Kotlikoff: The Case for a Carbon Tax

Our country is split down the middle on man-made climate change. Roughly half of us believe it’s real, and half of us believe it’s fake. Deep down, though, we all have our doubts.

Take NASA’s assessment. “Climate-warming trends over the past century are extremely likely due to human activities.” While NASA’s pulling no punches, it’s not expressing absolute certainty.

As for the climate deniers, even Vice President Pence secretly thinks climate change may be man-made and solvable. In a recent interview, he let the following slip: “…we’re making progress on reducing carbon emissions.”

Suppose deniers believe the probability of anthropogenic climate change is only one in 1,000. They should oppose carbon taxation, right?

Wrong—for two reasons.

The first is risk. Things can be highly unlikely and still be very risky. Risk involves not just the chance something will happen, but its impact if it does. The probability that our house burns down is, incidentally, also one in 1,000. But the costs, financial and psychological, from this happening are so high that we all buy homeowners insurance.

Unfortunately, the debate between climate believers and climate deniers is about the probability of man-made climate change, not the size of damages, particularly worst-case damages. But we’ve all heard enough from enough credible sources to know those costs may be enormous. Consequently, if we could buy climate-change insurance, everyone, even President Trump, would run to do so.

Insurance markets require suppliers as well as demanders. And when it comes to climate change, we earthlings are all in the same boat. We all want to buy, not sell insurance. This kills the market.

When insurance markets fail, people self-insure, i.e., they take steps to reduce their risk. Taxing carbon is the best way to self-insure against man-made climate change. Hence, carbon believers and deniers should strongly support carbon taxation, which is a way to ensure that everyone pulls together to self-insure.

But there’s a rub. Today’s and tomorrow’s children face far bigger risks than do we. Hence, taxing carbon now will mostly cost us and mostly help people not yet born. Why sacrifice for them? Better to believe the problem isn’t happening so we can sleep at night.

Ah, but carbon taxation done right can be a generational win-win. The mechanism is simple. The government compensates current generations for accepting carbon taxation by cutting one or more of the other taxes current generations pay. If the cuts are large enough, current generations, climate deniers and climate believers alike will end up better off. Of course, cutting taxes means more government borrowing, which future generations will need to service. Yet future generations will inherit a cooler planet, so, on balance, they’ll also be better off.

That’s the message of my recent co-authored study. It shows that all generations – those now alive and those yet to be born – can gain from carbon taxation to the tune of a 5 percent increase in their annual living standards. The optimal carbon tax policy – the policy that produces this largest possible generationally uniform win-win – features a $70 per-cubic ton of CO2 carbon tax rising annually at 2 percent. Win-win carbon taxation coupled with appropriate deficit policy is a reason climate deniers should favor carbon taxation. It will make them better off.

Sound too good to be true? It’s not. Anyone who has studied the economics of externalities knows that fixing them makes the economy more efficient and that these efficiency gains can be shared across and within generations.

Contrast this generationally uniform win-win approach to optimal carbon taxation with that of William Nordhaus, who won the Nobel Prize last October for his seminal work on climate change. Nordhaus’ climate model posits a fictitious economic god, called a “social planner,” who has particular preferences about the treatment of current and future generations. The planner chooses her carbon tax policy to maximize her preferences over different cohorts. If she strongly weighs future generations relative to current generations, she’ll set a high carbon tax. If she strongly weighs current generations over future generations, she’ll set a low carbon tax.

Nordhaus’ approach, which has been adopted in most large-scale, optimal carbon tax studies, conflates morality (how we should treat different generations) with economic efficiency. Indeed, absent other means to redistribute across cohorts, Nordhaus’ social planner would tax carbon even if she knew it caused no damage just to redistribute from generations she disliked to generations she liked.

Economics needs to steer clear of religion. Nordhaus’ framework pits generation against generation. It turns carbon taxation into a win-lose since his “optimal” tax will, depending on the planner’s preferences, make some generations worse off compared to the no-carbon tax outcome. This may explain why so many people deny man-made climate change when the proof seems overwhelming. Their position may reflect a concern that if they agree it’s happening, they’ll personally have to pay for the problem. The truth is very different.

Carbon taxation can lower our risk and make us all better off—something no carbon denier who’s seen the right analysis can deny.

Read the original article on TheHill.com

Laurence Kotlikoff is a professor at Boston University (BU) and professor of economics at BU. He is also a fellow of the American Academy of Arts and Sciences, a research associate of the National Bureau of Economic Research, a fellow of the Econometric Society and was formerly on President Ronald Reagan’s Council of Economic Advisers. Follow him on Twitter: @Kotlikoff