Politics and the Economics of the Carbon Tax

Published February 5, 2019

A carbon tax involves some good economics and is probably the best way to address global warming.  And yet I think that adopting the tax represents bad policy.  My reservations involve the politics of policy implementation as examined by Nobel prize-winning economist James Buchanan.

Before getting to my concerns, let’s consider two other arguments against limiting greenhouse gas (GHG) emissions.  The first is that reducing U.S. emissions will have little effect on global temperatures.  The Clean Power Plan’s emissions cuts, for instance, were projected to prevent 0.02 degrees Celsius warming by 2100.

This just reflects the global nature of the challenge.  The U.S. will likely generate 10 to 20 percent of global GHG emissions through 2100.  We cannot stabilize atmospheric carbon dioxide alone.  Whether leading by example or conditioning our actions on other nations’ efforts makes more sense is a matter of international diplomacy, not economics.

Another argument is the overestimation of the costs of warming by economists’ Integrated Assessment Models (IAMs).  This could happen for two reasons.  First, future GHG emissions may produce less warming than currently forecast.  Second, the projected warming may occur and not prove extremely costly.

Climate models are a crucial component of an IAM; the costs of warming come entirely from predicted climate impacts.  The Intergovernmental Panel on Climate Change’s (IPCC) climate models have been running hot: since 1990, only about half of the predicted warming has been observed.  This raises questions about the models.

Humans will adapt to higher temperatures and rising sea levels.  Inadequate modeling of adaptation means that IAMs will overestimate the costs of warming.  And climate engineering could potentially remove carbon dioxide from the atmosphere, allowing continued use of fossil fuels while limiting warming.

And yet these climate and economic concerns, I think, recommend a smaller tax than currently estimated as opposed to no tax.  Unrestrained use of fossil fuels over 200 or 300 years may eventually produce dramatic and costly warming, even if emissions through 2100 merely constitute a nuisance.

James Buchanan pioneered the integration of economic and political analysis.  He criticized policy recommendations based exclusively on economics.  Such advice implicitly assumes government by a benevolent despot who does exactly what economists recommend.  Ignoring politics leads to useless and potentially harmful policy recommendations.

Economists advocating for initiating carbon taxation based on the benefits from an optimal tax are committing the error Buchanan warned against.  The IPCC in 2018 announced a new goal of keeping global temperatures from rising more than 1.5 degrees Celsius.  Attainting this goal will essentially require ending the use of fossil fuels by mid-century.  IAM pioneer William Nordhaus’ model estimates an optimal tax of almost $50 per ton, or $0.50 per gallon of gas.  The optimal tax increases over time but not enough to halt use of fossil fuels anytime soon.  Ending fossil fuel use might require a tax of as much as $5,000 per ton.

The debate is now whether to end the use of fossil fuels.  If the U.S. begins taxing GHG, we will almost certainly within a few years end up with a tax set well above $50 a ton.  Why?  After we initiate taxation of GHGs, politicians would then need to set and adjust the tax.  Politicians will likely balance the views of tax supporters in setting a rate, having resigned themselves to losing the votes of tax opponents.  All proponents other than a handful of economists will want a tax much in excess of $50.

The IAMs underlying economists’ support for a carbon tax show that costs rise sharply if we limit GHG emissions more than optimally.  The IPCC’s new 1.5 degrees of warming goal would, according to Professor Nordhaus’s model, produce net losses for the global economy even relative to no limits on GHGs.

An optimal carbon tax may well be sound economically.  But if we enact carbon taxation, politics will likely produce a very costly tax rate.  Economists should not let the allure of an optimal tax create an impression that carbon taxation will benefit the economy.