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Friday Morning Economics Quiz
November 8, 2013 Price System

For those of you who like to draw supply and demand curves, please help your dear professor with this little exercise. ¬†Suppose that the demand for activities that generate carbon and carbon dioxide is sharply inelastic, or even in the world of unicorns, perfectly inelastic. What IS the social cost problem in that situation? And what would it mean to “solve” it in that case. Show your work and discuss the real world implications of such a thought exercise.

UPDATE: For those of you who commented on this already over on my FB thread, I’ll repeat two of my follow-up questions again.

First, given the answer above, suppose we agree that:

  1. Even from a Coasean perspective imposing a tax is the least costly way to “mitigate” the problem, AND
  2. That we know, even vaguely, the appropriate size, dynamics and implementation of this tax, AND
  3. We get global coordination on the tax.

What do you think folks’ response would be if indeed the demand for carbon generating activities is sufficiently inelastic, and the value of those activities sufficiently high, that the “solution” is for “everyone” to pay the tax and continue on largely with “business as usual.” In a very real economic sense, the “problem of global warming” is solved. Really. It is. Why? Because in the case of an optimally designed and fully implemented carbon tax, if people choose to pay the tax and continue emitting, then the “social costs” have all been “paid for.” In other words, there would no longer be any “externality” even as emissions continue and the planet warms (let’s now argue on the sciency-goodness parts for now). In other words, people around the world would have demonstrated that they prefer to pay for their lifestyles PLUS a warmer planet than to avoid the carbon intensive activities for the possibility of a cooler planet. Now call me crazy, even though in this case the problem is indeed solved, find me many people that would understand that it is solved, or find me many people that would be “happy” about this. You see, this is not about policy. This is not about “getting it right.” It really isn’t. My judgment is that the only “satisfactory” solution for people is to stop the planet from warming. And even the best designed carbon tax says NOTHING about whether this is likely to happen. All a well-designed carbon tax, or any good policy for that matter, is designed to do is to make people pay for the costs they impose on others. That’s it. That’s all.

In addition, and perhaps I should blog this separately, a carbon tax that is consistent with the current Integrated Assessment Models and IPCC science would end up putting about a 30 cent per gallon tax on gasoline. Do folks think that such a tax will change the world? Yes of course such a tax would shift the mean gas price up, but 30 cents per gallon is well within the seasonal variation of gas prices if we were to detrend them. Gasoline today is indeed about 40 cents cheaper than it was a few months back, and is sure to be 40 cents more expensive sometime early next summer. My behavior has not changed one iota.

 

Second, while many folks like me would actually like to see a carbon tax implemented, those of you who believe that there is some grand bargain to be had, I think, are really way out there on a perilously hanging limb. Why first do I want a carbon tax? First, I think it would be less distortionary than other existing taxes, like the payroll tax. So, in unicorn world, we would see us raise carbon taxes and lower or eliminate payroll taxes. Of course, this is not unicorn world, and you know as well as I do that the moment we get momentum for a carbon tax, that we are going to get it WITH the existing tax structure. The burden of proof is NOT on me here folks, it is on you. Indeed, I will not any longer advocate for a carbon tax unless FIRST we see the elimination of a worse tax. Second, the carbon tax is sort of a “no regrets” policy, if we get the other tax reductions. If AGW is bad, then we have the tax in place. If it is not bad, the tax is just another arbitrary way to raise government revenues. So whether or not AGW turns out to be a big problem, having taxes on things like carbon are likely to be better than the existing tax structure, and this should make both “skeptics” and “alarmists” happy, no? If not, why not?

In any case, the point I would make is that some of you like to argue that we need a carbon tax because right now we get terrible policy in the name of climate. And you cite, correctly, things like ethanol subsidies, DOE loan guarantees, CAFE standards, light-rail construction and all manner of disasterous policy – and that by having a carbon tax is going to end all of those things. But again, the burden of proof is on YOU. I no longer believe that if we get a carbon tax that those horrible policies are going away, or that new ones like it will not continue to be implemented. Please DO show me evidence any time in the last 100 years that such a grand bargain was had. And no, just ending the aviation commission that set prices does not qualify. That stuff simply is not going away – just like farm subsidies. So, as long as we wish to be talking about what actually may work in terms of climate policy going forward, let’s start having a discussion about what to do given the likely states of the political world going forward.

In this regard, I am now leaning toward the belief that not only is the carbon tax dead, but any reasonable “deal” on climate is dead. I’d be willing to wager up to $500 (can someone set up the terms and contracts?) that within the next 10 years we will not see anything resembling the grand bargain at the federal level. And that the only way forward on climate is to hope that human ingenuity “saves” us, or indeed that it turns out not to be that big a deal.

"2" Comments
  1. Since you asked the question, WC, about supply and demand curves, the curves intersect at a price where a willing buyer and seller agree, for example, to exchange all of New York for a few bushels of beads. As you might say, let’s put aside the merits of that transaction, which occurred when the King (William?) was in charge of the English, and when the wily Dutch did the deal.

    This intersection represents a tautology about prices, and where one is ruled by despots, one need not be on each side be willing. The result is that the market does not clear, and you get shortages on one side, like food, and surpluses on the other side, like a million tons of wheat rotting by a Siberian railroad siding.

    So, because the Dutch rolled the Indians, do we need to scrap economic freedom and impose a big tax on carbon, and put the United Nations in charge of where to ship that money we earned, net of taxes?

    OK — give back Manhattan and the Bronx to the Native Americans in Oklahoma and Florida. Deed holders in the other boroughs, plus the people in the rest of New York, along with the rest of the country who have a combined AGI of under $251,000 per year and do not have more than $85,000 in their IRA get to keep their property if the total value of their property does not exceed the federal standard.

    So, a broad-based carbon tax would indeed raise a hell of a lot of money, and if it were properly applied, would be hardly noticeable. Like boiling a frog.

    By the way, what were gas prices in 2008? What were they in 1984?

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