Is failure to tax a subsidy?
In a comment on Bryan Caplan’s recent blog post titled “I Win My Climate Shock Bet,” November 9, 2021, better Daniel Reeves writes:
They [Wagner and Weitzman] do spend a lot of time in the book on the absurdity of the current fossil fuel subsidies, which I’m sure you also despise.
Reeves is right that they do spent a lot of time on it. What the authors don’t do, though, is tell the reader how their huge estimates were reached. They state on p. 22, “The world subsidizes fossil fuels at a rate of over $500 billion per year.” If you look at the notes at the back, you see a long discussion of this number on pp. 171-172. But the discussion doesn’t tell you how the number was reached. Instead, it gives a source. In the Bibliography, on p. 212, you can find the source and, fortunately, accompanying the source is a link.
I went to the link and started reading. What I noticed right away was that the authors, Clements et al, didn’t define a subsidy the way we normally define a subsidy. You can check that for yourself on pp. 5-8.
Here’s a highlight from pp. 5-6:
Consumer subsidies include two components: a pretax subsidy, if the price paid by firms and households is below supply and distribution costs, and a tax subsidy, if taxes are below their efficient level. Box 2.1 describes the calculation of these two components. Most economies impose consumption taxes to raise revenue to help finance public expenditures. Efficient taxation requires that all consumption, including that of energy products, be subject to this taxation. The efficient taxation of energy further requires corrective taxes to capture negative environmental and other externalities owing to energy use, such as global warming and local pollution.
In other words, failing to tax energy at the level that the authors think is needed to internalize the externalities that fossil fuels create amounts to subsidizing these fuels.
Clements et al could make a case for this. But there are two problems.
First, it’s classic question-begging. Clements et al take as given that fossil fuels should be stiffly taxed. But in the discussion between Caplan and Reeves, that’s one of the major items at issue.
Second, even if you think, as Scott Sumner does, that taxing carbon is low-hanging fruit, if you use the Wagner/Weitzman estimate to make your case, you’re misleading almost everyone. (I’m not saying that Scott is misleading everyone: he argues independent of the current level of subsidy.) Nowhere in Climate Shock could I find any hint that the authors count failure to tax as a subsidy. That’s not what most people mean and it’s not what 99 out of 100 readers would take way from Wagner’s and Weitzman’s discussion.
READER COMMENTS
Stéphane Couvreur
May 3 2022 at 4:55am
Regarding the carbon tax at 23:20, I am not surprised that a government official speaks of this instrument as her preferred option to reduce carbon emissions. What I find more surprising is the lack of reaction of economists, who could argue that cap-and-trade is preferable. There can be a reasonable debate about this claim, of course, but I believe cap-and-trade to be preferable because:
1) it doesn’t have the word “tax” in the title and generates no revenue for the governement (provided that the quotas are allocated for free),
2) as a consequence of 1), there is no need to redistribute the receipts from the carbon tax as is standard with a Pigouvian tax,
3)
Jon Leonard
May 6 2022 at 5:36pm
A key difference between a carbon tax and a cap-and-trade system is how they handle errors in forecasting. That is, under a tax system it is easier for individual businesses to adjust if the overall target was chosen incorrectly. Under a cap-and-trade regime, the total amount of pollution is pre-determined; this either pollutes more than necessary if the cap is “too high”, or stifles the economy more than necessary if the cap is “too low”. As in many cases in economics, the central plan can be suboptimal.
Stéphane Couvreur
May 3 2022 at 5:08am
(Oops!)
3) as a consequence of 2), there are fewer opportunities of rent-seeking and buying constituencies with the said tax receipts.
I have seen no economist making those points. Nordhaus prefers the tax because, as he writes in an endnote, quotas are more susceptible to cause corruption in developing countries. Sumner considers “foolish” the idea of allocating the quotas for free in a cap-and-trade system (I don’t understand why, cf. opportunity cost). Harford considers that a tax or a cap-and-trade are almost equivalent and points to Weitzman’s 1974 “Prices vs quantities” article. Levitt fears that firms would be better at distorting politically the allocation procedure in a cap-and-trade system than with a tax.
Do you have an opinion on the subject, David?
Best regards,
Stéphane
David Henderson
May 3 2022 at 7:03pm
Stephane,
I have two opinions.
First, either the tax or the cap and trade opens things to rent seeking. Your point #3 applies, but you didn’t mention the extensive fight that would go on as various firms, individuals, and governments pushed for more than their pro-rata share of permits. It’s hard for me to judge which is worse.
Second, your point about not getting revenue for the government is a good one. They’re likely to waste a lot of it. In my ideal world, which I think is highly unlikely, given the political system, the revenue would go to reducing the federal debt or reducing the most distorting taxes, dollar for dollar. Those are likely to be taxes on capital. But the political pressure would be strongly against that and in favor of giving each person and household a check. So the chance to either pay down the debt or reduce distorting taxes would be wasted.
A bigger point, in my view, is that there’s not much justification at this point for either. Remember that the goal is to “solve” global warming, not to reduce carbon usage per se. Reducing carbon usage is one way to do so, but there’s virtually no evidence that it’s the least-cost way. I think that some form of geo-engineering is likely to be substantially less costly.
Stéphane Couvreur
May 4 2022 at 1:07am
Thanks a lot for this long and thoughtful response.
A quick reaction:
Your third and bigger point is entirely right. No system solves for the optimal trade-off between reduction and adaptation. I will keep this in mind.
As for the first point, as long as there is some emission reduction, I believe cap-and-trade offers fewer opportunities for rent-seeking. Here’s why:
– it can be organized to be a one-time thing, so the rent-seeking contest occurs only once, initially, whereas the fight for the carbon tax receipts can go on forever;
– there is not much in it for bureaucrats, whose task would be to monitor emissions and not to regulate or collect a tax, so there’s a chance they will be more impartial.
Going back to your third point, I agree that cap-and-trade is far from “perfect” in any meaning of the word. Most economist I’ve heard criticizing it had a very different argument: “The price of tradable permits turns out to be too volatile to encourage firms to invest in carbon reduction technology”, they say (sic).
Your answer is implicitly that adaptation is better than reduction. This makes a lot more sense. It was also David Friedman’s answer.
Stéphane
David Henderson
May 5 2022 at 10:41pm
You’re welcome.
Good point about one-time.