I oppose a carbon tax for a very simple reason: I do not believe its benefits justify its costs. More specifically, I do not believe that that the incremental reduction in risk that it would provide over-and-above a much cheaper technology-focused policy would nearly offset its incremental costs over-and-above such a technology-focused policy for the foreseeable future.
As background to this post, I wrote a long article for National Review earlier this year that took a very broad-gauged look at global warming. It proceeded in three parts: (1) a review of the physical science that argued to conservatives that there is a real problem, (2) a set of policy proposals that argued for a technology-focused approach rather than a tax-focused approach to this problem, and (3) a political review that argued to Republican presidential candidates that this set of policies could be a winning political approach to the issue.
The body of this post is a copy of a follow-up article I wrote for the November 5th National Review (also available at National Review Online, but in a format that I find hard to read). This article goes into some detail about why I believe the economics of a carbon tax or cap-and-trade system are unattractive.
Before we start, I’ll note that this is a complex topic that depends upon inherently speculative predictions about the world’s environment and economy more than a century into the future, so there is plenty of room for principled disagreement. If you want to attack the positions that I’ve put forward here, however, please at least read the prior debates. From the Right (where I have been attacked at length and by name on Rush Limbaugh’s show and FoxNews) , please read these exchanges with Steven Milloy: Et tu, Cato? 1 and Et tu, Cato? 2. From the Left, please read this Ezra Klein post with the comments thread and the section of the first NR article that covers the Precautionary Principle, or more broadly Cass Sunstein’s book on the Precautionary Principle.
If you believe that human emissions of carbon dioxide create a significant risk of negative climate change, the solution seems obvious: reduce emissions. But this conventional wisdom is exactly wrong.
The United Nations Intergovernmental Panel on Climate Change (IPCC) — which recently, together with Al Gore, won the Nobel Peace Prize — projects that, under fairly reasonable assumptions for world population and economic growth, global temperatures will rise by 2.8°C by the year 2100, and that this will begin to create costs equal to 1 to 5 percent of global GDP sometime in the 22nd century. So, it is argued, we should begin, right now, to reduce emissions of carbon dioxide in order to prevent some or all of these costs. The most frequently discussed methods for doing this are 1) a straightforward tax on carbon and 2) an inefficient, back-door (and therefore politically more palatable) tax on carbon called a cap-and-trade system.
Now, 1 to 5 percent of global GDP is a huge amount of money, and an ounce of prevention can be worth a pound of cure. But, in the case of global warming, the values may be exactly reversed: Getting most of the carbon out of the energy cycle today would be very expensive, and a century is a long time to wait for the payoff from this investment.
As we all know from everyday life, normally I would rather have a dollar today than the promise of a dollar a year from now. I “discount” the promise: The amount of cash I would be willing to take today in lieu of that promised dollar is termed its “present value,” and the percentage lower I am willing to accept today is called the “discount rate.” When decisions are made on the timescale of centuries, however, discounting can have counterintuitively large effects: Consider that if the legendary sellers of Manhattan Island had put $28 in an account with a 4 percent real interest rate in 1626, they would have enough money in the bank today to buy back all of the land in Manhattan. Albert Einstein supposedly said that “the most powerful force in the universe is compound interest” — and this mathematical reality is central to the correct evaluation of plans to address the risk of climate change.
The “Stern Review,” produced by the British government last year, is cited frequently as demonstrating that the world should begin immediate, aggressive emissions abatement. But William Nordhaus, a Yale professor widely considered to be the world’s leading expert on this kind of integrated environmental-economic assessment, has pointed out that a crucial feature of the Stern Review was its assumption of a very low discount rate. To demonstrate just how unrealistic that assumption is, Nordhaus asks us to imagine a scenario in which global warming would lead to zero costs between now and the year 2200, at which point global economic growth would be permanently reduced by 0.1 percent — in other words, that economic output starting in 2200 would be 99.9 percent of what it would have been had there been no global warming. Under this scenario, how much should we be willing to pay today as a lump sum to avoid this cost? Using the assumptions of the Stern Review, Nordhaus points out, we would pay about $30 trillion, which is more than half of the world’s entire annual economic output. Thanks, but no thanks.
Why would sophisticated advocates for rapid, aggressive emissions abatement make such an obviously unrealistic assumption? Because they’re in a box. Given current global-warming-impact projections and normal economic assumptions, the costs of global warming justify only limited actions for the next several decades.
POLITICS OF THE IMPOSSIBLE
Nordhaus’s modeling group estimates that the total present value of global-warming-related costs is about $22.6 trillion, which is roughly 1 percent of the present value of total global income over the next several centuries. In other words: If we simply let global warming happen, the world would generate about 99 percent of the present value of wealth it would otherwise have generated had there been no such thing as global warming.
The models indicate that we should simply let $17 trillion (about 75 percent) of that $22.6 trillion in damages happen, because it would be more expensive to avoid the damages than to accept them. Nordhaus further estimates that we could avoid the remaining $5 trillion to $6 trillion of damages by “spending” about $2 trillion on a carbon tax designed to encourage abatement. This would provide a net benefit of around $3.4 trillion, or about 0.17 percent of the present value of global GDP over the next several centuries. This carbon tax would be fairly low for a number of years — e.g., in the case of gasoline, about 9 cents per gallon through 2010 — and then ramp up to fairly high levels by the second half of the century. So, if the U.N. forecasts are correct, the global-warming hysteria is about the opportunity to create a net economic benefit of less than 0.2 percent of future global wealth creation. While not everything that matters can be measured by money, this certainly provides a different perspective than the “Manhattan will be an underwater theme park” rhetoric would suggest.
Of course, in absolute terms, $3.4 trillion is normally thought of as an amount of money that’s worth pursuing. So why shouldn’t we implement such a tax?
To understand why we shouldn’t, let’s move from the world of academic model-building to the real world of geostrategic competition and domestic politics. To realize this gain of $3.4 trillion, we would have to agree to, and enforce, a global, harmonized tax on all significant uses of carbon in any material form. This would require the agreement of — just to take a few examples — the French National Assembly, the Parliament of India, the Brazilian National Congress, the Chinese Politburo, Vladimir Putin, John Dingell, and the U.S. ethanol lobby. As is well known, all these players are completely incorruptible and solely concerned with the comprehensive good of all mankind through all time, and will not let their better judgment be overruled by any narrow, sectarian interests.
All this aside, let’s imagine we actually could negotiate such a binding agreement. Isn’t it possible that all the side deals that would be required to get this done would create enough economic drag to more than offset the benefit of 0.17 percent of present value of global output? Our track record in closing and implementing such deals as the Kyoto Protocol, or even the current round of the GATT process — which, remember, is supposed to make the signatories richer — shouldn’t inspire much confidence that the theoretical net benefits will outweigh the costs created by the agreement.
Further, even if we got to an agreement de jure, we would then have to enforce a set of global laws for many decades that would run directly contrary to the narrow self-interest of most people currently alive on the planet. How likely do you think a rural Chinese official would be to enforce the rules on a local coal-fired power plant? These bottom-up pressures would likely render such an agreement a dead letter, or at least make it in effect a tax applicable only to the law-abiding developed countries that represent an ever-shrinking share of global carbon emissions.
In summary, then, the best available models indicate that 1) global warming is a problem that will have only a marginal impact on the world economy, and 2) it is economically rational only to reduce slightly this marginal impact through global carbon taxes. Further, practical knowledge of the world indicates that 1) such a global carbon-tax regime would be very unlikely ever to be implemented, and 2) even if it were implemented, the theoretical benefits it might create would probably be more than offset by the economic drag it would produce.
HEDGE AGAINST RISK?
Of course, another possibility remains: Our climate projections might be wrong, and global warming could turn out to be substantially worse than these models forecast. This is the other obvious way to argue for immediate, aggressive emissions abatement. This argument has a strong form (that we know global warming will be worse than consensus models project) and a weak form (that global warming might be worse than these models project).
The strong form requires that you either be a conspiracy theorist or believe that you have special knowledge, unavailable to the world scientific community, demonstrating conclusively that the IPCC process has reached an overly conservative consensus. (Ironically, this represents a perfect mirror image of the opposite extreme position, i.e., that global warming is a big hoax.) But this is pretty hard to believe. Any side in this debate can find respectable scientists who are outliers from the consensus position to support more-alarmist or less-alarmist predictions. Large-scale science is the best available means of grinding through these claims to find the best possible approximation to accurate, falsifiable predictions. This process can take time to work, and is imperfect, but like all markets it tends to be self-correcting. Science, in general, works.
On the other hand, the weak form — the contention that the impact of global warming might be worse than anticipated — is persuasive. Long-term climate prediction is in its infancy. Climate models are, at a minimum, non-validated, and predicting the cost impact of various potential warming scenarios requires us to concatenate their climate predictions with economic models that predict the cost impact of these predicted temperature changes on the economy in the 21st, 22nd, and 23rd centuries. It is hubris to imagine that these can guarantee accuracy, and impossible to validate such a claim in any event. Nordhaus is admirably realistic about long-term environmental-economic assessment models when he states that their functional purpose is to make sure that our “answers are at least internally consistent.” Ultimately, we can predict reliably neither what impact human activities will have on the climate nor the resulting impact of these climate changes on the economy over multiple decades and centuries.
So, once we clear away the underbrush, we can see that the case for a carbon tax is really that it would be a hedge against the risk that actual damages from warming will be worse than current projections. Would it be a smart investment?
To evaluate this, start with the observation that the primary purpose of such a tax is not to encourage conservation per se, but rather to induce the development of new technologies that can de-link economic growth from damaging accumulations of atmospheric carbon dioxide. Increasing the price of carbon would cause some direct reduction in fossil-fuel consumption (e.g., biking to work instead of driving), and get more people to use some pre-existing technologies (e.g., efficient light bulbs), but these effects would be limited: Hairshirts are not enough. We would have to develop new technologies that use energy more efficiently, emit less carbon per unit of energy, remove carbon from the atmosphere, and/or reduce the harm done by carbon dioxide. The real costs of a program to address global warming are crucially dependent on how much time and money it would take to develop and diffuse these technologies, plus the incremental costs per unit of energy (if any) they would impose once deployed.
Seen from this perspective, many aspects of the carbon-tax debate become clearer. Carbon-tax advocates pay lip service to the naïve idea that the developing world will impose large carbon taxes if we just “lead by example.” Of course, under the reasonable assumption that the relevant technologies will be developed primarily in the U.S., EU, Japan, Canada, and Australia, it doesn’t really matter that much whether the developing world introduces these taxes, or fails to do so for a long time. The global crusade is a smokescreen: The goal is to tax the use of carbon in the developed world. Further, in spite of the fact that most analyses indicate that the optimum theoretical carbon tax should be quite low for a number of years, most advocates want to push for as large a tax as possible, as soon as possible, in order to force industry to create new technologies quickly. The pain of the tax is the whole point, and, to this way of thinking, more pain means more gain.
This would probably “work,” in that it would spur new technological development; but it would be insanely expensive. It’s hard to predict accurately the costs of such a program, but it would certainly start at hundreds of billions of dollars in the U.S. alone. In practice, the reality is that no matter what happens in the future, the tax would almost certainly not go away for many years, and it would be almost politically impossible to somehow trade away other taxes to keep the total tax burden unchanged.
Of course, there are other ways to try to stimulate the development of the required technologies. One obvious approach is to have the government fund technology development directly. I have proposed just such a research program in this magazine (“Game Plan,” June 25, 2007). Even if it had a controlled funding mechanism, it would, like all such programs, be rife with inefficiencies. But consider that the cost of such a program could be single-digit billions per year — a tiny fraction of the costs of imposing a large U.S. carbon tax. You could be massively inefficient, and still be far better off.
A large carbon tax is also, most likely, a one-way door: Once we introduce it we’re stuck with it for a long time. Therefore, keeping our options open has great value. What if our models are too aggressive, and there is no practical economic justification for emissions reductions for centuries, if ever? What if the technological leverage point turns out to be a non-point-source scrubber that can remove carbon dioxide from the atmosphere at low cost, so that there is really no reason not to emit CO2 all day long? There are very large potential regrets to a carbon tax.
The only real argument for implementing a large, immediate carbon tax boils down to the point that you can’t prove a negative. If it turns out that our predictions for global-warming impacts are enormously conservative and disaster looms if we don’t change our ways radically and this instant, then we really should start shutting down power plants and confiscating cars tomorrow morning. We have no good evidence that such a disaster scenario is imminent, but nobody can conceivably prove it to be impossible.
Hedging against the risk to future generations of potential unanticipated impacts from global warming is a legitimate job for the U.S. government. Ideally, it would be tackled by the governments of the small number of countries with a sophisticated technology-development capability acting in some kind of coordinated fashion. A massive carbon tax, or its equivalent in the form of a cap-and-trade system, is billed as a prudent reaction to this risk, but it is the opposite: an impractical, panicky reaction unworthy of a serious government.