I rarely get down and beg, but if you are a serious student of the economics of climate change debate, I implore you to watch Ross McKitrick’s presentation from IER’s carbon tax conference over the summer. I’m embedding the video and then adding my commentary, but for more context go read my post at IER.
The takeaway message here is that McKitrick–who is truly a world expert on the subject–shows that the peer-reviewed literature comes down on the conclusion that even a 100% dollar-for-dollar swap of income tax cuts for a new carbon tax would probably hurt conventional economic growth. So the people running around saying a carbon tax is a “win-win” because now we’re going to “tax bads, not goods” are Consensus Deniers.
- 1:00 – 2:00 McKitrick explains the “Pigovian” (named after the economist Pigou) analysis in which a tax on a “negative externality” is supposed to help, by reducing the behavior, such as emissions, toward the “socially optimal” level. But nobody really looked at how the tax revenue was used.
- Around the 3:00 mark, McKitrick explains that in the 1990s, economists began studying the effects of a completely revenue-neutral tax on a negative externality. This is where the “double dividend” idea comes into play, since—in theory—it should be good to (a) levy a tax on the behavior causing the negative externality and (b) raise revenue that will allow taxes on socially useful things (like labor and saving) to be reduced. Some economists became excited that “revenue recycling” (where the revenue from an emissions tax, say, is devoted to income tax or capital gains tax cuts) provided a painless way for the government to help both the economy and the environment.
- At 4:05 McKitrick raises the issue of the “tax interaction effect,” which caused researchers to pause in their tracks. The new tax—even if it’s levied on a negative externality—will still interact with the pre-existing tax code, exacerbating the original inefficiency in the code (or raising the “excess burden” of those original taxes). Thus the benefits of “revenue recycling” must be contrasted with the harms of the tax interaction effect. Is there a double dividend? Only if the former outweighs the latter.
- At 4:30 McKitrick says the “overly strong” claim was clearly false: We can’t say that any emissions tax that is coupled with 100 percent revenue recycling is always better than the status quo, even though that’s what some economists had originally thought. Thus, the people today who say matter-of-factly that the government should “tax bads not goods” are decades out of date, with respect to the actual published literature on the topic.
- At 4:45 McKitrick discusses a weaker version of the double dividend claim, which says that once we consider the possibility of revenue recycling, the government ought to set the emissions tax higher than the level that reflecting the negative externality. So for example, if the “social cost of carbon” is $35 per ton, then this weaker version of the double dividend hypothesis says that the government should set the actual carbon tax at higher than that, perhaps $40 per ton, since the carbon tax receipts not only help mitigate global warming, but also allow for pro-growth income tax cuts. Yet, McKitrick says that researchers in the field quickly concluded that even this weaker claim was probably false.
- Starting around 6:45 McKitrick explains that the first economists to develop models with enough detail to show the possibility of a revenue recycling effect, discovered that in fact the government should set a carbon tax much lower than the “social cost of carbon.” In fact, with plausible estimates of the actual “social cost of carbon,” the optimal carbon tax could be $0 per ton. This shows the tremendous importance of the tax interaction effect.
- Starting at 8:00 McKitrick tries to explain why the pre-existing tax code matters so much in these analyses. Part of the explanation is that the emissions tax has a smaller “base” than broader taxes such as income taxes. There is a general rule in the tax literature that a tax should be applied on as large a base as possible; this is one reason that a “revenue neutral carbon tax” can harm the economy.
- Around the 12:00 mark, McKitrick showed that actually Sandmo in 1975 had provided the general framework for thinking about these issues. These remarks will probably only help professional economists make sense of the seemingly counterintuitive result that the government should set an “optimal” carbon tax less than the “social cost of carbon.”