Thursday, October 27, 2011

Carbon tax--why would we?

This idea has been shelved in congress for a while, but because of a couple of recent conversations I wanted to flesh it out and explain a couple of little understood principles. One’s immediate reaction to something such as carbon taxes is usually quite predictable from which side of the political aisle you subscribe to, but when a couple points are clarified, the benefits should seem rather obvious to everyone.

To start, it’d be useful to explain what a negative externality is. The field of economics has described it as when a cost (or negative effect) is passed on to a party not involved in a transaction, which results in market failure. This is what happens when we burn CO2-based fuels. We pay the price to the oil companies for pulling the stuff out of the ground, and to the refineries for doing their bit, but the pollution put into the air affects society at large through higher health care costs from air pollution, a contaminated environment, the possibly dramatic effects of climate change, etc. Other costs include enriching despotic (and often war-mongering) leaders in places such as Iran, Saudi Arabia, Russia, and Venezuela. So, the goal of the carbon tax is to fix this market failure by making the price of the energy fully reflect all of its costs. The carbon tax is basically a price instrument, and is called a Pigovian tax after the economist Arthur Pigou.

While those are the basics as to why it’s needed, the practicalities of implementation are more complicated. First, it’s a another tax, which obviously raises costs for everyone. This particular kind of tax is regressive, since it would disproportionately effect low-income groups (who have a greater share of income going to energy-related costs). One often-proposed way to mitigate this is would be to lower, for example, the payroll tax on low-income workers. Those in the middle class would mitigate the cost by changing parts of their lifestyle to use less energy. While changes in lifestyle would probably allow us to mitigate the impact of a small carbon tax (as we pick the low-hanging fruit), a higher tax would surely inflict pain. But, at the right price, we’d simply be dealing with the costs of the CO2 transparently and up front, rather than paying for them ambiguously and later through higher costs related to health care, the defense department budget, and climate change. One of the biggest benefits is that, with fossil fuels costing more, renewable energy sources will be economically viable and people will be able to move in that direction without the government trying to pick winners in the clean energy sector.

To sum up, a carbon tax causes the price of fossil fuels to reflect their full cost and fixes a market failure. The tax would allow the government to step out of the clean energy business, where its success has obviously been limited. One would think both parties would welcome such a step. And finally, it helps us all to use less energy and dump less pollution into the air (which amounts to some 27 billion tons of CO2 worldwide each year).

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