The recent U.N. Conference on Climate (COP27) ended with a commitment for so called rich countries to provide “loss and damage” transfers to poor countries to help deal with the consequences of climate change. The Centrist Independent Voter believes that climate change is a serious problem and supports a variety of solutions including a significant greenhouse gas tax and tariff system.
I, personally, do not believe that wealth transfers from richer to poorer nations should be a part of that policy package. In my opinion, there are two major reasons to exclude these wealth transfers from the public policy approach to climate change. The first is political and the second is ethical.
The Political Case Against Loss and Damage Payments
Given the general animosity in the U.S. and Europe toward the loss of jobs to third world countries from free trade, which provides substantial benefits to rich countries, I see the likelihood of popular support for loss and damage programs as close to zero. It strikes me that we will need all of the political capital we can muster to get the consent of the citizens of rich countries to accept the kind of carbon tax systems necessary to help slow the rate of climate change. It would be a shame to squander that political capital trying to get the citizens of rich countries to also accept wealth transfers to poor countries.
The Ethical Case Against Loss and Damage Payments
Loss and damage payments to poorer countries are often defended because most of the carbon in the atmosphere got there as a result of the use of fossil fuels to feed the industrial revolution in rich countries. While that is certainly true, we don’t charge poor countries for the benefits of the industrial revolution either. If faced with the choice of living without the technological changes or the global markets that emerged as a result of the industrial revolution or dealing with the consequences of climate change, I think most poor countries would opt for the technology and the markets. That might not be true for the Maldives, or other nations that face catastrophic losses from climate change, but I think it would be true for most poor countries.
The Centrist Independent Voter does support a number of responses to climate change that will benefit poorer countries.
First and foremost is the tax and tariff solution, which holds out the best hope for actually having an impact on the rate of climate change. These taxes will be borne disproportionately by consumers in rich countries who consume significantly more energy, and therefore fossil fuels. The benefits in terms of reduced climate change impacts will be enjoyed globally.
Second, we support federally funded basic research into technological alternatives that will reduce the emission of greenhouse gases. Basic research is by its nature a public good and other nations, rich and poor, will be able to take advantage of this research at no charge.
Third, we support research in and potential use of geo-engineering solutions to remove greenhouse gases from the atmosphere. If these technologies prove to be economically justifiable, they will be available globally and the benefits of using them will be felt globally.
Fourth, we might support loan guarantees and insurance arrangements funded by the IMF or World Bank that are intended to offset “market imperfections” that retard private investment in climate friendly technologies in poor countries. I am suspicious of this argument because the “market imperfections” that are often cited are not market imperfections at all. For example, the expected rate of return necessary for a private sector investor to build a solar or wind power generation facility in a poor country might be significantly higher than that required to induce the same investment in a rich country. The reasons are many but include: unstable economic and political (tax) environments and corrupt, or potentially corrupt, government officials. These risks are real and do not constitute market imperfections. If, however, the World Bank and IMF have sufficient clout in poor countries that the participation of these organizations can actually lower the likelihood of expropriation through taxation or corruption then these kinds of loan guarantees or insurance programs for private sector investment might be justifiable. It should be obvious that a quid pro quo for any such programs would be participation by the host country in a climate tax and tariff arrangement. It should also be obvious that threats on the part of poor (debtor) countries to withhold interest payments on debt in order to extract “loss and damage” payments are counterproductive to efforts to create these loan guarantee or insurance programs.
Fifth, I think it also might be reasonable to add incentive arrangements for some countries to the list of policy options to deal with climate change. Rich countries might pay countries that control sensitive ecosystems to restrain the rate of development of these ecosystems. An obvious example would be paying Brazil to restrict the development of the Amazon rain forest.
While much can, and should, be done to reduce the impact of climate change on poor countries, direct wealth transfer programs are both politically counter-productive and ethically unjustified. Nevertheless, the fact that climate change will often have devastating effects on poor countries should help motivate rich countries to embrace the kinds of public polices that will reduce or slow climate change such as: carbon tax and tariff arrangements, funding basic research on climate friendly technologies and geo-engineering alternatives, loan guarantees through the World Bank and IMF that would reduce the disincentives for private investment in climate friendly investment in poor countries, and incentives for the preservation of critical natural environments (such as the Amazon rain forest). The argument here is like the one for free trade: we should do these things because they are good for us and because they are good for others.
Doing Something is Not Always Better than Doing Nothing
I came across an opinion piece in the Wall Street Journal this weekend that reminded me about why a carbon tax is not only the best solution, but it may be the only solution. Specifically, the author of the piece, Holman W. Jenkins, pointed out that subsidies for electric vehicles will lower the demand for oil and therefore oil prices. Lower oil prices mean that the owners of gasoline powered vehicles, in the U.S. and elsewhere, will drive those cars more and that purchasers of new gas powered vehicles will buy larger and less fuel efficient vehicles. In the short run this effect may be small, but in the long run it may wipe out much of the benefit of subsidizing electric vehicles. It is unlikely that the subsidies will entirely wipe out the carbon benefits, but these subsidies are not free. It is easy to imagine that the net benefit could be negative.
The Centrist Independent Voter makes the same point in the Energy Policy section as a reason for opposing Corporate Average Fuel Economy (CAFE) Standards. CAFE standards, by forcing some cars to be more efficient, lower the demand for gasoline and therefore gas prices, which encourages drivers to drive more. This problem is well documented.
Taxing carbon does not have this shortcoming. Carbon taxes raise the cost of all fossil fuels, which not only provides an incentive for buying electric vehicles, it also encourages consumers to drive less and buy smaller cars.
Why Not a Carbon Tax?
The most common argument against a carbon tax is that it will only discourage fossil fuel use in the U.S., make American manufacturers less competitive, and encourage fossil fuel use in other countries like China and India.
Those are good arguments, but the solution is to match the tax with a comparable tariff on the carbon content of imported goods. A few countries in Europe are experimenting with just such a tax and tariff scheme. Imports from countries that impose the same tax and tariff scheme on themselves would be exempt from the tariff. When you think about it, why would any country allow its exports to be taxed by a foreign government when it could avoid the tariff and capture the tax revenues for itself by imposing its own carbon tax? It is easy to see how such a scheme could rapidly result in a virtuous cycle leading to a nearly universal global carbon tax.
Another argument against a carbon tax is that it is a political impossibility. To this I have to ask, what is the politically palatable action that will actually solve the problem? The carbon tax has something for everyone. It would actually work to address climate change and it would produce a revenue stream that could be used to reduce the deficit. It works, politically, precisely because it asks everyone to bear at least some of the cost of dealing with the problem.
Is Climate Change an Existential Problem?
If you think climate change is an existential problem, I would think that you might be willing to accept that the most, perhaps the only, effective way to deal with it is a carbon tax. Progressives seem to shy away from this solution because they like to pretend that the problem can be solved by taxing the rich to subsidize low-carbon technologies. As the analysis above suggests, these subsidies may not be capable of solving the problem.
What should be done with the revenues collected from a carbon tax? The left would like to see them redistributed. That could be done and it would be better than not having a carbon tax at all. However, if the left expects to get centrists and moderate Republicans to buy into a carbon tax, it might help if the revenues were used to offset the deficit.
In addition, it would be helpful if the left would get out of the way with respect to the use of nuclear power. In the presence of a significant carbon tax, nuclear power could be scaled up far more quickly than solar and wind power. Are there risks? Sure, but I thought we were talking about an existential problem.
First, let’s all admit the “Inflation Reduction Act” of 2022 (IRA) has virtually nothing to do with controlling inflation. Whatever its merits or failures are, they are not about controlling inflation. The name of the act is shameless marketing. The non-partisan Congressional Budget Office estimated the Act’s effect on future prices to be between +0.1% and -0.1%. Some news sources have been referring to the IRA, more accurately, as the climate, health care, and tax act or something similar. Although a number of economists support this legislation, I am unaware of any serious economist who believes that the IRA will have a meaningful impact on inflation. However, for simplicity I will refer to it as the “IRA,” but don’t be fooled.
The IRA has a number of subsidies, tax credits, and regulatory incentives to encourage faster adoption of electric and hydrogen cars. It has incentives for rapid development of solar, wind, and nuclear power. It also provides for subsidized loans to encourage consumers to buy various kinds of equipment to reduce their use of energy and/or carbon emissions. Finally, it includes subsidies to make existing energy production, including fossil energy, cleaner.
The Bargain with Manchin
In order to get this package of incentives past Sen. Joe Manchin (D) of West Virginia, Sen. Chuck Schumer (D-NY), the Democratic Majority Leader in the Senate, had to facilitate additional fossil fuel production through promises about federal lease sales and facilitating future build out of energy infrastructure. The fulfillment of these promises is dependent upon separate legislation that could not be passed as part of the reconciliation process. This energy infrastructure legislation faces threats from both the right and the left.
If Sen. Manchin’s quid-pro-quo for supporting the IRA, a separate bill facilitating faster build out of energy infrastructure is passed, that would be a good thing. If it fails because of resistance from progressive environmentalists, we should expect to see a new Republican senator from West Virginia in a few years. If it fails because of mean-spirited resistance from Republican senators, maybe we will end up with two Democratic senators from West Virginia.
Are the Climate Provisions Good Public Policy?
None of the climate change legislation in the IRA is especially bad and some of it may be good, but all of it is suboptimal when compared to a carbon tax and tariff system. Such a system would not only be more efficient in reducing green house gas emissions, it would also have provided a new source of government revenue. If the government did not turn around and spend those additional funds on new programs but simply used them to reduce the deficit, this approach might actually reduce inflation. (But that is a more complicated issue best addressed elsewhere.)
Are the IRA’s climate provisions better than nothing? The climate change provisions, while suboptimal, will encourage the deployment of electric vehicles and electric vehicle infrastructure. These climate change provisions will also encourage the development of solar, wind, and nuclear energy production which will all certainly play a part in addressing climate change in the long run.
We can only hope that, in the not too far distant future, these kinds of credit and subsidy approaches will be replaced by a broad based carbon tax and tariff approach. If this happens, the capital investments encouraged by the IRA will not have been wasted. Unfortunately, the costs of these investments will be born disproportionately by the general taxpayer rather than carbon consumers. In addition, uncountable other activities that would have contributed to reducing carbon emissions under a broad based tax and tariff plan will have been passed over by focusing on a few governmentally favored solutions.
Health Care Legislation
Extending Subsidies Under the Affordable Care Act
The IRA would extend, for three years, the Affordable Care Act subsidies that were included in the 2021 American Rescue Plan. Subsidies are wealth transfers. They are not anti-inflationary. The right level of subsidy for health care insurance is a legitimate area for debate. I would be more inclined to support larger subsidies for ACA premiums, if they were matched with higher deductibles and co-pays. For more on this question visit the Centrist Independent Voter’s policy position on Health Care.
Allowing Medicare to “Negotiate” Drug Prices
For those of you who think that the IRA fights inflation by controlling health care costs, please remember subsidies and price controls do not lower prices. Subsidies and price controls simply hide costs or shift them to other consumers or to the taxpayer.
Giving the government the ability to “negotiate” prices with drug companies is really just a kind of price control. In this case, the government’s ability to “negotiate” arises because it can forbid drug companies from charging more than the government’s offered price for the drugs. Without that, the government’s offer to pay, say $100/dose, might be met with “fine pay what you want, but we (the drug companies) are going to charge the patient $500.” The government “negotiation” only works because it can prevent the drug company from charging the patient any more than the government offer.
This is not to say that giving Medicare the ability to negotiate prices with pharmaceutical companies is a bad thing. Within limits, it might be a good thing. But follow the process through. (I am ignoring co-pays here for simplicity.) Let’s assume that Medicare says that it will only pay $100 for a given drug and the drug company is forbidden from selling the drug to Medicare patients for any more than $100. The drug company has a number of choices, it can: 1) accept that price and produce as much as is demanded at that price; or 2) it can accept that price, but limit the amount of the drug that it produces, creating shortages and possibly black markets; or 3) it can simply refuse to sell the drug to Medicare patients at all.
The challenge for the government is to figure out the price that will induce the drug company to provide the amount demanded at that price. This is not always an easy thing to do, but it can be done. The challenge for the drug company in these negotiations will be to persuade the government that, absent a higher price, the company will choose option 2 or 3 above.
The drug company also has a choice to make about investments in research on future drugs. Drugs that are likely to face enormous demand, if successful, may well be developed normally even in the face of possible limits on prices imposed by Medicare. But research on drugs with more limited potential demand may simply not receive funding. This has been the case pushed by the pharmaceutical industry, and it has at least a little bit of merit. If the government uses its power under the IRA aggressively, it may lower the price on drugs in the short run, but choke off the supply of many new drugs in the future.
International Equity in Funding Drug Research
For a long time, U.S. consumers have been providing benefits to drug consumers in other countries. The highly profitable market in the U.S. encouraged the development of new drugs and Canadian, European and other consumers benefited by being able to buy those drugs at substantially lower prices. The best policy for Medicare, in the long run, might be to demand “most favored nation status.” That would mean that drug companies could not charge Medicare patients any more than the lowest price that they charge in any other developed country. This will discourage U.S. drug companies from offering drugs at heavily discounted prices outside of the U.S. Most favored nation treatments will, therefore, not result in U.S. consumers paying the current heavily discounted prices that many non-U.S. customers now get. It will result in higher prices outside of the U.S. and lower, but equivalent, prices in the U.S. In this way, the burden of supporting the development of future drugs will be more equitably shared across the developed world.
Capping Out-of-Pocket Drug Costs for Medicare Recipients
Similarly, capping out-of-pocket costs for those on Part D of Medicare does not curb inflation. It simply shifts the costs of these drugs to others. How does that happen? Drug companies confronted with the out-of-pocket cap will simply raise the premium for all those insured under their plans. This is not collusion. It will be driven by the underlying economics in the presence of the cap. The losers will be those people who opted for low cost “catastrophic coverage” plans and were never confronted with the need for expensive drugs. In the face of higher premiums, some people may forego Part D drug plans altogether. Is this good public policy? I don’t know; I much prefer the current situation in which individuals can choose the amount of risk they are willing to take.
The provisions for capping out-of-pocket costs are a wealth transfer plan between various low and middle income people. The only unambiguously bad thing about this plan is that it will probably discourage some people from carrying any Part D drug coverage.
Tax Law Changes
Without the changes in the tax law incorporated in the IRA, it could have been called the Inflation, Climate, and Health Care Act. If the spending on climate and health care incorporated in the IRA had not been accompanied by higher tax revenues, it would have constituted stimulative fiscal policy. Stimulative fiscal policy, in the face of a fixed monetary policy, is inflationary. If one accepts the wisdom of the climate and health care aspects of IRA, one has to conclude that increasing tax revenues was a good idea. But what about the way in which tax revenues were increased? Did those make sense, relative to other alternatives?
The Carried Interest Provision
One thing that was stripped from the bill at the insistence of Sen. Kyrsten Sinema (D-AZ), was the taxation of capital gains as ordinary income in the case of private equity managers. Taxing capital gains at a lower rate than ordinary income makes sense on a number of grounds that I won’t go into here. However, the carried interest compensation that private equity managers receive is much more analogous to ordinary income than it is to a capital gain on an investment. I think leaving the carried interest provision in the act would have improved the IRA.
Minimum Corporate Income Tax
Progressive Democrats love to rail against large corporations that pay no or little taxes in some years. They rarely mention the reasons why these corporations pay low taxes. The reasons for low or no taxes can include massive losses accumulated over years. These corporations may also have lowered their taxes by taking advantage of tax credits and accelerated depreciation supported by the very same progressive Democrats. To fix the offensive optics of large corporations paying low taxes in some years, the IRA provides a “book” based minimum tax system.
To understand this, one must realize that Generally Accepted Accounting Principles (GAAP) differ from the accounting rules used to calculate corporate income taxes. Reported corporate income is calculated using GAAP. Taxes are based using a different set of rules that generally result in lower taxable income because of things like accelerated depreciation and tax credits. I have not read the details of the bill, at this time, but I am guessing that, like the Alternative Minimum Tax for individuals, the Corporate Minimum Tax allows firms to roll forward their Alternative Minimum Tax payments as credits for future years. In large part, this results in front loading tax revenue, increasing it in the near term but lowering it in the future. If one focuses on the first ten years following adoption (as many analysts do), this aspect of the act will overstate the amount of revenues raised.
In response to complaints that the alternative minimum tax would hurt manufacturing, the Democrats allowed “manufacturers” to retain accelerated depreciation. This of course means that corporations must maintain essentially three sets of books. One set based on GAAP for SEC reporting purposes, one based on the regular tax code, and one based on a complicated hybrid of GAAP and tax accounting rules.
This is all incredibly complicated and largely pointless. In fact, the minimum corporate tax undermines the effectiveness of many of the tax credits included in the IRA to help on climate change.
Taxation of Stock Buybacks
The IRA includes a 1% excise tax on stock buybacks. Stock buybacks used to be considered a tax efficient way for corporations to return money to shareholders. It was tax efficient because it returned money to shareholders in the form of capital gains rather than as dividends which were taxed as ordinary income. Now that corporate dividends are typically treated as Qualified Dividends for tax purposes and receive the same treatment as capital gains, this is a moot point. Progressives, like Sen. Elizabeth Warren (D-MA), continue to complain about stock buybacks for reasons that elude me. All this accomplishes is to push corporations to return money to shareholders in the form of dividends. I expect that the Democrats are counting the revenue from this tax as part of their fiscal restraint. In all likelihood, there will be little to no revenue raised by this tax.
Fossil Fuel Taxes
The IRA imposes a number of taxes on fossil fuels. Some of these may make sense, but they are definitely suboptimal when compared to a broad based carbon tax. Some of these taxes are reasonable apart from their climate effects, such as making permanent an excise tax on coal mining that is the chief source of funding for the Black Lung Disability Trust Fund.
Additional Funding for the IRS
The IRA provides some funding to improve the audit capabilities of the IRS. I think this is a good thing, although some of the money will be wasted on ensuring compliance with the new Corporate Alternative Minimum Tax.
Obviously, we need to carefully monitor the IRS to ensure that it does not use its considerable powers to target political enemies. Nevertheless, our tax system is dependent on voluntary compliance and a robust audit capability helps to encourage that voluntary compliance.
Are the Tax Law Changes Good Public Policy?
In terms of taxation, I would have preferred a broad based carbon tax and tariff approach. Absent that, I would have preferred they leave in the carried interest provisions and accomplished the rest of the revenue gain with an across the board increase in all marginal tax rates both personal and corporate.
The best that can be said for the tax policies in the IRA is that these taxes finance the subsidies and tax credits in the act with some kind of tax revenue. That is at least better than the half hearted attempts to claim fiscal neutrality in the original Build Back Better plan.
The Bottom Line
If I had been presented with the IRA and told that I had a choice between it and nothing, I would have supported it. It is sad that it is our only choice.
Invitation for Comments
Finally, I have not had time to read the entire act and this analysis was prepared based on a number of summaries of the act. If the reader is aware of any inaccuracies, please let me know by commenting below. If there are any aspects of the IRA not mentioned here that you would like to address, please do so in the comment area below.
I think it is time for us to publish a list of policy ideas that are so counterproductive that we would never support them. To achieve this august status, a policy proposal has to not only be less than the best solution, it has to actually make the situation it is intended to solve, worse. I propose that we call these policies “Galactically Stupid.” The phrase is borrowed from “A Few Good Men,” a movie from 1992.
Not all bad public policies are “Galactically Stupid.” Some policies are just bad because there are better ways of accomplishing the same thing. Regulations on emissions of pollution are worse than taxing pollutants but such regulations are better than doing nothing at all.
That said, some policy ideas are just dumb on an interstellar scale.
Galactically Stupid Ideason the Left
Candidates for the status of Galactically Stupid on the left include: wage and price controls, “windfall” profits taxes, anti-price gouging laws, and rent controls. If you sense a common theme, you are right. All of these involve the government trying to regulate prices.
Prices serve a vital role in an economy. They signal goods whose production needs to be increased or decreased. They signal places where goods are in short supply and thereby direct supplies to those regions. They signal activities that require more investment, or less. Attempt to governmentally control prices and you create shortages, lines and other inefficient forms of rationing, including black markets.
Generally, price controls raise the real price of goods being regulated by making those goods more scarce. You may not see that price, but you will experience it through the difficulty of finding the regulated good at the official price.
President Biden’s implicit threat to regulate refinery margins qualifies as Galactically Stupid. Elizabeth Warren’s anti-price gouging legislation also falls into this group. To understand how bad these policy positions are, it is helpful to reflect on why refinery margins are high right now. Demand for gasoline and refinery margins cratered during the pandemic and many refineries were shut down. When gasoline demand rebounded, refiners were reluctant to invest in reopening those refineries or building new ones. Who would feel like doing so in a “heads I lose, tails you win” environment? Talk of eliminating fossil fuels doesn’t help either, in terms of incentives for refinery expansion.
So having created a problem by destroying incentives for refinery expansion or new refineries, left wing populists use the inevitably higher refinery margins that follow to justify price controls or windfall profits taxes that make the situation worse.
Non-Global Solutions to Global Warming
Unilateral approaches to climate change that fail to address the global nature of the problem also strike me as Galactically Stupid. Banning the use of fossil fuels in America is counterproductive if it simply shifts the production of energy intensive goods to China or India. Remember, the goods then have to be shipped back here with a net increase in green house gas emissions.
Right wing isolationists, like Sen. Rand Paul, also increase the likelihood that the United States will have to expend lives and money defending ourselves against emboldened and strengthened adversaries, made more powerful by America’s failure to confront them earlier. For these and other reasons, Rand Paul appears in the Centrist Independent Voter’s Rogues Gallery of candidates we can never endorse.
Galactically Stupid Populist Ideas
It has now become acceptable for both Republican and Democratic populist politicians to blame international trade for the loss of U.S. manufacturing jobs. The policy suggestion is higher tariffs on imports and re-writing free trade agreements, like NAFTA, to reflect a more protectionist point of view. (This the purpose of Trump’s USMCA agreement.) The truth is that the relative decline in U.S. manufacturing jobs has far more to do with technological change than foreign competition. It is also important to remember that low cost supply chains are crucial for U.S. competitiveness in global markets.
So what happens when we institute protective tariffs? Well, first the world becomes poorer as other countries do the same and global manufacturing becomes more expensive. Second, the temporarily higher wages in the U.S. accelerate automation and those jobs are permanently eliminated.
I am also aware that some technologies should not be shared with countries that are antagonistic toward U.S. interests, like Russia and China.
If you can think of other policy proposals that deserve to be labeled Galactically Stupid, please submit them in the comment section below. Remember the key thing that qualifies a policy for this category is that it is counterproductive to solving the problem that the policy addresses.