Avoiding Climate Change Without Sinking the Poor

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Coline Buch / Flickr

Higher gas taxes were one of the sparks that set off France’s Yellow Vest riots, according to most of the reporting on the matter. This fact has set the stage for heated and confusing discussions about climate policy in the US with some seeming to claim that you cannot fix climate change without all income groups taking a hit and others suggesting that you can avoid dinging the poor provided you avoid regressive taxes on fossil fuels. Both claims are a little off.

One of the problems with transitioning to a green economy is that it is costly. A large amount of labor and material will have to be put towards the transition that would otherwise be used producing other kinds of goods and services. This means that the average standard of living is likely to fall in the short term, especially if you transition rapidly.

So a key question is how do we distribute this decline in living standards across the population. If you allow the costs of the transition to be distributed via energy prices, then the poor and middle class will suffer larger reductions in living standards than the rich. This is because poor and middle class people put a larger share of their income towards energy than rich people do.

To avoid this outcome, you either need to (1) use subsidies to keep energy prices from rising or (2) allow energy prices to rise but provide transfer payments that offset the effect of the price rises for poor and middle class people. You can also do (1) and (2) at the same time.

For various confusing reasons, some on the left have decided that carbon taxes are uniquely bad instruments to use in climate change policy because they are “regressive taxes.” But this is wrong.

Alternative proposals, like clean energy mandates that require local power companies to switch to costlier clean energy sources, are similarly regressive because they too will increase the price of energy for all consumers. So there is nothing unique about the carbon tax in this regard: anything that pushes energy prices upwards is regressive so defined and basically all transition plans have this effect absent subsidies or transfer payments.

Additionally, it is not just carbon taxes that raise the price of carbon energy sources. Blocking pipelines and taking other actions to “keep it in the ground” restricts supply and drives up prices, assuming it is effective. And that’s regressive. Removing subsidies for fossil fuels also should push up carbon prices for consumers. That too is regressive.

In fact, the removal of a carbon subsidy and the imposition of a carbon tax are two sides of the same coin at least as far as prices and regressivity are concerned. If you think it is OK to cause carbon energy prices to increase by $1 by removing a subsidy, then you should think it is OK to cause carbon energy prices to increase by $1 by imposing a carbon tax. If you think both are bad because of the regressivity of higher energy prices, then why not subsidize the price of carbon energy down to $0? If you think there should be neither subsidies nor taxes, does that mean you think the market price (whatever that might be) of carbon-based energy is the correct one? Why? Because it’s the one the market has set?

When it comes to avoiding climate change without sinking the poor, the coherent way forward is not to get worked up about the distributive effects of each and every climate policy instrument. Rather what we need to do is have an overall commitment to maintaining the inflation-adjusted incomes of the lower class throughout the clean energy transition. By far the easiest way to do that, as a technical matter, is to send some extra cash their way in order to make room for price rises and the other regressive elements of an effective climate agenda. A carbon dividend like the one proposed by Mark Paul and Anders Fremstad does precisely that.