October 30, 2008

Taxing Carbon

About the firmest star in my political constellation is the belief that the United States should have long been taxing carbon consumption generally, and gasoline specifically. Twenty years ago, there was already a case for it in terms of addressing the budget deficit, limiting dependence on the Persian Gulf, and mitigating the emerging problem of global warming.

This was hardly an original view. It was widely propounded at the time. But most of the American people and, as it turned out, most politicians would have none of it. The Clinton/Gore administration wisely proposed such carbon taxes in 1993 but got savaged by the Republicans, led by Newt Gingrich. Then the Democrats got crushed in the 1994 mid-term elections. So that was about the end of it.

Painful though it may be, such taxes are simply an essential element of a rational and coherent energy policy. They are the way in which we register the economic, environmental, and political costs that are not registered in the market price; they are the way in which a coherent umbrella of national policy is created under which we allow market forces to function.

People who face higher energy costs will conserve more, and especially so if they know these higher costs are in store for the long run. As Daniel Yergin and Daniel Stobaugh pointed out some thirty years ago, the easiest way to get additional sources of energy is via conservation.

The same is true on the production side. With the assurance that oil producers could not, at some propitious moment, drive down the price so as to make solar, or wind, or natural gas, uneconomic, thus driving competitors from the field, we would have a solid basis for creating the market fundamentals that would support these enterprises over the long run, that would justify investors in placing long term capital in them, and that would thereby encourage entrepreneurial solutions within the framework of national and international security.

We need those solutions very badly, but we are unlikely to get them, or to get them on the scale necessary, without the overarching framework of a national policy that penalizes, through taxes, carbon consumption, and that rewards, through subsidies or other forms of support, the production of energy less costly to other vital public purposes.

Another way of expressing the main point: the real cost of oil and coal is much higher than the nominal cost. By contrast, the real cost of wind, solar, and natural gas is much less than the nominal cost. By paying up for those alternatives, we get a whole range of additional benefits: less warming from carbon emissions, less dependence on hostile oil, less risk of catastrophic disruption.

How to design such a system is tricky. If you are looking at reducing carbon emissions, a carbon tax is the way to go. If you want to limit dependence on foreign oil, a tariff would be advisable. But oil tariffs would violate other agreements under the WTO--at least I'm pretty sure they would--and you could achieve the same benefit of reducing foreign oil dependence via a carbon tax.

In principle, there is no reason why such a system of taxation could not be "revenue neutral." Increased taxes on carbon consumption could be paired with the reduction or elimination of Social Security taxes, as Al Gore has proposed. (Unemployment insurance, as Gore reminds us, was an innovation of Bismarck's.)

Ultimately, some international agreement is needed. We will want to investigate that further later on, but the need for it is pretty obvious.

The United States and China need to step up with tough but responsible measures. On no issue is their collaboration more necessary than on a new energy regime.

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