Monday, October 31, 2016

Washington Ballot on Enacting First Statewide Carbon Tax: Yea or Nay?

The carbon tax can hardly be considered a new innovation in the world of environmental public policy anymore. Finland implemented the first carbon tax back in 1990, and 13 other countries and the Canadian province of British Columbia have since followed suit. Some of the taxes are more modest (e.g., Japanese carbon tax of $2 per metric tonne of carbon emitted), and other countries show more eagerness, such as Sweden's $169 per metric tonne of carbon emitted. That is on the international level. For the United States, the City of Boulder, Colorado and the San Francisco Bay area have passed local carbon taxes: $7 and 3¢, respectively. Compared to the vast majority of international carbon taxes, these local carbon taxes are small. Even so, nothing has been passed in the United States on a state or national level. If Washington State passes Initiative 732, then it would be the first state to do so.

Initiative 732 (I-732) was founded by Yoram Bauman, who is an economist whose claim is that he is the world's only stand-up economist. I actually saw his comedy routine a few years back, and I have to say that he is funny (see his cartoon on the carbon tax here). However, I do have to wonder if I-732 is a laughing matter. In July 2017, I-732 would establish a carbon tax of $15 per metric ton. A year later, that would increase to $25 per metric ton. That figure would increase 3.5 percent [plus inflation] annually until it reaches $100 [in current 2016 dollars adjusted for inflation] per carbon ton emitted, an amount that should take place by midcentury.

While the main goal is to reduce consumption of fossil fuels and greenhouse emissions, the Initiative still has a secondary goal of being revenue-neutral. The Initiative would reduce the sales tax from 6.5 to 5.5 percent, as well as reduce the business and occupation tax rate from 0.484 to 0.001 percent. There is also a Working Family Tax Exemption for low-income tax workers since, as I explained four years ago in my criticism of the carbon tax, the poor are disproportionately affected by the regressive nature of the tax. Given the nature of the carbon tax, I was expecting some opposition, such as various Chambers of Commerce and certain industry associations. However, there were some unusual and atypical opponents, such as the Washington State Democratic Party, labor unions, and the Sierra Club. It also does have some Republican legislators supporting the Initiative, thereby making this Initiative all the more unusual. Some questions to answer here: How problematic is the Initiative? To what extent is the problematic nature due to the nature of the Initiative's text, and to what extent is it due to issues intrinsic to the carbon tax?

Potential Issues With Initiative 732
  • Tax Amount and Social Cost of Carbon (SCC): One of my initial reactions was that the ultimate goal of $100 per metric tonne of carbon emitted is high. A lot of my criticism comes from the idea of SCC, which I discussed a couple years ago. The discount rate is supposed to reflect how much we are willing to pay now in order to prevent or mitigate future problems. A higher discount rate means we are willing to pay less now because we want more benefits now. It is bad enough that the EPA does not include a discount rate of 7 percent, which is standard for cost-benefit analyses. If you look at the social costs calculated by the EPA last year, even the very low discount rate of 2.5 percent, which is tenuous, only puts the cost of carbon at $56 per metric tonne [in 2007 dollars]. The cost of carbon with a 5 percent discount rate is $11 per metric tonne [in 2007 dollars]. Even adjusted for inflation, that is a range of $12.78-$65.06 in 2016 dollars. Regardless of discount rate used, the social cost of carbon in Initiative 732 is simply too high. 
  • Is It Revenue-Neutral?: Washington State's Office of Financial Management found that it would decrease revenue by $797.2 million over the first six years. Proponents of the Initiative dispute the State's estimations. However, if even if the State's estimations are correct, the $80 million annual shortfall would be less than 1 percent of the State's biennial budget of $39 billion.
  • Energy Prices: How much will the Exemption be offset by increased energy costs? Even the proponents admit that the Initiative would increase gasoline prices by 25¢ per gallon. This increase would be on top of the recent gasoline tax price increase that has made Washington the second most expensive state to purchase gasoline. As for general electricity prices, Resources for the Future estimates that electricity prices will increase by 6 to 7 percent by 2020, which is about a third of what the No campaign estimated.    
  • Affecting Low-Income Households: While the Working Family Tax Exemption would help out 460,000 low-income families, 340,000 low-income families do not qualify for the Exemption, which is disconcerting. On the other hand, the proponents calculated that the net effect for low-income households, even with the increased energy prices, would be in their favor because the tax exemption would offset increased energy prices. Also, I would think that making the state tax code would make the Left happier, given how regressive it presently is. 
  • Driving Down Emissions: The Washington Environmental Council is opposed to the Initiative primarily because the carbon tax relies on economic signals to reduce pollution. In short, the Council prefers a cap-and-trade system over a carbon tax. My issue with cap-and-trade is that in spite of whatever flaws there are with the carbon tax, cap-and-trade is a worse policy alternative.

My Verdict: A little over a year ago, I wrote about how there could be a case made for the carbon tax for those who believe in limited government. To summarize the long blog entry, there would be five criteria that would need to be met: revenue-neutrality, replacing the carbon tax with more inefficient taxes, replacing the carbon tax with command-and-control regulation with the carbon tax, revenue funds would need to go to energy research and development, and that the tax needs to be modest. One thing that I certainly do like about I-732 is that it is revenue-neutral.The revenue-neutral nature of the bill has annoyed environmentalists and others on the Left because there are not funds for additional pet projects, but as Bauman brought up, the concern is more about reducing carbon than it is aggrandizing the government. I-732 also plans on eliminating an inefficient manufacturing tax while reducing the sales tax, so it gets kudos for that. Removing commend-and-control is trickier because that comes from the EPA and whether or not the Clean Power Plan becomes law, so that is not as much in the control of state policy as it is federal. The revenue allocation bit is also tricky since part of it is going to the Working Family Tax Exemption, but this criterion is secondary.

That leaves my primary concern, which is that I think the tax is too high. Even if you want to go with the higher estimates from the EPA, those EPA estimates are still lower than what Bauman is proposing. There are two other concerns more general to the carbon tax, which were brought up by the American Enterprise Institute's recent analysis on I-732. Even if the State of Washington stopped emitting carbon dioxide today, it would be twenty-five one-hundred-thousandths of a degree. Bauman's hope is that Washington's example will inspire everyone else to cut carbon. Let's assume that it does. As AEI brings up, even if the entire world cut carbon emissions by 20 percent, that would mean a 0.5 degree Celsius reduction, which is only about a quarter of what we would need to avoid climate change catastrophe, according to the International Energy Administration. The third concern has to do with how the tax would distort incentives. While the tax is created with the intention to reduce carbon consumption, it can just as easily have the ability to reduce investment in energy-using plant and equipment, which has broader implications for the Washington state economy.

One could counter by saying that we should do whatever we can to avoid catastrophe, even if it is not 100 percent. Given the importance of risk management in a non-diversifiable, low-probability, high-risk scenario, there is a case to be made to err on the side of caution. I am worried about high carbon tax rates, not only because it overvalues the social cost of carbon, but also because of the effects it would have on consumption of and investment in energy. Much like Bill Gates, I still believe that research and development subsidies are preferable to the carbon tax. As far as carbon reduction policy goes, the carbon tax is the second-best out of the major policy alternatives. And as far as carbon tax plans go, this one is not all bad. However, given the high tax rate, I worry that the distortions of the new carbon tax would exceed those of the current tax code. If the tax rate in I-732 were lower, I might tell my friends in Washington state to vote "Yes" on I-732. Since I have to analyze the tax based on what it is versus how I would tweak it, I have to say that I am against I-732.

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