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Cutting the Gordian Knot

Wednesday, August 15, 2007

A new and better carbon tax proposal.

The emerging policy consensus that we ought to do something to limit carbon emissions faces two fundamental challenges. First, it remains difficult to measure the impact of any policy on the actual level of emissions. Second, these policies may impose substantial economic harms, which are also hard to measure. An ideal policy response to the danger of global warming would both monitor the degree to which human activities are leading to warming, and adjust the incentives so that once the desired level of emissions reduction is reached, no further harm is imposed on the economy.

Fortunately, economist Ross McKitrick has found a way to do just that with a very innovative twist on the carbon tax idea. McKitrick argues that for each country, the dollar rate of the carbon tax be pegged to the three-year average change in global tropical temperatures.* The tax would be assessed per ton of carbon dioxide emissions, and updated annually. It would be administered for all domestic carbon dioxide emissions, be matched with income tax cuts and would come with no cap on emissions.

Implementing a carbon tax that is tied to warming and a futures market are ideas whose time has come.

Currently, according to McKitrick, the tax would come out to $4.70 per ton, which is rather low. But if global warming forecasts are correct, the tax would eventually climb at a rate of between $4 and $24 per decade, according to McKitrick’s findings. He calculates that if the current upper end of forecasts hold, the tax could reach $200 per ton by 2100, which would necessitate a move to non-carbon energy sources and an effort to cut carbon emissions.

Of course, it is possible that the current models will not hold, which would mean that the tax would increase very little, if at all. As McKitrick points out, it is even possible—according to some scientists—that we might experience global cooling, in which case we could end up subsidizing carbon emissions.

These two scenarios—and all of the scenarios in between—highlight the uncertainty in our climate future. McKitrick’s proposed carbon tax allows us to measure the degree to which human activity is contributing to global warming by looking at the tax rate. If increases in the tax rate lead to decreases in warming, then the alarmists are right about our impact on climate—if it doesn’t, they are not. As McKitrick himself says, with this tax, “the regulator gets to call everyone’s bluff at once, without gambling in advance on who is right.” Moreover, the structure of the tax will encourage both public and private sector forecasting that will take global warming into account and will decrease the lag between the effects of climate change and the design and implementation of policy options to address that change.

We can add to or amend McKitrick’s proposal by taking into account economist Arnold Kling’s idea of having a futures market in the temperature indicator, where the tax is tied to the futures price. I’m a big fan of futures markets; the Iowa Electronics Market has an excellent reputation for correctly predicting the outcome of Presidential elections and futures markets would even help forecast—and prevent—terrorist attacks if only people got over some of their squeamishness. Tying a futures market to the carbon tax McKitrick envisions would go a long way towards making the tax rational.

Implementing a carbon tax that is tied to warming and a futures market are ideas whose time has come. Both the tax and the futures market will help lend greater certainty to the climate debate. Intellectual checks and balances will be imposed on each side. And since no particular liberty principle is at issue, the taxation of externalities is certainly something free market types like me can get behind. It is better than the taxation of income, after all.

Or as Bill Murray put it in Ghostbusters, “I like this plan! I'm proud to be a part of it!”

Pejman Yousefzadeh is an attorney living in Illinois. He blogs at A Chequer-board of Nights and Days, and Red State.

Image credit: Photo by flickr user LarsVegas.


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