The Conservative Roots of Carbon Pricing

Spencer Banzhaf

Current Issue

Even before the coronavirus outbreak, America was racing toward future fiscal challenges. By the end of 2019, the national debt stood at a record $17.2 trillion. As a percentage of gross domestic product, the debt was at a post-WWII high of 79% and, according to estimates from the Congressional Budget Office, was already on track to blow past that dubious distinction and reach 98% by 2030. Not surprisingly, the Government Accountability Office called America's fiscal trajectory "unsustainable." The Coronavirus Aid, Relief, and Economic Security Act alone has added another $2 trillion to the tab, and the economic shutdowns will hit tax revenues well into the future.

When America emerges from the short-term agonies of this pandemic, she will confront new fiscal realities. That will be the perfect time to reconsider a carbon tax, which not only makes for good environmental policy, but good fiscal policy as well.

Of course, nobody likes taxes. Taxpayers dislike them because they reduce income and revenues. Economists dislike them because they distort the economy: They make businesses less productive and give consumers less for their dollar.

Yet taxes are a necessary evil. Fortunately, the math behind them is simple: Taxing items or activities produces fewer of those items or activities. It is thus better to tax what we want less of, like pollution, than what we want more of, like income or sales. A tax on carbon of the scale suggested here would raise about $250 billion annually in revenue — enough to not only substantially reduce the debt over time, but also lessen our reliance on other kinds of taxes.

Some on the political right may balk at such a suggestion. After all, isn't the carbon tax — or indeed, any pollution tax — an inherently progressive idea rooted in misguided beliefs that government bureaucrats and other "experts" can manage the economy better than the market can?

Actually, the opposite is true. Various proposals to tax or price pollution have, from their beginnings, been championed by conservatives and their libertarian allies, including such right-of-center folk heroes as William F. Buckley, Jr., and Milton Friedman. In their time, pollution-tax proponents could be found on both sides of the political aisle, but the early history of practical proposals can be traced almost exclusively through Republican administrations.

Indeed, a look at the historical conservative and libertarian champions of a pollution tax shows that they viewed such proposals through a right-of-center philosophical lens. That is, while analysts across the political spectrum have agreed that pollution taxation can be useful policy, conservatives and libertarians of the last century emphasized reasons for favoring such policies that differ from the ones those on the left embrace.

Unfortunately, textbook arguments for pollution taxes often emphasize a powerful centralized government acting on elite expertise, reflecting a left-leaning bias that tends to alienate right-leaning audiences. But conservative and libertarian advocates of pollution taxes in earlier eras grounded their rationales in the ignorance of policymakers and the importance of long-run economic dynamism — two touchstones of the political right. Thus, when taking up the idea of a carbon tax, conservatives and libertarians need neither re-invent the wheel nor feel like they are embracing a progressive idea. Rather, they can support a fiscally and environmentally prudent policy by drawing on market-friendly political traditions.

PRICING POLLUTION

Before delving into those traditions, a brief primer on proposals to price pollution — from taxes to cap-and-trade — may be useful.

As Ted Gayer has discussed in these pages, pollution taxes and cap-and-trade systems are distinct but related ideas linked to pollution pricing. A pollution tax is as simple as it sounds: Just as other activities can be taxed, so too can the emission of pollutants such as carbon. To tax an activity, one must monitor the activity — for an income tax, income must be monitored; for a sales tax, sales are monitored. This is actually easier to do in the case of carbon than it is for other types of pollution — or even other types of taxes — because the carbon content of a fuel at a mine or pump simply passes through the supply chain one-for-one until it is emitted. Thus, carbon can be taxed at the relatively few points where it is drilled, mined, or imported.

As environmental policy, a carbon tax would impose a cost on harmful emissions, thereby creating incentives to reduce them. It would also encourage the development of new and better ways to reduce pollution, since such discoveries will allow industries to reduce their tax burdens.

As fiscal policy, taxation of carbon — in contrast to taxing income or consumption — has the virtue of discouraging something we want less of rather than something we want more of. A revenue-neutral carbon tax that displaces other, more distortionary taxes would thus increase the efficiency of the tax system. Of course, in the wake of the fiscal costs associated with the Covid-19 response, what qualifies as "revenue neutral" may be ambiguous. But if increased revenues ultimately prove necessary because of unsustainable debt, introducing a carbon tax would be an efficient alternative to increasing income taxes.

A carbon tax would set a price at which carbon emissions can be obtained. The price would be stable over time, adding predictability for industry. In textbook economic theory, the price per unit — say, one ton — of carbon would be set at the marginal damages imposed by one ton of carbon emissions. Thus, if one ton of carbon causes $50 of damage to the economy, the price should be set at $50 per ton. This also happens to be the principle by which prices of other private goods are set. For example, if using a ton of iron has a cost of $100 in terms of other opportunities foregone, the market price of one ton of iron will be set at $100.

Though useful, estimates of damages should be taken as no more than a rough gauge. Ultimately, setting the tax at the correct price, as suggested by basic textbook presentations, is simply beyond the reach of human calculation. Pollution prices cannot be determined any more accurately than the prices of any input could be calculated in a planned socialist economy. As Friedrich Hayek explained 75 years ago, only markets can distill into a price the many complex, dispersed, and conflicting information signals related to the value of a commodity.

Having internalized Hayek's lesson over the years, pro-market conservatives and libertarians are naturally skeptical of the textbook case for carbon taxes. Yet even if such taxes are not set at some theoretically ideal level, they have the benefit of channeling ingenuity and innovation toward the reduction of harmful activities. Moreover, any "mistakes" made in setting a carbon tax must be compared to the alternatives. Is the income-tax system — or any other aspect of the current system — remotely "optimal"? What about existing environmental policies that ignore market incentives and market signals (perhaps by mandating and thereby locking into place a particular technology and enforcing those mandates through endless lawsuits)? Viewed in this way, the carbon tax emerges as a far more efficient option than the alternatives.

A second form of pollution pricing is known as cap-and-trade. Cap-and-trade is in many ways the mirror image of a pollution tax. The "cap" aspect of cap-and-trade works by limiting — or "capping" — the total quantity of carbon produced. The "trade" aspect works by commodifying units of carbon under the cap and allowing those units to be traded so that the highest bidders can claim use of the atmosphere. Whereas pollution taxes lock in a price and allow the quantity to be set by the market, cap-and-trade locks in a quantity of carbon emitted and allows the price to vary depending on the demand for that quantity in any given year.

Although the price of carbon would be less predictable under cap-and-trade than under a tax, most cap-and-trade policies allow for "banking" of carbon over time, which helps smooth the price path and allows the amount of carbon used to vary from year to year. Moreover, just as people today can buy carbon "offsets" when flying or engaging in other emissions-heavy activities, under a cap-and-trade system, firms and individuals could buy out a portion of the cap. Such offsets create the possibility of trades between polluters and environmentalists, which would facilitate the market's discovery of prices.

Many cap-and-trade programs work by giving away pollution rights, often to past polluters. Such giveaways reduce the degree to which the policy re-allocates existing property rights and help create buy-in from industry. On the other hand, they forego the opportunity to raise revenue. A variant of cap-and-trade, which would have advantages similar to those of pollution taxes with respect to raising needed revenue, would auction off all or some of the permits rather than giving them away.

CONSERVATIVES AND THE ENVIRONMENT

Conservatives and libertarians alike are rightly skeptical of experts who claim that the environmental crisis du jour requires radical social change. But while they've adopted a posture of healthy distrust toward would-be technocrats, this does not by itself establish a coherent theory of atmospheric physics. To say "I believe in limited government, therefore I do not believe in anthropogenic climate change" is to utter a non sequitur. As Hayek put it, "[s]hould our moral beliefs really prove to be dependent on factual assumptions shown to be incorrect, it would hardly be moral to defend them by refusing to acknowledge facts." Thus, to hold a truly robust belief in the power of free markets, one must look at problems like global climate change in the eye and offer solutions to them grounded in free-market principles.

Historically, this was precisely the posture adopted by leaders of the modern conservative movement. From Barry Goldwater to Ronald Reagan, Milton Friedman to Ronald Coase, the leading politicians, public intellectuals, and academics of the movement argued that government should be limited, that there are rational criteria for defining its limits, and that protection of the natural environment met the test for action even from limited governments. They also believed environmental policy could and should follow conservative principles.

Pollution taxes — and their cousin, cap-and-trade — represent a quintessentially conservative approach to environmental problems. The impulse behind them was, from the beginning, consistent with the conservative/libertarian philosophy that markets are the most efficient method of allocating resources, that they effectively encourage the dynamic development of new technologies and ways of acting to solve problems, and that they work best in the presence of clear property rights and low transaction costs.

Goldwater, whose political career sprung from his travel lectures on the Southwest, defended these landscapes as essential symbols of the American character. An ardent anti-communist, he felt such spiritual virtues should never be sacrificed upon the godless altar of materialism. In this respect, Goldwater can be understood as a bridge between modern conservativism and Theodore Roosevelt's earlier version, which wedded progressive management to a conservative emphasis on what he called the "manly virtues" of rugged individualism and strength of character as shaped by the experience of wilderness.

Goldwater was struck by the growing problems of air and water pollution in the 1960s. Tellingly, even before a time when environmental issues like climate change had become ubiquitous matters of public concern, he looked upon the Lake Erie fire of 1969 and argued that it is "scarcely possible to claim that man's ability to destroy his environment has any serious limitations."

What to do about it was another matter. Goldwater was no philosopher, and he clearly struggled to reconcile his conviction that something should be done to address environmental problems with his conservative principles of self-reliance, limited government, and free enterprise. His proposals were admittedly scattershot.

Friedman, an advisor to Goldwater's 1964 campaign, had more definite ideas on the subject. Although he did not contribute to the environmental literature in his academic work, he discussed the matter in his more popular writings, interviews, and other public forums. In Capitalism and Freedom, Friedman argued that environmental problems were a classic example for which there is a case even for a limited government to act. In a 1970 statement in support of the Coalition to Tax Pollution, he pointed out that the normal remedies to which a free society first turns to rectify wrongs do not work with air pollution because the damage to each individual is so indirectly related to the polluter that individuals cannot plausibly sue in a court of law. "In those cases," he said, "it is perfectly appropriate that government step in on behalf of the people...and impose the cost on the producers [of electricity]."

Later, in Free to Choose, he and his wife, Rose Friedman, explained that our goal should not be to eliminate pollution entirely, but to balance the environmental benefits of reducing it against the economic costs. Cost-benefit calculations, the Friedmans asserted, could help find that balance. More importantly, they argued that the best way to achieve such a balance was by pricing pollution through what they called "effluent charges":

Most economists agree that a far better way to control pollution than the present method of specific regulation and supervision is to introduce market discipline by imposing effluent charges. For example, instead of requiring firms to erect specific kinds of waste disposal plants or to achieve a specified level of water quality...impose a tax of a specified amount per unit of effluent discharged. That way, the firm would have an incentive to use the cheapest way to keep down the effluent. Equally important, that way there would be objective evidence of the costs of reducing pollution. If a small tax led to a large reduction, that would be a clear indication that there is little to gain from permitting the discharge. On the other hand, if even a high tax left much discharge, that would indicate the reverse, but also would provide substantial sums to compensate the losers or undo the damage.

In short, Friedman believed that pollution met the test for when government should act, but that when it did so, it should use market principles to the greatest extent possible — as with a pollution tax.

A public intellectual and architect of conservative coalitions, William F. Buckley, Jr., occupied a middle ground between politicians like Goldwater and Reagan and academics like Friedman. He, too, believed that pollution was a challenge that could be met with conservative ideas. Like Friedman, he argued that although limited government was a core conservative principle, pollution was an example of a truly "legitimate concern of government — a classic example of the kind of thing that government should do, according to Lincoln's test, because the people cannot do it as well or better themselves."

In his quixotic 1965 campaign for mayor of New York, Buckley made several environmental policy proposals that can be grouped into three categories. First, he argued that government should clean up its own mess — for example, by putting pollution controls on city-owned vehicles. Second, he called for adopting a few commonsense local regulations, like a ban on the burning of garbage. At a time when local pollution was more severe and many local pollution sources were relatively uncontrolled, such proposals were consistent with the principle of matching the remedy to the geographic scale of the harm (for climate change, that principle would suggest action at the national level).

Third, and most important for our purposes, Buckley contended that the government should combat pollution by adopting pollution pricing and other incentive-based regulations. One example was a system of effluent fees for water pollution. "The flow of pollutants from industrial sources should be monitored," Buckley asserted, with fees "based on the amount of pollutants that enter the water flow." He argued that industrial air pollution should be dealt with in the same way — with fees on emissions.

THE IVORY TOWER

Even as Buckley was making these proposals, economists and other academics were developing the broad intellectual foundation for them and the practical details of implementation. The idea of pollution pricing has a complex history, with no single economist or even school of thought able to claim unique credit. But the very fact that the intellectual base of pollution pricing is so broad is itself important for two reasons. First, it reinforces Friedman's point that "most economists," of all schools, support pollution pricing. Second, it means there are different intellectual traditions, with their own particular perspectives on pollution problems, on which conservatives and libertarians can draw. That is, pollution pricing is a policy about which right-leaning thinkers can agree with their liberal neighbors, even while offering different reasons for doing so.

Four important schools of thought behind pollution pricing can give us a taste of these varied intellectual origins: Arthur Cecil Pigou's work on externalities, American institutional economics scholars' historical analysis of property rights, Ronald Coase's new-property-rights approach to environmental issues, and the writings of Allen Kneese, Thomas Crocker, and John Dales on pollution taxes and cap-and-trade.

Undoubtedly, one of the most important of these sources is the public-economics tradition of Pigou, the British economist who, in the early decades of the 20th century, articulated the concept of "externalities" — situations where there exist important effects on people not directly involved in an economic decision. Though often associated with activities where the effects that spill over onto third parties amount to costs, as in the case of "smoke from factory chimneys" and other forms of pollution, externalities, Pigou noted, can be positive when they benefit third parties. Negative externalities, however, justify government intervention on behalf of the parties harmed — in Pigou's mind, via taxation of the underlying activity.

Pigou's name has developed a bad reputation in some conservative circles, since his program seemingly calls for elite experts to divine the "correct" prices for pollution, as in a planned economy. In fact, to some degree, the distaste for carbon pricing today may involve guilt by association with Pigou. That is too bad, because Pigou was in many ways quite cautious about government intervention, recognizing the fallibility of experts and the potential for rent-seeking.

Moreover, while his work certainly played a role in the development of pollution pricing, Pigou's impact on the field is likely overstated. For one, there appears to be a gap of several decades between the time Pigou wrote and the modern development of the theory of externalities by the generation of scholars that followed, especially as applied to environmental problems. When that generation did develop those ideas, scholars rarely cited or referred to Pigou in their initial work, suggesting the adjective "Pigouvian" was more a convenient post hoc moniker than a signal of hereditary lineage. What's more, Pigou's earlier writings covered a wide range of topics, some with only tenuous connections to environmental problems. Alongside factory smoke, Pigou discussed questions of how an individual firm's investments could create industry-wide efficiencies, as well as questions of property rights, such as the disincentives a tenant farmer has to maintain the fertility of the land. In attempting to read modern theories of environmental problems back into Pigou's work, one is hard-pressed to decide whether it fits better with his discussion of factory smoke or his thoughts on industrial productivity and land tenancy.

Perhaps one reason why later economists do not appear to have relied heavily on Pigou is that, when it came to discussions of productivity and property rights, there were plenty of other traditions to build upon. In the United States, American institutional economics — with its emphasis on embedding economics in a cultural and legal framework — and agricultural and natural-resource economics — with its emphasis on applied problems — would have been equally compelling sources on which to draw.

These points of view were encapsulated nicely by America's 26th president, Theodore Roosevelt. The problem of overuse of natural resources, said Roosevelt, could be understood through an analogy to a farmer's stewardship of the soil. "Every one knows that a really good farmer leaves his farm more valuable at the end of his life than it was when he first took hold of it. So with the waterways. So with the forests." Stewardship of the land, he observed, is grounded in the incentives of property rights:

We should exercise foresight now, as the ordinarily prudent man exercises foresight in conserving and wisely using the property which contains the assurance of well-being for himself and his children. We want to see a man own his farm rather than rent it, because we want to see it an object to him to transfer it in better order to his children. We want to see him exercise forethought for the next generation. We need to exercise it in some fashion ourselves as a nation for the next generation.

In other words, stewardship of all natural resources can be understood on the same terms as stewardship of land, which requires private property.

A third important facet of the intellectual foundations of pollution pricing is the "new institutional economics" and property-rights approach to the environment, which was pioneered by Coase. Along with Friedman, Coase was a major figure in the Chicago school of economics, which emphasizes freedom and market forces. In "The Problem of Social Cost," Coase argues that if rights are well-defined, and if transaction costs are low, markets will allocate resources efficiently. The environment is a scarce resource, the argument goes, with its use as a sink for disposing carbon and other wastes competing with its use in maintaining ecosystem services. But when, as a matter of course, this scarcity is ignored and the atmosphere is treated like a free good, environmental harm results from overuse. Coase also observed that pollution markets do not evolve organically, largely because rights to the environment are ill-defined. After all, nobody will purchase a right if they aren't convinced someone has it to sell.

Coase's ideas helped inspire the cap-and-trade approach to environmental pricing. Put simply, cap-and-trade defines rights to a resource like the atmosphere, allocates a level of access to industry, and lowers transaction costs by commodifying the resource and creating a trading platform. Coase's emphasis on trade between polluters and environmentalists is consistent with the idea that cap-and-trade can include purchases of offsets to reduce emissions.

In other work, Coase argues that if transaction costs are high — which makes trading difficult — it may make sense to auction rights to a resource. Carbon taxes can be viewed through this lens, as they entail the government claiming the right to the air as a public resource and selling it at a posted price. The only difference is the terms of the sale: Whereas an auction involves setting a fixed quantity and selling it at the price equilibrating demand to that quantity, a carbon tax involves setting a price and selling any amount demanded at that price.

Perhaps the clearest, most concrete ideas about pollution pricing come from three resource economists writing in the 1960s: Allen Kneese, Thomas Crocker, and John Dales. These economists drew on all the aforementioned schools of thought in various proportions, though probably the least from Pigou.

Kneese, more than anybody, developed a theory of pollution taxes — which, like Friedman, he referred to as "effluent charges." Though not overtly political in his writings, he grounded his ideas in a set of principles that conservatives and libertarians can embrace. First, he argued that to allow for flexibility in relation to local conditions, pollution markets should be tied to an authority at the appropriate spatial scale — that is, markets should be overseen by the agency at the most immediate competent level. In the case of water pollution, for instance, Kneese advocated pricing at the scale of the water basin. In making these arguments, he drew on Coase's analysis of a firm that internalizes erstwhile externalities within its own operations.

Second, rather than focus on the fallacy of a planner who can set optimal policy, Kneese recommended a more bottom-up discovery process through trial and error. As he noted, pollution pricing actually limits the need for bureaucratic expertise because the market will allocate pollution abatement across industrial sectors, across firms within sectors, and across pathways for achieving abatement within a firm.

Crocker and Dales, meanwhile, are best known for developing early cap-and-trade proposals. Both were influenced by American resource and development economics as well as Coase's theories.

Crocker developed his ideas within a framework of property rights. Pollution problems, he said, arise because the atmosphere is treated as common property, as "it is difficult to define property rights in the mobile gas known as air as distinguished simply from air space." Drawing on the historical analogies to farmland, he further pointed out that with farmland and most other resources, one can modify its physical characteristics to maximize its economic value (e.g., by reducing soil erosion). But with air, that is not possible. Thus, he argued that one should not say deposition of wastes is always bad, but rather find a way to define property rights to the air that recognizes the reciprocal opportunity costs, where one person's use of the air for depositing wastes reduces its ecosystem services and vice versa.

Dales agreed, and further emphasized the advantage of cap-and-trade as a system that does not require cost-benefit analysis or other expert calculations; rather, it sets the price through market negotiation. He credited Coase as an important inspiration for the idea, and Coase himself was happy to accept the credit, viewing the idea through the lens of his own intellectual framework.

FROM THE IVORY TOWER TO THE WHITE HOUSE

Contrary to what today's environmental discourse might lead one to believe, all the early precedents moving federal environmental policy toward pollution pricing came from Republican administrations.

The first serious proposals to tax pollution came from the Nixon administration. In 1970, President Richard Nixon proposed a tax on the lead content of gasoline, at $4.25 per pound of lead. The proposal aimed to incentivize the development of car models using catalytic converters, which would reduce smog, and to reduce lead emissions themselves. Then in 1972, Nixon proposed a tax on sulfur emissions. The tax was to be levied on actual emissions, which would be monitored, with exceptions allowing for a tax on fuel content where emissions monitoring was not feasible.

In its public statements, the Nixon administration focused its rationale for using a pollution tax on incentivizing research into and development of new methods of pollution control, which, in the long run, would lower abatement costs. Thus, the administration viewed pollution pricing not so much from the top-down perspective of an omniscient social planner who could compute the point where marginal benefits equal marginal costs, but from the perspective of incentivizing emergent dynamism in the technology and technique of creating a cleaner environment.

However, it was early going for pollution pricing as an idea. Although Friedman and a wide array of other economists supported them, Nixon's proposals met fierce opposition from industry and gained only mixed support from environmentalists. The lead tax died in the House Ways and Means Committee, while the sulfur tax failed to find a single Republican sponsor in the House.

But it was not the end for the pricing of either leaded gasoline or sulfur emissions. The next major policy development for pollution pricing in the United States came during the Reagan administration. Though Reagan generally felt U.S. industry was over-burdened and over-regulated, when regulations were required, he preferred them to be as economically efficient as possible. Thus, his administration elevated the importance of cost-benefit analysis (a test based on market logic) for environmental regulations and tasked a new agency at the Office of Management and Budget (OMB) with overseeing them. The idea was to ensure, in Friedman's words, the "balance of benefits over costs."

In accordance with this philosophy, when regulation was called for because of the potential environmental benefits, the Reagan administration wanted to regulate in the least-costly manner. Since the Nixon administration, the phase-out of leaded gasoline had been one example of an environmentally justified goal, but one that raised questions of cost, especially for small refineries. To navigate this dilemma, the Reagan administration adopted pollution pricing in the form of a tradable permit program for lead content — arguably the first major cap-and-trade program. The idea originated in OMB, not the Environmental Protection Agency, making it technically an idea of the Reagan White House. As with Nixon's proposed tax on lead, small refineries were crying for an exception to the lead-content regulations. The trading program allowed them to blend more lead into their gasoline, but only by buying those rights from other firms at a market-determined price. In this way, the market steered lead to refineries that needed it most and steered pollution reductions to those that could provide it best. The government's role was limited to setting the cap (in this case, computed as a share of total leaded gasoline) and allocating rights while letting the market work.

Following in the footsteps of this experience, the Clean Air Act Amendments of 1990 introduced trading for sulfur emissions on a large scale — the most comprehensive pollution-pricing scheme ever contemplated and a blueprint for future cap-and-trade systems. Pushed by the George H. W. Bush administration over a skeptical environmental lobby, the policy was hailed at the time as a victory for conservative, market-based approaches to environmental policy.

BLINDED BY POLARIZATION

Since the early 1990s, progressives of various stripes have embraced carbon pricing as the go-to approach for addressing climate change. In doing so, they have effectively admitted that conservatives were right all along.

But the polarized nature of our political culture has meant that many conservatives have responded to this victory by treating it as a defeat — by taking the left's embrace of carbon pricing as a sign that the right should reject the idea. This is a sad commentary on the condition of our politics, as well as an obstacle to reasonable tax and energy policy. It is time conservatives returned to their roots and took up this cause once again.

Spencer Banzhaf is a professor of economics at Georgia State University.


Insight

from the

Archives

A weekly newsletter with free essays from past issues of National Affairs and The Public Interest that shed light on the week's pressing issues.

advertisement

Sign-in to your National Affairs subscriber account.


Already a subscriber? Activate your account.


subscribe

Unlimited access to intelligent essays on the nation’s affairs.

SUBSCRIBE
Subscribe to National Affairs.