The politics of carbon taxes versus clean energy subsidies



Thu, November 25, 2021

Economists on both the left and the right tend to favor carbon taxes as the most efficient way of addressing global warming. In contrast, politicians on both the left and the right are reluctant to embrace this approach, due to a perception that carbon taxes are highly unpopular. Instead, politicians often implement something less effective: clean energy subsidies.

But why are carbon taxes unpopular? When economists say a policy is "more efficient," they usually mean it results in a higher level of real income for society. What if a carbon tax passes this test, and is a superior approach to policies that are already in place? Here, I'll argue that an appropriately constructed set of carbon taxes would not have to be politically unpopular.

To understand the politics of carbon taxes, we need to begin by recalling that economists view terms such as "taxes" and "subsidies" differently than the general public does. Economists know the concepts to be quite similar - two sides of the same coin. Both move money from one group to another, and both raise the relative price of some goods and reduce the relative price of other goods.

Many non-economists see taxes and subsidies as being quite distinct: taxes as money taken from the people by the government, and subsidies as money provided from the government. In one case, the money seems to just disappear, and in the other, it magically appears almost as if from nowhere. Of course, neither perception is accurate, but this means that subsidies are the easier sell.

One reason economists prefer carbon taxes is that they don't cause an increase in the national debt; indeed they can reduce it. But carbon taxes would be more efficient than clean energy subsidies even if they increased the public debt by the same amount. As a result, it should be possible to construct a carbon tax program that has the same fiscal impact as clean energy subsidies but is far more popular.

Assume the adult population of the United States is 250 million. If we (hypothetically) say the government is spending $200 per adult on clean energy subsidies, then the total cost of the program would be $50 billion each year. Let's also make the assumption that the full $50 billion is financed by the budget deficit, to match the mistaken perception that subsidies are free money.

Now, consider an alternative idea: a carbon tax that instead raises $50 billion each year. By itself, this would reduce the deficit by that amount. Thus, to have an equal fiscal impact to the clean energy subsidies, the government would need to rebate twice as much ($100 billion) back to the public.

Thus, Americans would on average pay an additional $200 in carbon taxes each year - but everyone would receive a fixed carbon tax rebate of $400, regardless of how much carbon tax one pays. For the same $50 billion price tag as the clean energy subsidies, we'd have a carbon tax program that looks more appealing to the public.

How does this reduce carbon emissions? While the rebate is constant, the amount paid in carbon taxes is proportional to one's energy use. Consumers would have a powerful incentive to move away from fossil fuel usage.

Only a very modest percentage would be paying out more than the $400 they'd be receiving - and those would be mostly affluent Americans. The net direct effect would be to put money in the pockets of the vast majority of Americans. That, plus the potential environmental benefits, should make it politically popular.

Of course, there are also indirect effects, as this program would continue boosting the budget deficit, just as with subsidies. But from a political standpoint, standalone carbon taxes are less popular than clean energy subsidies because people don't care about (or don't understand) budget deficits in the first place.

Carbon taxes are not unpopular due to the "carbon" part of the phrase - it's more about the "tax." But if economists are correct that at a fundamental level taxes and subsidies are the same thing, then it should be possible to construct a carbon tax-and-rebate regime that's just as enticing to the public as a subsidy, and more efficient.

Scott Sumner is the Ralph G. Hawtrey Chair of Monetary Policy with the Mercatus Center at George Mason University and a professor emeritus at Bentley University