Esty and Porter’s Call for a Carbon Tax Misses Badly

In yesterday’s New York Times, Connecticut Department of Environmental Protection chief Daniel Esty and Harvard Business School professor Michael Porter issued a call for an “emissions charge” (i.e. a carbon tax) to address the nation’s oil dependence and climate risks, joining a long line of others who continue to do the same. Specifically:

The best way to drive energy innovation would be an emissions charge of $5 per ton of greenhouse gases beginning in 2012, rising to $100 per ton by 2032. The low initial charge, starting next year, would make the short-term burden on consumers and businesses almost negligible…. Our proposal would apply to all greenhouse gas emissions, so that everybody, and every fossil-fuel-dependent form of energy, would be included…Yes, these costs would be passed on to consumers, but this is what motivates changes in behavior and technological investments.

It’s the neoclassical view that’s reverberated throughout the debate for years: get the prices right, get government out of the way, and let the market do its thing. Andrew Revkin has a point when he refers to the piece’s “retro feel.”

Of course, being retro is the least of their problems. First off, their proposal is almost exactly the wrong path to take if we’re to solve the problems they want to solve. The way to get off of foreign and domestic fossil fuels is to shift to a robust portfolio of cleaner technology options, and that portfolio will include some stuff that’s recognizable, and plenty of other stuff that’s radically more advanced. Neither of these categories would receive much of a boost from the Porter/Esty proposal, and in fact could conceivably be harmed. Let’s look at them separately.

Among the more developed technology choices, some are ready to roll, but most remain too expensive to compete on the market unsubsidized, and will remain so without substantial learning investment to drive costs down. Where can this investment come from? Private firms are already doing some of it, but investment requires revenues. A carbon tax might expand the market and help provide those additional revenues, but to make up for the substantial cost differences, the tax would have to be large indeed. The Esty/Porter proposal is not. As Michael Levi points out, a $100 per ton carbon charge only means an additional $1 at the pump, and the authors themselves even state that the impact is meant to be “negligible.”

So there’s minimal chance their proposal actually drives any energy substitution. And even if a high-enough carbon tax made it somehow through the American political system, many firms would naturally underinvest in innovation anyway, due to costs, risks, or competitive pressures. You need to do things like expand tax incentives and find other ways to further accelerate these investments in innovation – and expanding such incentives would be more effective than some small carbon price.

The advanced stuff is even more important, for upside in emissions reduction and in economic growth potential. And some new energy technologies or technological enablers, like advanced materials at nano scales, could even become general purpose technologies that fundamentally reshape economic activity, like ICT has done in our time and electricity itself did a century ago. But it’s also more problematic for the market to pursue, as most of it requires a mix of research, development, demonstration projects, high risk tolerance, and big investments to drive costs down. Contrary to the Esty/Porter piece, a carbon price doesn’t help with any of these tasks, because early-stage technology is much riskier and technology outcomes are more uncertain, and it’s too far from the market to “feel” the effect of a carbon price anyway (for more, see our paper on induced innovation). Just as government can facilitate innovative activity in the private sector, it also can facilitate—and, in fact, drive—this kind of development.

Indeed, radical technology has always been a product of focused development efforts, and government has played a role in those efforts time and time again. This gets to another mistake in the Esty/Porter piece:

Experience in fields like information technology and telecommunications suggests that creating demand for innovation is far more effective than subsidizing company-specific research projects or providing incentives for particular technologies. Governments just aren’t good at picking winners; witness the billions wasted on corn-based ethanol subsidies.

Yes, ethanol is a waste; otherwise, this passage is a major whiff. Demand is an effective source of driving some kinds of innovation, but demand didn’t lead to the creation of these industries in the first place. What actually did lead to their creation? Noted economist Vernon Ruttan provided the answer: “Public sector investment has played an important role in the emergence of every U.S. industry that is competitive on a global scale.” How’s that for picking winners?

The irony is that the examples they use – IT and telecommunications – are two of the clearest examples of public investment, and not market demand, creating innovative new industries in partnership with private firms and universities. There are countless other examples of this kind (see again our report, as well as this Breakthrough Institute report, for more). Government does “pick winners,” but not in the sense that Esty and Porter mean it: government’s role is not to pick favored firms or national champions, but to expand the knowledge base and the technology menu in strategic sectors, so that private firms can build on these foundations, develop products, and let the market select the technologies that work best.

The faulty assumptions outlined above thus lead them to one last mistake, in the form of a missed opportunity:

“Let’s be clear: the main goal is not to raise revenue.”

Of course not: if the market can do it all, then government has no role and thus no need for revenues. They do argue that the revenues could be put towards deficit reduction (again, Revkin has more), but treat this as an ancillary, politically attractive benefit. Yet a Pigouvian carbon tax actually offers an attractive, natural option for raising revenue for the kinds of things government needs to do on energy innovation, as we’ve argued in a recent proposal. Our proposal suggests a $15 per ton price, but even just a $5 tax as proposed by Esty and Porter would raise billions. If connected with more robust tax expenditures and other investment to boost energy innovation and education, it would drive towards a clean energy future more effectively than a carbon tax alone would, and without sacrificing competitiveness.

Lastly, why a price-only approach is actually a risk: if enacted, a carbon price may well lull the political system to sleep. Some of the most powerful advocates for policy action on climate and energy seek “price-and-deploy,” even though it’s an incomplete solution. These folks will do us all a disservice if they don’t recognize the limitations of the pricing approach, fight for passage, and subsequently declare “victory” over foreign oil and climate change when none is in sight.

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