As long-term readers here will know, I argued for quite a few years that, of the possible ways of putting a price on carbon, an emissions trading scheme was preferable to a tax (I set out my position here). But following the collapse of the Rudd government’s ETS deal with Malcolm Turnbull, and Rudd’s ultimately disastrous failure to call a double dissolution on the issue, I changed my mind.
This was partly because of changed circumstances, and partly because of a reconsideration of the politics surrounding compensation. In both cases, the driving force was the massively complicated set of free permits, exemptions and cash handouts with which the final ETS was saddled, nearly all of these going to large-scale emitters. I had seen the possibility of a limited issue of free permits as an advantage of an ETS, but now I think it was actually a weakness. And in political terms, the inordinate complexity of the CPRS made a strong case for something simple and comprehensible, where everyone understood that consumers would ultimately pay the price of carbon. Unlike with emissions permits, everyone understands that a tax on producers will be passed on (partially in the short run, and totally in the long run) to consumers, and therefore that any offsets or compensation should be directed primarily at consumers.
So, I now think a carbon tax is the best short-run option. There’s even a case, which a plan to discuss later, for leaving the tax in place when we come to introduce an emissions trading scheme, which is still the desirable outcome in the long run.
While I’ve come to support a carbon tax, John Humphreys, who formerly thought it the best (or perhaps least bad) option, is now vigorously opposing it. His change in position coincides with a change in political alignment, from the libertarian LDP to the Liberal Party, for which he was briefly an endorsed candidate last year. A few observations over the fold
First up, I don’t think being a member of a political party is a great idea for an economist who wants to comment on public policy. The shifts and turns by both parties on global warming policy illustrate the problem. In the last year, Labor has successively supported an ETS, a ‘wait-and-see’ policy, direct action like ‘cash for clunkers’ and now a carbon tax. The Libs have cycled through the same set of positions. For a party-aligned economist, the options include:
(a) loyally push the ever-changing party line, and explain away the inconsistency
(b) take a stand against the party line when you disagree
(c) interpret the party line in such a way that you can agree with it
(d) keep quiet when you disagree, and support the policy strongly when you agree
As regards carbon pricing, Andrew Leigh seems to have taken some combination of (c) and (d). John Humphrey’s early support of a carbon tax was an example of (b) since most libertarians oppose this measure (most, because they reject physical reality). But the Libs are tougher than the LDP and he has now shifted to (a).
Explaining his shift of position, Humphreys says that his support was conditional on the revenue being returned to households and businesses through cuts in other taxes. By contrast, while the current proposal does not specify a mechanism, but it’s been announced that all revenue will either be (a) returned to households (b) used to offset costs on business (c) used to reduce the costs of moving to low-emissions technology
Humphries says the crucial difference is between returning revenue as tax cuts and returning it as higher expenditure, and criticises me and Tim Lambert for saying that the change is marginal. He concludes “I think the difference between government spending and tax cuts is pretty obvious and very important. ”
As an economist rather than a politician, Humphreys is surely aware that it doesn’t matter much which side of the budget (revenue or expenditure) a given policy initiative affects – what matters are the effects on relative prices, incentives and the distribution of income. That’s why economists worry about things like tax expenditures and effective marginal tax rates, and why we analyse the tax-welfare system rather than treating the two separate.
Taking this approach to the carbon tax, let’s begin with households. As far as taxpayers are concerned, it makes no difference whether compensation for the effects of a carbon tax comes in the form of a lump-sum cash payment or an increase in the tax-free threshold, to take the two simplest possibilities. But one is classed as expenditure and the other as a reduction in revenue.
UpdatedThat accounts for income taxpayers, but what about those who don’t pay income tax. The answer, first put forward by Milton Friedman (someone I assume Humphries would not regard as a lefty economist) is that a combination of tax and transfer payments may be treated (analytically and for policy purposes) as being equivalent to a negative income tax for those below some threshold. In such a system, a universal cash payment is exactly equivalent to a reduction in the net tax payment. Humphries seems to have completely missed this point, both in his original post and in comments here. He persists in writing as if there is an unproblematic distinction between taxation and expenditure. This may be good politics, at least for a Liberal party member, but it’s bad economics. End update
Similarly, as regards business, the policy relevant concerns are the price of carbon and the distribution of the net tax burden. Whether compensation to business is undertaken through some form of cash allowance to firms with a large investment in carbon-intensive capital or by making some part of historic emissions tax-free makes no economic difference, it just changes the account.
Finally, there are expenditures on funding for direct action to reduce emissions. Here Humphreys has a point, except that
(a) Gillard has already cut a number of these programs on the basis that a carbon price is coming
(b) His own party is committed to achieve Labor’s emissions targets entirely through direct action. Obviously, this will require much more public expenditure than an approach based on a carbon price