The Case for Carbon Taxes, Part II: Political Sustainability
by Eric Kramer
The Case for Carbon Taxes, Part II: Political Sustainability
In a prior post, I argued that carbon taxes are not vulnerable to political subversion by hostile courts and regulators, and that this is an important advantage of carbon taxes over traditional regulation based on mandates, and also an advantage over subsidies. Once they are passed, carbon taxes can work more or less on auto-pilot to drive a clean energy transition, unless they are affirmatively repealed by Congress. In this post I consider whether carbon taxes are likely to sustain the support they need to remain in place. There is certainly no guarantee of this; any ambitious climate policy is likely to remain controversial. However, there are reasons to be optimistic that a carbon tax will not provoke a self-defeating backlash, and mandates and subsidies will also encounter political headwinds.
When it comes to political viability, it is natural to think that subsidies are the best policy, mandates are second-best, and carbon taxes rate poorly.
Subsidies are politically popular – at least if they are funded through deficit spending – because the benefits to voters are clear and they seem to reward people for virtuous behavior (like buying an electric vehicle), but the costs of deficit spending are indirect and hidden from view. Subsidies do not force anyone to do something that they would rather not do, like convert from natural gas to electric heat, or purchase an electric vehicle. They are all carrot, no stick. (This advantage of subsidies is entirely dependent on deficit financing. Telling people that we will give them a $10,000 tax credit to use on the purchase of an electric vehicle at some point over the next ten years is not particularly appealing if we also tell them that their taxes will go up $1,000 per year to pay for it.)
Mandates do not have the obvious direct benefits of subsidies, but the costs of mandates are sometimes indirect and hidden from view. Fuel economy standards, renewable portfolio standards, and green building codes raise the costs of cars and housing, but the effects are at least somewhat indirect and may be difficult for voters to attribute to climate policy. This is a political advantage of mandates, although mandates might become quite intrusive (as well as very inefficient) if we used them to substantially decarbonize the economy, rather than just nibbling around the edges. (Imagine using mandates to get homeowners to switch from gas to electric heat, for example.)
Carbon taxes are problematic because they directly and visibly lead to higher energy prices, and spending on energy is a major item in the budgets of most families. However, to offset the visible costs of a carbon tax, the government can simply return the tax revenue directly to consumers. Proponents of a carbon tax frequently suggest rebating carbon tax revenue to households on a per capita basis. This would help keep family budgets in balance, and some argue that it would allay concerns that government would waste the tax revenue. (Some climate advocates believe that carbon tax revenue should be used to fund other climate initiatives, such as research or green infrastructure or climate adaptation. Although some of these ideas poll well, and they are reflected in some proposed legislation, I suspect that a substantial carbon tax will only be sustainable if most or all of the revenue is returned to households. Without a substantial rebate, using a carbon tax to fund green infrastructure will be about as popular as increasing the gas tax to fund highway construction.)
Let’s consider the political sustainability of a carbon tax with a simple per capita rebate. A critical question is whether families will tend to perceive this policy as a net financial benefit or cost. There are reasons to think that many people would find it to be at least tolerable, and it could turn out to be reasonably popular.
Initially, before anyone adjusts to a carbon tax, the average family is no worse off under a carbon tax with a rebate than they would be with no tax at all. To see this, suppose that we adopt a carbon tax with a rebate, and no one changes their behavior. In this case, the average family is in the same position with the tax and rebate that they were in without it – they can afford to purchase the same basket of goods and services they consumed before the tax was imposed. Furthermore, the rebate received by the average family will exceed the higher energy prices that are directly attributable to the carbon tax because part of the cost of a carbon tax to consumers is indirect, hidden in often modest increases in the prices of a range of goods and services. If consumers do not attribute these price changes to the carbon tax, the average rebate may exceed the perceived costs of the tax.
Before people adjust to a carbon tax, then, let us assume that the average family does not feel harmed by a carbon tax with a rebate. This is just the beginning of the story, because the tax gives people an incentive to reduce their carbon footprint, and as consumers and firms adjust to the carbon tax and reduce their carbon footprint, they will incur costs. With a rebate in place, however, the incidence of these costs is indirect and difficult for people to attribute to climate policy.
Consider the position of a family that decides soon after a tax is imposed that it makes sense financially to invest in electric heating. This family will be better off under a carbon tax with a rebate than it was before the tax was imposed – initially, the family is not hurt by the tax, and it benefits financially from switching to electric heat. However, other families are hurt when the family invests in electric heating, because carbon tax revenue and rebates will go down very slightly.
This effect of the carbon tax is highly indirect and incremental. Costs are spread out over time as people make green investments and the carbon rebate gradually declines. If the carbon tax rises over time, rebates may rise for many years before declining as people reduce their carbon use. The upshot is that the costs of a carbon tax will be obscure, spread out over time, and difficult to trace back to the tax.
What will be clear to consumers and firms is that their investments in green technologies will only pay off if the carbon tax remains in place. Furthermore, people who invest in green technologies or adjust their lifestyles to reduce their carbon footprint will feel a strong sense of entitlement to their rebate. If you purchase an electric vehicle or install electric heating in your home due to the carbon tax, you will be understandably upset if the tax is repealed, your tax rebate goes away, and the price of gasoline or heating oil falls. Similarly, businesses that invest in green technologies will object if a carbon tax is removed, because this will reduce their return on their green investment. Many families are likely to use their carbon tax rebate to finance electric vehicles and green home improvements, which will give banks and other lenders an incentive to lobby for continuation of the tax and rebate scheme.
Subsidies, in contrast, will tend to undermine their political support over time. Once you purchase your electric vehicle with a subsidy, you no longer have a reason to support continuation of the policy. In addition, the cost of subsidies will make them a perennial target of fiscal hawks.
So far, we have focused on the impact of a carbon tax on the average family. However, as several studies have documented, a carbon tax with a rebate is progressive. Most low- and middle-income families will gain from a carbon tax, at least initially, because they have a smaller carbon footprint than wealthier families. This progressivity should be a welcome feature of carbon taxes to progressives, and it also suggests that most families will perceive a benefit from a carbon tax, because lower-income families are more numerous than wealthier families.
To repeat, there is no guarantee that a carbon tax, or any climate policy, will be politically sustainable. There is a real possibility that we will lose the battle against climate change. But there is reason to believe that a carbon tax can remain in place if it is passed and that it can function effectively even in the face of resistance from conservative courts and hostile Republican administrations. These political advantages, together with standard efficiency concerns and the strongly favorable effects of a carbon tax rebate on the economic welfare of poor and modest-income families, creates a strong case for Democrats to make carbon taxation a high priority as they think about climate policy.
Don’t forget that the geographic pattern of American life has adapted to the low (and subsidized) price of fossil fuels. A considerable number of low- and middle-income families are so exposed to fuel prices that they would take losses that are much larger than their shares of a uniform rebate, with their homes and cars becoming partially stranded assets. This is a political problem that must be addressed.
Yikes. Another long post with not even a single commenter aside from me noting that neither of these long posts has mentioned the real rival to taxes, cap and trade, which does not look as politically toxic as taxes, although taxes are currently very fashionable among many economists, with that huge petition for them that went around not too long ago.
Go look at that petition closely. Guess who did not sign it: actual environmental economists like the late Martin Weitzman, not to mention Robert Stavins of Harvard, and, oh, me, although I am not all that famous for being an enviro ecnoomist even though I have been one for decades, indeed having been involved in setting up the very first government-run cap and trade program ever anywhere back in the 1970s in the state of Wisconsin for BOD on the Fox River, a successful program, btw.
Rick you are correct but not so much so that electric/smaller vehicles/better insulation could not offset the disadvantages to some extent.
With regard to the income from the taxes shrinking over time. Not so fast. The taxes rates could INCREASE over time.
I agree that cap and trade is a better policy from the point of view of obtaining the objective (reducing total CO2). However, the disadvantage is the politics are difficult, in particular the current worst sinners get the bulk of the permits and will try to undermine the process of reducing the cap, and it will be seen as unfair to reward sinners (as they can get easy money from low hanging fruit).
P.S. Rick, maybe the people in remote locations should have a conversation with people getting flooded in low lying locations. Should be an interesting conversation.