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US conservatives embrace carbon tax: Is there a message for Australia?

This is a proposal whose main merit is its political economy mix.

Photo: Flickr/Stephen Bowler
Photo: Flickr/Stephen Bowler
Published 14 Feb 2017 

With the Trump presidency now underway, this would seem to be a singularly unpropitious moment to revive the idea of a carbon tax to address global warming. Yet this seemingly spitting-into-the-wind proposal has been put forward by a high-powered group of Republicans, including James Baker, George Shultz, economic heavyweight Martin Feldstein and top academic Greg Mankiw.

This has not only had widespread backing from other Republicans; leading Democrat economist Larry Summers has given the idea unstinting endorsement. And there is a political economy lesson here for Australia.

Shultz and Baker summarise the proposal this way:

We suggest a solution that rests on four pillars. First, creating a gradually increasing carbon tax. Second, returning the tax proceeds to the American people in the form of dividends. Third, establishing border carbon adjustments that protect American competitiveness and encourage other countries to follow suit. And fourth, rolling back government regulations once such a system is in place.

The elements of this proposal are neither new nor revolutionary, but the specific mix could give the proposal traction, even in this inhospitable environment.

The combination of tax and dividend ought to make the proposal palatable to Republicans who favour small government: there is no net tax collected. Even so, there is a powerful incentive to reduce carbon emissions. Individuals can reduce their carbon tax by cutting back on carbon emissions and still receive the same dividend: the harder you work on getting your emissions down, the more you become a net cash beneficiary.

Republicans have an innate dislike of progressive taxes, but might be attracted to the income-distribution implication of the proposal. Although the US Treasury estimates that the lowest 70% in the income distribution pyramid would get back a bigger dividend than they pay in carbon tax, this is not a progressive tax in the usual sense that the rich pay a higher proportion of their income: in this proposal the rich pay more tax only to the extent that they have more emissions than the less-well-off community and they get the same dollar-amount dividend as everyone else.

Some Republicans will be particularly attracted by the idea that this would replace current climate change regulations, especially President Barack Obama's Clean Power Plan. For those who believe that the market always delivers the best outcome, there is unanimity that this price-based approach is optimal. Indeed, there would be very wide agreement that such a tax (starting at $40 per ton of carbon and rising over time if needed to achieve objectives) would be a very powerful instrument towards meeting climate change targets. If a bigger tax is needed later, this also comes with a bigger dividend for everyone.

This proposal would encourage other countries to adopt a similar tax if they want to export carbon-containing goods to America: better to tax your own carbon exports rather than have America tax them when they are imported into the USA.

What is there not to like? Of course, for climate change deniers, this would all be a futile waste of time that stops people from having the benefit of cheap energy. And as far as the attraction of getting rid of regulation, deniers would see nothing to stop this from happening as a stand-alone policy. If President Trump withdraws from the Paris Accord, that may be the end of the story.

The key attraction of this proposal is that it is tailored to the politics of the time. It may not be the very best way of tackling climate change, but it has a chance of attracting diverse support. If it is tilted towards characteristics that conservatives will applaud, that just reflects the reality that Republicans are in control in the US for the next four years.

This is a proposal whose main merit is its political economy mix. One reason why the proposals of economists and environmentalists have been so ineffectual is that they have spent a good part of their energy in arguing with each other on the special overwhelming merits of their own pet proposals – and, by implication, the deficiencies of rival proposals. Some would attack this proposal because it doesn't cover non-carbon emissions. Others would argue that returning the tax revenue as an equal dividend misses opportunities to take direct action climate change measures, such as paying polluters to stop or funding climate change research. Others want the revenue to be used to reduce existing high-distortionary taxes. But this proposal has the huge merit of being acceptable to a wide constituency.

One political economy aspect may resonate with Australians. Former Prime Minister Tony Abbott's argument that a carbon tax was 'great big new tax' was stunningly successful in ending any market-based climate change approach for Australia, leaving the country with a series of direct actions that many consider inadequate for the task of meeting our objectives and seriously inefficient in economic terms. Here is a proposal that shows how misguided this 'great big new tax' argument was in the context of the broader debate: it was always possible to structure a carbon tax so that it was revenue neutral and protected those with modest incomes. The only issue was what was to be done with the revenue collected. Would it be used to achieve additional climate change measures (direct action); or to reduce other taxes; or, as in this proposal, given back in the form of a dividend. The US Treasury's work on the impact of various possible approaches carries a powerful rebuttal of the 'great big new tax' line: it is possible to leave the 70% least-rich with higher dollar income after a $40/ton tax by the simple expedient of giving the revenue back as a per-capita dividend. Next time you hear someone talk about a 'great big new tax', tell them to read the US Treasury paper.

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