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The Case against "Smart Taxes" on Carbon

April 22, 2009

Tags The EnvironmentFree MarketsTaxes and SpendingInterventionism

[An MP3 audio version of this article, read by Floy Liley, is available as a free download.]

Earth Day Tax 

Today is Earth day, and a week ago we "celebrated" tax day. It is fitting, in a sense, that Earth Day and Tax Day are only one week apart. Those who blame global warming on human activity see taxation as an effective and desirable means of preventing environmental global catastrophe. In a recent publication, former Bush advisor Greg Mankiw has extended an "open invitation to join the Pigou club" by embracing the idea of regulating greenhouse gases with corrective taxes.[1]

The idea behind corrective taxes is relatively simple. British economist A.C. Pigou explained how markets need correction: the use of goods we buy in markets generates external costs. The price we pay for goods are internal, but any type of pollution (noise, air or water borne) imposes a real cost on other people outside the transaction. In such instances the amount of goods that consumers buy will be excessive because they do not bear the full costs. Taxes on goods that generate negative externalities internalize costs to consumers, provided that they are set at the right level. Hence taxes can correct markets that oversupply goods, in theory.

Professor Mankiw advocates taxing carbon, which includes taxes on gasoline. Taxes on gasoline would reduce greenhouse gas emissions, while also reducing road congestion and auto accidents. There are several standard economic objections to such proposals for corrective taxation.

First of all, corrective taxation requires knowledge of the magnitude of externalities. Externalities are by definition not priced through any social mechanism or institution. But Mankiw admits to problems with calculating the right level of taxation.

Second, the case for corrective taxation often derives from the nirvana fallacy. Mankiw does mention that markets are efficient according to "the first welfare theorem of economics," which is characterized by the total absence of externalities. The idea that markets are efficient only when externalities are absent suggests that markets should be held to an impossible standard of perfection. Economist Ronald Coase demonstrated that externalities vanish only in the wholly unreal world where people can negotiate and carry out transactions at zero cost. Such a world of zero transaction costs would deliver economic perfection.[2]

"Mankiw has mistaken intellectuals for experts."

The fact of the matter is that neither government nor markets deliver us into nirvana. We could then accuse Professor Mankiw of making a false comparison between flawed markets and an idealized government that always corrects market flaws, but he skips this trap. The main problem with our government is supposedly that politicians listen to voters rather than experts. Mankiw borrows a few lines from Bryan Caplan to argue that voters are irrational. Voters block the implementation of good policies, like free trade and corrective carbon taxes, because they disagree with the real experts.

I would agree with the first example that experts (i.e., economists) favor free trade, and the public should pay us heed. The second example is more problematic. Mankiw claims that as an economist he is not qualified to comment on scientific theories of climate change. I agree. Neither of us are experts on these matters. I do not understand the details of various theories of climate change concerning greenhouse gases, volcanic eruptions, ocean currents, and solar activity.

Mankiw further claims that there is a consensus among experts in climate science that global warming is both real and caused by human actions. In this case we need only examine empirical data to see why we should decline invitations to the Pigou club. RSS and UAH data on global temperatures indicate that global warming peaked in 1998 and went flat during the past decade, while CO2 levels continued to rise.[3]

 Figure 1  Figure 2 

The data indicate that global temperatures in the atmosphere actually fell in 2007 and 2008. Some scientists claim that 90% of global warming takes place in oceans, but a detailed study indicates that ocean temperatures fell from 2003 to 2008.[4]

Mankiw is simply wrong. There is a scientific consensus that global warming ceased ten years ago, and the idea that greenhouse gasses drive global climate change is under dispute. As a Harvard professor, Dr. Mankiw could consult with his colleague, Harvard astrophysicist Dr. Willie Soon, to find out more about how solar activity drives global temperatures.[5] Dr. Soon is far from the only scientist who doubts the theory of man-made global warming. Last summer 31,000 scientists signed a petition asserting that

There is no convincing scientific evidence that human release of … greenhouse gases is causing or will, in the forseeable future, cause catastrophic heating of the Earth's atmosphere and disruption of the Earth's climate … there is substantial scientific evidence that increases in atmospheric carbon dioxide produce many beneficial effects upon the natural plant and animal environments.[6]

Furthermore, there is a growing number of scientists who predict global cooling over the next twenty or thirty years.[7] Meteorologists Henrik Svensmark and Eigil Friis-Christensen have found evidence that solar activity affects global temperatures.[8] Scientific projections of solar activity predict a solar minimum over the next two decades.[9] Of course, there are scientists with different opinions of climate change, but the point here is that scientific opinion is divided on the causes of climate change. Moreover, the actual evidence on recent climate change does not support the case for carbon taxes.

Mankiw has mistaken intellectuals for experts. F.A. Hayek characterized intellectuals as people who convey the ideas of experts to the general public through the mass media.[10] A large part of print and broadcast media does promote the idea of anthropogenic global warming. However, these intellectuals are well behind the curve of expert opinion. There was a consensus on the existence of global warming ten years ago (though the causes of this trend were still debated). It is now clear that global warming has ceased, and we may have entered a period of global cooling.

"Once again, the market proves wiser than economists."– Murray N. Rothbard

Mankiw has twisted Bryan Caplan's idea that voters hold irrational beliefs to argue that experts should devise corrective carbon taxes. Gasoline taxes supposedly make sense because of externalities, and voters reject these taxes supposedly because they are foolish. The idea that gas prices are too low and must be raised with corrective taxes derives from a false notion of reason. The idea that experts can do a better job of directing the use of resources, including gasoline, than can markets and market prices derives from the faulty assumption that experts know more than the whole of society.

The price of gasoline is formed out of competition for labor and capital by various industries. The industries that garner the most revenue from consumers gain the capital and labor needed to expand production towards efficient levels. Market prices therefore reflect marginal consumer demands for products. Market prices do not reflect perfect knowledge, but there is no better source of data on the efficient use of resources. Self-described experts claim to possess superior knowledge of consumer desires, but they are engaged in empty speculation. The effects of externalities on consumers are unobserved by definition, and in this case the existence of the source of externality in question is in serious doubt.

The good news is that Mankiw is not personally capable of implementing so-called smart taxes. The bad news is that the Obama administration has been taken in by proponents of the anthropogenic-global-warming theory. On Friday, the EPA announced that carbon emissions "endanger the health and welfare of current and future generations." Officials at the EPA have concluded that increasing concentrations of C02 are a pollutant. The EPA gained authority in this matter through a Supreme Court decision that defined C02 as a pollutant under the Clean Air Act. This move by the EPA indicates higher taxes and regulation — targeting industrial and auto emissions — in the coming decade. Unfortunately, this is not just a matter of ivory-tower discussions at Harvard. Public officials are poised to move on this issue, and their policies could impose heavy costs on American consumers.

Hayek Collection "Join the Hayek Club"and get a free Hayek T-shirt

Given the flaws in Professor Mankiw's arguments, I will have to decline his invitation to join the Pigou club. Members of the Pigou Club may think experts are smart enough to improve upon the results of market competition, but this is an unproven proposition. Market prices reflect the collective knowledge of all members of society who buy and sell in markets, and there is no better source of data on how to best satisfy consumer demands. Prices are certainly imperfect representations of economic reality. But the limits of individual human reason make efforts by experts to outguess markets futile.

Since the case for "smart taxes" is unfounded, I will reply to Professor Mankiw by extending an invitation for him to join the "Hayek Club" by acknowledging that market prices are the only practicable means of directing global production towards the satisfaction of the most urgent consumer demands.

[bio] See his [AuthorArchive]. Comment on the blog.

An MP3 audio version of this article, read by Floy Liley, is available as a free download.

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[1] See Greg Mankiw, "Smart Taxes: An Open Invitation to Join the Pigou Club," The Eastern Economic Journal (2009).

[2] This proposition also assumes perfect information, perfect competition, and perfect property rights.

[3] See "Global Warming On Hold?" by Michael Reilly, Discovery News.

[4] See "The Mystery of Global Warming's Missing Heat" by Richard Harris, NPR.org.

[5] The blog Trade And Taxes discusses how Dr. Soon lost his federal funding for challenging the pollution theory of global warming. Dr. Soon himself can be heard in this YouTube video.

[6] See "Scientists sign petition denying man-made global warming" by Graham Tibbets, Telegraph.co.uk.

[7] See "Not Putting their money where their mouths are," by Alex Tabbarok, Marginal Revolution, "Russian Scientist says Earth could face new ice age," FreeRepublic.com, and " Global cooling gains momentum among scientists" by Elton Robinson, DeltaFarmPress.com.

[8] See "The sun moves climate change," Canada.com.

[9] See "Long Range Solar Forecast: Solar Cycle 25 peaking around 2022 could be one of the weakest in centuries," NASA.gov.

[10] See F.A. Hayek, The Intellectuals and Socialism.Download PDF University of Chicago Press, 1948.

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