Should We Re-Evaluate Carbon Taxes?

I've long been an advocate of some form of carbon taxation--gas tax, source fuels tax, even cap-and-trade if nothing else is available.  The tax seems like a three-fer: raise revenue, discourage use, and encourage innovation.  

However, Jim Manzi has been making a pretty compelling argument that such a tax will do much less than people like me have been anticipating.  Even the long-term response to price increases is simply too low:

Broadly, this means that even in the rich countries, a 1% increase in price leads to less than a 0.1% decrease in consumption over the long term.  And that's the best-case; in the short term, and in poorer countries, it's even less.  Meanwhile, income elasticity (how demand changes with rising or falling incomes) is positive, and a much larger effect.  As long as income growth continues, demand will also grow unless the price changes are very, very large.

Ryan Avent argues that a gas/carbon tax is still a good idea, even if it won't deter usage.  But Manzi demurs:

Avent's second criticism is that if one believes (as I do, and as I stated in the post) that the key to reducing ceteris paribus fossil fuels consumption in the U.S. is improved technology, " then higher prices are a good way to encourage their development." They are a way to do this, certainly, but not necessarily a good way. 
. . . Now, to evaluate Avent's argument that taxing fossil fuels is a good way to induce new technology, consider an analogy. Suppose that there is a chemotherapy drug that increases 5-year survival rate for a specialized type of cancer from 10% to 60%, but with horrible side-effects. Some scientists in a couple of university labs have had some promising results with basic compounds that might or might not ultimately be precursors to a new drug that could get better increases in survival rates, and without many of the awful side effects. If you believed that improving treatment for this disease should be a major public priority, would your preferred approach be to add a large tax to chemotherapy? This is, in effect, what Avent is proposing as way to encourage the development of alternative energy technologies. I'd fund NIH research into the new alternative drug.
I think there are a few reasons to still support a carbon tax.  The first is that this analogy doesn't quite work: until something new comes along, we don't actually want people to use less chemotherapy.  But we do want people to use less carbon, even if the elasticities are low.  So our instinct that taxing chemotherapy is a terrible idea (and I think it is!) doesn't really fully transfer.

The other thing is that we need a way to fund this new research we want to be doing.  Normally, we'd take that money from income taxes (or corporate income taxes, or payroll taxes on wages).  But all of these things penalize activities we actually desire: working, producing valuable products to sell your customers.  Taxing carbon emissions, on the other hand, penalizes something we want less of; even if the elasticities aren't large, it could still be good tax policy.

There are two potential rejoinders to this, however, that I don't have great answers for.  The first is that such taxes are almost always regressive, and though there are various ways we could make them less so, none of them fully solve the problem.

Given that these taxes are regressive, we have to ask whether they're really worth it.  As Robert Laughlin recently pointed out in the American Scholar, slightly delaying the amount of carbon we pump into the atmosphere isn't going to do much good.  On a geologic scale, the difference between burning all the accessible fossil fuels over the span of 300 years, and burning them over the span of 350-400 years, is not large enough to get very excited about.  

Even if a carbon tax didn't eliminate all fossil fuel usage, or even drive it down to sustainable levels, it would be worthwhile if it bought us enough time to develop alternative energy sources.  But the low price elasticity suggests that it won't buy us that much time--and as one of Andrew Sullivan's readers points out, the elasticity of innovation to energy price changes also seems to be low, at least in the transport sector:

The problem is that just as price changes have to be severe to manifest any impacts on gas consumption, price changes on their own also tend not to do much to inspire the development of radical new tech solutions, unless prices are through the roof. This is mainly due to the high levels of risk and uncertainty that come with new tech: private firms would generally rather seek out low-risk, low-cost alternatives (i.e. more efficient internal processes or capital goods) than to invest time and effort into developing high-risk, initially-high cost alternatives (i.e. hydrogen fuel cells). It takes a real, permanent shock to get any real effects, and suffice to say the American political system is unlikely to ever pass a gas tax high enough to drive these kinds of changes.

Europe is a great example: they have high gas prices, but they don't drive electric cars much more than we do. They drive diesels, and they drive a bit less, but they're still dealing in petrol. So as much as I hate to say it, anyone who is advocating for a gas tax has to deal with the double-whammy of low elasticity of demand AND low upside for induced innovation.

This is not to say we shouldn't have a gas tax, as we should, if for no other reason than to price the associated externalities (environmental and national security alike). It just means it's somewhat limited as a solution to fuel emissions and fossil dependence.

There are probably better chances in the electricity sector, where industrial users--who have both the capital and the incentives to cut costs in response to price changes--are the heaviest consumers of power.  But while substantial improvements are possible, they're probably not on the order of 75% unless we develop some form of reliable, cheap, carbon-free energy.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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