be subject to independent scrutiny — need not be challenged here. The second and third foundations, that global warming imposes costs and that government action can deliver us from those costs, are where IER’s strongest opposition lies.

Social Cost of Carbon

The claim that global warming will impose costs on human society is more tenuous than it at first appears. Some aspects of this claim are certainly true. For example, a warming planet causes sea levels to rise, threatening coastal real estate. This aspect of the claim is rather uncontroversial. The tenuous element of the claim is that the costs of, say, building a sea wall can be quantified and credibly attributed to a unit of carbon dioxide emissions. The attempt at quantifying this cost is a cottage industry unto itself and it has generated a construct known as the “social cost of carbon.” IER has spilled much ink over the past decade in dissecting the so-called SCC.

The social cost of carbon is an attempt at measuring the harm from emitting 1 ton of carbon dioxide warming impacts in dollar value terms. And it is this value that then anchors carbon tax proposals. Simple though it may sound, the SCC is an interdisciplinary Frankenstein’s monster — one with no redemption in sight.

The tools with which we analyze the potential effects — positive and negative — of increased carbon dioxide emissions to generate an SCC are called Integrated Assessment Models (IAMs). IAMs link climate projections with economic projections. But what is often overlooked is that even taking climate projections as given and accepting the selection of economic variables intended to present a picture of economic costs and benefits decades in the future, the SCC estimate relies largely upon an arbitrary discount rate.

The discount rate is a concept that seeks to translate future costs and benefits into present dollar terms. As described by economist William Nordhaus, “Discounting is a factor in climate-change policy — indeed in all investment decisions — that involves the relative weight of future and present payoffs.”

While the costs of global warming’s most adverse effects will accrue well into the future, the costs of taxing energy hurt each of us here and now. The discount rate quantifies how much benefit we require in the future to prompt us to take on a cost today. This choice has a profound impact on the social cost of carbon, as shown in the chart below.

As you can see, these calculations from Nordhaus’s DICE model supply an SCC for the year 2020 as high as $56.92 at the 2.5 percent rate, but as low as $5.87 at the 7 percent rate.

The importance of this arbitrary number to the ultimate value that is generated for the SCC undermines the credibility of the metric and should call into question the validity of the carbon taxes that rest upon it.

Tax Interaction Effect

Another strike against the carbon tax case is that it would plague us with what is known as the tax interaction effect.

As first illustrated by A. Lans Bovenberg and Lawrence H. Goulder in the late 1990s carbon taxes are a relatively inefficient way to raise revenue. Their research indicates that the economic cost of raising revenue through carbon taxes will tend to be higher than through taxes with a broader base, like income taxes. Broad tax bases allow tax rates to be low while maximizing revenue. A carbon tax, however, zeros in on a narrow range of commodities and activities. As a result, carbon taxes will tend to exacerbate distortions in markets for intermediate inputs, consumer goods, labor and capital. Therefore, goes the argument of Bovenberg and Goulder, it is likely that a revenue-neutral carbon tax will impose more deadweight loss on the economy than the tax status quo.

So even if we ignore the arbitrary nature of the SCC, the tax interaction effect casts doubt on the wisdom of carbon taxes.

Climate Action Comes at a Cost

The growing drumbeat in favor of a carbon tax harps on the costs of inaction, but all too often tax proponents fail to consider fully the costs of action.

Take, for instance, the admonitions of the United Nations that governments around the world must strive to limit global warming to 1.5°C. This call for aggressive action, with its implied carbon tax of at least $135 by 2030, would entail economic upheaval in the near term. And it is not obvious — again, even if we accept SCC calculations — that pursuing aggressive government action to mitigate climate change would produce benefits in excess of costs.

As IER economist Robert P. Murphy wrote upon the announcement of William Nordhaus’s Nobel nod in October, Nordhaus’s work shows that the recent mitigation goals announced by the United Nations are likely to cause far more damage to economic growth than they would alleviate in terms of warming damages.

Final Word

Instead of handcuffing our capacity for productive growth, our best path forward may simply be enriching ourselves as much as possible to prepare for any vagaries of climate we may face. Our species is the most adaptable the world has ever seen. Through free markets and wealth maximization, we will put ourselves into the best position to manage threats of all kinds. The case for a carbon tax is not of the open-and-shut variety. Global warming may be a problem as we move further into the 21st century, but that alone does not provide terra firma to tax the energy sources that power our prosperity.

About the author: Jordan McGillis is a policy analyst at the Institute for Energy Research. He focuses on the carbon tax debate and federal lands.

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  1. The photo you present in this article, of stacks with steam, is just that, steam. More than likely it’s from a nuclear power facility where no smoke or chemicals are in the steam.


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