It Looks Like Carbon Taxes Do Not Significantly Harm the Economy

Economy v. Environment. It sounds like a court case, but it is how many perceive the discussion on environmental policy. The discourse goes something like this. If we try to lower carbon, it's at the expense of the economy. If we care about the economy, then it puts the environment at peril. That sounds about right as far as the discussion goes. This sort of argumentation has played out in the debate of carbon taxes: If we raise carbon taxes, it will hurt the economy. 

This is the sort of economic argument I made back in 2012. By taxing carbon emissions, the government is de facto taxing an important input of many industries: energy. I also expressed concern about deadweight loss, as well as the regressive nature of a tax that is arguably type of consumption tax. Also, the elasticity of the tax matters. It is plausible to believe that the elasticity of demand for coal and oil is low enough that polluters will more than likely not bear the cost of the tax instead of reducing carbon emissions.

On the other hand, I found an argument for carbon tax to be compelling when considering risk management. Personally, I have believed and still believe a carbon tax makes for better environmental policy than cap-and-trade. It still does not answer whether a carbon tax has negative impacts on the environment. 

I started questioning my previously conceived notion of the effect of carbon taxes on the economy when I read an economic paper entitled Five Myths About Carbon Pricing (Metcalf, 2023). The author argues that endogenous firm creation and technology adaptation lead to modest, positive growth in long-term GDP growth. I have at least some skepticism of the long-term prospect, especially if government imposes such heavy-handed regulations as Biden's vehicle standards.

Then I read an argument from an unexpected source: the Right-leaning Tax Foundation. In its analysis entitled Carbon Taxes in Theory and Practice that it released earlier this week, it shows that in practice, carbon taxes a) do not cause a significant, negative impact on GDP growth, b) are effective at lowering carbon emissions, and c) can be more revenue-neutral when paired with a tax reduction elsewhere (a capital tax reduction in particular). For sure, the effects of a carbon tax depend on the tax amount, who pays it, which sectors are affected the most, and what happens with the carbon tax revenue. While these are legitimate concerns, evidence from Europe shows that carbon taxes in practice have either had no or a modest, positive effect on GDP and employment.

As I argued in 2015, I am in favor of a carbon tax if it means replacing it with such distortive taxes as the wealth tax or corporate tax. Since the carbon tax acts as a consumption tax, it does less economic damage. I do have concerns about the particulars when it comes to implementation, much like I do with any policy. Provided that the social cost of carbon is not priced too high, it looks like carbon taxes are an effective way to lower carbon without causing notable harm to the economy.