In his December 29 piece for National Review Online, Irwin Stelzer tries to convince conservatives that they should support a carbon tax because — coupled with cuts in payroll taxes — it would boost the economy. Stelzer thinks conservatives can put aside their differences with Al Gore and other extreme environmentalists: A carbon tax, the title of the piece asserts, offers “something for everyone.”
However, this is not what the peer-reviewed economics literature says. There are several reasons that a carbon tax will not deliver the boost to the economy that Stelzer and a few other conservative icons have been promising, even if it’s 100 percent revenue neutral. Some of these reasons are straightforward, while others are quite subtle.
First and most obvious: A carbon tax will most definitely not be revenue neutral, and it will not be used to phase out existing regulations. Environmentalists have a long wish list of renewable-energy and other “green” projects for which they will earmark at least some of the receipts from a major carbon tax. Furthermore, they are not even pretending that they would be willing to trade a carbon tax for other policy concessions or to make it revenue neutral. Senator Sheldon Whitehouse (D., R.I.), leader of the Senate’s carbon-tax coterie, has mused that revenues from a carbon tax “should be returned to the American people,” but his actual proposal classifies increased federal spending as one way of doing that.
Second, even to the extent that a new carbon tax’s revenues were devoted to minimizing the blow to the economy, any politically plausible legislation would be quite inefficient from the perspective of supply-side economics. For example, many proposals include provisions to direct funds from a new carbon tax to lower-income households, since they will be disproportionately hit by higher energy prices. This makes perfect sense from an egalitarian point of view, but it does little to promote economic growth. Suggestions of payroll-tax reductions are poorly suited to unleash entrepreneurs and job creation: On the margin, a given amount of tax reduction would be much better targeted at the corporate rate or the top personal-income-tax bracket.
Third, the true policy wonk who wants to assess the impact of a carbon tax needs to research the so-called “tax interaction effect.” This is a well-known result in the economics literature, but it has had surprisingly little impact on the broader carbon-tax policy debate. Most people in the public-policy debate get this issue exactly backwards.
It is true that, given a massive new carbon tax, the blow to the economy can be reduced if the revenues are devoted to reducing preexisting taxes, rather than funding more government spending. However, that is not the same thing as saying that a new carbon tax, tied dollar-for-dollar with tax cuts elsewhere, is better for the economy than not having a carbon tax at all.
Stelzer says a dollar-for-dollar swap would boost the economy by “shifting the tax burden from good stuff like work to bad stuff like pollutants.” But the tax interaction effect shows that when you start out with preexisting distortionary taxes on labor and capital, a new carbon tax exacerbates their harm. Specifically, the carbon tax makes prices rise, reducing the effective after-tax income from working and investing, and thus increasing the deadweight loss from taxes on labor and capital. Because a carbon tax is levied on a much smaller base than broader labor or capital taxes, the baseline result in the formal modeling is that even if 100 percent of the carbon tax receipts are devoted to other tax cuts, the conventional economy will probably be hurt.
Far from offering something for everyone, a revenue-neutral carbon tax advances the policy agenda of the environmental Left at the expense of the American people. The economic theory of a carbon tax is unmoored from political reality. In practice, carbon-tax supporters have shown that they would rather spend the revenue on pet projects than reduce taxes, thereby hindering economic growth. Conservatives should resist the temptation to give central planners in Washington more money to waste and more control over our economic affairs.
— Robert P. Murphy is a senior economist at the Institute for Energy Research.