Stephen Gordon: Carbon tax open letter rebuttal challenge accepted

On X, Professor Stephen Gordon issued a challenge to rebut An Open Letter from Economists on Canadian Carbon Pricing. Professor Gordon, challenge accepted.

First, I want to make clear that we are talking about the real world – and that includes everything that goes into the climate change agenda, from carbon taxes to public choice. The carbon tax debate is about something much larger than an idealized commodity tax used to mitigate an externality as argued from a second year undergraduate econ textbook. The public and the political parties are well aware of the real debate taking place: Climate change mitigation is an invitation to an incredible centralization of government power of which a carbon tax is not a replacement for inefficient alternative policies, but the first of many potentially slippery steps toward dirigisme. How much centralization of power, with all the risks and threats to liberty and economic growth that that power entails, is worth it for mitigating the externality created by greenhouse gas emissions? In that sense An Open Letter from Economists on Canadian Carbon Pricing is naively partisan and the letter will be used by the political class for its partisan implications. They’ve already started.

Yes, the economists are right about the efficiency of a commodity tax with rebate, which is the essential content of their letter. Carbon burning activities are normal goods and higher prices will reduce demand. Wealth compensation will restore, and in many cases improve, the original utility level of most consumers at a lower level of carbon consumption, even if they can afford their previous consumption level. Distorting effects follow the standard triangle of the second order of smallness deadweight loss arguments (provided the absence of other pre-existing margins of distortion). As policies go, using prices to do the work of resource reallocation is far more efficient than top-down government decree. The basic idea is that the market price of carbon burning does not reflect the full cost to society and the commodity tax restores cost/benefit margins across consumption. Basic econ; got it. And it has nothing to do with the carbon tax debate in Canada.

Let’s deal with the size of the externality. The open letter is a little sneaky here and I think academics who are trying to educate the public on an important issue could do better. They state:

“A conservative estimate is that the impacts of climate change will cost our economy at least $35 billion by 2030, and much more in future decades.”

Fine, but starting from when? What the letter leaves out is that the $35 billion by 2030 is the estimated cumulative total cost from 2015. The $35 billion is not an annual figure; the letter should have made this point more clear. Canada’s GDP is about $2,000 billion per year. From 2015 to 2030, the total cumulative GDP is about $30,000 billion making the effect size of climate change about 0.1% of GDP per year. Economics always stresses the opportunity costs of alternatives. Why are we spending so much time and energy, let alone real money, on a problem with an effect size of 0.1% per year of GDP? How is that a “a real threat to Canadians’ economic well-being”? Even if the effect grows to 0.2% per year, it means that the economy would be about 15% smaller than it otherwise would have been in the year 2100. The real problem is that are in fact many pre-existing margins of distortion much more severe than climate change – inefficient taxes on capital and labour, rent control, marketing boards, red-tape in small business formation, over-regulation, protectionist tariffs, misaligned entitlements, and rent-seeking channels in nearly every walk of life from health care to hair styling. All of these issues shave off growth at least ten times greater than climate change and perhaps much more, and they are potentially much easier to deal with. Getting the basics wrong means we will squander perhaps as much as 1,000% of economic growth potential over this century – the difference between 5% and 2% GDP growth per year. Just imagine if the airplane was invented today. In our hyper-regulated world, how long would it have taken before a government would have allowed a business to carry passengers? Thankfully, the real world saw its first regularly scheduled airline service just 10 years after the Wright brothers at Kitty Hawk. If the signatories wish to be taken as non-partisan as they claim, perhaps instead of presenting the idealized arguments from an undergraduate lecture about the efficiency of a commodity tax with rebate that is super important to only one side of the political spectrum, they could pen a full-throated open letter that emphasizes those areas where Canada could make the greatest improvements to the growth rate of the economy. In the end, it’s economic growth that shatters poverty, pays for social programs, and eventually leads to a world with cleaner energy and a cleaner environment. A sclerotic and an anemic economy is the real threat to Canadians’ well-being; climate change mitigation chases couch change.

The Canadian public understands the carbon tax debate far better than the experts might imagine. The public is being asked to pay for a small, if not minuscule, externality in the present that will not move the needle on the issue globally. More importantly, the Canadian public sees climate change mitigation as an overwhelming call to centralize power. Politicians and activists supportive of the carbon tax also generally advocate for heavy government industry intrusion, with the carbon tax but one of a plethora of dirigiste policies. For similar reasons Milton Friedman opposed creating a negative income tax as just another welfare program on top of a behemoth system. The public will not believe any party that promises to implement a carbon tax in lieu of all other climate change mitigation programs and nor should it. The public also sees many, if not most, of those same advocates and politicians using climate change as an opportunity to address a long wish list of progressive causes. Whatever the merits of those causes, they have nothing to do with the simple argument of restoring marginal costs and benefits associated with an externality, and the public knows it. It’s true that climate change is a big collective action problem but mitigation creates a giant public choice problem with all its attendant real world capture issues. No government that depends on the climate change mitigation vote can withstand those power-centralizing pressures. Perhaps this is the reason so much political capital is spent on the climate change agenda. Opposition to the carbon tax is a political signal that says:

Given the smallness of climate change effect sizes on the economy, the trade-off from living with the externality is worth it, rather than accepting a slippery slope that centralizes power, magnifies regulatory capture, and portends a threat to liberal democracy itself.

Maybe the opposition is wrong and we have nothing to fear from the centralization of power, despite Eisenhower’s warning, but this is the real value-based debate Canadians are having through their elected representatives. The signatories might be right on the academics of curve pushing, but they are very wrong in understanding the nature of the political question being put to the Canadian public. And that’s why democracy with all its sham, political theatrics, and broken promises is far better at judging the real evidence than economists give credit. Let’s not forget Kennedy’s lament after the Bay of Pigs disaster:

“How could I have been so foolish to have trusted the experts?”