The good (and bad) of carbon tax economics

National Post, 4 April 2019

The economic problem with a 'tax on everything' is that it leaves few options outside of the 'everything' for consumers to make changes in their behaviour

The federal carbon tax, implemented on Monday, has been defended as the option most favoured by economists to reduce carbon emissions.

At the risk of trying the patience of readers with economic analysis two weeks running, that claim is both more true and less true.

Given the desideratum that less of X be consumed, then economists argue that a tax on X will achieve that more efficiently than regulations that would otherwise impose hidden costs and distort the economy. In regard to pollution, such taxes — called “Pigouvian taxes” — might be used to reduce the volume of an activity that has harmful side effects — “externalities” — that the producer or consumer is not responsible for.

That seems to be the logic of the federal government, as it advertises its carbon tax as a “price on pollution.” It’s an odd appellation for carbon dioxide, which thee and me breathe out constantly without considering it a pollutant, halitosis notwithstanding.

Yet, if the premise is accepted, is a carbon tax the best way to go? That’s where it becomes more complicated.

Not all goods are the same, and consumers do not regard them the same way. Demand for this or that good depends on two factors: the price and the “elasticity” of demand. In general, for most goods, as the price goes up, demand goes down. That’s the logic of applying the carbon tax, or any Pigouvian tax.

But the effect is not always the same, as the elasticity of demand varies from good to good, depending on whether it is easy to make substitutions, or reduce the amount consumed.

If the government were to slap a tax on Ford vehicles, sales would immediately decline, as it is easy to substitute another brand. If there was to be a tax on poultry, there would like be decline in chicken purchased, as shoppers shift to beef or pork. Those goods are elastic.

That seems to be the logic of the federal government, as it advertises its carbon tax as a “price on pollution.” It’s an odd appellation for carbon dioxide, which thee and me breathe out constantly without considering it a pollutant, halitosis notwithstanding.

Yet, if the premise is accepted, is a carbon tax the best way to go? That’s where it becomes more complicated.

Not all goods are the same, and consumers do not regard them the same way. Demand for this or that good depends on two factors: the price and the “elasticity” of demand. In general, for most goods, as the price goes up, demand goes down. That’s the logic of applying the carbon tax, or any Pigouvian tax.

But the effect is not always the same, as the elasticity of demand varies from good to good, depending on whether it is easy to make substitutions, or reduce the amount consumed.

If the government were to slap a tax on Ford vehicles, sales would immediately decline, as it is easy to substitute another brand. If there was to be a tax on poultry, there would like be decline in chicken purchased, as shoppers shift to beef or pork. Those goods are elastic.

But what about goods that are inelastic? Or if the tax is applied to all the goods in a certain category?

That’s what the government does on alcohol and tobacco, with a tax on everything in that category, so substitutions are not really possible. It is possible to drink or smoke less, but given the habit-forming — even addictive — qualities of those goods, it may be that the tax does not diminish consumption, but just fills government coffers. Or it could accomplish both, lower consumption and higher revenues.

The carbon tax is like the taxes on alcohol and tobacco; it is a tax on everything in a certain category. And because that category — energy consumption — is part of every other activity, it is legitimate to call it a “tax on everything.” That alone doesn’t make it illegitimate of course, as we already have “taxes on everything” — consumption or sales taxes.

We also already have a “carbon tax” when it comes to gasoline (but not home heating fuel, except under carbon taxes levied by British Columbia and Alberta). The federal excise tax is 10¢/litre, and provinces add another roughly 15¢/litre to that.

Current gas taxes are far greater than the 4.4¢/litre carbon tax that went into effect this week. So have those taxes decreased the amount of gas consumption over the past decades? If not to a significant degree — at least not sufficiently in the eyes of the federal government — then it is because gasoline is a relatively inelastic good. The price can go up, but consumers will still buy roughly the same quantity, as it is difficult to make substitutions. We see that more or less every long weekend, as prices at the pump spike upwards and no one cancels a driving trip.

The economic problem with a “tax on everything” is precisely that it leaves few options outside of the “everything” for consumers to make changes in their behaviour. Alberta has a carbon tax on furnace oil and natural gas for home heating; there are not really many alternatives to heating one’s home in the Prairie winter.

Continue reading at the National Post: https://nationalpost.com/opinion/father-raymond-j-de-souza-the-good-and-bad-of-carbon-tax-economics?video_autoplay=true