Conservatives Shouldn’t Trust Stelzer on Carbon Tax

Irwin Stelzer has a PhD in economics from Cornell and decades of experience in academia, the financial world, and public policy. He is a frequent columnist in right-leaning outlets and was the editor of the 2004 The Neocon Reader. As such, readers may have taken Stelzer very seriously when he recently argued in The Weekly Standard that conservatives should support a carbon tax because it would (he claims) be good for economic growth. Yet as I’ll show, Stelzer’s article shows that he is unfamiliar with the technical literature in this area, and moreover, displays a shocking naïveté about how government grows.

Stelzer Cares About Economy – Not Environment

Knowing that many conservative readers are deeply suspicious of Al Gore and anything smacking of “green” concerns, Stelzer completely dismisses considerations of global climate change. Indeed he writes:

Conservatives know that whatever effect, if any, the climate-warming theoreticians believe a carbon tax might have on the incidence of floods (or is it droughts?) has nothing to do with the advance of the conservative economic agenda that carbon taxes can produce. We can remain skeptical about the so-called settled science of climate change, allow a few chortles from the greens, and get on with stimulative tax and economic reform.

Thus Stelzer’s wise-alecky commentary shows that he is not warning conservatives, “Hey, we actually need to take this IPCC stuff seriously. Humans shouldn’t keep emitting so much carbon dioxide.”

No, on the contrary, Stelzer is making his case for a carbon tax entirely dependent on its (alleged) ability to reduce harmful taxes and regulations. I’ll spend the rest of this article showing how ignorant of the literature, and naïve politically, his case really is.

Standard Literature Says A Revenue-Neutral Carbon Tax Will HURT Economy

As with many others who claim that a carbon tax will be a “win-win,” Stelzer simply asserts matter-of-factly that a tax-swap will boost economic growth:

Conflate two separate issues and you get one policy error. That is what too many opponents of carbon taxes are doing, getting caught up in the argument about climate change, which really has nothing to do with the case for a carbon tax. That case is that such a tax can make growth-inducing tax reform easier to achieve, and reduce the need for an expansion of the regulatory state, while protecting the competitiveness of our industries.

There is broad agreement that our tax structure is slowing economic growth and job creation.…Our payroll taxes, layered over with new taxes concealed in Obamacare, discourage work and risk-taking, and discriminate against modest earners. Our corporations sit on billions overseas rather than pay a huge fee for repatriating the cash.

A carbon tax would provide funds to make an attack on these nonsensical features of our tax code far easier. At minimum such a tax can be revenue-neutral, with the proceeds offsetting reductions in other taxes; at maximum, it might be what Wall Street calls revenue-accretive, generating new revenues by stimulating growth and job creation.

As the above makes clear, Stelzer simply takes it for granted that levying a carbon tax and then using the revenues dollar-for-dollar to reduce payroll, corporate, or other distortionary taxes would be good for economic growth. Yet he is simply wrong; that’s not what the standard results in the economics literature say.

Stelzer’s mistake is understandable. Intuitively, it first it sounds reasonable to suppose that if the government should impose a carbon tax to correct for climate change “externalities,” then that is a much more efficient way to raise revenues than to tax obviously productive things like work and saving. In the popular catchphrase of the pro-carbon-tax crowd: “Tax bads, not goods.”

Yet this analysis leaves out something important, which economists who publish in this area have labeled the “tax interaction effect.” Specifically, by enacting a carbon tax in the presence of pre-existing taxes on labor and capital, the distortions caused by those pre-existing taxes are amplified. In other words, adding in the carbon tax makes the payroll, personal income, and corporate taxes more harmful to the economy than they were originally. This is the “tax interaction effect”: The name comes from the fact that the new carbon tax interacts with the pre-existing taxes, making them more harmful.

Now it’s true, if some or even all of the revenues from the new carbon tax are used to reduce the marginal rates of the payroll tax or corporate tax, then that will help the economy compared to the new, awful position it’s in. Yet that’s not the same thing as saying the economy will be better off, compared to the original position when there was no carbon tax.

This is a subtle point, and it takes a minute to think it through if you’ve never heard it before. In this EconLib article I walk through the logic, and point to the published literature establishing the result and estimating its size—it’s huge. Also, for those who prefer to watch a live presentation, at IER’s conference last summer Dr. Ross McKitrick explained the published literature and why people get things backwards when they simply assume that a “revenue-neutral carbon tax swap” would boost economic growth. (In this post I highlight McKitrick’s key points and post the 17-minute video.)

Using Stelzer’s Own Authorities Against Him

Perhaps Dr. Stelzer doesn’t trust my analysis or McKitrick’s (even though the latter has written a graduate-level textbook on the economic analysis of environmental policy). Well then, let’s find a source whom Stelzer does trust. In his Weekly Standard article, when Stelzer is discussing whether a carbon tax would be regressive, he relies on commentary from Resources for the Future (RFF) and says matter-of-factly that RFF is “the think tank all sides agree is doing the most careful and non-partisan research on environmental issues.”

OK, so if Stelzer thinks RFF can be trusted on such issues, let me quote from a 2003 RFF study on the fiscal considerations surrounding a carbon tax. The author, Ian Perry, first explains that a “double dividend” would mean that a carbon tax hypothetically could kill two birds with one stone: it would help the environment (by penalizing harmful carbon dioxide emissions), but it would also boost conventional economic growth by using its revenues to reduce other, harmful taxes. So this “double dividend” is exactly what Stelzer is using to get conservatives to embrace a carbon tax. Yet the RFF author Perry then goes on to explain that economists publishing in this field eventually realized that the “double dividend” can be knocked out by the tax interaction effect:

A second wave of papers revealed another linkage with the labor market that undermines the double-dividend….A carbon tax increases the price of electricity, gasoline, and other energy goods; in turn, this drives up the prices of products in general, since they require energy inputs in production. The general increase in the price level reduces real household wages, which should slightly reduce employment given econometric evidence that lower real household wages lead to lower labor force participation and work effort.

This leads to an efficiency loss…And labor tax revenues fall…; to maintain revenues, labor taxes must be increased slightly, resulting in an efficiency cost…The combined loss from these two effects…is referred to as the tax-interaction effect.…

Comparing [equations] (3) and (4), the tax-interaction effect exceeds the revenue-recycling effect for all levels of emissions reduction; that is, the net effect of the carbon tax is to increase rather than decrease the efficiency costs of preexisting labor taxes, and there is no double dividend. [Bold added.]

I don’t want to oversell my case: There are peer-reviewed papers in which the author builds a model of the economy in which the introduction of a carbon tax can boost conventional economic growth. Even so, these are somewhat contrived models that make assumptions that deviate from what economists would use in other settings; the default in the literature is still to conclude that a carbon tax—even with 100% revenue recycling—would stifle conventional economic growth.

To repeat, the standard result in the literature—as even the RFF author reports, and Stelzer tells us that RFF is a trusted, non-biased authority on these matters—is that even 100% revenue-recycling will hurt conventional economic growth. There would still be a prima facie case for a carbon tax on environmental grounds, but you would be hurting the economy in order to reduce (alleged) climate change. If you go Stelzer’s rhetorical route and throw out the climate change issue altogether, then the case for a carbon tax collapses. That’s what the standard literature shows, and it’s disturbing that Stelzer apparently doesn’t even realize this, despite the confidence with which he lectures the Weekly Standard’s readers.

Stelzer Ignores Real-World Examples of Carbon Taxes

Besides Stelzer’s apparent unfamiliarity with the theory of carbon taxes, he also ignores the practice. Specifically, Stelzer apparently believes that if the U.S. implemented a carbon tax at the federal level, then environmentalists would grudgingly go along with a repeal of all of the other “green” interventions in the economy. In Stelzer’s words:

The president says he is proposing his new, complicated, agency-growing regulations to reduce emissions only because Congress has denied him a carbon tax. The administration’s hench-economist Paul Krugman helpfully chimed in with support: if we can’t have what Krugman joins the president in believing is the first-best solution of a carbon tax, well then, let’s live with the second-best solution, a regulation-heavy restructuring of the energy sector. The president’s flaccid support for a carbon tax and Krugman’s gleeful acceptance of a second-best solution have to make one wonder whether advocates of more centrally directed regulation actually prefer second- to first-best, more efficient solutions. After all, the health care sector has already been “transformed,” “core” standards have education en route to transformation from local to Washington control, and government control of the energy sector would make it three-out-of-three successes for Obama’s plan to “fundamentally transform … the United States of America” from a market-based to a government-directed, European style economy.

Here is an opportunity to give the president what he says he wants, and at the same time strike a blow for less regulation and smaller government. Impose carbon taxes, but in legislation that repeals the mare’s nest of admittedly second-best regulations and gives our coal industry a better chance of surviving.

The above argument from Stelzer is shocking in its glibness: He comes pretty close to arguing, “Let’s go along with a carbon tax just to prove what a bunch of liars these guys are.”

As Stelzer himself notes, many of the people clamoring for a carbon tax are not doing so because they are sleepless at 3am, worrying about atmospheric CO₂ concentrations. No, many of the most powerful people pushing a carbon tax (and other “green” policies) do so because they have a disposition of favoring central planning over market outcomes. (That’s why, for example, so many of the people who warn about the imminent threats from CO₂ emissions also oppose nuclear power, even though it is emission-free.)

Stelzer is right when he considers Krugman’s hypocrisy on these matters; Krugman only pays lip service to the “market solution” of a carbon tax, and has no problem with the EPA acting directly to shut down coal-fired power plants since Krugman thinks it’s obvious that this is the “optimal” outcome.

Yet Krugman’s hypocrisy on this point is hardly a reason to call his bluff, as Stelzer recommends. If the U.S. government were to implement a carbon tax, and if this allowed coal-fired plants to survive, Krugman then would claim that the carbon tax wasn’t high enough, or that it needed to be supplemented by other top-down interventions. He wouldn’t shrug his shoulders and say, “Aww shucks, you wily conservatives got me, I guess coal-fired power plants are good for America after all.”

When you step back and look at the situation, it’s very odd that Stelzer is actually using the progressive Left’s inconsistency on carbon tax rhetoric as a reason for giving them what they demand. On the contrary, when you realize the people you are bargaining with are being dishonest about their true objectives, if anything that’s a reason to walk away from the bargaining table.

We don’t need to speculate on these matters; we can look at actual history. Australia really did have a carbon tax in place (though its voters threw out the Prime Minister who installed their carbon tax and voted in a new PM who promptly repealed it). But while its carbon tax was in place, the Australian government increased its other “green” measures, as Dr. Alex Robson explained in his hard-hitting study. There was no shrinkage of the now “unnecessary regulations” in Australia, after they got their carbon tax in place.

Look at the unbelievable rhetoric that the environmentalist Left has used in denouncing carbon emissions, calling coal “dirty energy” and referring to “polluters.” Does Stelzer really think progressive pundits will suddenly write op-eds endorsing the Keystone Pipeline if a revenue-neutral carbon tax should be installed?

At IER’s carbon tax conference, Ken Green explained his own personal odyssey in this dimension. He had originally given tentative support to a carbon tax, because he thought a properly designed program—involving tax cuts and elimination of top-down regulations—could improve upon the status quo. Yet Green soon realized that he was just being used; it was only conservatives and libertarians who made such concessions. The typical environmentalist progressive never announced any intention of shrinking government elsewhere, once a carbon tax had been introduced.

Finally, let me quote Marlo Lewis to illustrate the danger and folly in Stelzer’s strategy of having conservatives support a carbon tax to win concessions from the Left:

Let’s get real. When was the last time you heard the Sierra Club, NRDC, Bill McKibben, or Gina McCarthy say that Massachusetts v. EPA, EPA’s greenhouse gas regulations, the Renewable Fuel Standard, new-car fuel economy standards, DOE energy efficiency standards, the incandescent light bulb ban, stimulus subsidies for Solyndra, and the proliferation of state-level renewable energy quota were all just a strategy to put conservatives over a barrel so we’d finally ask for a carbon tax to make those regulations, mandates, and subsidies go away?

Conclusion

Irwin Stelzer is a smart guy with excellent training and business experience. Yet his Weekly Standard article in support of a carbon tax is remarkably deficient in both theory and practice. He completely missed a large portion of the technical literature, which shows a default presumption that even a revenue-neutral carbon tax would hurt conventional economic growth. Furthermore, Stelzer is naïve when he argues that progressive pundits and policymakers would go along with phasing out other “green” policies in exchange for a carbon tax. Their rhetoric suggests otherwise, and in the real world, we simply don’t see such quid pro quo deals being made in the countries that have introduced carbon taxes.

IER Senior Economist Robert Murphy authored this post.