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Carbon-Tax Fantasies



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Two Republican lawmakers have apparently introduced a “revenue neutral” carbon-tax bill. In practical terms, Reps. Inglis and Flake’s basic idea is to increase carbon taxes, and then reduce payroll taxes by the exact same amount.

Flake says that “The first axiom of economics is if you want less of something, you tax it.” Well, lots of very smart economists believe that, but I don’t know that I’d call it an axiom. A tax on something we want less of is usually called a Pigovian tax in honor of the famous economist Arthur Cecil Pigou who proposed the idea. Ronald Coase’s lecture upon receiving the Nobel Prize in economics is a very instructive counter-argument. When discussing one of the two papers for which he won the award, The Problem of Social Cost, he had this to say:

I was exposing the weaknesses of Pigou’s analysis of the divergence between private and social products, an analysis generally accepted by economists, and that was all. … Pigou’s conclusion and that of most economists using standard economic theory was, and perhaps still is, that some kind of government action (usually the imposition of taxes) was required to restrain those whose actions had harmful effects on others, often termed negative externalities. What I showed in that article, as I thought, was that in a regime of zero transaction costs, an assumption of standard economic theory, negotiations between the parties would lead to those arrangements being made which would maximise wealth…

A revenue-neutral carbon tax is superficially appealing. It sounds like something as close to a free lunch as we are offered in this fallen world. But like most free lunches, it turns out to be expensive.

The most important point is that revenue neutrality is most likely a mirage. We would have to maintain the carbon tax for decades in order to generate the consumption reductions that advocates argue will occur, but FICA rates aren’t static over decades. In 1950 the FICA rate was 1.5%; by 1970 it was 4.8%; by 1990 it had risen to its current rate of 7.65%. It has been stable for about two decades, but meanwhile the programs that it (in theory) funds are in crisis.

Over the next few decades, we should expect to be in bitter political fights over changing retirement ages, benefit levels, access to publicly-funded medical care, tax rates, and other measures designed to make these programs financially stable. The FICA rate will not be insulated from this process. Who could possibly say that when it has increased in irregular and unpredictable steps to, say, 15.3 percent between now and 2028 in response to various political crises, that, but for the carbon tax, it would otherwise have been 16.5 percent?

In fact, remember that FICA is theoretically a dedicated funding source for Social Security and Medicare. They are already underfunded. This proposal would massively reduce the collections that support these programs, which would serve to ratchet up exactly the pressure to increase FICA tax rates that will then serve to make this a net tax increase.

The idealized carbon tax is an almost perfect example of what Coase famously called “blackboard economics” — abstract economic theory that proceeds by ignoring a detailed knowledge of the actual economic system.



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