How to Slow Climate Change Without Hurting the Poor

"Energy is the lifeblood of any economy,” writes H. Sterling Burnett, a fellow at the Heartland Institute. “A carbon tax would increase energy prices and thus cost jobs, making it difficult U.S. companies to compete with foreign rivals and punishing the poor.”

The Manhattan Institute’s Robert Bryce agrees. In an article for the National Review, he tells us that a carbon tax would “disproportionately hurt low-income consumers,” especially those who “live in rural areas and must drive long distances to get to and from their job sites.”

The American Energy Alliance echoes that sentiment, placing the “it will hurt the poor” argument in the third spot on a list of 10 reasons to oppose carbon taxes:

The carbon tax is by nature regressive, because it will raise the prices of gasoline, electricity, and other goods by the same dollar amount for all consumers, regardless of their incomes. This disproportionately affects the poor, because energy costs are a bigger portion of their overall budgets. A carbon tax will therefore hurt low-income families and seniors more than it will hurt middle- and upper-class households.

It is true, as we will see, that poor households do devote larger shares of their incomes to energy than do those with higher incomes, but there is more to the story than that. If we properly measure the impacts of carbon pricing and look at the full range of policy alternatives, there is no reason why concern for the poor should block policies to protect the environment.

The wrong way to help the poor

Let’s begin with the conventional wisdom, which holds that low-income households would be disproportionately impacted by a carbon tax since they devote a relatively high share of their incomes to energy. For example, a 2009 study by Corbett A. Grainger and Charles D. Kolstad found such a pattern, as shown by the blue bars in the following chart:

The population is divided into five income quintiles, from lowest to highest. The blue bars show how many kilograms of carbon each quintile emits per dollar of income; this proportion is much higher for the lowest quintile than the highest, indicating that the poor do spend more of their budgets on energy. But the red diamonds indicate the proportion of national carbon emissions emitted by each quintile, and they move in the opposite direction. In other words, as you move up the income ladder, a smaller portion of your budget goes to energy, but you still emit more. As a result, the top income quintile is responsible for almost 35 percent of total emissions, compared to just under 10 percent for the lowest quintile.

Even if we take these numbers at face value, it is clear that forgoing a carbon tax in order to keep energy prices low is an absurdly inefficient way to help the poor. Based on their share of national emissions, the top two income quintiles would capture 58 percent of the benefits of such a policy, compared to just 24 percent for the bottom two quintiles. The very richest households would gain three-and-a-half times more than the very poorest.

Furthermore, looking only at incomes and energy use gives a misleading picture of the degree to which the effects of a carbon tax would be concentrated on the poor. A more recent study by Julie Anne Cronin, Don Fullerton, and Steven E. Sexton took a different approach. Cronin et al. considered not only the direct impact of a carbon tax on household energy prices, but also indirect impacts on the prices of goods like housing, food, and clothing. In addition to income, they also looked at the impact of carbon taxes in proportion to household consumption expenditures, which are more stable from year to year than incomes. They also accounted for the fact that transfer payments to low-income households are indexed to rise automatically when prices increase, whether because of general inflation or due to a policy change like a carbon tax.

When all of those factors are considered, Cronin et al. found that the impact of a carbon tax is more equally distributed in proportion to household income and consumption than the conventional wisdom assumes. As the next chart shows, the burden of a carbon tax as a percentage of household income varies only slightly, from 0.54 percent of income for the poorest income decile to 0.46 percent of income for the wealthiest decile. If the calculation is done as a percentage of consumption rather than a percentage of income, the impact of a carbon tax on wealthy households is actually proportionally greater than on poor households.

If we judge by the Cronin method rather than the earlier Grainger method, the idea of helping the poor by keeping carbon prices low is even more suspect. According to the Cronin data, the top two income quintiles would capture 77 percent of the benefit of forgoing a carbon tax, rather than the 58 percent they would capture based on the older data. Meanwhile, the poorest two income quintiles would receive only 10 percent of the benefit of a low-price policy, rather than the 24 percent they would get based on the older data.

Still, though, a carbon tax would have some adverse effect on the poor, even if its impact would not be as regressive as the conventional wisdom suggests. If forgoing a carbon tax is the wrong way to help the poor, what is the right way?

How to help the poor and the planet

The right way to assist low-income families would be to give them extra income to pay the higher prices that a carbon tax would bring. Every serious carbon pricing proposal that I have seen includes some such compensation scheme.

For example, the Citizens’ Climate Lobby, one of the leading backers of a carbon tax, proposes distributing the tax revenue equally among the entire population as a “citizen’s dividend.” A group of 45 prominent economists recently wrote an open letter in support of a carbon tax that would take the same approach.

Alternatively, some favor a revenue-neutral tax swap that would offset carbon tax revenues by reducing the rates of other taxes. If enough of the rate reductions were focused on payroll taxes or other taxes that are disproportionately burdensome for low-wage households, the net impacts of a revenue-neutral tax swap could be made neutral with respect to income, or even moderately progressive. Still other carbon tax backers propose distributing all or part of the compensation in the form of increased benefits for existing income-support programs, such as food stamps, Social Security, and the earned income tax credit.

Finally, some backers favor spending carbon tax revenues to address climate change directly, for example, by investing in clean-energy infrastructure or adaptation. If the benefits of slowing climate change are enjoyed equally by everyone, regardless of income, the distributional effects of such a policy would be similar to those of a tax-and-dividend scheme. If, as is sometimes claimed, climate change hurts the poor disproportionately, using carbon tax revenue for climate mitigation would could be even more progressive than a citizens’ dividend.

These are not either-or options. Carbon tax revenue could be divided in some way among all of them. In a report for the Brookings Institution, Aparna Mathur and Adele Morris calculate that compensating low-income households for the impact of a carbon tax could take as little as 11 percent of the tax revenues. In an analysis of the 2018 Market Choice Act, researchers from Columbia University and Rice University found that allocating 10 percent of carbon tax revenue to transfers to the lowest 20 percent of income earners increased household wealth and especially benefited younger workers.

However, Cronin et al. add a big caveat. They point out that not all families in a given income bracket are equally affected. Those who live in temperate climates use less energy for heating and cooling than do those in more severe climates. People who commute to jobs use more energy than retirees with equal incomes, and so on. The impacts from family to family within an income bracket can vary more than the average effect of the tax across income brackets. The implication is that to be sure that most in the poorest quintile were not hurt, it would be necessary to spend more on compensation than Mathur and Morris’s 11 percent, or to target compensation to regions or activities with high carbon consumption.

One final point regarding compensation: The basic point of carbon pricing is to incentivize conservation of energy, investments in low-carbon technology, and other behaviors that reduce emissions. There is a trade-off between compensation and incentives. On the one hand, to make compensation more effective, it makes sense to tailor it to the specific circumstances of beneficiaries, so that fewer are undercompensated or overcompensated. On the other hand, it is important not to allow the compensation plan itself to undermine incentives.

For example, low-wage workers who have to drive a long way to their jobs will be more severely impacted by a carbon tax than those who have access to public transportation or can work from home. It would be a mistake, though, to automatically offer extra compensation in proportion to miles driven, or to provide vouchers to allow purchase of gasoline at pretax prices. Any such forms of compensation would remove incentives to move closer to work, use public transportation, or buy a more efficient car. Similarly, fully compensating people who live in hot or cold climates for their extra home heating costs could erode incentives to make their homes more energy efficient or even to move to more temperate areas.

The Bottom Line

When considerations both of efficiency and fairness are taken into account, “It will hurt the poor” does not ever have to override “It’s good for the environment.” In any democratic political system, there are going to be differences of opinion on the relative priorities of distributional equity and environmental protection, but to say we must abandon one goal to pursue the other is simply false. It is perfectly possible to protect the environment and, at the same time, to protect low-income consumers from any undue effects of doing so.

Based on a version published previously by NiskanenCenter.com

How Universal Catastrophic Coverage Could Ease the Transition to Health Care for All

The vision of universal access to health care that lies behind Medicare for All has wide appeal. However, as David Brooks noted in a recent column for the New York Times, the problem is less the vision than the transition. Medicare for All, in both its Senate (Sanders) and House (Jayapal) versions seems designed without a thought to the problem of transition. If we can’t get there from here, what is the use of a glittering vision of health care reform?

Fortunately, Medicare for All is not the only path to affordable access to health care for all Americans. Our team at the Niskanen Center has been working on an alternative health care reform known as universal catastrophic coverage (UCC). UCC would cover the needs of the very poor and the very sick in full, as does Medicare for All. At the same time, it would also require those who can afford to do so to pay a fair share of their routine medical expenses through income-based deductibles, coinsurance, and copays. That gives UCC a greater flexibility that would ease many of the transition problems that Brooks lists.

Sticker Shock

The sheer cost of Medicare for All is one of the biggest obstacles to its adoption. As measured by the Kaiser Family Foundation, Public support for comprehensive national health care drops from 56 percent to 37 percent when people are told that it would require higher taxes.

Backers of Medicare for All point out, correctly, that most people would get those taxes back through lower premiums and out-of-pocket costs. But taxation is a leaky bucket. Taxes distort financial decisions made by families and businesses. There are administrative costs of collecting taxes and disbursing benefits. As a result, it takes more than one dollar in tax burden to support each dollar of benefits.

Because of the leaky bucket effect, it makes no sense to impose heavy new taxes on upper-income households and then give that money right back as health care benefits. That is all the more true since the benefit in Medicare for All are more generous than in other countries. Highly regarded health care systems, such as those in Australia, Singapore, and France, require at least modest deductibles or copayments. What is more, they do not cover as wide a range of services as Medicare for All would do.

By comparison, universal catastrophic coverage would cost at least 30 percent less than Medicare for All. Based on reasonable assumptions, the government could finance UCC entirely from funds it now spends directly on health care, plus funds that now go to mandated and tax-advantaged employer plans. The lower cost of UCC would greatly reduce the problem of sticker shock.

What Role for the Insurance Industry?

Observers like Brooks rightly worry about the impact of health care reform on the half-million-odd people who work in health insurance. The fragmented and adversarial nature of our health care payment system is a big part of the reason for its high costs relative to those our high-income peers. Any serious reform will, and should, have a big impact on the insurance industry.
Still, it would be possible to implement UCC in a way that would be less disruptive to the insurance sector and its employees than Medicare for All, under which the entire industry would effectively disappear.

Under UCC, many higher-income households would have deductibles and coinsurance of thousands or even tens of thousands of dollars. Many of them would probably choose to buy some form of supplemental insurance. Private companies would serve that market, much as they serve today’s market for Medigap coverage.

UCC could also create a role for private insurers as payment agents for the federal catastrophic program. For example, they could offer a private option, similar to Medicare Advantage, even if the Centers for Medicare and Medicaid Services administered the basic UCC program.

Instead, UCC could contract out all coverage to competing private insurers, as the highly-rated Dutch and Swiss systems do. Those countries regulate insurance companies much more tightly than the U.S. system currently does. The regulations ensure that companies compete by offering lower costs and better customer service, rather than boosting profits by denying as many claims as possible. But even with its much tighter regulation, the transition to a Dutch or Swiss model would be far less disruptive for insurance companies and their employees than Medicare for All.

If You Like Your Plan . . .

The failure of the Affordable Care Act to deliver on President Obama’s incautious promise, “If you like your health care plan, you can keep it,” helped spark a widespread backlash against that program. No such promise should ever have been made. There are too many health care plans in today’s system that make no sense even to try to keep.

Employer-sponsored health insurance (ESHI) is Exhibit A in that regard. ESHI, which covers about half of all households, came into being in the 1940s as a wartime accident. It has been nothing but trouble ever since. It is a source of job lock that ties millions of Americans, terrified of losing coverage, to unsuitable careers. What is more, it contributes to fragmentation and raises administrative costs.

Above all, ESHI is appallingly inequitable. Economists Robert Kaestner and Darren Lubotsky  estimate that workers in the bottom fifth of the family income distribution get annual tax benefits of less than $500 from ESHI, while those in the top fifth get benefits averaging $4,500. What is more, their data show that inequity to have become worse over time.

Still, surveys have repeatedly shown that more than two-thirds of people on ESHI like their plans. Presumably, many of those are people who have little chance of getting other coverage. Others have no interest in changing jobs, or are on the favored end of the unequal distribution of tax benefits. Whatever the reason, Medicare for All’s determination to throw millions who like what they have into an unfamiliar new system is a major barrier to its adoption.

UCC, in contrast, could be phased in more gradually than Medicare for All, especially for employer-provided plans. One possibility would be to lift the employer mandate, phase out the tax deductibility of ESHI, and allow employees to opt into UCC if they chose. Most lower-paid workers would probably take that option. Employers who wanted to use health care benefits to retain higher-paid employees could offer them supplemental policies. That way many fewer people would have to make a change of plans against their will.

Cost Controls

Any successful health care reform will have to deal with the high prices charged by American doctors, hospitals, and pharmaceutical companies.  Medicare for All takes a risky and simplistic approach to cost control through across the board cuts in of as much as 40 percent in reimbursement rates for doctors and hospitals. That could be very disruptive to the many communities where hospitals are among the biggest employers.

UCC, too, would need to put downward pressure on excessive prices, but it could do so in a more nuanced way. Like Medicare for All, UCC would empower government administrators to bargain for favorable prices with hospitals, doctors, and drug companies. However, direct bargaining would be only one of several cost-control mechanisms. Market-based cost controls would back up administrative actions for consumers who have not reached their oout-of-pocket limits. Measures to promote competition and transparency, and to reward those providers who offer the best value for money, would make it easier than it is today for such consumers to shop wisely for health care services.

Transition Will Never be Easy

No matter what the final design, comprehensive health care reform will encounter problems of transition. Our existing system is not a product of rational design. It performs so far from optimally that there will be no way to fix it without big changes, necessarily disruptive. Providers and consumers who exploit imperfections in the system to their own advantage will resist change.
Transition will never be easy, but there is no reason to make it harder than it needs to be. The versions of Medicare for All now on the table in the House and Senate face obstacles that are likely to prove insurmountable. The greater pragmatism and flexibility of universal catastrophic coverage offers a less hazardous path forward.

Based on a version previously published at NiskanenCenter.com

Why Any Green New Deal Must Include a Carbon Tax

No Democrat is going to win the 2020 presidential nomination without a position on the Green New Deal. At least six of the declared Democratic presidential candidates have endorsed the GND to one degree or another. Some of their endorsements have been notably lacking in specifics. 

For example,  Sen. Kamala Harris,  endorsing the GND in her first-of-the-season town hall on CNN, 

stuck to safe generalities. Climate change is an “existential threat,” she said. “Children need to breathe clean air and drink clean water,” “we have to invest in solar and wind,” she went on.

We would expect such sentiments from a Democratic candidate, but as Brett Hartl,  government affairs director for the Center for Biological Diversity, recently told the Washington Examiner,  “Just saying you support the goals of the Green New Deal is better than nothing, but it really does matter what those details are.”

One detail that definitely matters is the role for a carbon tax in the GND package. The draft version of the GND resolution currently being circulated in Congress is clearly still a work in progress. Section 4(B) of the draft speaks of  "ensuring that the Federal Government takes into account the complete environmental and social costs and impacts of emissions" through "existing laws" and "new policies and programs." That certainly could means a carbon tax.

Properly Measured, It's Never Cost Less to Drive your Car

You have probably noticed that the price of gasoline has fallen a little lately. In January, the national average retail price of gasoline in the US fell to $2.20, as low as it's been in 15 years. I filled my car at Costco a few weeks ago for just $1.92 a gallon.

But how much does it really cost to fuel your car? Or, as an economist would put it, what is the opportunity cost of buying motor fuel? I would argue that the proper measure of opportunity cost in this case is the number of hours your have to work to buy the gasoline you need to drive your car 100 miles. That turns out to be lower now than it has ever been in the history of the automobile. Let's take a little tour through the ages to see just how cheap gasoline is today.

Two Charts That Show Why We Are Not Ready for the Next Recession

Writing recently for Project Syndicate, Brad DeLong offers some sobering thoughts on our readiness for the next recession:

If a recession comes anytime soon, the US government will not have the tools to fight it. The White House and Congress will once again prove inept at deploying fiscal policy as a counter-cyclical stabilizer; and the Fed will not have enough room to provide adequate stimulus through interest-rate cuts.

Running the economy hot has produced some good numbers in the short run, but warning signs are beginning to accumulate. Although there is no natural life-span for a business cycle, this one has already been the longest on record, measured the previous peak of December 2007. It is only prudent to give some thought to our preparedness for the next recession — or our lack of it.

Let’s start with the monetary side. The Fed’s primary tool for fighting recessions is to cut its key interest rate, the federal funds rate, in order to encourage lending and maintain liquidity of the banking system. However, for that tool to work well, the rate has to be high enough before the downturn starts to make room for significant cuts.

The following chart, in which gray bars show recessions, allows us to compare the present situation with business cycles of the past. For example, in late 2000, as the dot-com boom began to wind down, the fed funds rate stood at 6.5 percent. Over the next year, the Fed cut the rate by four and a half points, helping to keep the 2001 recession short and shallow. That still left room to cut another point over the next two years, speeding the recovery.

By the summer of 2007, when it was becoming hard to ignore the growing weakness of the housing sector, the fed funds rate had risen to 5.25 percent. Between July 2007 and December 2008, the Fed cut it as close to zero as was technically possible. This time, even a 5-percentage-point rate cut was not enough to avoid a serious slump.

In both 2001 and 2007, the Fed was able to begin cutting the fed funds rate based on early indications of trouble, and still have room for maneuver. Today’s situation is not as favorable. If a strong expansion continues through 2019, the rate may rise a bit higher than its current 2.4 percent, but if a recession were to come sooner, the Fed would have far less countercyclical ammunition than it did at the two previous cyclical peaks.

Let’s turn now to fiscal policy. As the next chart shows, the federal deficit normally moves toward surplus as the business cycle approaches its peak. When a recession begins, or seems about to begin, having the deficit under control creates “fiscal space” that makes it easier to use tax cuts and spending increases to moderate the downturn and boost the subsequent recovery.

This time, however, the budget began moving toward deficit already in 2016. The turning point came with a package of spending increases and tax cuts, designed to keep the government running through the 2016 elections, that was passed in December 2015. That was followed by an even larger tax cut, not matched by spending cuts, at the end of 2017. Although final numbers for 2018 are not yet available, the deficit for 2018 (shown by the extension of the line at the far right) is estimated to have been 3.9 percent of GDP. That makes the downturn earlier and the pre-recession deficit larger than in any other business cycle since World War II.

Under these conditions If a recession were to come any time soon, the deficit will quickly eclipse the 10 percent mark that it approached at the bottom of the Great Recession. Even if we accept the technical feasibility of large-scale stimulus under those conditions, it would take a Congress with a lot more political courage than the one we have now to pass a robust countercyclical package of tax cuts and spending increases under those conditions.

The bottom line: DeLong is right. We are not ready for the next recession.

Previously posted at Medium.com

Podcast: Russ Roberts Talks with Ed Dolan on Employer Sponsored Health Insurance

In early December, Russ Roberts of EconTalk was kind enough to invite me to talk with him for an hour or so for his podcast series. The podcast was posted on January 7. You can listen to it in full here.

Our discussion centers on employer-sponsored health insurance, but toward the end we also get into universal catastrophic coverage as a possible path to reform.

Why Do We Work So Much and Take So Little Leisure?

America’s obsession with work has produced a record-low unemployment rate and the developed world’s shortest vacations. It has also produced a backlash.

A loosely organized movement has emerged that urges its members to live modestly and work less. One version, known as FIRE (Financial Independence, Retire Early), is popular among high-earning young professionals. Adherents aim to save much of what they earn and retire at 40. However, as financial independence guru Mr. Money Mustache points out, the basic idea of living within your means and rejecting slavery to work is just as good an idea, or even a better one, for people with modest incomes.

None of this is new. In a 1928 lecture, John Maynard Keynes predicted that his grandchildren would live in a world where people worked fare less than they did in his own time:

We may be on the eve of improvements in the efficiency of food production as great as those which have already taken place in mining, manufacture, and transport. In quite a few years — in in our own lifetimes I mean — we may be able to perform all the operations of agriculture, mining, and manufacture with a quarter of the human effort to which we have been accustomed. . . .
Thus for the first time since his creation man will be faced with his real, his permanent problem — how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well. . . .
Three-hour shifts or a fifteen-hour week . . . is quite enough to satisfy the old Adam in most of us!

Paradoxically, it turns out that we are actually ahead of Keynes’ schedule in terms of productivity, yet we still work only about 20 percent fewer hours per week than they did in the 1920s. Why?