The Taiwan Banker

It’s a cliché of political reporting to always note how important the current election is, yet the events of the past few months confirm that the presidential elections in November of last year (and Georgia Senate runoffs in January) were probably in fact the most significant US elections so far this century. With victories in both Georgia races, the Democrats unexpectedly won control of the Senate, which controls most fiscal matters, by a razor-thin margin, giving them a clean sweep of the presidency and both houses. Democrats are in no mood to negotiate after former president Trump’s January power grab. President Biden planned a blitz of new legislation in the first 100 days of his administration, a symbolic period which references Franklin Delano’s Roosevelt’s efforts to counteract his predecessor’s inaction following the Great Depression. The result of that push is known as the New Deal, perhaps the closest historical precedent to the stimulus that has now passed and is being proposed. Key elements of the Reagan revolution are now being refuted. Two bills are being proposed, and one already passed, costing an equivalent of about 25% of US GDP. The USD 1.9 trillion pandemic package reinforces the importance of state capacity in public health. The proposed USD 1.8 trillion American Families Plan entrusts parents with direct payments for their children, and a further USD 2 trillion proposal will fund infrastructure construction bill will promote a number of green priorities, including affordable housing, electric vehicles, power grid upgrades, public transit, and R&D. It allocates USD 10 billion for a “Civilian Climate Corps,” a nod to Roosevelt’s Civilian Conservation Corps, as well as possibly to previous proposals for a Green New Deal from the left of the Democratic party. All of this comes after the US re-entered the Paris Agreement on the first day of Biden’s presidency. Despite the current political and economic situation, however, the one policy that both economists and climate scientists both agree is key to stopping global warming remains out of reach. Carbon taxes shouldn’t be considered a drag on growth, at least any more than any other tax, yet they were still left out of Biden’s new New Deal. The infrastructure proposal even raises taxes on corporate profits, working somewhat against the efforts of the Fed to pump money into the economy, while pointedly ignoring the issue of greatest importance for the future of the Earth. One of the reasons carbon pricing remains a radioactive political issue is that individuals don’t feel that they benefit directly from it. Which carbon policy? A tax by itself is only half of a policy. It’s hard to analyze who benefits and loses from a carbon pricing policy until it’s clear where the funds will end up; and until that occurs, taxes are the only aspect of the policy that voters perceive either. Carbon taxes could be used to fund consumption, reduce other taxes, or subsidize other energy sources, among other options – each of which has different political economy implications. It’s important to get all aspects of the design right, not only so that it can succeed based on technical measures, but also for it to be enacted in the first place. Some have drawn a distinction between the terms “fee” and “tax.” The US has a long tradition of antipathy towards taxes in general, but this nomenclature in fact also corresponds to real design choices. A fee doesn’t enter the general budget, helping guard against a stealth expansion of government powers through an ostensibly free-market measure. The funds can potentially be returned to taxpayers as a carbon dividend. Doing so would help neutralize one criticism of carbon taxes on the left, that they are regressive, because low-income people spend more of their money on energy. A dividend would help ensure that a carbon tax does not exacerbate existing inequality. The more important consideration is that it would create political constituencies to protect the tax policy. An important point that frequently gets lost in discussions about the costs, benefits, and distributional effects of carbon pricing is reducing the costs to governments and political parties of onboarding, and likewise increasing the costs of offboarding. Countries have a tendency to backtrack on previous climate gains, harming the confidence that credit providers need to have in order to fund a multi-decade carbon reduction project. Australia, for instance, cancelled its carbon tax after only two years in operation. The revenue of its tax was offset by income tax cuts, which did not benefit every taxpayer. Both Biden and former president Trump have found that direct benefits tend to be very popular, so it should in principle be harder to eliminate a structure that pays out to individuals. A separate entity set up to receive the funds could even conceivably be pre-funded, so that the benefits, and corresponding political support, begin before the fees. Secondary effects Despite the difficulty in the US so far in getting carbon taxes over the finish line, the political terrain is indeed shifting in positive ways. In March, the American Petroleum Institute, which counts giants like ExxonMobil and Chevron as its members, endorsed carbon pricing. “Rather than a patchwork of federal and state regulations and mandates that could ineffectively address the climate challenge, an economywide government carbon price policy is the most impactful and transparent way to achieve meaningful progress.” This position change marks a sea change from the days when the industry outright denied the existence of global warming. The question is how much distance remains between the recent talk and meaningful action. A study by Martin Ross of Duke University found that the CO2intensities of different regions of the US varies by a factor of 2-3 times. In general, the inland areas use more carbon, while both coasts use less. This map unfortunately corresponds closely with the political map: the Democratic base is centered around the knowledge economy. This finding can almost entirely explain why carbon taxes are supported mostly on the left, and will be an important factor for any future effort to overcome. An efficient and socially beneficial use of the funds from a carbon tax helps refute the notion that the pricing system takes money out of the economy. Nevertheless, this answer alone isn’t completely convincing, because not every part of the economy is equally carbon intensive. A tax must be evaluated not only on its overall costs and benefits, but also the differential costs on the various entities and activities it targets. Debates and Meta-debates Marginality is important not only due to questions of fairness and politics, but also the concrete incentives a policy may create for future actions. Consider how one might go about dodging a carbon tax. The easiest strategy from the perspective of a consumer would simply be to import a carbon-intensive product from a jurisdiction without a tax. This phenomenon, called leakage, is a major fear lurking behind opposition to carbon taxes, whether stated or not. People wonder whether a tax on production on one jurisdiction will simply cause it to move to another jurisdiction, resulting in de-industrialization. Forward-looking governments are aware of this problem. In March, the European Parliament announced that the EU would seek a carbon border tax on electricity and certain industrial products by 2023, which would eventually expand to include all items under the current domestic tax regime. One implication of this measure will be that US producers of exports to the EU will essentially already be paying a carbon tax, regardless of the what the US government does – which should reduce their resistance to a further domestic tax. It’s not enough to consider just the two states of a carbon tax existing or not existing. Instead, we’ll increasingly need to think about a world containing various policies with different strength levels of carbon abatement. The rise of ESG investing shows how global capital can set the investment environment within smaller domestic markets. The previous “bond vigilantes,” who punished any sign of attention to factors beyond profits, are now gone, and the notion of carbon taxes as “anti-business” may also eventually fall by the wayside. As more countries employ border adjustment measures, one could imagine a critical mass effect, eventually making it easier for the stragglers to join the bandwagon.