15 July 2019

Pondering Pigouvian possibilities

By Skakel McCooey

Last November, a small group of Democratic and Republican House lawmakers in America introduced the first bipartisan carbon tax legislation in nearly a decade.

In a move that reflected the urgency of the climate change issue, the bill was a compromise between Democrats’ favoured strategy — massive regulatory schemes — and the Republicans’ favourite — denying the issue’s existence.

That bill was ultimately unsuccessful. But it marked a shift in thinking about how to effect change.  It relied on a promising market-based mechanism — a monetary charge that would disincentivise undesirable behaviours — like a mining firm polluting a river or a noisy rider disturbing a train. These kind of charges known as Pigouvian taxes (after early 20th Century British economist Arthur Pigou) should be at the heart of any discussion on global warming.

Pigou, one of founding members of the Economics department at Cambridge, focused his work on externalities — consequences of activities that affect third parties but are often not reflected in the cost of the goods or services involved. Because these externalities are effectively “market failures”, Pigou suggested imposing taxes to raise the price associated with these actions. Therefore, activities that carry negative externalities would be disincentivised and their price would be, more or less, correct.

When confronted with a massively important externality, like CO2 emissions, politicians have historically preferred market distorting manoeuvres — regulations, mainly — instead of a Pigouvian approach. A higher cost associated with burning carbon would incentive firms to use it less, and eventually innovate away from CO2-intensive strategies of production and distribution, as some have already.

Despite their economic value, Pigouvian taxes have come under attack from both ends of the political spectrum in America. The left craves regulation and the rtght flinches at the mention of any sort of tax. Of the 585 senators, representatives, and state governors in the United States, 227 — most of whom are Republicans — have taken a pledge saying they will never raise taxes. Author of the tax pledge and influential anti-tax hawk Grover Nordquist recently said that he would not support any carbon tax plan, solely because it would violate his pledge.

The irony is that Pigouvian “taxes” hardly deserve their title. Unlike most other taxes, which warp the market, Pigou’s creation corrects a market flaw to reflect the true price of harmful actions.

To Republican politicians, a Pigouvian tax by any other name would certainly smell sweeter. Perhaps a simple re-brand to a “Carbon Correction” could dissociate the negative connotation of the word “tax” from positive action of curbing climate change.

Labels aside, some conservative groups have already jumped on board.

While many proposals exist, one which is especially popular is from the Climate Leadership Council (CLC) — a conservative group — which prices carbon at $40 per ton and gradually increase each year. This fee would be imposed at the point where fossil fuels enter the environment — the mine, well, or port. The returns would be rebated to the American public.

A clever “border carbon adjustment” would add a fee on foreign goods entering the US from countries that did not tax carbon. This would not only keep domestic goods competitive, but also incentivise trading partners — like China and India, who have significant emissions — to set ambitious prices on carbon as well.

As plans like these begin to emerge from conservative groups, the tide in the Republican Party may be shifting. Polling by Republican opinion guru Frank Luntz — who championed the term “climate change” as a less “frightening” alternative to “global warming”— suggests that the CLC plan enjoys 2-1 support among Republican voters, including 75 per cent support with GOP voters under 40. Many of the Republican ‘old guard’ — like George Shultz, James Baker, and Henry Paulson — have supported the plan.

As the acceptance of a carbon fee begins to gain momentum, environmental advocates should continue pushing for Pigouvian tax solutions in other areas.

Take, for instance, a tax on over-fishing, which carries the negative externality of decreasing populations and throwing global food chains into disequilibrium.

And there are more extreme, or more outlandish policies too, which stretch beyond externalities commonly seen in economic textbooks.

One economist has proposed a “destruction tax” which would tax arms dealers on international deals that helped contribute to the refugee crisis in order to pay for refugee resettlement. Another proposes a “fake news” tax meant to target free speech’s externality — misinformation.

Although the feasibility of these proposals might be dubious and their proposals far-fetched, the point remains that Pigouvian taxes are undervalued tools for trying to efficiently price harmful behaviours. Around the world, there have already been massive successes. In 2002, after Ireland passed a “plastic bag levy” usage dropped 90 per cent and raised $9.6 million toward an environmental project fund. The US should act, especially if the alternative to a common-sense solution is a repressive regulatory regime or indifference.

The crucial element to unlocking these taxes’ (sorry, “fees’ ” or better, “corrections’ ”) potential is in selling the concept to the American public and therefore having the political support to pass more Pigouvian taxes.

The question is whether there is the will among those inclined to rely on free-market solutions to change the mindset of the American public.

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Skakel McCooey is a Editorial Intern at CapX.