Climate Change Policy: Should We Tax the Poor to Help the Rich?

By David R. Henderson

One of the most common advantages affirmatives claim on the alternative energy topic is climate change.  The main reason for increasing alternative energy use is to decrease greenhouse gas emissions from fossil fuels that may contribute to global warming.  Thinking about global warming and efforts to combat it requires us to compare costs today with potential benefits that do not fully emerge until 100 years or more in the future.  How should we think about such tradeoffs? 

This paper provides strong offensive arguments against taking action today to combat global warming.  Negatives can argue that by investing the money affirmatives argue we should spend to offset global warming, we could increase our national income and therefore have more options in the future to deal with global warming if it does occur.  In what follows, I draw heavily from a presentation given by Kevin M. Murphy of the University of Chicago at the Mont Pelerin Society meeting in Tokyo in September 2008.

Comparing Generations.  My father's father was born in 1855 and my father's mother in 1875.  Although they were probably in the top two percent of the wealth distribution in the early 1900s, and my wife and I are not in the top five percent today, we are wealthier than my grandparents were.  We have a nicer car (two, actually), a nicer house, the ability to get information instantly rather than going to the library, and access to life-saving drugs.  I can also fly somewhere 3,000 miles away for a weekend and pay less than two days' salary to do so.  But how I wish they had saved early in their lives, invested that money, and set up a trust fund for me.  They were too selfish.  They should have thought of me.

Do you see anything wrong with this picture?  Had my grandparents done what I wished, they would have enjoyed even less consumption so that I could enjoy even more.  The gap between their standard of living and mine would have been even larger.  They would have been transferring wealth from the relatively poor (themselves) to the relatively rich (me). 

Tradeoffs.  This parable shows one problem with much thinking about global warming policy.  The odds are high that future generations will be wealthier than we are, just as we are wealthier than past generations.  If we impose large costs on ourselves today to create environmental benefits for our grandchildren, we will be sacrificing for people who will almost certainly have a higher standard of living than we have.

The claim that global warming will be a big problem is controversial.  But let's assume that global warming will be a big problem.  There are two important questions: (1) What should we do about it? and (2) When should we do it?  Broadly speaking, we can handle the problem of global warming in one of two ways: we can make a major adjustment now or we can wait and make gradual adjustments through time.

The advantage of doing something now is that we can slow down global warming so that we don't need to adjust as much when it happens.  But there are two huge disadvantages.  First, we would be making commitments based on current technology.  Because technology will almost certainly improve, we would be using cruder, more-expensive technology than if we waited.  Second, capital invested now in offsetting global warming could, instead, be invested in ways that would expand our national income-therefore making us wealthier and giving us even more options in future years. 

Comparing Today's Cost to Tomorrow's Benefit.  How can we compare costs and benefits that occur at various points in time?  One tool economists use is the discount rate..  The discount rate converts a future cost or benefit to a present cost or benefit.  Discount rates are necessary because a dollar received today is more desirable (and therefore more valuable) than a dollar received in the future.

For example, if $10 is invested today in the capital market and earns an annual rate of return of 10%, it will grow to $25.94 at the end of 10 years.  Reversing that process, $25.94 10 years from now is worth $10 today when "discounted" at a rate of 10%.  Discount rates reflect the forgone productivity of the capital.  Discount rates make explicit the tradeoff between a dollar's worth of services consumed now and  the higher future consumption made possible by the productivity of the investment.

Choosing the Right Discount Rate.  There is much debate about what is an acceptable discount rate.  The more you value today's dollars over tomorrow's, the higher your discount rate.  At one extreme, an infinitely high discount rate would imply that we place almost no value on future consumption.  At the other extreme, using a discount rate of zero means that benefits today are no more valuable than benefits experienced 100 years from now. 

Some philosophers and ethicists argue that present generations have a moral obligation to protect the interests of future generations, because these future recipients of benefits are as yet unborn and cannot express their own future preferences.  Economist Nicholas Stern, author of the 2006 Stern Review on the Economics of Climate Change, argued that we should use an interest rate of almost zero (0.1% per year).  At exactly 0%, $1 billion today is worth only $1 billion 100 years from now.  This was based on his ethical view that we shouldn't discount the welfare of future generations.  But this confuses the issue. 

The choice about which discount rate to use is not fundamentally about the weight we put on the well-being of future generations.  The choice about discount rates is fundamentally about opportunity cost.  Investments made in the economy today are likely to increase the future wealth of our descendants, giving them greater scope to exercise any preferences for environmental protection, so long as environmental damage is reversible.  The higher the return we can earn, the more we are depriving future generations if we spend that money now instead of investing it and giving them the proceeds.

Interestingly, Stern's own model assumes that people 200 years from now will have real incomes that are more than ten times our incomes today.  This means that if the government taxes people today-either explicitly or with regulation-to reduce climate change in 200 years, the government will be taxing the poor to help the rich.  Moreover, if we are concerned about future generations, the best way to help them is to consider all forms of wealth transfers to those generations, not just transfers of "climate wealth."

Kevin Murphy of the University of Chicago argues that we should use the market interest rate as the discount rate because that is the opportunity cost of climate mitigation.  In other words, we should not invest in any project that offers lower returns than the market would.

Adopting Optimal Climate Policy.  How does using the interest rate as the discount rate work in practice?  Imagine that the damage done by global warming due to carbon usage is $300 per ton of emissions 100 years from now.  Then, 100 years from now there should be a $300 per ton tax on carbon emissions to reflect the social cost of those emissions. What should this tax be in the intervening years?  At an interest rate of 6%, the tax on carbon:

• In 80 years should be $93.54;
• In 50 years should be $16.29;
• In 20 years should be $2.84; and
• Today should be 88¢.

Even with a low interest rate of 4%, a $300 per ton tax on carbon in 100 years implies a tax on carbon:

• In 80 years equal to $136.92;
• In 50 years equal to $42.21;
• In 20 years equal to $13.02; and
• Today equal to $5.94.

To put these numbers into perspective, a $1.00 per ton carbon tax translates into a one-third cent per gallon tax on gasoline. On that basis, the above numbers imply that the tax on gasoline today, given a $300 per ton carbon tax 100 years from now, would be only three-tenths cents per gallon (at an interest rate of 6%) or two cents per gallon (at an interest rate of 4%).  Today, the actual federal tax is 18.4¢ per gallon.  So, whether the right interest rate is 6% or 4%, the implication, if the correct carbon tax 100 years from now is $300, is that the gasoline tax today is much too high.        

Placing a Monetary Value on Climate Change.  It may be strange to compare monetary costs and benefits with environmental costs and benefits. But in a way we have no choice.  If we do anything to affect climate change, it will involve real resources and cause society as a whole to forgo goods and services it could otherwise have consumed.  Is this sacrifice worth it?  How much sacrifice should we make?  Answering these questions invariably involves putting a monetary value on environmental objectives.

For example, some economists propose a carbon tax of $300 per ton of emission.  That implies that the social cost of emissions is $300.  In the face of such a tax, no one would use carbon-based products unless the benefits were at least equal to the pre-tax price of carbon plus $300.  In economic terms, people using carbon would pay a price ($300 plus the pre-tax price) equal to the full social cost of their usage.

Additional Arguments for Delayed, Gradual Adjustment.  Three other factors argue for adjusting to global warming rather than trying to slow or prevent it.

First, a smaller and smaller percent of the gross domestic product (GDP) in countries with economic growth depends directly on the weather.  The main sector dependent on weather is farming, which, in the United States, has fallen from about 22 percent of GDP in 1900 to less than 1 percent of GDP today.  We already have experience with the kinds of technology needed to adjust.  In the Netherlands, for example, dikes have been used to keep out ocean water, and this technology for adjustment will only get better.

Second, we should never forget the law of unintended consequences.  A switch by the United States to lower-greenhouse-emissions technology would reduce the demand for existing carbon-based fuel, thus lowering its price.  One consequence: The lower price would cause users in other countries to increase their use of carbon-based fuels, thus blunting the reduction in carbon output.

Third, government is notoriously bad at solving problems.  Even with short-term problems, politicians and bureaucrats rarely have the right incentive to fix things.  They do not necessarily get paid more for solving problems and often, perversely, expand their powers and bureaucracy by failing to solve problems.  The incentive problem with government is especially acute with long-term problems because politicians have very short time horizons.  They rarely care strongly about any policy issue beyond their next election.  This absence of incentives for politicians and bureaucrats leaves special interests as the only people with strong incentives.  Their incentives are often to feather their own nests with special privileges rather than solve problems in ways that take account of the interests of the whole society.

Conclusion.  Many affirmative cases on this year's topic argue that we must enact an energy policy that decreases reliance on fossil fuels in order to protect future generations. This paper gives the negative case strong arguments to counter those claims.  Not only would these affirmatives mean taxing the poor to help the rich, but also they deprive future generations of additional capital we could accumulate if we invested money in the market instead of using it to combat climate change.