ECONOMICS : Paying for carbon emissions – tax or permit?

Pollution is an example of “an externality”, the term applied by economists to the costs imposed on society generally by producer’s activities. One way of trying to correct these externalities is by introducing “Pigovian tax”, to encourage the producer to reduce pollution and collect government revenues that may be used to counteract the negative effects of the pollution.
American Nobel laureate Joseph Stiglitz favours Pigovian tax for dealing with the causes of climate change. “A global externality can best be dealt with by globally agreed tax rate,” he argues. “This does not mean an increase in overall taxation, but simply substitution in each country of pollution (carbon) tax for some current taxes. It makes much more sense to tax things that are bad, like pollution, than things that are good, like savings and work.”
Greg Mankiw, professor of economics at Harvard University, is urging Americans to raise the tax on gasoline. Not quickly, but substantially. His reasoning: not only would this curb the pollution from petrol, but also it would address road congestion, replace heavy-handed regulation aimed at reducing energy dependence, and raise US$100 billion year that would make dent in the looming fiscal gap in the United States.
Mankiw, on his daily blog (, has been adding growing number of supporters to the “the Pigou Club” who favour Pigovian taxes. He recently noted that the club was bigger than he realised: Wall Street Journal survey shows 40 of 47 economists who responded believe the Bush government should help champion alternative fuels. Economists generally were in favour of free-market solutions, but acknowledged there are times when you need to intervene.
A majority of the economists said tax on fossil fuels would be the most economically sound way to encourage alternatives. tax would raise the price of fossil fuels and make alternatives, which today often are more costly to produce, more competitive in the consumer market. “A tax puts pressure on the market, rather than forcing an artificial solution on it,” says David Wyss at Standard & Poor’s. He warns that “we’re already in the danger zone” because of the outlook for oil supplies and concerns about climate change.
In this country, the Clark Government proposed introducing carbon tax to help it meet its Kyoto Protocol commitments to reduce greenhouse gas emissions. But farm leaders and business people opposed not only the tax, but also New Zealand becoming protocol signatory, back in 2002, saying the country’s productive sector would be penalised by commitment to reduce climate change effects. The Government backed away from pursuing carbon tax, at least for now, and opted to develop so-called cap-and-trade scheme. It would work like the fishing quota: businesses would have permits to emit certain volume of greenhouse gases, and if they didn’t want to use them, they could sell them.
The local business lobbies which opposed the signing of the Kyoto Protocol, joined under the umbrella of the Greenhouse Policy Coalition, are now cautioning against what they claim is “headlong rush” to finalise the scheme. But haste, rather than the need to do something, essentially is their grouch.
So what should be done? As business commentator Rod Oram recently noted in the Sunday Star-Times, cap-and-trade is, broadly speaking, the only alternative to tax or doing nothing at all. But Coalition members are divided: Business New Zealand is all for cap-and-trade; the Chambers of Commerce and Business Roundtable are for carbon tax; Federated Farmers prefers no action.
Roundtable chief executive Roger Kerr takes satisfaction from knowing that the world’s most noted economists are favouring carbon taxes. He has been keeping tally of recent contributions on the taxes versus permits debate. Among the specialist heavyweights in favour of taxes he lists Stiglitz, Mankiw, William Nordhaus, Robert Shapiro, David Henderson, Lee Lane, Glenn Hubbard and the Australian Productivity Commission (which favours taxes as precursor to possible trading regime). Also on the record in favour are The Economist magazine and former US Federal Reserve chairman Alan Greenspan.
“I haven’t spotted any heavyweights on the other side of the debate,” he says.
To Kerr, the big arguments in favour of carbon tax are greater price certainty, whereas there is the scope for rorting an emission trading scheme. But his organisation is trying to insist, first, that the Government produces solid justification for any further interventions, and then it says the Government must demonstrate that permits are superior to taxes. The Pigou Club’s increasing membership suggests this will be formidable task.

Bob Edlin is regular contributor to Management.

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