The words “carbon tax” are appearing ever more frequently on the lips of economists and policy makers. Earlier this month, former Rep. Bob Inglis (R., S.C.) received the John F. Kennedy Profile in Courage Award for advocating it. Last Wednesday Rep. John Delaney(D., Md.) announced at a Washington, D.C., symposium on the issue that he is drafting a bill. Also last week, unconstrained by a legislative process, Yale University imposed a carbon tax on itself. More on that later.
In each case, it is presented as an article of faith that such a tax shall be “revenue neutral,” meaning that every dollar raised will be offset by a rebate or a tax cut. This is a convenient and misleading fiction. It might work on the first day, when the tax goes into effect and people pay a tax on their carbon emissions while paying commensurately lower other taxes. But what happens when people respond to the tax by reducing their carbon emissions? What happens in year 10, when people have responded to the tax by shifting toward expensive alternatives to carbon-intensive energy production?
Two problems emerge. First, the tax base will have shifted onto something that we are trying to reduce. As carbon emissions decline, so too will tax revenues. This dynamic might seem appealing as a way to “starve the beast” and force cuts in government spending, but more likely it will trigger irresistible pressure for tax increases. It is a policy mistake to leave the government reliant on a diminishing-by-design tax base for its funding and political folly to program a strong demand for increased revenue into the tax code.
Moreover, a carbon tax may be revenue-neutral on the way up but it is not on the way back down. As taxable, carbon-intensive energy sources are replaced by higher-cost/lower-emissions alternatives—arguably the whole point of the policy—Americans will continue to pay a price implicitly inflated by the tax even though their government no longer receives the revenue from it. As substitute taxes come back online to make up the difference, even if that substitute is simply an ever-increasing rate on the remaining carbon emissions, the economy is left to pay for both the higher-cost energy and the full tax burden it already supports today.
The performance-art exhibit that is Yale University’s “revenue neutral” plan provides a helpful if abstract illustration. The university will charge the budgets of departments that use relatively more carbon while crediting the budgets that use relatively less. Each department therefore has an incentive to reduce its emissions and there is no net effect on the overall university budget. So far so good.
But what happens when the university’s departments respond to these incentives by adding real cost to their operations? Suppose a dormitory reduces its “tax” burden by $100,000 by adding solar panels at an amortized annual net cost of $50,000. The university takes in $100,000 less of tax “revenue” and will subsequently rebate $100,000 less elsewhere, so the “neutrality” is preserved. But it just spent $50,000 very real dollars.
Those dollars will ultimately have to come from budget cuts or tuition increases. The more strongly the tax affects behavior, the more damage it will do to the university’s finances despite remaining “neutral” every step of the way.
A comparable effect plays out through an economy-wide carbon tax. As soon as customers and businesses move to avoid the tax by paying for higher-cost renewable energy or hybrid cars, they will find their taxes as high as ever (assuming a fixed size of government) and their energy more expensive too.
One may defend such burdens on environmental grounds, but one cannot ignore the economic drag. Repealing other carbon-related regulations would help to reduce the drag, but those regulations are criticized today for their relative weakness and ineffectiveness. A key selling point of the tax is typically the expectation that its impact will be significantly stronger than that of current regulations.
Claims of “revenue neutrality” make a carbon tax sound like a free lunch, even though it imposes costs on the economy very similar to those that accompany cap-and-trade plans or command-and-control regulation. The Yale example is especially transparent: The university does not tax its departments to fund its operations today, and it will not in the future. Even if it did, it would obviously recycle those funds back into its budget anyway. So what could calling its new accounting program “revenue neutral” even mean, except to imply “costless” when it is anything but?
If one wants to reduce carbon emissions one might argue for a carbon tax as the best or most economically efficient approach. But adding the descriptor “revenue neutral” does not reduce the cost.
Mr. Cass is a senior fellow at the Manhattan Institute.
See the article here.
- On May 2, 2015