Tag Archives: externalities

variable carbon tax

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This post explains how a variable carbon tax could work. In summary, it automatically adjusts when oil prices rise or fall, damping out the effects of price fluctuations and raising more revenue when prices are low. It can be designed so that the overall, average tax increases over time, with those increases happening when the economy can best handle them.

The tax would decrease gradually as oil prices rise, and then increase again when prices eventually come back down.

If the adjustments are asymmetric – larger increases when prices fall, and smaller decreases when prices rise – this system would gradually raise the overall carbon tax, even as it follows a counter-cyclical pattern. Such an incremental increase is what most models for controlling climate change call for…

The key to this strategy’s political feasibility is to launch it while prices are very low. Once it is in place, it will become a little-noticed, politically uncontroversial part of pricing for gasoline (and other products) – one that produces far-reaching benefits. Some of the revenue could be returned to the public in the form of tax cuts or research support.

Other forms of environmental harm could be taxed in this way too – for example, building materials (pavement) that cause pollution and habitat destruction, emissions of air pollutants other than carbon, consumer packaging not designed to be reused or recycled. You could make the whole thing revenue-neutral by reducing taxes on hard work and productive investment.

external costs

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Here’s a clear explanation of the rationale for regulating or taxing external costs:

Environmental regulation addresses a particularly striking example of market failure. Markets are generally efficient if companies’ revenues correctly reflect all the benefits that their output bestows on third parties, while their costs reflect all the harms. In this case, maximizing profit leads to maximizing social welfare.

But if production entails environmental damage for which companies do not pay, incentives are distorted; companies may turn a profit, but they function inefficiently in economic terms. So the state “corrects” firms’ incentives by levying fines or issuing bans.

I find this elegant as long as the external costs are relatively small compared to the costs that are reflected in the market. However, what if the costs priced by the market represent only a small fraction of the total cost. Then the idea of taxing the external cost wouldn’t work.