Pigou and Climate Change

When you dislike something, it makes sense to tax it right? Taxing bads or undesirable goods is as old as recorded history. The abstemious Roman, Cato, the Elder, imposed a ten fold tax on goods costing more than 1500 drachmas, Plutarch tell us, to discourage luxury spending. Over the centuries, people have taxed luxuries (sumptuary taxes), alcohol and tobacco (sin taxes) and, recently, pollution.

Modern economic theory calls those taxes Pigovian after the British economist Arthur Pigou who formalized their study. However, to survey taxation today is to find that more often than not government taxes not bad things but good ones! Government taxes income, communications, housing and even jobs through payroll taxes. Since jobs are something we ought to subsidize, the obvious question is why tax them? The answer is that there are rarely enough bad things to go around so government ends up taxing things that are good.

With the realization that CO2 in the atmosphere creates a greenhouse effect that threatens life on the planet, it is now clear that CO2 in the air can be a bad thing. In 1993, this led Al Gore to propose a BTU tax-an indirect tax on carbon--that ended up dying on the congressional budget room floor, replaced with a small increase in the gas tax. More recently, however, it has led to serious efforts to explore the merits of a carbon tax. Indeed in his Nobel Prize acceptance speech last year, Vice President Gore called for just such a tax to put a price on carbon

The benefits of a carbon tax are obvious. The major challenge that a carbon tax is, after all, a tax and therefore would raise the price of energy at the expense of business and consumers. But what if the revenue from the tax were used to offset taxes on a good thing-for example, jobs? The result would be a revenue neutral shift from taxing good things to bad things and a net gain in social welfare.

NDN's Rob Shapiro has been studying the carbon tax for some time. Last year, drawing on research by William Nordhaus at Yale, he found that a carbon tax would compare favorably with other policy options in limiting price volatility in the energy sector. Recently, Rob co-founded the U.S. Climate Task Force to explore climate issues together with former Clinton Administration official, Elaine Kamarck who will be speaking on this and other issues at NDN's March 12th Forum.

Can a carbon tax regime find global acceptance? Other approaches to cutting CO2 such as a cap and trade system have their advantages as well. But whatever the final mix of policy levers, it is clear that a carbon tax coupled with a payroll reduction is gaining traction. Stay tuned.