Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

What is that, a gastrointestinal disorder?   No, it’s the title of one of my recent research papers  (joint with Dan Karney and Kathy Baylis) about unilateral efforts to reduce emissions of greenhouse gases (GHG).   When worldwide agreement is not possible, then the question is whether GHG abatement policy might be implemented by only one country, or bloc of countries (or region or sector).   The fear of any one country or bloc is that they would only raise their own cost of production, make themselves less competitive, and lose business to firms in other countries that may increase production and emissions.  When only one country limits their emissions, any positive effect on emissions elsewhere is called “leakage”.

Yes, that’s a word in economics, see http://en.wikipedia.org/wiki/Leakage .

In efforts to “abate” or to reduce GHG emissions, the fear of lost business has pretty much deterred any attempt at unilateral climate policy.  That positive leakage might be called a “terms of trade effect” (TTE), because unilateral policy raises the price of exports and reduces the price of imports.   But our recent research paper points out a major effect that could offset part of that positive leakage.  The “negative leakage” term in the equation might be called an “abatement resource effect” (ARE).   That is, one additional thing happening is that the domestic firms face higher costs of their emissions, and so they want to substitute away from GHG emissions and instead use other resources for abatement – such as windmills, solar cells, energy efficient machinery, hybrids, electric cars, and even “carbon capture and sequestration” (CCS).  Thus they have at least SOME incentive to draw resources AWAY from other sectors or other countries.  If that effect is large, the result might shrink those other sectors’ operations overall, and thus possibly SHRINK emissions elsewhere.

I don’t mean to oversell this idea, because it probably does not completely offset the usual  positive “terms of trade effect”.  But in some circumstances it COULD be large, and it COULD result in net negative leakage.  The best example is probably to think about a tax or permit price for carbon emissions only in the electricity generating sector, within one country.  For simplicity, suppose there’s no trade with any other countries, so the only choice for consumers in this country is how much to spend on “electricity” and how much to spend on “all other goods”.   Demand for electricity is usually thought to be inelastic, which means consumers buy almost the same amount even as the price rises.  If firms need to produce almost as much electricity, while substantially reducing their GHG emissions, they must invest a lot of labor AND capital into windmills, solar panels, and CCS.  With any given total number of workers and investment dollars in the economy, then fewer resources are used to produce “all other goods”.

The ability of consumers to substitute between the two goods (electricity vs “all other”) is called the “elasticity of substitution in utility.”  The ability of firms to substitute between GHG emissions and those OTHER inputs is called the “elasticity of substitution in production”.  If the former is bigger than the latter, then net leakage is positive.  If the latter is bigger than the former, then net leakage can be negative.

Okay, too technical.  But the point is that other researchers have missed this “abatement resource effect” and overstated the likely positive effect on leakage.  And that omission has led to overstated fears about the bad effects of unilateral carbon policy.  What we show is that those fears are overstated, in some cases, where leakage may not be that bad.  With some concentration on those favorable cases, one country might be able to undertake some good for the world without fear that they just lose business to other sectors.

My green choice is to get about 12 miles to the gallon.  Here is why it’s so green.

Some people think it’s obvious that I ought to buy a hybrid or other fuel-efficient vehicle.  But that’s just wrong.  Certainly some drivers should have a hybrid car to reduce emissions and energy use, namely somebody like my brother who has an hour commute each day, driving 20,000 or more miles per year.   But not everybody.   Take for example a person like me who lives near work, rides a bicycle, and doesn’t like spending hours in the car – even for a road trip to the Grand Canyon or Yosemite.  I use the car once a week for the grocery store, or a restaurant, driving less than 5,000 miles per year.

Let’s suppose a hybrid gets 50 miles per gallon, so my 5,000 miles per year would cost about 100 gallons ($300 per year).   The standard non-hybrid gets 25 miles per gallon, which would cost twice as much ($600 per year).  I’d save $300 per year in the hybrid.  But that doesn’t mean I should buy a hybrid.  A new hybrid like a Toyota Prius costs about $6,000 extra to get that great fuel-efficiency (about $26,000 instead of $20,000).    In other words, it would take twenty years for my $300-per-year savings to make up for the extra $6,000.  It’s not worthwhile for me.  If my brother drives four times as much, however, he could break even in just five years.

So far, that means I should not buy a hybrid.  Does that mean I buy the normal new car with 25 mpg for $20,000?  No!  I should buy a beaten old 8-cylinder Bonneville, which looks like a tank and gets only half the mileage!  That Bonneville may be headed for the junk heap, so it’s certainly cheaper, even if I have to pay more for gas.

But even ignoring the price of the Bonneville, I claim that the fuel-use of the Bonneville is less than the fuel use of the normal new car!  Why?  Consider the emissions from fuel used in production.  The fuel used to make the Bonneville back in 1980 is a “sunk cost”, a done deal that does not change whether that car gets junked now or later.  In other words, keeping that Bonneville off the junk heap requires no extra fuel and emissions to produce it.  But buying a new car does involve more fuel and emissions just to produce it.  Think about all the emissions from the steel mill, the tire factory, the glass furnace, and the electric generating plant that provides power for the tools and machinery to make the new car.

In other words, I can reduce total fuel use and emissions much more if I purchase the 1980 Bonneville and drive it 5,000 miles per year, than if I buy a new car with twice the mpg.  Now all I need is a bumper sticker for my 1980 Bonneville to say how green I really am!

If one town’s water pollution flows into another town, the two towns can negotiate a solution with no need for the state to intervene.  But if all towns are polluting all neighboring towns, the lines of communication are too complex to negotiate – requiring the state to pass a law to solve the problem.

If one state’s water pollution flows into another state, the two states can negotiate a solution with no need for Federal intervention.  But if all states are polluting all neighboring states, the lines of communication are too complex to negotiate – and it takes a national government to solve the problem.

In other words, those problems have solutions.  If one nation’s water pollution flows into another nation, then (potentially, at least) the two nations can negotiate a solution with no need for a global government to intervene.  But if all nations are polluting all neighboring nations, the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

I’m currently pessimistic about two of the worst problems the world has faced: global climate change, and global financial contagion.  Both are “externalities” in the classic sense.  Each nation’s greenhouse gas emissions pollute the whole world, and the only really effective solution is a worldwide global agreement to reduce emissions.  In fact, we don’t really “need” all nations to reduce emissions; all we really need is an agreement among all nations saying that if SOME countries reduce emissions then the other countries won’t increase emissions to steal their business.  But the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

Environmental policy is my usual bailiwick.  At the moment, however, I’m even more worried about global financial contagion.  It seems that one small country can have lax financial regulations that allow banks or investment companies to take on too much risk.  Or a small country can overspend, taking on too much debt.  In the olden days, that country could go down in flames, with no big problem for the rest of the world.  With tremendously increased globalization, however, all financial markets are highly integrated.  One country’s borrowing may come from any or all other countries of the world, and one nation’s problem become the world’s problem.  If banks in other countries loan to that small country, then a financial crisis in that small country may create fear about the financial well-being of the banks that lent to them, causing a run on the banks in all those other countries.  Moreover, globalization means much more trade in commodities.  If one small country faces severe financial difficulties and must cut back all spending, that reduces aggregate demand worldwide, and can spread a recession worldwide.

A strong global government could rein in the poorly managed countries by requiring larger capital requirements, careful financial scrutiny, and only tax-financed spending.  But we don’t have any such global government.  As a result, even a small country like Greece can over-spend for years without oversight.  The situation in Greece may be made worse when banks in other countries raise the rate at which Greece can turn over its debt and borrow again, making the financial situation in Greece even worse.

The problem may be caused by Greece or not.  Regardless of “fault”, if Greece any small country were to go into default in years past, then the cost would be primarily on that small country.  Now Greece could go bankrupt and impose horrible costs on the entire World?!?

Carbon Dioxide Causes Global Warming of Climatologists

Dateline: August 6, 2011, Champaign, Illinois

Researchers at the University of Illinois have discovered new environmental damages from the burning of fossil fuel with resulting emissions of carbon dioxide (CO₂) and other Greenhouse Gases (GHG).  In particular, when these anthropogenic emissions accumulate in the atmosphere and react with sunlight, they may cause climatologists to become hotter and hotter.  So far, this effect has only been observed experimentally in the laboratory, but these experiments confirm the theory among atmospheric chemists that continuation of such emissions for several decades is bound to result not only in global warming of these climatologists and other environmentalists, but also extreme behavioral events similar to hurricanes, floods, and droughts.  

The next key step of this research program, at the University, is to increase data collection quickly, in order to try to ascertain whether the recent aberrations in climatologists’  behavior is within the normal statistical variations or may in fact already by caused by the existing increases in atmospheric levels of greenhouse gases.  The stronger hypothesis, yet to be tested, is that the increased concentrations of these gasses in the atmosphere is not just predicted globally to cause agitation and warming of these environmental scientists, but that it is already having such effects.  Already, certain climatologists have experienced high blood pressure, increased internal temperatures above 98.6 degrees Fahrenheit, and occasional apoplectic seizures.  These extreme behavioral events could be occurring naturally, however, so the hypothesis is not yet proven that these events can be attributed to anthropogenic greenhouse gas concentrations in the atmosphere.  More research is required, and researchers at the University of Illinois are applying to the National Science Foundation for that research funding, which may require millions of dollars.

In my last two blogs, I wrote about ways to meet the Illinois state revenue needs, ways that might work better than the increase in the income tax.  This blog continues the list of possible “green taxes”.  In general, a green tax applies either directly on pollution emissions or on goods whose use causes pollution.  For raising a given amount of revenue, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate what caused the fiscal crisis in Illinois, nor argue the merits of cutting spending versus raising revenue.  Instead, we just take it as given that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of a few green taxes as alternative ways to raise revenue.

While many green taxes are possible, we focus on four examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  In past weeks we covered Carbon Pricing and Gasoline Taxes.  This week we cover Trucking Toll and Garbage Fees.

Every day hundreds of thousands of vehicles crowd Illinois’s roads and highways.   Data from the Federal Highway Administration indicates that over 50,000 trucks (six tires and over) cross into Illinois from neighboring states along the interstate highway system.  While these trucks bring needed goods to Illinois, they also congest the roads, degrade the road surfaces, and fill the air with soot.  They also become involved in vehicle accidents that cost the lives of many in Illinois.  To compensate the state, Illinois can impose a toll for long-haul trucks using Illinois’s highways.  For example, a $5 per truck toll on 50,000 trucks daily would raise almost $100 million annually.  (In comparison, the existing Illinois toll road system generates approximately $600 million annually.)  The truck toll can be implemented using existing transponder technology deployed at weigh stations along the interstate highways.  (As an aside, we note, the constitutionality of state trucking tolls is not clear, because the federal government determines the rules of interstate commerce; however, major portions of the existing interstate highway system are subject to tolls, including the heavily travelled I-95 corridor in Delaware. )

Next, residents of Illinois generate approximately 19 million tons of garbage per year (or more than one ton per person per year), and 60 percent of that waste ends up in landfills.  Currently, large municipal waste landfill operators currently pay state fees that total $2.22 per ton of solid waste dumped.  But few municipalities in Illinois charge fees designed to discourage the creation of waste by residents (Don Fullerton and Sarah M. Miller, 2010, “Waste and Recycling in Illinois,” Illinois Report 2010, pp.70-80). 

However, empirical evidence shows that taxing garbage at the residential level does reduce garbage production (Don Fullerton and Thomas C. Kinnaman, 1996, “Household Responses to Pricing Garbage by the Bag,” American Economic Review, 86, pp. 971-84).  Yet the exact garbage taxation mechanism varies by program.  For instance, a fee can be levied on garbage bags themselves or on the containers that hold the garbage bags.  Regardless, a tax rate equivalent to one penny per pound of garbage would generate almost $240 million in revenue per year, or 6.3% of the expected revenue from the income tax increase.

Finally, consider a Portfolio Approach.  Remember, at issue here is not whether to raise taxes.  We presume the State has decided to raise taxes by $3.8 billion (as done already through the income tax increase).  Here, we merely explore alternative ways to raise revenue other than through the income tax. 

Anyway, instead of implementing only one of the green taxes describe above, Illinois could choose to implement several green taxes simultaneously.   This portfolio approach would keep rates low for each individual green tax, but still generate large amounts of total revenue that can add up to a large share of the total expected revenue from the recent income tax hike.  According to the numbers in all three blogs, one simple and moderate plan would combine the following green taxes and pay for more than  half of the needed revenue:  A carbon tax of $10/ton would collect $1 billion (raising electricity prices by about 7.5%), a gas tax increase of 14 cents per gallon would collect $0.7 billion (raising gas prices by about 4.4%), a trucking toll of $5 would collect $100 million, and a garbage fee of one penny per pound would collect $240 million.  Then the recent income tax increase could be cut by more than half.

Moreover, green taxes have the added benefit that they provide incentives to reduce the polluting effects of carbon emissions, gasoline use, truck exhaust, and household garbage generation.

Last week, I wrote about carbon pricing as a way to meet the Illinois state revenue needs (instead of an increase in the income tax).  This week, in the “continuation”, I write about a possible increase in the gasoline tax.  First, I’ll set the stage again.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate the reasons for the underlying fiscal crisis in the State of Illinois, nor argue the merits of cutting spending versus raising revenue to balance the budget.  Instead, we just stipulate that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of “green taxes” as an alternate means of raising revenue that could mitigate or eliminate the need for increasing income taxes.

In general, green taxes are taxes either directly on pollution emissions or on goods whose use causes pollution.  In the revenue-raising context however, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

While many green taxes could be implemented, we focus on four specific examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  This week: Gasoline Taxes.

Gasoline sales in Illinois are subject to a state excise tax set in 1990 at $0.19 per gallon.  In addition, other state fees and a federal excise tax of $0.18 per gallon are applied to gasoline sales for a total tax rate in Illinois of $0.61 per gallon, according to the American Petroleum Institute.  However, economic studies find that the existing tax rates on gasoline are below the optimal rate that would account for all the costs of pollution and time wasted due to traffic jams.  For instance, the “optimal” U.S. total gasoline tax has been estimated to be about $1 per gallon, according to Ian Parry and Kenneth Small (2005), “Does Britain of the United States Have the Right Gasoline Tax” [American Economic Review, 95(4): 1276-89].  Illinois would have to raise the tax rate by 40 cents to reach that $1 total optimal rate.  The third line of table 2 shows that a $0.40 per gallon gasoline tax hike would collect approximately $2.0 billion (just over half of the $3.8 billion from the income tax increase).  Yet that tax increase would raise by 12.4 percent the $15.9 billion Illinoisans spend annually on gasoline.

Table 2 includes alternative calculations of revenue generation levels from a gasoline tax.  For example, a generic 5 cent per gallon excise tax increase would generate $250 million (see table 2 line 1). 

The existing $0.19 per gallon excise tax in Illinois is not indexed to inflation, so the real revenue to the State from the gasoline excise tax has steady fallen over time.  The second line of table 2 calculates that the state could adjust the tax rate back to its 1990 purchasing power by raising the rate 14 cents per gallon (from 19 cents to 33 cents).  That would just account for inflation since 1990.  The increase in revenue would be $700 million (which is 18.3% of the expected revenue from the income tax increase).

Illinois residents would then pay 4.4% more for gasoline, INSTEAD of paying more income tax.  The point is that the gas tax would discourage driving and air pollution, instead of discouraging workers from earning income.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion), according to the University of Illinois and their Institute of Government and Public Affairs (IGPA Fiscal Fallout #5).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  Dan Karney and I wrote a recent piece for the IGPA Forum, but we don’t debate the reasons for the underlying fiscal crisis in the State of Illinois, nor argue the merits of cutting spending versus raising revenue to balance the budget.  Instead, we just stipulate that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of “green taxes” as an alternate means of raising revenue that could mitigate or eliminate the need for increasing income taxes.

In general, green taxes are taxes either directly on pollution emissions or on goods whose use causes pollution.  In the revenue-raising context however, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.  That is, taxes on labor income discourages workers from engaging in productive activities and thus hurts society, while taxing waste discourages harmful pollution and thus benefits society.  In addition, the revenue raised from these green taxes can help the State’s fiscal crisis. 

While many green taxes could be implemented, we focus on four specific examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  That is, imposing green taxes can completely fill the $3.8 billion difference between the projected baseline deficit ($10.9 billion) and the post-tax deficit ($7.1 billion). 

Yet we omit many other potentially high-revenue green taxes.  For example, the State could tax nitrogen-based fertilizers that contribute to nitrogen run-off pollution in streams, rivers, and lakes.  These omissions do not imply that other green taxes could not be implemented.  Also, the simple analysis does not include behavioral responses by consumers and businesses.  Rather, we apply hypothetical green taxes directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation.  

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  This week: Carbon Pricing.

In 2008, electricity generators in the State of Illinois emitted almost 100 million metric tons of carbon dioxide (CO₂) according to the U.S. Department of Energy’s Energy Information Agency (EIA).  See the State Historical Tables of their Estimated Emissions by State (EIA-767 and EIA-906).  While the United States has no nationwide price on carbon – neither a tax nor a cap-and-trade (permit) policy – some jurisdictions within the United States have imposed their own carbon policies.  For instance, a coalition of Northeastern states implemented the Regional Greenhouse Gas Initiative (RGGI) to limit CO₂ emissions using a permit policy.  To date, RGGI’s modest effort has already generated close to $1 billion in revenue for the coalition states.

If Illinois were to adopt its own carbon pricing policy, then even a modest tax rate or permit price could raise significant revenue.  For instance, a $5 per metric ton CO₂ price on emissions from electricity producers generates about $500 million in revenue (or 14.4% of the $3.8 billion raised from the state’s income tax hike).  By way of comparison, if the extra $500 million in emission taxes were entirely passed on to consumers in the form of higher electricity bills, then the average consumer’s bill would increase by 3.75%  (where $13.3 billion is spent annually on electricity in Illinois).

Table 1 reports the possible “revenue enhancement” from the $5 per metric ton tax, along with three other pricing scenarios.  Both the $5 and $10 rates are hypothetical prices created by the authors for expositional purposes.  In contrast, the $20 per metric ton price is approximately the carbon price faced by electricity producers in Europe’s Emission Trading System (ETS).  At the $20 rate, a carbon tax in Illinois generates almost $2 billion – over half of the tax revenue from the income tax increases.  Finally, the $40 tax rate (or carbon price) is from Richard S. J. Tol (2009), “The Economic Effects of Climate Change,” Journal of Economic Perspectives, 23(2): 29-51.  It is an estimate of the optimal carbon price that accounts for all of the negative effects from carbon emissions.  At this “optimal” price, the revenue from pricing carbon in Illinois by itself could replace the needed tax revenue from the State’s income tax increase.

The usual argument against unilateral U.S. effort to cut greenhouse gas emissions and reduce climate change is that we’d impose significant costs on ourselves, with most benefits going to other countries.   Thus, we should wait for an international agreement.  By the way, an international agreement is not going to happen.  Meanwhile we wait, which means more global warming, sea level rise, and increased extreme weather events like floods, droughts, and hurricanes.   That argument may also include the claim that U.S. agricultural productivity might increase from a little global warming, and the U.S. is rich enough to protect itself against sea level rise. 

According to that logic, we can’t worry too much about damages to other countries, as we can’t take care of the whole world by ourselves.

The problem with that logic is that those costs to other countries will unavoidably become costs on us!  Take two examples.  First, a Reuters article points out that “a third of Bangladesh’s coastline could be flooded if the sea rises one meter in the next 50 years, creating an additional 20 million Bangladeshis displaced from their homes and farms.”   Some large percentage of the nation could disappear under water.  And that’s only one such nation.  Global warming and sea level rise could displace hundreds of millions of poor people.  The U.S. will find itself unable to turn its back on such a disaster, for humanitarian reasons.  Moreover, the costs would come back to haunt us in other ways, through increased wars and other political disruptions of great danger to the U.S. itself.

A second example appears in a recent NY Times article about the effects of global warming on agricultural productivity.   It starts by describing terrific recent technological advances: “Forty years ago, a third of the population in the developing world was undernourished. By the tail end of the Green Revolution, in the mid-1990s, the share had fallen below 20 percent, and the absolute number of hungry people dipped below 800 million for the first time in modern history.”  But those technological advances have leveled off, while growing demands have reflected huge growth in worldwide population and incomes.  The resulting grain price spikes have contributed to the largest increases in world hunger in decades, perhaps 925 million last year (see screen-shot).

What is the role of human-induced climate change?  The level of carbon dioxide in the atmosphere has already increased by 40 percent since the Industrial Revolution.  We are on course to double or triple this level within a hundred years.  This climate change contributes to extreme weather events.  “Many of the failed harvests of the past decade were a consequence of weather disasters, like floods in the United States, drought in Australia and blistering heat waves in Europe and Russia. Scientists believe some, though not all, of those events were caused or worsened by human-induced global warming. …  In 2007 and 2008, with grain stockpiles low, prices doubled and in some cases tripled. Whole countries began hoarding food, and panic buying ensued in some markets, notably for rice. Food riots broke out in more than 30 countries.”

The world’s population was less than 3 billion in 1950.  It is now about 7 billion, and is expected to grow to 10 billion by the year 2100. “Unlike in the past, that demand must somehow be met on a planet where little new land is available for farming, where water supplies are tightening, where the temperature is rising, where the weather has become erratic and where the food system is already showing serious signs of instability.”

Suppose the U.S. is only to look out only for itself.  Forget altruism.  Forget unilateral efforts to save the world.  Wouldn’t we merely be protecting ourselves by doing something now to reduce worldwide political instability that could result from a hundred million refugees and famines of that magnitude?

Lately, mandates seem to be an increasingly popular choice of policy by the Federal government.  Just the last few years have seen health care mandates, automobile fuel efficiency mandates, and now – coming January 1^st, 2012 – light bulbs.  That’s right, those pear-shaped incandescent bulbs have lit American homes for the last 130 years, but they begin phasing out of stores in favor of Light Emitting Diodes (LED) and Compact Fluorescent Light (CFL) bulbs, thanks to a 2007 bi-partisan mandate signed into law by then-President George W. Bush.  As an economist, I cringe when I think of mandates, as they remove incentives for innovation, take choices away from consumers, and put the decision-making into the less-informed hands of the policy makers in Washington. 

The end-goal of the light bulb policy is to reduce polluting emissions.  News stories such as USA Today provide information regarding the extra efficiency of CFL and LED bulbs in comparison to incandescent bulbs.  When the law takes full effect in 2015, the U.S. Department of Energy estimates that “Families nationwide will save nearly $6 billion a year and will help eliminate 30 million metric tons of carbon dioxide emissions annually — the equivalent of taking about 8 million cars off the road each year.”  Other nations already have policies in effect that are more stringent than those here in the United States, including Canada, Russia, Australia, and the European Union.

Limiting families to purchase only these new light bulbs means paying a higher price up-front in order to cut emissions.  But the enacted “ban” applies to everybody, no matter whether the use of the old style bulb might be very important to some individuals.   To ban all incandescent light bulbs is not efficient, if certain individuals could use them with benefits that exceed the social cost.  The alternative is a price incentive, such as a price on greenhouse gas emissions in a cap-and-trade type system.  Then firms and individuals get to decide for themselves whether and how to reduce electricity use and cut emissions most cheaply and effectively.  When government policymakers issue a mandate, they are effectively saying they know what is best for us.  And with heterogeneity among firms and individuals, those policymakers can’t possibly know what single set of abatement methods is best for all different people simultaneously.

South Carolina has seen significant innovation on the part of policy makers in figuring out a way around this new light bulb law that could have ramifications for federal mandates of all sorts.  The Commerce Clause gives the Federal government the authority to regulate commerce between the states.  As Martin Hutchinson from Money Morning writes, “According to the Supreme Court’s 1935 decision in the case of Schechter Poultry vs. United States, the federal government does not have the power to regulate commerce that is entirely conducted within a state.”  In other words, if the state of South Carolina has a manufacturer that produces light bulbs in the state and for sale within the state, they could theoretically escape this mandate. 

The 2007 law doesn’t make incandescent bulbs illegal but instead sets requirements on their efficiency; these standards are proving to be quite difficult for the industry meet.  It is similar to the Corporate Average Fuel Efficiency (CAFE) standards established for the automobile industry, where producers are told to increase the miles per gallon (MPG) of cars produced, but the government does not attempt to dictate how this must be done.

In the long-run, this policy may save families money on their electric bill and reduce emissions.  But any one such law is not a comprehensive co-ordinated policy that chooses the cheapest forms of pollution abatement.  I’d rather see government address the problem in a comprehensive cost-effective way.

I saw an interview on CNN this morning of James Woolsey, former CIA Director, who noted that oil played a key role in bin Laden’s 1998 fatwa, in which he called for violent jihad against the U.S.  Woolsey now drives an electric car, and he has a bumper sticker on the back that says something along the lines of “Osama bin Laden hates this car.”  The idea is that the U.S. addiction to foreign oil – particularly oil from regions of the world that are hostile to our values – is helping to feed and finance our enemies. 

This got me thinking, once again, about the immense economic logic of taxing carbon.  By taxing carbon, and thus reducing domestic demand for carbon-intensive energy such as oil, we can reduce our dependence on imports from volatile regions of the world. 

Politically, Republicans have long been opposed to carbon taxes, just as they have been opposed to raising nearly any tax.  I happen to be a Republican.  I share the conservative view that government is too big, that the growth of entitlements and other spending is a threat to our long-run economic vitality and our economic leadership.  I don’t want to raise taxes either (although neither do I want to run huge deficits – which means, of course, we have to cut spending).  But even so, I remain a supporter of a carbon tax, so long as it replaces other taxes that are far more damaging to our economy.  I also remain completely baffled by the knee-jerk Republican resistance to it.

So let me briefly make my case for what I call the “Osama bin Laden Tax.”

My plan, such as it is, has two simple elements:

1.  We impose a tax on carbon in order to shift demand to less carbon-intensive energy sources.  This reduces our demand for foreign oil, and indirectly, provides fewer resources in the support of anti-American terrorism.  
2. However much money is raised by this tax, we use to reduce other taxes.  We could reduce the marginal corporate tax rate, or marginal income tax rates, or – for those concerned about the distributional consequences – we could reduce the payroll taxes for Social Security (which are widely viewed as regressive).  So the plan does NOT raise the net tax burden.  Rather, it simply replaces highly distorting taxes (i.e., those that discourage labor supply) with a beneficial tax (i.e., one that discourages oil use).

What are the benefits?

1. We would improve national security by reducing our dependence on foreign oil, a policy goal that has been shared, but not achieved, by nearly every Democratic and Republican administration for decades.  
2. We would also get big environmental benefits, given that carbon emissions are known to contribute to climate change.  This is the usual motivation for the call for a carbon tax, and I also support it for this reason.  But I recognize that some of my fellow Republicans are not as concerned about climate change.  So the key point here is that even if you think the environmental benefits are zero, there is still a compelling case to replace inefficient taxes on income and investment with a more efficient tax that reduces our indirect reliance on a volatile part of the world that often has interests that are counter to ours. 
3. The usual arguments against a carbon tax, e.g., that it would hurt American competitiveness or cause job losses, are simply not true in this case!  This is because for every dollar we raise, we are reducing taxes by a dollar somewhere else in the economy (e.g., reducing the wage bill).  Thus, the net tax burden would NOT rise. 
4. Because it is revenue neutral, there is no reason for even the Tea Party to oppose it, as it would NOT grow the government.  Indeed, as I point out in my next bullet below, it could actually reduce government intervention in our lives. 
5. Best of all for my fellow believers in the power of markets – if we have a carbon tax, then we can get rid of all the command-and-control regulations on energy.  We would no longer need the Department of Energy or the EPA to regulate emissions.  We would no longer need Congress or Presidents to pick winners and losers by subsidizing ethanol or wind power or clean coal.  We just tax carbon, and then we let the market work with minimal government intervention!

In fairness, there would be some individual losers – energy intensive industries would see their costs rise.  But for every loser, there is a winner, such as other industries that are less energy-intensive, but perhaps more labor or capital intensive, which would see their costs go down.  So there would be a transition period during which some U.S. industries would become more competitive while others less so.  But the key is that OVERALL U.S. competitiveness would not be harmed whatsoever.  Our precise areas of comparative advantage might shift, but not the overall level of our ability to compete.

So that is it.  Now, politically, I know this is not easy.  I know that big energy companies, energy-intensive manufacturers, etc. – would oppose this on narrow self-interested grounds.  And I know they are big campaign contributors.  But on philosophical, ideological, and economic policy grounds, it is hard to come up with much of an argument against a revenue neutral carbon tax that is used instead of other taxes, rather than on top of them.

So, let me go on the record as a Republican in favor of an Osama bin Laden tax on carbon.  Anyone care to join me?