The New York Times turned over some of its valuable opinion space to Harvard economics professor Gregory Mankiw last weekend, so that he could discuss the merits of various carbon policies. His record on that score is not great, and he doesn't have any special training or experience on the subject, but as far as Big Media is concerned, being an economist makes you a wise commentator on literally any policy issue. All you need is theory!
Mankiw's main point is that a refunded carbon tax would be preferable to a cap-and-trade system, because ... economists prefer it. If they can't have that, they'll take a fully auctioned cap-and-trade system, which would be functionally equivalent to a tax. Obama campaigned on such a system, but now the ACES bill has been corrupted by "powerful special interests" and "most" of the allowances are given away, so Obama should veto the bill. Blah blah. It's familiar ground; Ryan Avent does some good work bashing it.
I want to hone in on one of Mankiw's background assumptions, a deep-rooted and ubiquitous assumption in economics that doesn't get discussed enough.
Mankiw makes the familiar economic point that it's good to "internalize an externality" (make polluters pay for the environmental damage they cause) by charging for carbon emissions. Also familiar is his follow-on point: whether we tax emissions or do auctioned cap-and-trade, it's crucial to return all the revenue the government gathers directly to taxpayers by reducing other taxes (either income or payroll). This so-called "tax shift" would be revenue neutral.
Now, I've argued at some length that under ACES most of the allowance value is not, in fact, "given away to powerful special interests." In fact, the bulk of the allowance value is returned to consumers. But for Mankiw, that's almost irrelevant. For mainstream Chicago School and neoliberal economists, it is a baseline assumption that money is more productively deployed by the private sector than by the government. Left to its devices, the market deploys capital efficiently (the "invisible hand" and all that). When government collects taxes and spends revenue, the capital is deployed less efficiently. Taxes result in "reduced economic activity" meaning "reduced growth of GDP." Government spending cannot compensate for that reduced growth, because governments aren't as smart as markets.
Insofar as government wants to secure a social benefit -- say, a clean environment or public health -- by a) constraining the private market through regulation, or b) spending tax revenue on public programs, it necessarily reduces economic productivity and GDP. There is no way around that trade-off. If you want a cleaner environment, you have to pay for it. You can't get something for nothing. No free lunch. Etc.
That's the root economic assumption. That's why economists (and elites who view the approval of economists as a mark of Seriousness) favor a tax shift: it is the absolute minimum government intervention required to secure the social benefit of reduced CO2 emissions. It does not "adversely affect the tax code" -- econospeak for raising taxes. It disturbs the precious, fragile, magical free market as little as possible.
It's impossible to exaggerate how much this assumption shapes U.S. policy discussions. Anyone who proposes a regulation or public investment is inevitably faced with the kneejerk Blue Dog response: "We can't afford that." We have a deficit, you see, and since government action by definition reduces economic productivity and GDP, it increases the deficit. We can't have government do one thing unless it stops doing something else -- it's a zero-sum game.
You won't be surprised to hear that I think this assumption is wrong. Both regulation and public investment, when done properly, can increase economic productivity. Their effect on GDP is uncertain, but GDP is an absurd measure of public welfare anyway. On more sensible measures of public welfare, regulation and public investment can produce net gains.
Most importantly, carbon pricing (whether carbon tax or cap-and-trade) cannot do the job on its own. If complementary policies are ruled out, we're dooming ourselves to failure. (I'm going to make this point at much more length soon. Aren't you excited?)
Obviously this kind of fundamental dispute in economics won't get resolved in a blog post. But everyone fighting for vigorous, multifaceted government action to address climate change needs to be aware of it -- aware of the fact that they are ultimately fighting against the core faith of mainstream economics. As long as they accept that faith, the best they can argue is that tackling climate change will only moderately slow the economy and reduce GDP. And when you're fighting a battle this important, "moderate pain" is a pretty poor rallying cry.