Why Second Best Climate Solutions are Counterproductive.

U.S. Capital

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.

For more on Climate Change and Energy Policy visit the Centrist Independent Voter’s Policy Positions.

Inflation, Gas Taxes, and Ukraine

A number of states and the federal government are, or are considering, lowering gasoline taxes to offset the impact of inflation on consumers. Assuming that the gas taxes made sense in the first place, and that this is intended to be temporary, this is bad public policy.

What Causes Inflation?

Supply chain problems, surging demand as the global economy recovers from Covid and the impact of the war in Ukraine are all causes of relative price increases. As some commodities become harder to obtain, the price of the affected goods can be expected to rise relative to the price of other goods. These things are not in themselves the root causes of inflation. Absent accommodating monetary policies from central banks, like the Federal Reserve Bank (Fed) in the U.S., these price shocks would be accompanied by declines in the prices of other goods or an overall reduction in economic activity, rather than inflation.

Doesn’t Lowering Gas Taxes Reduce the Pain of Inflation?

Ok, you say, lowering gas taxes may not address the root causes of inflation, but doesn’t it reduce the pain to consumers?

Lower gas taxes can be thought of in two ways.

One, absent an increase in other forms of taxation, it is an economic stimulus payment, the exact opposite of what is needed in a period of escalating inflation.

Two, it is a relative price subsidy. If you subsidize the consumption of a commodity you get greater demand for it. One of the problems in persuading European countries to boycott Russian oil and gas exports is that the global demand and supply of oil and gas are highly inelastic, in the short run. That means that the quantity of oil and gas demanded and supplied does not change very quickly in response to price changes. As a result, even small changes in supply (or demand) result in very large changes in price, in the short run. By lowering gas taxes, the United States is subsidizing the purchase of oil and making the global demand for oil even more inelastic than it would otherwise be. That will mean that the pain of boycotting Russian oil and gas will be even higher in Europe than it would otherwise be.

Impact on OPEC Incentives.

A variable tax on oil imports was considered, in the 1970’s, but was rejected because, by reducing the elasticity of demand, a variable tax actually increases the incentive for OPEC to reduce supplies to drive up oil prices.

So What Should We Do?

What we should be doing, to lower inflation, is what we should have been doing for months. The Fed needs to end its open market purchases of bonds and begin raising interest rates. How far should this go? At least far enough that short and long-term interest rates meaningfully exceed the expected rate of inflation.