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Ed Dolan

Ed Dolan

Edwin G. Dolan holds a Ph.D. in economics from Yale University. Early in his career, he was a member of the economics faculty at Dartmouth…

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Energy Taxation – the Only Things Missing from Obama’s Climate Action Plan

Energy Taxation – the Only Things Missing from Obama’s Climate Action Plan

Last Week the White House released a long-anticipated Climate Action Plan. Conservatives have been swift to attack it as a “backdoor energy tax.” The critics could not be more wrong. A carbon tax, or energy tax of any kind, is the one big piece that is missing from the President’s plan.

Despite the criticism, though, some prominent conservatives see a better way of turning the issue of energy taxes to their advantage. Among those who support a carbon tax are Gregory Mankiw, Harvard professor and former Chairman of the President’s Council of Economic Advisers under George W. Bush; George P. Schultz, Treasury Secretary under Richard Nixon and Secretary of State under Ronald Regan; and  David Frum, former special assistant to George W. Bush.

Here are some of the reasons why conservatives, even the climate skeptics among them, should love a carbon tax.

A carbon tax would improve tax efficiency

Although conservatives don’t like taxes, they reluctantly agree that the government does need revenue. In recent years, their budget plans have called for a reduction in federal spending to a range of 18 to 20 percent of GDP. To fund even that level of spending without large deficits—which they also dislike—would require a lot of tax revenue. Where should it come from?

There is rare unanimity among economists in answering that question: Revenue should come from broad based taxes that have the lowest possible marginal rates and the fewest possible exemptions, deductions, and preferences. The current U.S. tax system is about as far from that ideal as you could get. As a result, it produces maximum distortions of business and consumer decisions while producing a minimum of revenue.

The corporate income tax is Exhibit A for these defects. Since Japan cut its rate last year, the United States has the world’s highest marginal tax rate on corporate income. However, the U.S. corporate tax has so many exemptions and deductions that many of the largest companies pay no tax at all, and the tax as a whole produces only a trickle of revenue. The corporate income tax today brings in revenue equal to just 2.7 percent of GDP, down from 6 percent in the 1950s. Because other countries have fewer loopholes, they get more revenue from their corporate taxes even though their rates are lower. Yet despite raising so little revenue, the corporate income tax distorts business decisions in major ways. To name just a few, it encourages financing with debt rather than equity, encourages moving operations offshore, and discourages repatriation of profits. Even companies that pay no tax to the government suffer, since tax avoidance requires them to use business practices that they would not otherwise choose. In many cases, the corporate tax subjects income to double taxation, once when it is earned by a company and again when distributed as dividends.

Related article: Obama Unveils his Climate Change Policies

A carbon tax, by contrast, is much more broadly based, since economic activity of every sort depends to some degree on carbon-based energy. Even a low rate of tax would raise a large amount of revenue. Introducing a carbon tax and using the proceeds to reduce rates on other taxes would maintain revenue neutrality while reducing tax distortions to business decisions.

A recent study from MIT gives some estimates, using a large-scale model of the economy. The study explores the effects of a tax of $20 per ton of CO2, beginning in 2013 and rising at a rate of 4 percent per year. (As a rough rule of thumb, each $1 per ton of CO2 is equivalent to about one cent per gallon of gasoline.) Such a tax would generate enough revenue to cut the corporate tax rate by 2.23 percentage points by 2015. The result would be net gains to the economy of $2.7 billion, when the economic burden of the carbon tax is balanced against the reduced burden of the corporate tax. The efficiency gains would be nearly as large if the carbon tax revenue were used instead to reduce personal income or payroll tax rates.

A carbon tax would make the economy more resilient

Although some on the political right continue to maintain that the whole idea of climate change is a hoax, many mainstream conservatives take a more considered view. For example, in a recent Washington Post op-ed, Rep. Lamar Smith (R-Texas), Chairman of the House Committee on Science, Space and Technology, writes that “climate change is an issue that needs to be discussed thoughtfully and objectively.”

As climate scientist Judith Curry points out in recent Congressional testimony, any thoughtful and objective discussion must acknowledge that many uncertainties remain in climate science. Not on basic points like the heat-trapping properties of CO2, where there is broad scientific consensus, but rather, on the times, places, and forms in which climate risks are likely to manifest themselves—whether as droughts, floods, coastal storms or something completely unanticipated. Those “deep uncertainties” make it impossible to calculate a single, optimal response to climate change.

As a result, climate scientists and economists, along with Curry, increasingly recognize that the proper response to climate risks is to promote resilience through policies that enable our economic and social system to cope with shocks and adapt to unexpected changes.

A carbon tax is an ideal way to encourage such resilience because it capitalizes on the inherent flexibility of the market. Even if we cannot calculate the optimal value of the tax—estimates range from a few dollars per ton to as high as three-hundred dollars—even a small tax will begin to exert steady pressure for change across a broad front. A carbon tax would give equal encouragement to development of low-carbon alternative energy sources and to energy conservation. It would not only spur the search for winners, it would winnow out losers before they become politically entrenched. (Corn-based ethanol is a case in point.) The result would be a more diverse and efficient energy mix.

Beyond environmental considerations, using a carbon tax to foster a more resilient energy economy would have other benefits.

For one thing, a carbon tax would make the U.S. economy more resilient to geopolitical shocks. Greater energy efficiency and a more diverse domestic energy base would make the country less vulnerable than it now is to political events in the often unstable and unfriendly countries that supply much of our imported energy.

Related article: Obama’s Climate Plans Have Keystone Opponents Worried

At the same time, a carbon tax would make the economy more competitive in international trade. That proposition might draw raised eyebrows from the “affordable energy” crowd, but it is a fact. There is little evidence that low domestic energy prices are either a necessary or a sufficient condition for strong export performance. Consider that export superstar Germany has among the highest energy prices in the world, while the list of countries with the lowest energy prices is littered with import-dependent basket-cases like Egypt and Pakistan. To be competitive, a country has to be ready to react to changes in the global economy—booms or busts in trading partners, changes in global commodity prices, and technological changes. An efficient tax system with low marginal rates plus a diverse energy mix would enhance the flexibility needed to meet trade challenges.

A carbon tax is better than the regulatory alternative


In contrast to the flexibility and resilience of market-based environmental policies like a carbon tax, command-and-control regulations are inherently rigid and brittle. Fuel economy standards for motor vehicles are a case in point. As I explained in an earlier post, regulatory standards lock in government-favored technologies while discouraging the exploration of innovative ways of achieving fuel efficiency. Worse, they actually provide perverse incentives to waste energy. Existing fuel economy standards encourage production of fuel-efficient cars, but once you own one, its low operating costs give you an incentive to drive more miles. The standards also encourage people to delay junking old cars since the new, regulation-compliant models cost more. In contrast, a carbon tax provides an incentive both to buy new, fuel-efficient cars and to drive existing cars fewer miles.

Unfortunately, conservative resistance to carbon taxes has the unintended consequence of encouraging greater reliance on regulation. That is very much evident in the new climate action plan. The plan contains not a word about a carbon tax, presumably because introducing one would require Congressional action. Instead, the plan consists entirely of measures that the administration can implement on its own authority. Most of the items proposed are subsidies for selected technologies (for example, solar panels for federally supported housing) and command-and-control efficiency standards (for power plants and heavy trucks). Yes, some of the ideas in the plan are good ones, but those would rise to the top under the market-based incentives provided by a carbon tax. The bad ideas in the plan would never see the light of day.

The bottom line

Putting all of this together, a carbon tax is a natural for conservatives. Conservatives know the tax system is broken; a carbon tax could be a key element in comprehensive tax reform that aims to broaden the base and lower marginal rates without increasing the deficit. A carbon tax would enhance the resilience that the economy needs to respond not just to environmental risks, but also to geopolitical and trade shocks. Finally, support for a carbon tax would help counter the impression that conservatives don’t care about the environment, a key turnoff for younger and more educated voters.

Prominent conservatives like Gregory Mankiw, George Schultz, and David Frum know this. Why aren’t more jumping on the bandwagon?

By. Ed Dolan

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Leave a comment
  • GregL on July 02 2013 said:
    "Why aren’t more jumping on the bandwagon?"

    Your joking, right? The GOP KNOWS that any and all taxes are evil. They would no more embrace a tax than vote Democratic.

    Ideology trumps good governance; live with it or drive a stake into the rotting corpse of the GOP and lets get on with life.

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