Matthew Lau: Why the right price for carbon is probably zero dollars

The views and opinions expressed in this article are those of the author and do not necessarily represent those of the CO2 Coalition. By Matthew Lau Recently, Canadians for Clean Prosperity published what it called the “Conservative Case for a Carbon Tax.” The organization, led by Mark Cameron, a former policy director to Stephen Harper, exists primarily to convince conservatives of the virtues of a carbon tax. To their credit, Canadians for Clean Prosperity does advocate that carbon taxes should be offset by equivalent cuts to corporate or personal income taxes and that they should replace — rather than add to — other regulations aimed at reducing emissions. Where Canadians for Clean Prosperity goes wrong is in the price it wants to put on carbon. It advocates a minimum price of $30 per tonne, which would increase to $100 by 2030. The logic is that $30 is approximately the “social cost of carbon” (the supposed present value of damages caused by future climate change, per tonne of emissions today) as modelled by the U.S. Environmental Protection Agency (EPA). The group argues that taxes must eventually rise to $100, however, to ensure Canada reaches its emissions targets. But ongoing uncertainties in the climate science prevent the social cost of carbon from being measured with much precision, and these estimates can be drastically changed simply by tweaking the discount rate used to convert future climate damages into present day value. The U.S. government’s Office of Management and Budget (OMB) states that government agencies performing regulatory analysis should provide estimates using discount rates of both three per cent and seven per cent. The latter figure is actually the default since seven per cent is “an estimate of the average before-tax rate of return to private capital in the U.S. economy.”

The optimal carbon price would likely be so low as to be not even worth pursuing
Economists with the Heritage Foundation based in Washington, D.C. calculated the effects of changing the discount rate from three to seven per cent for two of the three statistical models used by the EPA. This simple change causes the estimated social cost of carbon in 2010 to fall from US$30.04 to only US$4.02 in one model (the DICE model) and from US$16.98 to -US$0.53 for another (the FUND model). Alternatively, keeping the three per cent discount rate but updating the numbers to take into account the most recent peer-reviewed evidence on the sensitivity of the earth’s temperatures to carbon dioxide causes the estimated social cost of carbon in 2010 to fall from US$30.04 to only US$17.72 for DICE and from US$16.98 to US$6.27 for FUND.
Furthermore, contrary to Canadians for Clean Prosperity’s suggestion to tax carbon at or above the social cost, there are at least two reasons to set it well below the social cost. Firstly, a new carbon tax may simply cause businesses to relocate to jurisdictions without the tax, resulting in emissions relocation instead of abatement. Secondly, the carbon tax actually increases the distortions of the existing tax system, even if the revenues from the tax are used to reduce income taxes. This is known as the tax interaction effect, as quantified by economists A. Lans Bovemberg and Lawrence H. Goulder in the 1990s. (Oversimplified, it means that mixing a carbon-type tax with already existing taxes, makes both taxes disproportionately more harmful to economic efficiency). They found that based on the American tax system in the early 1990s, assuming the social cost of carbon to be US$25/ton, the optimal carbon tax would be only US$7 if offset by personal income tax cuts. As economist Robert Murphy of the Institute for Energy Research has noted, this result arises because a carbon tax is like a tax on labour and capital, but applied to a “narrower” base. Given that the actual social cost of carbon is probably well below US$30 and that the optimal tax is considerably lower than the social cost, the optimal carbon price would likely be so low as to be not even worth pursuing. A properly implemented carbon tax might not be a bad idea in theory, but the appropriate carbon price, at least for now, is zero dollars. This article appeared on the Financial Post website at http://business.financialpost.com/fp-comment/matthew-lau-why-the-right-price-for-carbon-is-probably-zero-dollars]]>

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