Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
8/19/09 12:38 PM
Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, RealityBased, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu. Weblog Home Page Weblog Archives Econ 115: 20th Century Economic History Econ 211: Economic History Seminar Economics Should-Reads Political Economy Should-Reads Politics and Elections Should-Reads Hot on Google Blogsearch Hot on Google Brad DeLong's Egregious Moderation August 14, 2009
Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again OK. I've finally figured out what is going on. Let's draw a graph, with the tax rate on labor (and capital, and other things) on the vertical axis and the tax rate on carbon on the horizontal axis, like so:
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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We would like, ideally, if there was nothing we wanted the government to do, to have a tax of zero on labor and a positive tax on carbon emissions to correct for the global-warming environmental externality--we would like to be at point O, if we could. But we can't be at point O. There are very valuable things that we need the government to do, and the government needs to spend money to do them. We need to impose taxes on labor and carbon in order to raise revenue. Thus the "required revenue line," running through points S and A. Our tax rates on labor and carbon must be such as to keep the economy on or above the required revenue line. At the moment we are at point S--the status quo. We would like to impose a carbon tax and use the revenue to lower our labor tax and thus get to point A--that is the social optimum, the point that (a) gets us as close as possible to getting prices right and thus getting allocative economic efficiency, while also (b) raising enough revenue for the government to do the things that the government ought to be doing. http://delong.typepad.com/sdj/2009/08/note-to-self-greg-mankiws-anti-environmental-bill-argument-once-again.html
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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revenue for the government to do the things that the government ought to be doing. To first order, at least, we can get to point A either by (i) imposing the right efficient carbon tax directly, or (ii) having the government sell the right efficient number of carbon-emission permits. The best thing to so would be to assemble a legislative coalition of: environmentalist Democrats Republicans interested in economic efficiency and pass a carbon tax or a cap-and-trade with a permit auction system to get us to point A. However, at the moment there are next to zero Republican legislators interested in economic efficiency. Instead, Republicans legislators appear to be exclusively interested in trying to make Obama's presidency appear a failure so that they can then benefit in the 2010 and 2012 elections--the Gingrich-Dole strategy, which they pursued with very short-term political but no other kind of success over 1993-1998, by the end of which both had been bounced out of the legislature. Thus Obama has to go for a second best. He has to assemble a legislative coalition of:L environmentalist Democrats blue dog Democrats where the blue dogs insist that we cannot tax but rather must pay the polluters: businesses that currently emit carbon must be given free permits that they can then sell on the open market, and thus profit from. This is the equivalent of (a) imposing a carbon tax, and (b) then giving the revenues raised away to last-year's polluters in lump sums. This gets us to point B. Point B is clearly better than the status quo of point S--prices are closer to being right. But point B is worse than point A. So the right strategy for Obama right now is (i) pass cap-and-trade with a permit giveaway now, and (ii) work toward some future in which the Republicans interested in economic efficiency wiill cooperate in a bipartisan faction. Hope that they will someday actually be willing to be bipartisan--to give a higher priority to the welfare of the country than to trying to make Obama's presidency a failure. Then whenever that, happens assemble the bipartisan legislative coalition of environmentalist Democrats and public-spirited Republicans and move from point B to point A. Now comes Greg Mankiw. Greg says: "Wait a minute. A tax on carbon is not just a tax on carbon--not a move parallel to the x-axis from point S to point B. Instead, whenever you tax carbon you automatically raise the tax on labor too--there is no way that the economy can reconfigure itself to emit less carbon and still employ as much labor as efficiently s it now does, and so a carbon tax is also a labor tax, and points up and to the right from point S to point C. Impose a carbon tax," Mankiw argues, "and we move not from S to B but from S to C and wind up further away from the point O that we want to be at." Hence Mankiw's call for Obama to veto cap-and-trade-with-permit-giveaway. http://delong.typepad.com/sdj/2009/08/note-to-self-greg-mankiws-anti-environmental-bill-argument-once-again.html
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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Is Mankiw right that carbon is emitted and labor employed in a process of production so joint that any carbon tax will raise taxes on labor enough to move after-tax prices along a vector that makes a more than 90 degree angle with the S-O line--which is what you need for a cap-and-trade-with-permit-giveaway to be a bad idea? He doesn't present any evidence that this is the case. Larry Goulder, Rob Stavins, and Severin Borenstein would certainly know. Let me try to call them... Reference: Laurence Goulder (1994), "Environmental Taxation and the Double Dividend: A Reader's Guide" Test: Mankiw Anti-Environmental Argument Graph (20090814) brought to you by Livescribe
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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Comments You can follow this conversation by subscribing to the comment feed for this post. Is there a variable to measure the impact of Gold Sachs and their peers running speculative trading with the cap-and-trade? Any way to control "abusive" trading? Posted by: save_the_rustbelt | August 14, 2009 at 10:12 AM Brad, You make the mistake of assuming that Mankiw is making good faith arguments with a view to improve public policy. He is not. Mankiw is saying and doing things that lead to short term Republican gains, such as making the current administration appear to be a failure. He is, in short, a hack. See, for example, his endorsement today of Charles Krauthammer's health care arguments. Hacks should not be engaged. Posted by: chn | August 14, 2009 at 10:23 AM Carbon creates negative externalities. Doesn't that mean that NOT taxing carbon is equivalent to imposing an INEFFICIENT tax (in the form of pollution) on everyone? Suppose we started with an optimal carbon tax and that carbon tax revenue was all dumped in the ocean. At least then, we would get all the efficient levels of effort and investment in carbon intensive activities. Now remove the carbon tax and incur the externalities. That's equivalent to subsidizing carbon-intensive activities beyond the optimal level. Now, production is an an inefficient point. How can Mankiw claim that the economy will be more efficient if the relative prices are wrong than if they are correct? Posted by: a student of economics | August 14, 2009 at 10:25 AM I would note that Obama never proposed point A, he always proposed B. For example in his budget he set aside the cap-and-trade revenue to use to finance "Wake-Work-Pay" "inframarginal" tax cuts and R&D spending on technologies to counter global warming. So, Mankiw's call for Obama to veto the legislation suggest because of the changes to cap-andtrade would have Obama changing his policy, not moving legislation back towards Obama's policy. If we look at the general equilibrium models that are run using cap and trade policies, like in the house bill find very small labor supply responses, as one would expect. I think Dr. Mankiw needs to consider the size of the elasticities and stop worrying about second order labor supply and begin worrying about the deficit. A better use for the cap-and-trade revenue would be to boost national saving. Posted by: rana | August 14, 2009 at 10:29 AM Is Mankiw right? The correct answer is always, "Who cares?" Posted by: elliottg | August 14, 2009 at 11:32 AM Brad, please stop feeding the troll (Mankiw) by considering his argument to be credible - and therefore worthy of an analytical refutation. The fact that he is a Bush economist (aka an oxymoron) should exempt him from a career in your field. Mankiw doesn't fight fair - why should you? He quite seriously deserves no more respect than Felix Salmon's treatment of Ben Stein. http://delong.typepad.com/sdj/2009/08/note-to-self-greg-mankiws-anti-environmental-bill-argument-once-again.html
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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Posted by: Unsympathetic | August 14, 2009 at 11:57 AM This posts stays too much in the world of neoclassical public finance. The U.S. could impose lump sum taxes but we have chosen not to. Where is this concern in your analysis? Also, the climate change externality is huge. Essentially infinite, if you believe Weitzman (I do). Deciding what to do with the revenue is small change in comparison. Posted by: Johnny Appleseed | August 14, 2009 at 12:49 PM Too complicated. Both the bill, the Mankiw's criticism, and Brad's retort. Posted by: Mattyoung | August 14, 2009 at 01:08 PM I just looked quickly at the paper, then glanced at one of the Bovenberg/de Mooij paper referenced (the earliest one, iirc). As Goulder points out, they make the claim that EVEN IF the tax revenues are used to reduce distortionary labor taxes, the tax system can be less efficient, overall. "Indeed, high estimates for the efficiency costs of existing taxes _weaken_ rather than _strengthen_ the case for environmental taxation." Which is different than Mankiw's claim, that the problem lies not with the environmental taxation, but with the manner in which it is rebated. This would be a lot easier if Mankiw had spelled out his argument more carefully. Posted by: jh | August 14, 2009 at 01:14 PM Mark Thoma links to Robert Stavins's arguments about the carbon credit allocations: http://economistsview.typepad.com/economistsview/2009/08/stavins-waxmanmarkley-isnot-a-massive-corporate-giveaway.html Posted by: jh | August 14, 2009 at 02:06 PM First, note that a paper by Parry, Williams, and Goulder (http://www.rff.org/rff/documents/rff-dp-97-18-rev.pdf) explicitly models some of these questions. Of particular interest is Figure 1, the chart of marginal cost of emissions reduction at the end of the document. The gap between the top curve (the cost estimate for a quota with a preexisting tax rate of 0.4 and no revenue recycling) and the middle curve (the cost estimate with revenue recycling used to offset the implicit income tax burden) starts at a little less than $20 1995 dollars per ton and increases to perhaps $60 1995 dollars per ton as we approach a 25% cut in overall carbon emissions. I think that they mean *carbon* rather than *carbon dioxide*, and translating to cost per ton of carbon dixiode in 2009 dollars we get $7.70 and $23.10, respectively. These aren't terribly high additional costs -- I think the expected marginal benefit from carbon reduction at that level is much higher -- but they're not trivial either. If one assumes that the costs from emissions reduction will be higher that Goulder et al. estimate, these additional costs will scale up as well and start to become very significant. (And if I am mistaken and they are using tons of carbon dioxide rather than carbon, you can multiply all the costs by about 3.7.) They are certainly relevant at the margin. Posted by: Matt Rognlie | August 14, 2009 at 02:54 PM I also think that you're going a little off track by focusing on whether carbon and labor are employed in a process "joint" enough. First, you can get effects of this kind while barely modeling the involvement of carbon in the production process at all. An 1994 AER paper by Bovenberg and de Mooij presents perhaps the intuitively simplest version of this argument: http://klevnas.net/hilda/local/514_BovenbergandRuud-EnvironmentalleviesanddistortionarytaxationAER1994.pdf
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The idea is that consumption consists of a "clean good" and a "dirty good," which have similar production functions and are both included in the typical consumer's consumption bundle. An environmental tax on the "dirty good" makes consumption more expensive, implicitly making labor less valuable. This would be fine, and the Piguovian optimum would still hold, if not for the influence of preexisting distortionary taxes -- but instead, these taxes "interact" with the new implicit tax and cause it to be much more expensive than it otherwise would be. This effect can be mostly (but not entirely) offset by recycling revenues. Now, a carbon tax us arguably more a tax on intermediate inputs than consumption of a dirty good, although in many cases the latter is a very close approximation (fuel for transportation, electricity from coal, etc). Even if you think this way, however, similar logic applies: much of the tax on inputs will translate directly into increased prices on various consumption items. When you consider the issue this way, it is not essential at all that the influence of carbon in the production process be particularly broad. If it affects only 5% of goods, but affects them dramatically, we can still get a nontrivial effect. For people who believe that capital taxation causes substantially more deadweight loss than labor taxation, viewing carbon as an input in a general equilibrium economy can imply further losses because a carbon tax is then implicitly a tax on producing many kinds of physical capital. Posted by: Matt Rognlie | August 14, 2009 at 03:14 PM I honestly don't understand some of the econ jargon well enough to know if maybe I'm repeating someone else's points here, but as I read it, Mankiw is seeing all the inefficiencies of a lower-carbon world (worst-case scenario is having old ladies seeding corn by hand rather than having a machine do the work) without seeing the efficiencies. The single biggest is reducing traffic, which is one of the biggest drags on labor efficiency. The fewer single-occupant vehicles you have, the more efficiently you can deploy labor, because you can give lots of people a couple hours apiece every day to use in more productive ways. There's also a health benefit. Millions of people die young, get asthma, and otherwise lose productivity because of the same machines that release carbon dioxide - cars and coal, basically. There is certainly a point of diminishing returns on pollution reduction (especially in places like the U.S. where lots of carbon can be burned relatively cleanly), but it makes no sense to ignore the ongoing benefits to carbon reduction. Finally, the one that he would probably like best, is that disincentivizing the use of carbonbased fuels can reduce government spending -- in your drawing, reducing where on that line we need to be. Fewer cars, planes and trucks and more trains and ships = lower government spending on roads and airports (and possibly less need for subsidies for mass transit as well). Posted by: maureendowd's friend who never wants any credit | August 14, 2009 at 06:52 PM @maureendowd's friend who never wants any credit: That doesn't seem to be what Mankiw is arguing. He seems to be saying that even if inefficiencies (externalities -- when your consumption of a good affects other people who aren't the buyer or seller) exist for carbon, reducing that externality by taxing carbon will -- somehow -- mix up with the labor tax to make an unholy beast of an inefficiency in the labor market (meaning, basically, that even though the income tax rate will be unchanged, a carbon tax will make it much worse than it is today -- employment and GDP will fall because of some way in which the carbon tax affects everything else). He claims the solution to this is to auction all the permits and reduce labor taxes. I don't understand the mechanism for this, and he hasn't made one clear. It does sound somewhat like the Bovenberg and de Mooij paper, like Matt Rognlie points out...although, as I said above, I don't _think_ they ARE saying the same thing. But I'm not really sure. http://delong.typepad.com/sdj/2009/08/note-to-self-greg-mankiws-anti-environmental-bill-argument-once-again.html
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Posted by: jh | August 14, 2009 at 07:29 PM @maureendowd's friend who never wants any credit: One common misconception about carbon pricing is that it will have a large effect on petroleum-fueled transportation, when this is actually the one area where it has relatively little effect. A $100-a-ton tax on carbon dioxide -- *well* above the level we'll see anytime soon, and enough to make the vast majority of carbon emissions uneconomical -- would raise the price of gasoline by a little less than a dollar. That's more than nothing, of course, but remember that this is under a hypothetical, super-stringent far-out-into-the-future carbon tax. The actual carbon price in the near future is likely to be much lower, leading to an increase in the price of gasoline of no more than 20 or 30 cents. Posted by: Matt Rognlie | August 14, 2009 at 07:42 PM @jh: The Bovenberg and de Mooij paper is essentially making the same points. The main issue here is that while it is normally optimal to set a tax on emissions equal to the marginal social cost of those emissions, the logic changes when other distortionary taxes already exist. These existing taxes "interact" with the new taxes in a way that makes the new levies much more costly. Classic partial equilibrium approximations like the Harberger triangles Brad used in his first post provide estimates that are far too low, as this paper by Goulder and Williams points out: http://iisdb.stanford.edu/pubs/20386/Substantial_Bias_in_Excess_Burden_Estim_(GoulderWilliams).pdf The Bovenberg and de Mooij paper shows that (under certain modeling assumptions) the "tax interaction" costs of emission taxes will be greater than the "revenue recycling" benefits of using revenues to cut income taxes. Thus there is no "double dividend" from carbon policy, and indeed there is slightly less than a single dividend: if you recycle the revenues, the combined effects of interaction with income taxes make the optimal tax a little less than it would otherwise be. Luckily, however, this is not a very big effect, and at the initial zero-tax margin it is actually zero. The corollary of the Bovenberg and de Mooij argument about the absence of a double dividend is the fact that if you don't recycle the revenues, the effects are substantial and negative. Remember that in most cases, the positive impact of recycled revenue *almost* entirely offsets the negative impact of tax-interaction. When you remove the first effect, however, suddenly you get a negative distortion in the labor market with no offsetting positive one, resulting in a much larger net loss. (Not counting, of course, the environmental benefits from the carbon tax itself.) The last paragraph of the Bovenberg and de Mooij paper discusses these issues. Posted by: Matt Rognlie | August 14, 2009 at 07:59 PM @Matt Rognlie: But aren't Bovenberg and de Mooij saying that even if you do "recycle" the carbon tax revenue by reducing income tax rates, you still get a negative overall effect (at least in many models)? I thought they were considering a revenue-neutral policy of this type. And that this effect is especially the case if you believe the labor income tax involves a large distortion (which I'm fairly certain is something that Mankiw believes)? In that case, why would Mankiw say that it would be good policy to implement a carbon tax and offset it by reducing income taxes? I have to look at this more carefully, I really don't understand the mechanism. These secondbest type situations are something I've never had any grasp of. http://delong.typepad.com/sdj/2009/08/note-to-self-greg-mankiws-anti-environmental-bill-argument-once-again.html
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Note to Self: Greg Mankiw's Anti-Environmental Bill Argument Once Again
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best type situations are something I've never had any grasp of. Posted by: jh | August 14, 2009 at 08:12 PM @jh "But aren't Bovenberg and de Mooij saying that even if you do "recycle" the carbon tax revenue by reducing income tax rates, you still get a negative overall effect (at least in many models)?" Yes, exactly -- but you get a much, much, much bigger negative overall effect if you don't recycle the revenue, and in both cases the negative effects are due almost entirely to tax interaction. Posted by: Matt Rognlie | August 14, 2009 at 09:07 PM Here, Brad, you have got Mankiw for sure. There is no need to appeal to wierd production functions or anything. If it is the case, as everyone (maybe not Mankiw!) supposes that there is a meaningful carbon externality, then the standard economic solution is to tax it (or, equivalently, to a first order, do so through a permit system). This, as is well known to schoolchildren, corrects the externality. To the extent that cross-elasticities of production are important, it will improve the allocation of labor too, because this had been distorted by the externality. Thus, the result is exactly the opposite of what Mankiw claims: taking account of the externality, labor will be more efficiently employed after the carbon tax, not less. Posted by: lloyd667 | August 15, 2009 at 03:56 AM @Matt Rognlie: Thanks for the notes. I'm still unconvinced that Mankiw is making quite the same argument, at least explicitly. But the paper is interesting. If you know, btw, I'm curious how strongly Bovenberg and de Mooij's results depend on the fixed price assumption. It's certainly reasonable for some goods (energy), but applying it to everything but labor makes me a bit queasy. Posted by: jh | August 15, 2009 at 06:19 AM "there is no way that the economy can reconfigure itself to emit less carbon and still employ as much labor as efficiently s it now does" There is no way for the market to re-adjust to full employment after a change in the scarcity of a resource?!?! Somebody better tell Adam Smith! Posted by: anonymous | August 15, 2009 at 06:35 PM What's the difference whether I tax Bob and Jim and give the revenue to Bob or tax Bob and Jim and give the revenue to Jim? Posted by: anonymous | August 15, 2009 at 06:41 PM Then it's a non-issue. The only important thing is that there not be too many permits, as there were in Europe. Auctioning all permits is better. Giving them out for free to high-carbon industries has the perverse effect of encouraging more carbon output in the reference year so as to score more permits. Posted by: maureendowd's friend who never wants any credit | August 16, 2009 at 08:16 AM
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