I’m a little perplexed by this Sean Casten post at Grist. It opens:

If you put a price on GHG emissions, will it raise the cost of energy?

That question goes to the core of carbon policy. Unfortunately, many people inside and outside the environmental community consistently get it wrong, with potentially disastrous results.

Consider: if the answer is yes, then we don’t need any incentives for GHG reduction. The costs of carbon-intensive energy will rise, giving we energy users the incentive they need to lower consumption.

But if the answer is no, we will find ourselves with a tax on dirty energy but no incentive to reduce its use. That is, we will end up with a greenhouse-gas policy that fails to do the one thing it’s supposed to do above all else: lower our greenhouse-gas emissions.

His point seems to be (and perhaps I’m misreading him) that prices for goods are set on the market. As such, the source companies paying a carbon tax won’t be able to pass the tax through into the prices of their product. Since retail prices won’t get higher, then, greenhouse gas emissions won’t go down. To which I say, huh? He goes on:

If energy companies can pass along costs by raising prices without compromising their bottom line, they will. But if in raising those prices they find that their revenue starts falling faster than margins can keep up, they will accept lower per-unit margins to protect revenues.

Well man, that’s awful nice of them. But how about this? If their margins are being squeezed because they can’t pass along costs on the carbon-intensive output they’re currently selling, mightn’t they have an incentive to reduce the carbon intensity of that output? After all, we don’t really care about the cost of energy, we care about the carbon intensity of energy.

He continues:

And watch what else they’ll do: Just like the airlines, they will find it much easier to pass along price increases to customers who have no other options. Big industrials that can invest in efficiency or other fuel supply options will probably end up seeing little movement in their costs of energy — they are the Expedia customer in this example. On the other hand, small residential consumers with little free cash and less technical savvy will probably see price increases. Which means that those sectors of the economy that have the most capability to lower their energy consumption will have the least incentive to do so.

First, there is a difference between market power and demand elasticity. Just because I’m an energy price taker doesn’t mean I’m unable to reduce my consumption easily. But the bottom line is this: firms can’t magically absorb new costs indefinitely. An energy company that can pass the cost of the tax along will. If it can’t, it will attempt to reduce its exposure to the tax, which is exactly what we want to happen. And if it can’t do that, it will go out of business, until energy supply has fallen enough that consumer prices will rise, thereby passing along the cost of the tax.

The story is the same for large consumers. If an energy company is passing along the tax to small consumers, then what incentive does it have to sell gobs of power at no profit to industrial users? If the big concerns can use other fuel sources or pursue efficiency, then that’s perfect–that’s what we want. If they can’t, then they can try to negotiate down the energy company as in the previous example until, as in the previous example, sufficient supply is taken off the market and wholesale rates, like retail rates, increase.

The point is, the constraints of scarcity will push the cost of the tax through the production chain, such that the consumers who can most easily reduce carbon intensity will do so. That’s why the carbon tax is an efficient solution to the emissions problem.