Last Saturday, I played woodwinds in a benefit concert in Camden. The Midcoast Community Choir, under the direction of Steve Weston, presented a beautiful collection of vocal performances. Those in charge decided, in light of the proposed federal budget to cut funding to Meals on Wheels, to give the net proceeds of the concert to that worthy institution.
During the past five months, we have seen a number of our institutions come under attack. A partial list of endangered institutions includes Meals on Wheels, Planned Parenthood, the EPA, public education, Medicaid, health insurance, climate accords, the World Trade Organization, and more.
To economists, this is alarming. After all, our standard of living depends on our ability to produce goods and services. That ability, in turn, is measured by five things: our labor force (human capital), our physical capital (buildings, factories, infrastructure, and other equipment), our technology, our natural resources, and our institutions.
To be sure, this has been going on for some time. Thirty-two years ago, libertarian Grover Norquist founded the Washington, D.C.-based lobby group Americans for Tax Reform. The group’s primary accomplishment has been the creation and implementation of the Taxpayer Protection Pledge which, since 1986, has been signed by more than 1,400 lawmakers, including the vast majority of federal Republican representatives.
The pledge has a federal and a state version. An individual who signs the federal pledge agrees to:
“One, oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and two, oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates.”
On the state level, the signer similarly pledges to oppose and vote against any and all efforts to increase taxes.
According to the group’s website, atr.org, currently 209 members of the U.S. House of Representatives and 45 members of the U.S. Senate have taken the federal pledge. As an economist, I would suggest that this is another example of the assault on a vital institution, namely, our federal government.
As I have noted in many past columns, the ability to tax is the ability to regulate our economy. And the ability to regulate our economy is also the ability to improve our standard of living, i.e., increase the size of the economic pie.
Recently, the U.S. president pulled the nation out of the Paris climate accord, another move to weaken institutions. Interestingly, the removal from the climate accord and the refusal to add new taxes intersect at an important economic junction.
Climatologists have determined with a high degree of certainty that observed global warming has occurred as a result of the “greenhouse effect,” i.e., warming that results when the atmosphere traps heat radiating from Earth toward space. The four gases of water vapor, nitrous oxide, carbon dioxide, and methane interact in ways to trap heat. The burning of fossil fuels over the past couple of centuries has altered the mix of these gases in such a way as to generate a rising heat level on the planet.
This is what economists call an “externality,” a byproduct of an activity whose byproduct is not captured in the direct costs of production or consumption. Such externalities typically insure that a “free market” will fail to produce the most efficient outcome. When an externality occurs, governmental action can nudge a market toward a more optimal production and consumption level, which in turn raises the standard of living, i.e., increases the size of the economic pie.
The tools within the hands of the government include taxation and regulation. The public sector can reduce greenhouse gases by taxing emissions or by limiting emissions through regulatory quotas. Generally, the U.S. has favored regulation, beginning with the National Environmental Policy Act of 1969 signed into law by President Nixon, who a year later signed an executive order to establish the U.S. Environmental Protection Agency.
In contrast, economists generally favor taxes as a more efficient way to deal with externalities of this sort. On June 19, The Washington Post published an op-ed piece by Harvard economist Larry Summers and Hoover Institute fellow George Shultz, which outlined a number of benefits from a proposal to tax carbon emissions. The proposal is backed by the Climate Leadership Council which includes BP, ExxonMobil, GM, Johnson & Johnson, P&G, Shell, Total, PepsiCo, and so forth.
In short, their proposal would initially tax carbon emissions at $40 per ton. The proceeds from the tax would be remitted back to households in the form of a dividend check on an equal basis. The U.S. Department of the Treasury has estimated that the bottom 70 percent of income earners in the U.S. would be net beneficiaries from the tax, with the typical family of four receiving roughly $2,000 per annum in dividends. Climatologists also favor the tax as an effective way to reduce greenhouse gas emissions.
Economists have for many years preferred corrective taxation over regulation as a means to nudge markets toward efficiency. The reason for this is not especially obvious to the noneconomist.
As an example, consider two corporations, a chemical plant and a steel mill, each of which dumps 1,000 tons of carbon dioxide into the air (2,000 tons combined). If the EPA would like to see this reduced to a total of 1,200 tons, it could require, through regulation, that each factory reduce emissions by 400 tons. Alternatively, it could require each factory to pay a tax for each ton it puts into the air.
If the tax is appropriately chosen, it will result in the same reduction of emissions. However, in the real world, as well as in theory, industries and factories differ on the costs associated with reducing greenhouse gases. For some factories, it is very costly, while for others it is less painful. By imposing a regulation, the EPA is, in effect, placing an equal reduction but a very unequal cost on each factory.
When polluters are taxed, each factory can choose for itself how much to cut back. For the plant whose cost is very high, reductions will be less. For factories whose cost to reduce pollution is low, reductions will be greater. I will not bore the reader with the mathematics that demonstrate that the corrective tax approach results in a higher standard of living than does the regulatory approach.
It is unfortunate that people such as Norquist have taken this option away from many of our legislators. Put another way, we need savvier lawmakers. But we already know that, don’t we?
(Marcus Hutchins is a former economist, treasury-bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at coastaleconomist@me.com.)
