A Mere Annoyance

I have to give Greg Mankiw credit. Since the last time he discussed the climate legislation making its way through the Congress (an effort with which I was none too pleased) he seems to have taken some of my criticisms to heart. In his column in today’s Times, he acknowledges that blame for many or most of the bill’s imperfections can be placed at Congress’ feet. He admits that the share of permits auctioned doesn’t affect the efficiency of the final distribution or the emission-limiting function of the cap. He spends much less time making inane gotcha points, which makes the piece much better.

But it’s still wrong. Mankiw writes:

The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.

This is the point at which some real world figures would help. In fact, most of the allowances will be used in ways that reduce the cost of the bill to consumers. Some of this is via direct refunds to households. Some is via household tax credits. Some is via investments in efficiency and research — programs that will make it easier for households to substitute away from carbon-intensive activities over time. Most of the value of the allowances will go toward reducing the incidence of the increased carbon costs on households. And this is why the CBO judged the bill to have such a low cost for households, particularly those with lower incomes. The lowest income quintile will actually enjoy a net benefit from Waxman-Markey (not including the benefit of reduced warming). This is important context when talking about the threat of “lower real take-home wages, reduced work incentives and depressed economic activity.”

I criticized Mankiw previously for supporting a veto of the climate bill without providing details on the mental model he was using that would make a bill with fully-auctioned permits acceptable and one without veto-worthy. He offers a hint today:

The hard question is whether, on net, such a policy is good or bad. Here you can find policy wonks on both sides. To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.

Mankiw then proceeds to urge the president to veto. I think this is ludicrous, but I appreciate what he’s done here. He has made it clear that his support of a carbon tax is primarily about improving the overall efficiency of the tax code. That’s good to know. It suggests that those interested above all else in improving tax policy in an environmentally-friendly manner can continue paying attention to Mankiw, while those of us focused on the problem of climate change while mindful of economic costs can ignore him.

Perhaps in the future, when he is fully convinced of the enormity of global warming (we’ll send him some generals to talk to), he’ll be worth paying attention to again.

Comments

  1. Doug says:

    A question meant genuinely as a question: If the 80% hand out 20% auction permitting has the same effect on marginal cost as 100% auction, then is it not the case the impact on prices would be the same in W-M as in a full auction but while only generating 1/5 or so of the revenue which could be rebated?

  2. ryan says:

    Yes, but the thing to remember is that households will benefit from the free allocations as well. An example: some share of allowances may go toward transit agencies, which can sell them to raise revenue for operations and capital investments, which would otherwise have to come out of general revenues.

  3. Micah K says:

    “The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.”

    I don’t understand how higher energy prices, supposedly adding to effective tax rates, would “reduce work incentives.” Income taxes and payroll taxes, sure, but energy prices? An increase energy prices should act the same as any other type of price increase. But I’ve never heard anyone argue that if the price of milk, or any other consumable, goes up people will have less incentive to work. They’ll buy less milk, buy less other stuff, or maybe even work a bit more. But work less? I thought inflation is usually associated with low unemployment rates?

    Did I miss the wrong day in econ class or something?

  4. Tim Worstall says:

    “Yes, but the thing to remember is that households will benefit from the free allocations as well.”

    No. Households will benefit from “some” of the free allocations.

    However, if all had been auctioned (or better yet, we had a carbon tax) then households would benefit from “all” of the revenue raised.

  5. TGGP says:

    Steve Walt doesn’t think much of the national security angle.

  6. Dave says:

    Could I make a suggested edit?

    Change:

    “It suggests that those interested above all else in improving tax policy in an environmentally-friendly manner can continue paying attention to Mankiw, while those of us focused on the problem of climate change while mindful of economic costs can ignore him.”

    To:

    “It suggests that those interested above all else in right wing talking points and propaganda can continue paying attention to Mankiw, while those of us focused on the problem of climate change while mindful of economic costs can ignore him.”

  7. Both Ryan and Mankiw’s basic points are that:
    1. all taxes (as well as any cap and trade plan) cause distortions that are harmful.
    2. if you auction permits, the revenue raised can be used to lower other taxes; thus an increase in one harmful distortion is used to lower another harmful distortion. So, in part, auctioned permits (or a carbon tax) are better than free permits.
    3. If climate change itself causes economic costs, then even a free permit system is welfare improving because the cap and trade distortions are smaller than the global warming distortions they prevent.

  8. John says:

    Unfortunately for Ryan and Mankiw, point 1 is wrong – not all taxes cause distortions that are harmful. This is well-known. Taxes can be used to correct the effects of externalities, which do cause distortions that are harmful. Such taxes bring the market allocation of resources more in line with what they would be if the parties to the externality-generating transaction had to pay the full economic costs of their actions. Pollution is one example – your power plant makes me sick, but your customers aren’t paying to make me well again, so they are, in effect, being subsidized by my paying to make myself well. Global warming is another.

  9. John Whitesell says:

    Doug seems to be saying that a full auction would not raise energy costs any more then a 20% auction. This puzzles me. A full auction would, by definition, raise production prices just like a carbon tax would. The reason the feds are giving the utilities 80% of the carbon credits for free at first is to subsidize the energy sector so that the costs are more spread out.
    Yes, we could auction 100% and give the money back to the wokring joe in tax credits, but the consumer would lose most of those rebates to price increases. Meanwhile, the pain of the transition would be much larger.

    But I do not believe that pain would translate into a greater push for a lower carbon economy because the value of a carbon credit would be slightly less (we’d be using less electricity due to higher prices), meaning the advantage that carbon credit’s give to greener energy would be slightly smaller. Both free permits and sold permits give an incentive to greener energy.

    I’m not saying there isn’t a case for auctioning all the permits and I think it’s good that they are all auctioned eventually. But I urge y’all to consider that the free permits do something: keep costs under control. I personally think it’s better to try to make the transition as painless as possible while still moving quickly.

  10. If the carbon tax/equivalent offset cuts in other taxes so the Government’s revenues were about the same, then we’d have the benefit of the reallocation of resources without the problem of increased total costs to industry etc.