Don't Be Tricked By Economists on the Carbon Tax

Here at IER, I have already directly critiqued the WSJ letter. At my personal blog, I wrote out a formal numerical example to illustrate why it was so misleading for the letter to claim that most American families will "benefit financially" from the dividend check. Yet from the reaction to my two pieces, I see that some readers still do not understand why I (or Tyler Cowen for that matter) consider this particular argument for a carbon tax to be so egregious. In the present post, I'll try to illustrate the problem with a simple analogy about a college professor who dreams up a wacky grading scheme.

Should Students Support a "Point-Neutral Exam Reform?"

Suppose a college math professor is very concerned about the self-esteem of her students, and so declares that for the upcoming exam, she will give each student the average of the actual scores that the class earns. That is, the professor will first grade the exam the normal way, then add up the total points earned by all of the students collectively, then divide the total by the number of students in the class, and finally she will award that result as the score to each student. When the professor announces the rule, at first the students are suspicious, as they have come to distrust anything proposed by adults--especially those in authority. However, the professor explains that out of the class of 100 students, there are 10 very high achievers, who get an A+ on every test. Another 87 students are pretty average, who all usually get a C+ through a B on their tests. And finally there are three students who are in danger of flunking, who get an F or a D on their tests.

The students in the class, however, still don't see where this is going. The professor reminds them that her proposal is--as she calls it--a "point-neutral exam reform." That is, the professor's new scheme won't create or destroy points, but instead will merely redistribute point among the students. The total number of points the students score on their exams, will end up being the total number the professor records in the grade report for the registrar. However, because of the different patterns in student scoring, the professor predicts that her scheme will mean that 90 percent of the students in the class will receive more points from the scheme than they will forfeit. That is, 90 percent of the students in the class will see their score bumped up after the professor applies the adjustment.

We Don't Need No Education (?)

Now that I've laid out the hypothetical story, we can ask: What will be the effect of the professor's new scheme? One obvious result is that most students will study a lot less for the exam . The top-achieving students will still probably get an A+ on the exam (before adjustment), because the material comes easy to them and they didn't really need to study much anyway. But for the C and B students, who originally would have spent a couple of days cramming for the exam, they won't have the incentive to work nearly as hard. They know that every student is going to get the same "class average" score on the exam, and so any one particular student's performance will effectively be diluted across all 100 students. And finally, for those students who would have failed originally, they certainly aren't going to pull an all-nighter trying to learn the material with the new rule in effect.

Because of the new incentive structure, the class as a whole will score very poorly, compared to the previous exam. The 10 high-achievers will still get an A (before adjustment), but the average students will each get a D or a C. And of course the weakest three students will all get an F. After adjustment, of course, the students will all get the same grade, maybe a C-. Now, is the professor's scheme good or bad? Well, it depends on whether you think the original amount of hours the students were devoting to studying, was a good use of their time. Some onlookers might think the material in the math class was very important for young people to learn, and so they would be horrified by the professor's egalitarian scheme, because it led the students to learn less by the end of the semester. However, other onlookers might think most of what occurs in colleges is a big "signaling game" for employers, and that the students are better off by having less knowledge of calculus and more leisure time.

Point- (Or Revenue-) Neutrality Is a Total Non Sequitur

Here's the takeaway point from my parable, of relevance for the carbon tax: Notice that in the above story, the fact that the professor's scheme is "point-neutral" is utterly irrelevant . Whether a particular student gains or loses points from the scheme per se isn't really decisive when we're asking if the student is helped or hurt by it, in the grand scheme. In particular, consider an average student who normally would have studied three hours and gotten a B. Under the new scheme, the student knows that his individual performance is virtually irrelevant. So he binge watches Netflix for three hours rather than studying. He gets a D on the exam, but then gets his "point dividend" from the professor and ends up with a C-. The redistribution of points helped the student on net, in the sense that he originally scored lower than the class average of a C-, and so was "pulled up" to it after the redistribution. But that fact is hardly decisive when we want to know if the scheme made the student better off .

Applying the Parable to a Revenue-Neutral Carbon Tax

Now that we've really thought through the implications of our hypothetical college scoring scheme, we can apply the same reasoning to the Climate Leadership Council's carbon tax (touted by the WSJ letter). If American households get hit with a stiff carbon tax, the obvious effect is that they will emit (directly or indirectly) less carbon dioxide . Of course, some households currently emit a lot of carbon dioxide, a large portion emit a middling amount, and very poor households (or individuals) don't emit much carbon dioxide at all. And this pattern will still be true after the imposition of a stiff new carbon tax, except that the baseline will have shifted down. Now after the carbon tax scheme is implemented, if the government sent lump-sum rebate checks to each household--and that's a very big if --then it's true (as the WSJ letter claimed) that the majority of households would receive more in their dividend than they paid out in higher prices (due to the carbon tax). But so what? That bit of trivia, by itself, is basically meaningless when it comes to the question of whether households are helped or hurt by the tax.

Remember the college professor's new grading scheme: There, the real issue wasn't whether a given student gained or lost exam points on net. No, the issue was: Is the student made better off by learning less math and enjoying more leisure time? Likewise, when it comes to a revenue-neutral carbon tax (even if we could trust the government to run such a scheme, which we can't), the issue isn't whether a given household receives more in dividend than it pays out in tax. No, the issue is whether the household is made better off by restricting its usage of carbon-intensive goods and services, including electricity and transportation, in exchange for living in a world with a (slightly) lower concentration of atmospheric CO₂. Americans have been pounded to a pulp with warnings of imminent climate catastrophe. Wonky experts propose new schemes, such as a stiff carbon tax. Americans understandably want to know, "What will this mean to my family?" The correct answer is: You will end up restricting your purchase of many goods and services you currently enjoy; your material standard of living (neglecting climate change) will be lower, in exchange for the ostensible environmental benefits of reduced emissions. Now some observers think this is a great tradeoff for American households while others think it is awful. But either way, counting up how many dollars come and go is utterly irrelevant. The real issue is how many transactions don't occur in the first place , and so can't be subject to the carbon tax . Just like in the college exam case, the real issue was that the students studied less and so earned fewer total points to be redistributed . The particular addition or subtraction of points after the studying had occurred and the exam was taken, is an irrelevant bit of trivia.

Conclusion

There is a reason the U.S. economy is so heavily reliant upon carbon-intensive fuels in its energy and transportation sectors: They are very reliable and convenient, given all the realities of our current situation. Yes, a new carbon tax, if draconian enough, could ultimately force households and businesses to sharply curtail their emissions. But doing so, especially quickly, would come at a huge cost in Americans' standard of living. Now if those concerned about climate change want to argue that the benefits outweigh the costs, they can do so. But they should make their case plainly, rather than trying to trick Americans into thinking that they can save the planet while making some extra spending money on the side. That argument is utterly deceptive, which the WSJ letter signers would be quick to point out if, say, Trump Administration officials tried to use a similar trick regarding tariffs.