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Wednesday, November 14, 2012

Carbon Taxes and the National Debt

I am hearing a lot lately about using a carbon tax to fill the budget gap. I'm all for a carbon tax, internalizing externalities so that these markets work better is a good idea if we can somehow get through the political barriers, but we shouldn't be overly optimistic about how much revenue such a tax will bring.

In order to get support for such a tax and to implement it equitably, some groups will need to be compensated for the higher energy costs they will face. For example, these proposals often come with a proposal to return some of the tax as a lump-sum payment to lower income households (the microeconomics of a tax on carbon combined with lump-sum payments can be found here). Presumably, the higher the threshold for "low income," the easier it will be to get support for a carbon tax proposal, so there will be pressure for the compensation to extend, perhaps on a sliding scale, to middle class households.

And, at least in the initial years, there are other groups that will likely need to be compensated (okay, bought off) in order to garner the necessary political support.

All of these attempts to insulate various groups from the consequences of the tax (through fancy schemes that retain te incentive to save energy) will eat into potential revenue, and the fact that the response to the tax will be greater as more time passes -- for example as people switch to more efficient cars and appliances -- will also reduce revenue (this is not a problem in a larger sense, such substitutions are the whole point of the tax, but it does reduce the revenue).

Overall, the point is a simple one: don't overestimate the revenue from a carbon tax.

    Posted by on Wednesday, November 14, 2012 at 01:47 PM in Budget Deficit, Economics, Market Failure, Oil, Taxes | Permalink  Comments (35)

          


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