REDISTRIBUTIVE EFFECT OF CARBON FEE AND DIVIDEND

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7 december 2018

Winning the culture war over climate change

By Martin Sandbu, Free Lunch
December 7, 2018

Why carbon tax-and-dividend is a winning policy

In my column for the FT on Wednesday, I highlighted the political economy challenge of climate change policy: the most efficient policies, which will reduce emissions by making carbon more expensive, tend to have regressive effects. I also pointed to the “carbon fee and dividend” proposal advocated by, among others, veteran climate scientist James Hansen as the sort of solution we need.

I will use this instalment of Free Lunch to delve into more detail, as well as address a number of comments, questions and objections I have received.

First off, while Hansen was the earliest proponent I have seen, the fee-and-dividend route has received support from many parts of the political spectrum. That itself is an answer to those who have reacted with scepticism about the political realism of the scheme. If Hansen supports it, many other environmentalists should find something to like. But it has also been endorsed by such grandees of the old US Republican establishment as George Shultz and James Baker.

Details of how such a scheme could work are sketched out by Hansen as well as the conservative-with-bipartisan-elements Climate Leadership Council. Both envisage a gradually rising carbon emissions tax (they prefer the term “fee”) “implemented at the first point where fossil fuels enter the economy” — interestingly including a border carbon tax on the carbon content of imported goods. But from a political economy perspective, the details of the “dividend” part are more consequential than the “fee” or tax part. How exactly carbon is made more expensive does not matter as much as long as the price of carbon goes up and the revenue is collected. A system of paid but tradable emissions quotas, or quota auctions, could work just as well (and are more realistic on an international level).

The revenue from carbon pricing would then be distributed as dividends to all citizens or legal residents of the jurisdiction; in the simplest version, all people would get an identical amount. This is the real political game changer of the scheme, because the amounts are substantial.

Hansen estimates that a $115/tonne carbon tax (which he says would add $1 to each gallon of petrol) would pay for “dividends of about $2,000 per legal adult resident or about $6,000 per year for a family with two or more children, with half a share for each child up to two children per family”. The US Treasury made a more recent analysis assuming a $49/tonne tax, which it found could pay an annual $539 per person, or more than $2,000 a year for a family of four (every person receiving the same amount in this modelling).

Note three things that a carbon tax and dividend would achieve.

The first is that it would be progressive. While environmental taxes risk being regressive or neutral — the US Treasury-modelled carbon tax would, on its own, roughly be distributionally neutral, reducing the incomes of all income deciles by about 1 per cent — an equal per capita dividend would obviously be highly progressive, as the chart below shows. (The poorest households would see after-tax incomes go up by almost 10 per cent in the Treasury estimate). It would, in other words, make climate change action work for such groups as France’s gilets jaunes.

Second, it would create incentives for everyone to reduce their carbon use, because the higher prices of carbon-intensive goods and activities would encourage people to change their behaviour, but the dividend would remain unaffected by individual choices.

And third, it would create a large constituency of people who would not just be made better off by the tax-and-dividend combination, but would have an interest in the taxes and dividends going up. In principle, everyone using less carbon than the national average would be in such a position. Since the average is likely to be higher than the median carbon use, this should be more than half the population (total carbon footprint, as opposed to carbon intensity, tends to follow total consumption, which is dominated by very high earners in unequal economies). In the Treasury estimate, the bottom 70 per cent of families would gain from higher carbon taxes and the dividends they would fund.

We should add that the extreme transparency of this scheme gives a lot more political traction for environmental taxes than other uses of the revenues. Some respond to the tax-and-dividend proposal by saying that the revenue should be spent on climate-related infrastructure or other mitigation strategies, not handed out in cash. But part of the intention here is to make very concrete the material advantage that a large part of the population will derive directly from and in proportion to environmental taxes. It is easier for politicians to pursue a more muscular carbon transition when the benefits are visibly directed to the worst off, and even better when to the majority.

One last objection I have encountered is to the very premise that the poor pay a cost for climate change policy. One version of this argument insists that decarbonisation has negative costs. This is probably true but irrelevant because a net economic gain can come with outright economic costs for some. Another version insists that the poor have most to lose from climate change so they benefit more from decarbonisation than the necessary policies cost them. But it is not at all convincing that this is true for the poor among the rich (people in France, countries in Europe). And even if it is, the poor may rightly put less weight on the distant future than the rich.

Above all, the benefits from decarbonisation, because of its impact on the planet, is independent from who decarbonises by how much. To take as given that those who benefit the most should therefore accept higher costs of decarbonisation is to close off a profoundly important moral and political argument by technocratic axiom. That is a sure-fire way to lose support and stoke the culture wars.


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