Understanding Taxes On Negative Externalties

TW: Krugman with support from Mankiw make an easy to forget point about climate change legislation. The point of climate change legislation is to discourage consumption of high carbon energy. The taxes or caps embedded in the legislation place a cost on the bad behavior but this tax revenue does not disappear into thin air. These revenues can be used, however, society wishes as defined by their legislators. Folks will no doubt argue vociferously about how to use the revenues (income tax cuts v. deficit reduction v. other spending etc.) but the revenues will exist.

Furthermore, there are additional negative externalities beyond the carbon emissions (e.g. imported oil subsidizing unfriendly regimes and our costs of protecting overseas oil sources etc.)

From Paul Krugman at NYT:
"...Basic economics says that if we want to discourage a negative externality, like pollution, we need to put a price on that externality. One way is through an emissions tax; an alternative, with very similar economic results, is a system of tradable permits. All this goes back to Pigou; Greg Mankiw has urged economists to join his Pigou Club of those who support externality taxes.

Now, a key point in all this is that the emissions tax...does not represent a net loss to society. It’s just a transfer from one set of people to another — from the emitters, and ultimately those who buy their products, to whoever collects the taxes or gets the permits, and ultimately whoever benefits from the revenue or rents thus generated. The only net loss is the Harberger triangle created by the reduction in emissions — which has to be set against the benefits of reduced pollution.

And the burden on households from cap and trade depends on what’s done with the rents (taxes). In the original Obama plan, the rents would be used to pay for middle-class tax cuts; in Waxman-Markey, many of the permits are initially granted to utilities — but since these utilities’ profits are regulated, many of the rents would end up being passed on to consumers through lower prices...

From Greg Mankiw (referring to Krugman's post above relative to utilities getting the permits for free initially) :
"...that is a bug, not a feature, of the Waxman-Markey bill. From the standpoint of economic efficiency, the price of carbon emissions should be passed on to consumers in the form of higher energy prices, so that consumers can make optimal decisions regarding energy consumption. Consumers should be compensated for paying these higher prices via cuts in income or payroll taxes. Those tax cuts would be financed by the revenues received from the auctioning of carbon rights (or, better yet, a carbon tax)."

TW: I agree with Mankiw the permits should not be given away initially but that appears to be a requisite in order to the get bill passed. The permits would eventually be auctioned creating the tax revenue and associated cost to consumers. Again the taxes would be "rebated" back to society in the potential forms mentioned above.


http://krugman.blogs.nytimes.com/2009/09/25/pigou-glenn-beck-and-the-false-case-against-cap-and-trade/