Al Gore, in a recent speech at New York University about the appropriate response to global climate change said:

“For the last fourteen years, I have advocated the elimination of all payroll taxes – including those for social security and unemployment compensation – and the replacement of that revenue in the form of pollution taxes – principally on CO2. The overall level of taxation would remain exactly the same. It would be, in other words, a revenue neutral tax swap. But, instead of discouraging businesses from hiring more employees, it would discourage business from producing more pollution.
Global warming pollution, indeed all pollution, is now described by economists as an ‘externality.’ This absurd label means, in essence: we don’t to keep track of this stuff so let’s pretend it doesn’t exist.”?

It sounds like a neat trick, killing two birds with one stone. Certainly, I am open to taxing externalities based on the difference between their social and private costs. In contrast to Mr. Gore’s aspersion on economists, the word “externality”? doesn’t mean we should pretend it doesn’t exist, it means the relevant actors (the polluters) pretend it doesn’t exist, which is a problem because it does.

Economists suggest several alternatives. Nobel Prize winner Ronald Coase suggests establishing legally enforceable property rights. The reason we have air pollution is because nobody owns the air. The reason we have less land pollution (e.g. dumping) hither and yon is because people do own the land.

The problem of course is (a) establishing ownership of the air and (b) tracking air pollution back to its source so that polluters can be legally charged.

The second solution is regulatory. With regards to traditional “criteria”? pollutants in the US (ozone, carbon monoxide, oxides of nitrogen, sulfur dioxide, lead, and particulates), tailpipe pollution is regulated by the Environmental Protection Agency, and cities have to ensure their transportation plans don’t pollute beyond a certain threshold. Currently, CO2 is not a criteria pollutant because it does not have health effects, at least not in the same way. This is a quantity-based strategy. Mr. Gore advocates this when he suggests “freezing”? carbon emissions.

A third solution, as Mr. Gore also suggests, is taxing pollution. In its pure form, we would allow anyone to pollute as much as they want, so long as they pay the carbon tax, which if properly set, would constrain the amount of pollution produced by providing the correct incentives. That tax (say X$/ton) would equal the social effect of the pollution. Establishing that social cost is not simple, nor is it uncontroversial. About 10 years ago I read a book about this by William Nordhaus, (the updated version is Warming the World: Economic Models of Global Warming by William D. Nordhaus and Joseph Boyer). The tax per ton would rise over time (as presumably would the impact of climate change, and our ability to pay for it). This is a price-based solution. The recent emergence of emissions trading combines quantity and price-based solutions.

Figuring out the proper level of the tax is no simple matter either. We can think about it in terms of damages: if the pollution went unprevented, what would it cost to fix. Or we can think about it in terms of prevention: how much would it cost to avoid the damage. If the cost of damage exceeds the cost of prevention, we should prevent, if the cost of damage is less than the cost of prevention, we should accept the damages. In practice we may prevent some damage and accept some damage.

Another point is that an externality requires two actors: the polluter and the pollutee. If I pollute, but no one is damaged, no harm is done. Think about noise: As the old koan goes, If a tree falls in the woods and no one is there to hear it, does it make a noise? No, the noise externality is only present if someone hears it and is harmed. By moving into the way of the harm, you are imposing costs on the polluter. Another example is the conflict that occurs with suburbanization into agricultural areas. As much as our politicians romanticize the family farm, farms smell. This isn’t a problem so long as only cows and farmers live there, but when suburbanites move in, this becomes a problem. Should the farmer pay, after all it is his farm producing the externality? Or should the suburbanites bear the cost, since without their presence, no externality would exist?

With climate change, because of its global nature, we might think consider the polluter clearly at fault. But what about people who move into low-lying, flood-prone areas? If no one lived below sea level in New Orleans, the economic and social damage of Hurricane Katrina would have been much less. Who should pay, the polluters (worldwide), who changed the climate and according to Mr. Gore, made the hurricane more likely, or those who moved into a vulnerable position? If you say some combination of both (which is of course the right answer), what is the combination?

So even if we have achieved consensus that we are spewing CO2 into the atmosphere, and are in agreement about the direction of that effect (it will make things warmer rather than colder in general), we are still in disagreement about the magnitudes of the climate effects resulting from that CO2, and in even greater disagreement about the economic cost that the climate effects imposes. I have worked with enough large-scale models to conclude that a plethora of assumptions founded on inadequate evidence must produce huge uncertainty.
Into this environment, Mr. Gore proposes a multi-part acronym-filled scheme that would make a Washington policy wonk swoon. Which leads us back to the carbon tax, which, if set correctly, is perhaps the most effective strategy. Mr. Gore proposes eliminating the Social Security payroll tax and replacing it with a carbon tax, ensuring the policy is “revenue neutral”?. This reminds me a lot of 1980 presidential candidate John Anderson’s proposal for a 50 cent tax on a gallon of gasoline in exchange for dropping the Social Security tax. So the idea is at least 26 years old.

The payroll tax has elements of unfairness. However Social Security has nothing to do with climate change (except, I guess, that old people pollute). This is an illogical linkage, and will produce a perverse result. If the carbon tax is successful, we lose our funding base for Social Security, which as popular polls suggest, already fails to engender much faith in its fiscal health.

Two more Nobel Prize winning economists have suggested some rules about managing economic policy:

1) Jan Tinbergen’s rule: Achieving a multiple number of independent policy targets requires an equal number of policy instruments.

2) Robert Mundell’s rule: Each policy instrument should be assigned to a policy target on which it has greatest relative effect.
source 

In other words, these economists posit one policy target per policy instrument (or one stone per bird). Trying to solve two problems requires two policy instruments, and so on.

If we levy a carbon tax, the revenue should be used to fix the damage global climate change causes or to prevent that damage in the first place. The amount of money that should be charged in a carbon tax is independent of the amount of money required for the payroll tax. By making the plan “revenue neutral”? we are either raising too much money (and wasting money by reducing more carbon than would economically efficient) or not enough money (and wasting the opportunity to provide incentives to invest in more carbon-reducing strategies).

That said, Social Security should be financed appropriately as well, but that bird deserves another stone. I believe that there should be one policy analyzed per policy essay.