Observations on the Alliance for Market Solutions’ “Conservative” Case for a Carbon Tax Benjamin Zycher MAY 2019 AMERICAN ENTERPRISE INSTITUTE Executive Summary he Alliance for Market Solutions (AMS) has pro- or delays of scheduled increases, analyzed under a Tposed a tax on “carbon” (emissions of green- “current law” rather than a “current policy” orienta- house gases, or GHG) as a “market-oriented solution tion. A “current law” perspective is wholly legitimate to one of America’s most pressing economic chal- and applied often in serious analyses, but in the con- lenges: . reducing carbon pollution.” It is among the text of the AMS proposal for a revenue-neutral car- more prominent of the proposals for a carbon tax now bon tax, the “current policy” assumption is far more drawing attention from policymakers and observers. realistic—in my view—because the current tax poli- This proposed carbon tax is described and intended by cies are unlikely actually to be allowed to lapse. AMS to be “revenue neutral” and part of a policy shift In short, the proposed AMS carbon tax is indepen- away from a regulatory regime for reductions in GHG dent of any actual environmental parameters, despite emissions, a shift that AMS argues would improve eco- its central asserted justification as a climate policy. nomic efficiency. Instead, it is a device intended to avoid a large increase Those arguments are problematic. Despite the in the budget deficit in the next10-year budget win- AMS focus on reducing GHG emissions as a pol- dow, as AMS admits more or less explicitly. Because icy addressing a negative environmental (climate) AMS does not ground its carbon tax proposal on a dis- externality and despite the AMS claim to be “moti- cussion of actual climate phenomena, an analysis of vated by our respect for science,” the actual proposal the magnitude of an assumed GHG externality, or a is not based on any references to actual climate phe- quantification of the environmental effects of its pro- nomena, a calculation of the magnitude of a pur- posed carbon tax, the magnitude of its tax to a sig- ported GHG externality, or an analysis of the climate nificant degree would be arbitrary, driven by AMS’s effects of the proposed tax. Instead, AMS references, preferred tax policies and the purported goal of rev- in passing, the dire climate predictions in two recent enue neutrality. reports, respectively from the Intergovernmental In other words, it is clear that AMS is advocating Panel on Climate Change and the federal govern- whatever carbon tax is needed to make its various pre- ment. These reports assume a future path for atmo- ferred policies (e.g., extending the 2017 tax cuts after spheric GHG concentrations that is unrealistic in 2025) “revenue neutral,” while assuming that adop- the extreme, and both are inconsistent with the find- tion of the carbon tax would not be accompanied with ings in the peer-reviewed literature and the actual any new spending in a congressional bargaining equi- evidence on climate phenomena. librium. It is clear also that the AMS “climate” justifi- Instead of being structured as a correction for a cation for its carbon tax is secondary, as the proposed market inefficiency, the AMS carbon tax much more tax would reduce temperatures in 2100 by 0.015°C centrally can be seen as a financing mechanism for a under assumptions highly favorable toward the AMS series of tax reductions (or extensions) preferred by climate policy stance, a figure smaller than the stan- AMS: “All revenue from a carbon tax should be used dard deviation of the surface temperature record by to reduce other, more distortionary taxes that hinder an order of magnitude. economic growth, including taxes on earnings and That it is revenue rather than any “climate” param- income.” Most of the AMS tax reductions are exten- eters that is the central focus of the AMS proposal is sions of current tax provisions now scheduled to end, illustrated by the AMS “2018 Year-End Report”: 1 OBSERVATIONS ON THE ALLIANCE FOR MARKET SOLUTIONS’ “CONSERVATIVE” CASE FOR A CARBON TAX BENJAMIN ZYCHER Pressure to address our country’s long-term fis- politically viable is problematic, as is the AMS asser- cal issues also grew. The Congressional Budget tion of substantial prospective Republican support Office reported that the deficit during the first two for climate policy generally and a carbon tax in partic- months of fiscal year 2018 was 50% higher than it ular. Moreover, the AMS assumption that a carbon tax was during the same period the previous year. And is needed politically to effect a reduction in the GHG the national debt is expected to reach $22 trillion by regulatory regime has been disproved: The Trump early 2019. Fiscally conservative Republicans, whose administration has begun the process of eliminating concerns about the federal deficit appeared to have the Clean Power Plan, weakening substantially the been lost in recent years, started to seriously evalu- transportation-sector fuel economy regulations, and ate long-term spending and revenue issues. The lack has initiated the process of exiting the international of other politically acceptable, multi-trillion-dollar Paris GHG emissions agreement. revenue options forced some conservatives who are It is possible that the AMS argument for a carbon usually unwilling to consider any new form of taxes tax is based upon alternative assumptions and ratio- to quietly contemplate a carbon tax. nales unstated in the various AMS promotional mate- rials and research efforts. One such argument might The implicit AMS definition of an “efficient” tax is be that enactment of a carbon tax by the US would problematic, in that it assumes that the size and com- facilitate an international effort to reduce GHG emis- position of the government budget are independent sions. The specifics of the international agreement of the tax instruments chosen to fund it. The AMS finally reached in Paris in late 2015—in particular, revenue-neutrality pledge would be difficult to achieve the small temperature effect (0.17°C by 2100) of the because a carbon tax in a congressional bargaining intended national contributions, even if taken at face equilibrium would likely be packaged with significant value—do not inspire confidence in this possible new spending compensating the losers, and with other justification for a carbon tax. Even a highly aggres- spending designed to forge a majority political coali- sive and thus implausible international effort would tion willing to impose the carbon tax. AMS recognizes reduce temperatures by only about half a degree. this explicitly in part. Because a carbon tax—and thus A second argument might be that a carbon tax the intended reduction in GHG emissions—must be would engender an incentive to invest in innova- chosen by government, it is not a “market” policy. tions reducing the cost of limiting GHG emissions. Notwithstanding the view of many economists, it is The small temperature effects of such innovation are likely to prove less efficient economically than a reg- striking: Were US emissions reduced by 60 percent, ulatory approach because the revenue stream from the maximum temperature reduction in 2100 would a tax would provide incentives for policymakers to be less than a tenth of a degree, and a 60 percent choose the tax rate that maximizes the present value reduction by the entire industrialized world would of the revenue stream over some time horizon rather yield less than a quarter of a degree. Moreover, such than the rate that optimizes emissions. This outcome innovation is not costless, and the tax would destroy is made more likely by the prospect that the marginal the economic value of part of the existing resource members of the congressional majority in this con- base and capital stock. Accordingly, the innovation text would be those most threatened in the next elec- argument is not far removed from a standard broken tion. That dynamic would be reinforced by the reality windows fallacy: A reduction in wealth can be wealth that the costs of the carbon tax would be hidden in the enhancing. prices of myriad goods and services. As with the tax/ A third argument might be that enactment now budget nexus, the emissions goal is not independent of a moderate carbon tax would begin the process of of the policy tool chosen to achieve it. implementing a US GHG policy, which then could The AMS assumption that a carbon tax coupled be strengthened over time. This rationale confronts with an elimination of the regulatory regime would be the same benefit/cost problem: Seemingly “strong” 2 OBSERVATIONS ON THE ALLIANCE FOR MARKET SOLUTIONS’ “CONSERVATIVE” CASE FOR A CARBON TAX BENJAMIN ZYCHER policies would have small effects at most. And at a The AMS carbon tax would not achieve its quali- political level, the demonstrated refusal by several tative stated climate goals, would not prove “revenue Congresses to enact policies yielding even small neutral,” and would be unlikely to prove more effi- GHG reductions does not bode well for the realism cient economically than a regulatory regime. It should of this possible justification. be rejected. 3 Observations on the Alliance for Market Solutions’ “Conservative” Case for a Carbon Tax Benjamin Zycher he Alliance for Market Solutions (AMS) describes With respect to “carbon pollution” as “one of Titself as an “organization of conservative leaders America’s most pressing economic challenges,” AMS . educat[ing] conservative policymakers on the ben- makes no reference to the substantial scientific dis- efits of market-oriented solutions to one of America’s putes over the timing, magnitude, and implications of most pressing economic challenges: . reducing car- anthropogenic increases in atmospheric greenhouse bon pollution.”1 And AMS supports “a revenue-neutral gas (GHG) concentrations.