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Don’t expect carbon taxes to both dramatically reduce greenhouse gasses and serve as a cash cow for government. They might succeed at one or the other, but not both. That’s the argument Monica Prasad makes in a provocative article in today’s New York Times.
The case she makes won’t surprise economists. But it is an important warning to politicians and those advocacy groups who are already lining up to spend an energy tax windfall on their favorite programs.
For a case in point, Prasad points to Denmark, which used a carbon tax to help reduce CO2 emissions by 15% from 1990 to 2005. The Danes did it, she says, by plowing some of the tax revenue back into industry to subsidize renewable energy and other environmental innovation.
The Danish system is more complicated—and much more controversial—than Prasad suggests. More about that another day. But she got me thinking about an important point that applies both to carbon taxes and to traditional “sin taxes” on cigarettes and alcohol. Government can always slash consumption by raising taxes so much that the product becomes unaffordable. But it rarely does so. Instead, it often boosts these levies just high enough to generate lots of tax revenue without discouraging too many people from buying the evil weed or the daemon rum. After all, if people really stopped consuming, the tax well would dry up.
In some ways, the trade-off between revenues and behavioral change may be easier to manage with energy. If the taxable price of booze or cigarettes gets too high, people will easily find illegal, tax-free sources of the stuff. It would be much harder, I suspect, to smuggle tax-free electricity.
Still, government is going to have to choose: more tax dollars or less carbon consumption. The issue will be more complicated because, if carbon taxes are raised by a lot, Democrats will want to use some of the new revenue to help offset these higher costs for poor people, who spend a much greater portion of their income on energy.
TPC’s Eric Toder has taken a somewhat different, but equally valuable look at the potentially conflicting goals of energy taxes. He notes an important potential inconsistency between two popular ideas: reducing greenhouse gasses and achieving energy independence. If you want to do the former, a carbon tax might be a fine solution. But, because coal would be taxed at a higher rate than oil, such a policy might actually encourage more consumption of foreign energy. By contrast, a tax on imported oil might push consumers to CO2-emitting coal.
When you hear politicians promise all good things from carbon taxes, keep all these trade-offs in mind. Things are a lot more complicated than they seem.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.