The Dubious Economics of Crop Insurance

Insurance is an essential part of the financial infrastructure of a market economy. By spreading losses among members of a group with similar exposure, insurance encourages people to take prudent risks while protecting individuals from ruin in case they are the unlucky ones. Not all risks are insurable, however. Attempts to insure the uninsurable create incentives to take excessive risks and burden the economy with costs to the many that exceed the gains to a few. So-called “crop insurance,” which has become a central feature of U.S. farm policy, is a case in point.

Why crop losses are not insurable

Over time, insurers have developed rules that identify which risks are insurable and which are not. Crop insurance violates at least three of them.

Not a pure loss.  Insurance is normally limited to situations in which people face a pure loss. For example, if I insure my house against fire, I either experience a fire, in which case I suffer a loss, or I do not, in which case I have neither a loss nor a gain. In contrast, if I build a house for resale, I may suffer a loss if no one likes it or if the market declines, or make a profit if someone falls in love with it and pays me a premium price. The risk of fire is a pure loss, and is insurable; the risk of a business venture that carries the possibility of gain as well as of loss is not.

Insurance against crop risks, especially in the popular form of crop revenue insurance, departs from the pure loss principle. Crop revenue insurance does not just protect farmers against bad harvests due to natural causes like drought or floods. It also protects their profits against the economic risk of low prices, even when a good harvest is the cause of the low price. In fact, if the premium is low enough and the benchmark price is high enough, crop revenue insurance provides a guaranteed profit no matter what happens. >>>Read more

Will Peak Phosphate Doom Humanity, or will Supply and Demand Save Us?

Although climate change catches the headlines, it is not the only doomsday scenario out there. A smaller but no less fervent band of worriers think that peak phosphate—a catastrophic decline in output of an essential fertilizer—will get us first.

One of the worriers is Jeremy Grantham of the global investment management firm GMO. Grantham foresees a coming crash of the earth’s population from a projected 10 billion to no more than 1.5 billion. He thinks the rest of humanity will starve to death because we are running out of phosphate fertilizer.  This post on Business Insider from late last year provides an array of alarming charts to back up his warning.

Foreign Policy agrees that phosphate shortages are a potential threat. “If we fail to meet this challenge,” write contributors James Elser and Stuart White, “humanity faces a Malthusian trap of widespread famine on a scale that we have not yet experienced. The geopolitical impacts of such disruptions will be severe, as an increasing number of states fail to provide their citizens with a sufficient food supply.”

What is going on here? Is this really “the biggest problem we’ve never heard of,” as Elser puts it? Or are phosphate shortages something that global markets can cope with? Let’s take a closer look. >>>Read more

Follow this link to view or download a classroom-ready slideshow that features peak phosphate as a case study in supply and demand.

US CPI Inflation Rose Sharply in June. How Concerned Should We Be?

U.S. consumer price inflation jumped to a seasonally adjusted annual rate of over 5.9 percent in June, according data released today by the Bureau of Labor Statistics. That was up from an inflation rate of just 1.8 percent in May. In March and April, the CPI actually decreased. How much do we need to worry about the sharp increase in inflation, or the increasing volatility of inflation over the past year, both of which are evident in the following chart? Here are some points to consider.



First, the jump in the monthly inflation rate and the volatility of recent months are almost completely due to ups and downs in the seasonally adjusted price of gasoline. It rose 6.1 percent in the month of June alone after no change in May and decreases of 8.1 percent in April and 4.4 percent in March (all monthly changes, not annualized). The price of gasoline is notoriously volatile. It depends not only on world oil prices, but also on the dynamics of domestic refining and on driving habits.>>>Read more

Follow this link to view or download a classroom-ready slideshow with complete charts of the latest consumer inflation data

Why Libertarians Should Support a Carbon Tax—Even if They Can’t Love It

In the first two parts of this series, I discussed the reasons why both conservatives and progressives should love a carbon tax, and why many of each political persuasion do. In this third installment, I take up the more difficult case of libertarians.

There is no way that a good libertarian could love a carbon tax, or any tax, for that matter. Classical liberal principles hold that the state should play a role in economic affairs only when there are problems the cannot feasibly be handled in the private sector. Even those who support a role for the state in, say, criminal justice or national defense, do so only reluctantly. They secretly pine for a libertarian utopia like that in Robert Henlein’s The Moon is a Harsh Mistress, where even those functions were the responsibility of the marketplace.

Nonetheless, I think it is possible to make as good a case that libertarians should support a carbon tax as that they should endorse a government role in courts or the military. Here are some reasons why.

The polluter should pay

To begin, the principle that the polluter should pay has long been a part of libertarian theory. In his 1962 classic, Man, Economy, and State, Murray Rothbard expressed it this way:

In so far as the outpouring of smoke by factories pollutes the air and damages the persons and property of others, it is an invasive act. . . . Air pollution is not an example of a defect in a system of absolute property rights, but of failure on the part of the government to preserve property rights.

A person whose pollution harms another’s person or property should pay for the resulting harm. People do not pollute just for the fun of it. They do so because polluting, when unrestricted, is a cheap way of disposing of wastes. Paying for waste disposal is just as much a proper cost of business or household management as paying for any thing else—energy, labor, transportation, or whatever.

A polluter cannot escape the duty to pay for harm to others simply because it would be expensive to avoid polluting. Yes, it may cost more to build a smokestack with a filter than one without, or more to treat sewage than to dump it directly into a river. Beyond some point, the harm, at the margin, may be less than the cost of abatement, in which case releasing pollutants into the environment may be the economically efficient decision. Efficient or not, however, the polluter should still pay for any remaining harm done even after the efficient degree of abatement has been carried out.

All this leaves open the question of how to ensure that the polluter pays. First, though, we need to address another important issue.

Are greenhouse gas emissions really harmful?

Specifically, we need to ask whether carbon dioxide and other greenhouse gasses (GHGs) are, in fact, harmful pollutants. If they are not, libertarians are off the hook: No harm done, no payment due, no need for a tax. However, if you are tempted to seek that escape route, you need to ask yourself, which comes first? Are you evaluating the relevant science objectively, or is your judgment of the scientific evidence influenced by an a priori aversion to taxes or other government interventions?

The libertarian icon Friedrich Hayek saw attitudes toward science as one of the key distinctions between libertarians (he preferred the term “liberal,” in the European sense) and conservatives. In his famous essay, “Why I Am Not a Conservative,” he wrote:

Personally, I find that the most objectionable feature of the conservative attitude is its propensity to reject well-substantiated new knowledge because it dislikes some of the consequences which seem to follow from it—or to put it bluntly, its obscurantism. I will not deny that scientists as much as others are given to fads and fashions and that we have much reason to be cautious in accepting the conclusions that they draw from their latest theories. But the reasons for our reluctance must themselves be rational  and must be kept separate from our regret that the new theories upset our cherished beliefs. . .  By refusing to face the facts, the conservative only weakens his own position.  . .  Should our moral beliefs really prove to be dependent on factual assumptions shown to be incorrect, it would hardly be moral to defend them by refusing to acknowledge facts.

He was not writing specifically about climate change (the example he gave was the theory of evolution), but his point applies. We should separate our rational evaluation of climate science from our regret that human responsibility for climate change might upset our cherished beliefs about the ability of a market economy to operate justly and efficiently without the intervention of government.

Mere uncertainty is not enough. Some aspects of climate science are almost universally accepted,  for example, that concentrations of GHG in the atmosphere influence the climate and that human activity has affected concentrations of GHG. Other points are not fully settled, for example, the sensitivity of global temperatures to a doubling of CO2, the interaction of natural and anthropogenic climate drivers, and the relationship between climate change and specific weather events. However, complete certainty is not required in this case.

There are many areas of both private life and public policy where we act to avoid harm that is not certain to occur, or, if it does occur, is not easily quantified. We accept limits on driving while intoxicated even though there is a good chance that any individual drunk driver will make it home from the tavern without hitting anyone. We allow victims of assaults or negligent acts to sue for pain and suffering even though placing a monetary value on the pain is highly inexact. By the same token, we should be willing to accept restraints of GHG emissions if we think the preponderance of evidence suggests that they are harmful, and to place an estimated value on the harm even if we know it may only be an approximation.

If you have looked dispassionately at the relevant science, and you are satisfied, based on the preponderance of evidence, that GHG emissions pose no risk, so be it. Otherwise, read on.

How should polluters be made to pay?

If we accept the principle that polluters should pay, and accept that GHG emissions are a form of harmful pollution, we still have to deal with the issues of how polluters should be made to pay.

For many libertarians, the preferred approach is to rely on private negotiations backed by the right to take legal action for the pollution-related torts of trespass, nuisance, or negligence. If toxic fumes from a neighboring factory damage your health or your property, sue the owners for damages or ask for an injunction requiring them to stop. A 1982 paper by Rothbard, “Law, Property Rights, and Air Pollution” describes this approach in detail.

Unfortunately, the tort law approach to making the polluter pay works less well as the number of pollution sources and victims grows. Yes, you, or you together with a group of close neighbors, can very likely get somewhere with a lawsuit against pollution from a factory next door, easily traced to its source. However, when there are many sources, some of which are far from the many victims, it is difficult to show that pollution from any one source caused the harm to any one individual, even if the harm is collectively large. That is often the case with air pollution, not only climate change, but also urban smog or acid rain.

When a large number of sources and remote victims make the tort law approach unworkable, we have to choose a second-best approach. Our options include regulations that require specific technologies or impose source-by-source emission standards, placing a price on pollution by means of a tax or cap-and-trade mechanism, or doing nothing.

Command-and-control regulations, which are both intrusive and inefficient, are the least attractive alternative to libertarians. Doing nothing would be the preferred alternative in cases where the harm was trivial. When the harm is not trivial, a policy that puts a price on pollution should be the preferred approach.

This is not the place to get into a long discussion of the relative merits of pollution taxes vs. cap-and-trade. Briefly, it seems to me that on libertarian grounds, pollution taxes are less objectionable than cap-and-trade for three reasons. First, they are arguably the more economically efficient alternative. Second, they are less complex and less open to political favoritism and corruption. Third, revenue from pollution taxes can be used to reduce marginal rates on other taxes that produce well-known distortions of market incentives, such as payroll taxes or corporate profits taxes.

The bottom line

The issue of climate change is a source of cognitive dissonance for libertarians. It creates a tension between the principle that pollution is an unjust assault on the persons and property of others, and the principle that disputes are best resolved through private negotiations and civil law. Some libertarians, like many conservatives, manage to suppress the dissonance by convincing themselves that greenhouse gas emissions are harmless. If they are unable to do that, it is reasonable for them to support the least intrusive, least inefficient government intervention available to deal with the problem. In my view, that alternative is a carbon tax. Even if it is a tax that libertarians cannot love, it is one they should support.

This is the conclusion of a three-part series. The first two parts were Why Conservatives Should Love a Carbon Tax—and Why Some of Them Do and Why Progressives Should Love a Carbon Tax—Although Not All of them Do. 

For more on the topic of this post, see my book TANSTAAFL: A Libertarian Perspective on Environmental Policy,  and also my two-part post on Austrian Environmental Economics.

 
Addendum: About a year after I wrote this, Jerry Taylor, formerly of the Cato Institute, founded the Niskanen Center, a libertarian 501(c)(3) think tank that works to change public policy through direct engagement in the policymaking process. The center's blog Climate Unplugged quickly became a leading source for libertarian support of a carbon tax and libertarian critique of conservative views on climate change.

Why Progressives Should Love a Carbon Tax—Although Not All of Them Do

Progressives should love a carbon tax. Most progressives love the environment and believe that carbon emissions cause environmental harm. Unlike conservatives, whose attitudes toward carbon taxes were the subject of my last post, progressives have no generalized aversion to taxes. Carbon taxes should be a natural for progressives, then, if they can accept the power of economic incentives to slow the destruction of the planet.

To be sure, many progressives do express strong support for carbon taxes. Here are just three of many examples:

• The Center for American Progress has put out a position paper titled “A Progressive Carbon Tax Will Fight Climate Change and Stimulate the Economy.” It argues that climate change, economic growth, and fiscal responsibility are intimately linked, and that a price on carbon should be part of a policy to deal with each of these issues.
• Gernot Wagner, an economist at the Environmental Defense Fund, argues that it makes eminent sense to tax what you want less of in his excellent book, But Will the Planet Notice: How Smart Economics Can Save the World.
• In Green Illusions: The Limits of Alternative Energy Ozzie Zehner argues against the wishful thinking that solar, wind, or other technological fixes will bring a future of cheap, clean, and abundant energy. Insisting that a strong push for energy conservation has to be part of the mix, he advocates carbon taxes to counteract what he calls “the boomerang effect”—the tendency for subsidies for clean energy to make energy in general cheaper, therefore discouraging conservation.

Yet, not all progressives are convinced. Many are skeptical on principle of our capitalist economic system and instinctively distrust market-based environmental policy. Others fear that a carbon tax would disproportionately harm the poor. Still others have ethical objections to the whole idea of bribing people to do things they ought to choose voluntarily, out of love and respect for the planet. Let’s look at each of these objections in turn.

Doubt that people really respond to market incentives

One reason that some progressives are skeptical of a carbon tax is a simple doubt that people really respond to prices. If you want to get people to stop doing something, they think, you need a government regulation that commands them not to do it in no uncertain terms.

For example, here is how Earthjustice President Trip Van Noppen puts it in an interview published on the organization’s website:

The problem with a carbon tax, as a nice and tidy solution for climate change, is that some things we tax we still use. We've got really, really high cigarette taxes, and people still smoke. It doesn't necessarily guarantee the reductions that you'd need to have to prevent climate change. So in other words, we wouldn't know whether the tax would be at a sufficient level to change behavior at the pace we'd need to change behavior . . . we don't really know how much the market would respond.

The economic term for the responsiveness of demand to a change in price is elasticity. A large negative value for elasticity of demand means that people make a large reduction in the quantity they buy when the price rises. For example, an elasticity of -0.8 would mean that a 10 percent rise in the price of a product would lead to an 8 percent decrease in the quantity purchased. So what is the price elasticity of demand for carbon-based energy?

The fuel for which economists have most extensively studied elasticity is gasoline. One widely cited source is a 1996 meta-analysis by Molly Espey. She concluded that the best estimate for the price elasticity of gasoline demand was -0.26 in the short run and -0.58 in the long run. A 2011 study by Todd Litman of the Victoria Transport Policy Institute provides a comprehensive review of the literature since Espey’s paper. Litman finds long-run fuel price elasticities in the range of -0.4 to -0.8. Those numbers suggest that a tax that added $1 per gallon to the cost of gasoline—still leaving it well below European levels—would cut use by 10 to 20 percent. (For a more detailed discussion of the evidence on elasticity, see this earlier post.)
If elasticity numbers are too abstract, here is a chart from the Litman study, which shows a convincingly tight relationship between fuel prices and fuel use across OECD countries. Can it really be just coincidence that the United States, with the lowest fuel prices, also has the highest fuel consumption?


Prices are having an effect on fuel choice in other industries, as well. One of the strongest trends is increased replacement of coal by natural gas in the generation of electricity.  Duke Energy is one of several big utilities that are rapidly moving from coal to natural gas, in large part because of lower gas prices. According to a report in Forbes, Duke Energy’s chief executive, Jim Rogers, is calling for the government to put a price on carbon with either a tax or a cap-and-trade system. According to Rogers, who should know, doing so would accelerate a trend away from coal, not only toward gas but also toward solar and wind power.

In short, the preponderance of evidence is that prices work, both to promote energy conservation in general and to motivate the choice of cleaner over dirtier sources of energy.

A carbon tax would hurt the poor

Critics of a carbon tax frequently object that any policy that raises the cost of energy would disproportionately hurt the poor. They base the claim on data that indicate that lower income families spend a higher percentage of their budget on transportation, home heating, and electric utilities than do the more affluent. However, even if we accept the truth of that claim, it does not constitute a valid objection to a carbon tax.

The main reason is that policies to keep energy prices low are a poorly targeted way to help the poor. Just do the math. Start with data indicating that families in the bottom half of the income distribution spend an average of about 20 percent of their budgets on energy, compared with less than 10 percent for those in the top half. Combine that with the fact that households in the lower half of the income distribution receive only about 20 percent of all income. Comparing 10 percent of 80 percent to 20 percent of 20 percent makes it clear that lower-income families, despite their greater relative expenditures, consume only about a third of all energy. The much smaller number of households that fall below the federal poverty line probably consume only about 15 percent of all energy. That would mean that for every dollar by which national consumer energy costs decrease, the poor gain only 15 cents.

There are many proposals for combining a carbon tax with targeted mechanisms for offsetting its impact on the poor. One way to do so would be to refund part of the tax directly to low-income households, either through a special rebate or by expanding some existing program like the Low Income Home Energy Assistance Program. As long as the rebate came in a lump sum, rather than in proportion to energy use, it would offset the distributional effect of the tax without reducing its incentive to conserve.

Another approach—one that is consistent with revenue neutrality—would be to use some of the money from a carbon tax to lower the marginal rate of the payroll tax. Because the payroll tax is inherently regressive, reducing it would disproportionately help lower-income households. With either of these approaches, just a fraction of the revenue from a carbon tax would be enough to compensate low-income households. The rest would be available for other purposes—reducing the deficit, lowering the rates on other tax rates, or expanding other federal programs.

There is also another way to think about the effect of a carbon tax on the poor. Keep in mind that the reason for such a tax in the first place is the belief that carbon dioxide emissions are harmful to the environment. If so, it is just as true for the CO₂ emitted by the poor as by the rich.

We do not, as a rule, exempt poor people from restrictions on socially harmful behavior. We do not suspend rules against littering in public parks on the basis of income. We do not allow poor people to shoplift their food from supermarkets; we give them food stamps, instead. By the same token, it is reasonable to require poor people to behave responsibly toward the environment. If we are concerned that a carbon tax pinches the budgets of poor households, we should provide relief through other channels, not give them a pass on the need to conserve energy and reduce pollution.

We should protect the planet because we love it

A third objection voiced by some progressives is that we should protect the planet because we love it, not for purely economic motives. Ethical objections to economic incentives are not limited to carbon taxes; they apply to all efforts to put a price on pollution, whether through taxes, marketable pollution permits, carbon offsets, or other mechanisms.

Harvard philosopher Michael Sandel, author of What Money Can’t Buy: The Moral Limits of Markets, has expressed this view with particular force. All policies that rely on economic incentives, he says, pose the danger that those who pay a pollution tax, buy a carbon offset, or trade pollution permits are likely to consider themselves absolved of any further responsibility for climate change. Such incentives become “a painless mechanism to buy our way out of the more fundamental changes in habits, attitudes, and ways of life that may be required to address the climate problem.”

He applies his moral reasoning not just to individuals, but also to nations. Suppose that some wealthy county imposes a carbon tax or cap-and-trade mechanism. “Letting rich countries buy their way out of meaningful changes in their own wasteful behavior,” he says, “reinforces a bad attitude—that nature is a dumping ground for those who can afford it.” Whatever the efficiency of market-based mechanisms for combatting pollution, they “make it harder to cultivate the habits of self-restraint and shared sacrifice that a responsible environmental ethic requires.”

The best response to this ethical argument, in my view, is one made by Gernot Wagner in his book But Will the Planet Notice, cited at the beginning of this post. Here is what he writes in response to Sandel:

By all means, make the moral case. Teach it in philosophy classes and preach it from the pulpits, but let’s not wait for it to have an impact while the planet burns.
By all means, declutter your life. . . Downsize your apartment. Carry around a canvas bag. Bike. . . But everyone else won’t catch up to your good deeds voluntarily—not in time, and not with sufficiently strong action.

That’s where economics enters the room There’s simply no way to go about tackling this problem other than taking seriously the incentives all of us face. Getting several billion of us to behave differently—to behave morally—means guiding market forces in the right direction, making it in our interest to do the right thing. It’s the only way to make the planet notice.

The bottom line

The good news is that, despite initial skepticism, progressives are increasingly supportive of carbon taxes and other market-based environmental policies. Ironically, it is now conservatives who are more likely to reject them.

That is not to say that progressives have come around all the way. One sign of the sometimes half-hearted acceptance of market-based policies is an insistence on a belt-and-suspenders approach: Carbon taxes, marketable permits, or carbon offsets are acceptable as a supplement to existing command-and-control regulations, but not as a replacement for them. For example, a position statement from the Sierra Club reads as follows:

The Sierra Club advocates the establishment of pollution taxes which would make it less expensive for a polluter to adopt alternative processes or invest in additional equipment to curtail releases to the environment than it would be for him to continue as before. Such taxes would supplement, and not replace, standards on maximum permissible emissions.

That attitude poses a significant barrier to the kind of coalition-building that will be necessary if progressive and conservative advocates of carbon taxes are ever to agree on mutually acceptable legislation. Conservative advocates of market-based environmental policy like it, in large part, because it would replace the mish-mash of grossly inefficient taxes and regulations that they see as shackles to business. To many of them, adding a carbon tax on top of CAFE standards, clean energy mandates, ethanol subsidies, and the rest would make matters worse—not only worse for the business environment, but worse for the physical environment.

In a rational world, there would be room for a win-win compromise. Conservatives could make concessions to progressives on the need to protect the poor, for example, by using part of the revenue from carbon taxes to lower payroll taxes. Progressives, in turn, could offer conservatives some relief from the red tape of overlapping mandates, subsidies, and performance standards. In exchange they would get market-based policies that have lower compliance costs, but are equally or more effective in cutting pollution. Whether such a rational compromise is possible in today’s politically polarized America is, of course, another question.

This is the second part of a series. Follow these links for the first part, “Why Conservatives Should Love a Carbon Tax—and Why Some Do,” and the  third part, “Why Libertarians Should Support a Carbon Tax—Even if they Can’t Love It.”  

Originally posted at Economonitor.com

US Economy Adds 195,000 Payroll Jobs in June; Voluntary Part-Time Work Increases

The U.S. labor market continued to strengthen in June, according to the latest data from the Bureau of Labor Statistics. Strong June data and upward revisions for April and May put payroll job gains for the second quarter of 2013 ahead of those for the first three months of the year. The unemployment rate remained unchanged as both the labor force and the number of employed workers grew. Involuntary part-time work fell to its lowest level since early 2009, and long-term unemployment also fell to a low for the recovery.

The economy gained 202,000 private-sector payroll jobs in June. Most of those came in the service sector, although goods-producing industries also gained slightly. The government sector as a whole lost 7,000 jobs, but trends differed strongly by level of government. The federal government lost 5,000 jobs, continuing a long decline. State governments reduced payroll employment by 15,000 jobs, but that was almost fully offset by a gain of 13,000 jobs in local government.

As the following chart shows, payroll job gains were revised upward from data first reported for April and May. The revisions raise the total number of payroll jobs added in Q2 2013 to 535,000, significantly more than the 481,000 added in the first quarter. The good quarterly job data provide a reason for optimism regarding Q2 GDP, for which the first estimate is due at the end of the month.

 
The unemployment rate for June remained steady at 7.6 percent, near its low for the recovery. The unemployment rate is the ratio of unemployed persons to the civilian labor force. The labor force grew by 177,000 in the month, the number of employed by 160,000 and the number of unemployed by 17,000. These data are based on a separate household survey that does not always agree with the survey of employers on which the payroll jobs data are based. The two differ partly because of sampling error and partly because the payroll jobs data exclude farm workers and the self-employed. >>>Read more

Follow this link to view or download a classroom-ready slideshow with charts of the latest employment data

Why Conservatives Should Love a Carbon Tax—and Why Some of Them Do

 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.

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.

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?

This is the first in a three-part series. Here are links to Part 2 (progressives) and Part 3 (libertarians).

Originally posted to Economonitor.com

Update: In early 2017, Gregory Mankiw,George Schultz, James Baker and other conservatives released a plan for carbon tax called the "Conservative Carbon Dividend."  Read my full evaluation of the pros and cons of their plan.