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Mass. Gubernatorial Race Shows Economic Ignorance of Carbon Tax

Written by Robert Murphy

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Prim GRESOne of the most surprising things about climate activists is that they ignore what the peer-reviewed economic literature actually says about climate change.

This ClimateProgress post by Emily Atkin on the Democratic candidates running for governor in Massachusetts beautifully illustrates this. I’ll highlight just some of the biggest problems, relying on the actual technical economic models as developed in the peer-reviewed literature. I don’t have to bring in any cynicism about the political process here; the candidates (and even the ClimateProgress writer) really don’t know what the actual economics says.

The article focuses on the willingness of several candidates to impose a state-wide tax on carbon. Atkin writes:

One of the lesser-known Democratic candidates for Massachusetts governor, former administrator of the Centers for Medicare and Medicaid Services Don Berwick, is calling for his state to become the first in the nation to establish a tax on carbon emissions.

In a Tuesday post on political commentary site Blue Mass Group, Berwick said an “undeniable climate crisis” was one of the driving factors in his decision to support a carbon tax.

Berwick’s announcement is the latest in a string of statements by candidates for the state’s highest office in support of various environmental measures including a carbon tax and cap-and-trade system, signalling [sic] the race may have a strong focus on climate-related issues.

Out of the five Democratic candidates for Massachusetts governor, Berwick is actually one of three that has expressed support for a tax on carbon pollution.  [Bold added.]

Even if you truly believed that humanity faced an “undeniable climate crisis,” a carbon tax levied on the state of Massachusetts would not be a very effective method of addressing the problem. The problem here is what economists call “leakage.” This refers to the fact that when one jurisdiction clamps down on carbon dioxide emissions, industry and even households (given time) will relocate to other jurisdictions, increasing their emissions. Thus the reduction in emissions in the newly-regulation (or taxed) zone is not really a global reduction, because some percentage of that reduction is offset by increased emissions outside of the zone.

The problem of leakage is bad enough when we’re considering national carbon taxes; a 2008 Congressional Research Report cites the IPCC estimate that countries embracing the Kyoto Protocol level of emission cuts would face 5 percent to 20 percent leakage rates. But in general, leakage rates get higher, the smaller the zone of the policy. Consider: There would be no leakage—0 percent—if a world government implemented a carbon tax on all of Earth. On the other hand, there would be 100 percent leakage if a local town board decided to place a carbon tax on one specific business at a particular address; that location would shut down, and move down the street.

Once we see how this works, we should realize just how ineffective a state-wide carbon tax would be, particularly for a mid-sized state like Massachusetts, which only has about 2 percent of the U.S. population and less than 3 percent of national output (in 2009). Even draconian efforts to crack down on Massachusetts emissions would largely result simply in making people there poorer, as businesses and population moved to other states. The drop in emissions coming from Massachusetts would be largely offset by increases in emissions from other states, meaning that net effect on global warming would be negligible—though the harmful impact on the people of Massachusetts would be quite significant.

The gubernatorial candidates try to downplay the harm of their proposals by tying it to tax cuts. As the ClimateProgress article explains:

Biotech executive Joe Avellone has said that he would support a revenue neutral carbon tax if elected, meaning there would be corresponding reductions in personal or corporate income taxes, and Homeland Security official Juliette Kayyem told MassLive that she would also support a carbon tax, “as long as it can be done in a revenue neutral way and does not have a disparate impact on car-dependent communities.”

Here again, the candidates and the blogger completely ignore a very important component of the technical literature: It’s called the “tax interaction effect.” I have summarized the issue here, and in this longer paper I explain its relevance to the “carbon tax swap” proposals.

To summarize for our purposes here, the problem is that when you impose a carbon tax on an economy already suffering from distortionary income taxes, then the new carbon tax “interacts” with them and makes the burden of the carbon tax worse than it would be, just considered in isolation. The baseline conclusion in this part of the economics literature is that even with a 100 percent revenue-neutral carbon tax, where income (or other) taxes are reduced dollar-for-dollar, the “tax interaction effect” is so severe that on net, the conventional economy is hurt.

It would be one thing if the proponents of a revenue-neutral carbon tax said, “Now we know the baseline literature says this will hurt the economy, but I favour the minority of models that make particular assumptions in which it actually helps.” But no, they don’t say that. In fact, from my experience it seems many of them don’t even know that there is a possible downside, and then if you do bring it up to them, they blow off the objection as it’s a minor annoyance.

Conclusion

The Democratic gubernatorial candidates in Massachusetts are obviously trying to gain their green “street cred” without scaring too many voters. Yet even if we just trusted the political system to do what the textbooks say—which of course we can’t—the proposals for a revenue-neutral state-wide carbon tax are economically harmful and climatically meaningless. These proposals ignore the critical problems of leakage and the tax interaction effect. It’s understandable that political candidates would be ignorant of such subtleties, but it would be nice if the alleged experts at ClimateProgress brought them up.

IER

The Institute for Energy Research (IER) is a not-for-profit organization that conducts intensive research and analysis on the functions, operations, and government regulation of global energy markets. IER maintains that freely-functioning energy markets provide the most efficient and effective solutions to today’s global energy and environmental challenges and, as such, are critical to the well-being of individuals and society.

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