Guppies have been known to eat their young. There are probably evolutionary reasons for this. In our vernacular, however, the idiom implies a short sighted benefit at the expense of long term advances – a quick snack endangering survival of the species. In this sense, both the carbon tax with revenue recycling and the cap and trade with auctioned allowances may also eat their young.

Both approaches create a significant revenue stream to which government, politicians and the public will quickly be addicted adding to the problem of higher taxes, fees and consumer prices created by the tax. Recycling these revenues to offset regressive consumer price hikes will be politically necessary. The Climate Leadership Council proposes starting a carbon tax in 2017 dollars at $40 per ton of emissions and gradually increasing the tax until emissions fall to an acceptable level. CLC projects a tax escalating annually at inflation plus 4% would by 2025 reduce GHG emissions 24% from 2016 levels.

This necessarily implies about 76% of emissions or 4,399 million metric tonnes (“MMT”) would still be generated and taxed. In current dollars, 2016 and 2017 U.S. GDP were $18,624.5 and $19,390.6 billion, respectively. A $40 tax would increase government revenues by $176 billion or about 0.9% of GDP, and may go up from there.

This is a huge amount of money. Politicians heatedly argue whether GDP growth will be 2% or 3% under a new tax policy. Yet, CLC would claim almost that difference or more as new government revenues each year. This is not a formula for political popularity. To overcome this, CLC suggests recycling these revenues back into the private sector as “carbon dividends for all Americans.” The first check under a $40 tax would be about $2,000 for a family of four. Others have proposed recycling the new revenues in the form of reductions to existing taxes.

Put aside for a moment the obvious question of why impose a tax to be collected only when emissions have not been abated. Let’s not even talk about whether these revenues will be log-rolled into one pork-barrel after another, never to be recycled as dividends or reductions in other tax rates. Whether through dividend check or tax cut, the opportunity for unintended mischief and eating one’s young begins here. Recycling the revenue means a new government entitlement. If carbon tax revenues decline as they must, however, the entitlement cannot be sustained. In a June 2018 paper, CLC models a tax escalating at 4% annually. Mathematically, if the tax rate increases 4%, revenues fall unless emissions decline less than 3.8%. The math is this: (1 + 4%) x (1 – 3.8%) = 1.

Any emission reduction more than 3.8% will result in a funding shortfall, and the program will not be revenue neutral. Perhaps reducing GHG emissions by 3.8% annually is the right goal. But, what happens if emissions go down by 4% or 5%? Do we cut the entitlement to match lower revenues? That’ll never happen. Do we raise the tax? Good luck with that one. And, a higher tax might mean even lower emissions and larger revenue shortfalls. If the program slips into this black hole, there will be no choice but to raise the tax, lower emissions and revenues even more and thereby destroy the dividend’s own source of funding, i.e., the tax will eat its young. Obviously, once emissions are totally eliminated, revenues and entitlements will disappear.

Perhaps there is some balancing point where equilibrium is reached: a Goldilocks tax rate where neither emissions or revenues decrease too much. Are we willing to start down this path just to find out? I, for one, am not. Once we have a carbon tax and once dividend checks are written or other tax breaks implemented, there will be no going back. The hubris required to pilot our huge economy safely through this minefield is that of a tragic hero whose best intentions and admirable qualities nevertheless lead to a bad ending.

Even more troubling, however, is the basic truth that a carbon tax with recycled revenues hobbles our flexibility to limit emissions. Politically and economically, new tax and auction revenues must be recycled to the larger economy, and, in the language of systems analysts, would create a constraint or remove a degree of freedom. Sustaining emission levels or even slowing the rate of decrease in order to maintain revenues would be met with raucous environmental opposition. On the other hand, emission cuts threatening entitlement funding could engender an even louder popular uprising. A carbon tax runs unacceptable risks of becoming its own barrier to desirable GHG reductions. A carbon tax creates its own constraints on GHG reductions. This is unacceptable.

What I have said here about a carbon tax applies equally to an auctioned cap and trade. Why a cap and trade has auctioned allowances is a topic worthy of one or more separate posts and will not be discussed here. For this post, it is sufficient to say making GHG emissions less affordable means fewer of them, and entitlement funding based on emissions will be at risk as emissions disappear and the tax base erodes. There is a better way. Young need not be eaten. Stay tuned.

Best,

Bob