The quietism of mainstream economics

Economist Greg Mankiw’s bottom line on climate policy: Government can’t do anything right 10

Gregory Mankiw.Gregory MankiwThe New York Times turned over some of its valuable opinion space to Harvard economics professor Gregory Mankiw last weekend, so that he could discuss the merits of various carbon policies. His record on that score is not great, and he doesn’t have any special training or experience on the subject, but as far as Big Media is concerned, being an economist makes you a wise commentator on literally any policy issue. All you need is theory!

Mankiw’s main point is that a refunded carbon tax would be preferable to a cap-and-trade system, because ... economists prefer it. If they can’t have that, they’ll take a fully auctioned cap-and-trade system, which would be functionally equivalent to a tax. Obama campaigned on such a system, but now the ACES bill has been corrupted by “powerful special interests” and “most” of the allowances are given away, so Obama should veto the bill. Blah blah. It’s familiar ground; Ryan Avent does some good work bashing it.

I want to hone in on one of Mankiw’s background assumptions, a deep-rooted and ubiquitous assumption in economics that doesn’t get discussed enough.

Mankiw makes the familiar economic point that it’s good to “internalize an externality” (make polluters pay for the environmental damage they cause) by charging for carbon emissions. Also familiar is his follow-on point: whether we tax emissions or do auctioned cap-and-trade, it’s crucial to return all the revenue the government gathers directly to taxpayers by reducing other taxes (either income or payroll). This so-called “tax shift” would be revenue neutral.

Now, I’ve argued at some length that under ACES most of the allowance value is not, in fact, “given away to powerful special interests.” In fact, the bulk of the allowance value is returned to consumers. But for Mankiw, that’s almost irrelevant. For mainstream Chicago School and neoliberal economists, it is a baseline assumption that money is more productively deployed by the private sector than by the government. Left to its devices, the market deploys capital efficiently (the “invisible hand” and all that). When government collects taxes and spends revenue, the capital is deployed less efficiently. Taxes result in “TK”—“reduced economic activity” meaning “reduced growth of GDP.” Government spending cannot compensate for that reduced growth, because governments aren’t as smart as markets.

Insofar as government wants to secure a social benefit—say, a clean environment or public health—by a) constraining the private market through regulation, or b) spending tax revenue on public programs, it necessarily reduces economic productivity and GDP. There is no way around that trade-off. If you want a cleaner environment, you have to pay for it. You can’t get something for nothing. No free lunch. Etc.

That’s the root economic assumption. That’s why economists (and elites who view the approval of economists as a mark of Seriousness) favor a tax shift: it is the absolute minimum government intervention required to secure the social benefit of reduced CO2 emissions. It does not “adversely affect the tax code”—econospeak for raising taxes. It disturbs the precious, fragile, magical free market as little as possible.

It’s impossible to exaggerate how much this assumption shapes U.S. policy discussions. Anyone who proposes a regulation or public investment is inevitably faced with the kneejerk Blue Dog response: “we can’t afford that.” We have a deficit, you see, and since gov’t action by definition reduces economic productivity and GDP, it increases the deficit. We can’t have government do one thing unless it stops doing something else—it’s a zero-sum game.

You won’t be surprised to hear that I think this assumption is wrong. Both regulation and public investment, when done properly, can increase economic productivity. Their effect on GDP is uncertain, but GDP is an absurd measure of public welfare anyway. On more sensible measures of public welfare, regulation and public investment can produce net gains.

Most importantly, carbon pricing (whether carbon tax or cap-and-trade) cannot do the job on its own. If complementary policies are ruled out, we’re dooming ourselves to failure. (I’m going to make this point at much more length soon. Aren’t you excited.)

Obviously this kind of fundamental dispute in economics won’t get resolved in a blog post. But everyone fighting for vigorous, multifaceted government action to address climate change needs to be aware of it—aware of the fact that they are ultimately fighting against the core faith of mainstream economics. As long as they accept that faith, the best they can argue is that tackling climate change will only moderately slow the economy and reduce GDP. And when you’re fighting a battle this important, “moderate pain” is a pretty poor rallying cry.

David Roberts is staff writer for Grist. You can follow his Twitter feed at twitter.com/drgrist.

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  1. veritone Posted 11:05 am
    13 Aug 2009

    Let's see Nobel Prizes won:Paul Krugman 1; Greg Mankiw 0. I'll go with Krugman and this piece he wrote in the NY Times on May 1st entitled, "An Affordable Salvation," (below). I have a degree in economics myself and often describe myself as a recovering economist. I believe economists do have something to offer, but only if they take the biophysical world into account and part with much of what they learned as undergraduates.http://www.nytimes.com/2009/05/01/opinion/01krugman.htmlKrugman has written quite a few pieces on this subject, every one of them favorable.

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  2. Teryn Norris's avatar

    Teryn Norris Posted 12:56 pm
    13 Aug 2009

    "Most importantly, carbon pricing (whether carbon tax or cap-and-trade) cannot do the job on its own.
    If complementary policies are ruled out, we’re dooming ourselves to
    failure. (I’m going to make this point at much more length soon. Aren’t
    you excited.)"    Well said, David.  Carbon pricing has an important role to play, but the neoclassical economists are dead wrong that a pollution externality can be solved simply by pricing the pollutant, just as many climate advocates are wrong that it can be solved by implementing a pollution "cap." As the World Economic Forum explained in a recent report:"Carbon prices alone, however, will not be high enough -- at least for
    the next few decades -- to prompt a large-scale roll-out of renewable
    energy... Prices will be set for many years to come by cheaper
    sources of credit -- energy efficiency and project-based mechanisms in
    the developing world. So a carbon price is an essential driver towards
    a lower carbon economy, but additional policy interventions will still
    be required."    Looking forward to your longer review of additional policy strategies.

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  3. Ken Johnson's avatar

    Ken Johnson Posted 3:37 pm
    13 Aug 2009

    There's one thing I don't understand about Mankiw's theory of "Pigovian taxation". Take the electricity sector, for example. If you are going to impose a carbon tax for the purpose of reducing carbon emissions from electricity generation, would it not make sense to apply the tax revenue to reduce carbon emissions from electricity generation? For example, revenue could be used to subsidize new low-carbon energy sources. This would help ratepayers by ensuring an adequate supply of price-competitive, clean energy. How competitive? If new low-carbon energy sources make up ten percent of the electricity market, for example, then a $10-per-ton carbon fee, with revenue used to subsidize new low-carbon energy, could give the latter a $100-per-ton price advantage over fossil fuel. $10 is Waxman-Markey's initial price floor. The $100 price incentive, ten times the carbon fee, would apply immediately -- not ten or twenty or thirty years in the future. Renewable energy would get a large initial stimulus, which would quickly stimulate capacity expansion, economies of scale, and attainment of grid parity.I don't care whether you call this kind of subsidization "carbon pricing" or a "complementary policy", but can anyone explain how giving the money to consumers would be more effective at decarbonizing electricity and maintaining affordable electricity rates?

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  4. Matt Rognlie Posted 3:45 am
    14 Aug 2009

    You miss the point entirely here when you snark: "Government spending cannot compensate for that reduced growth, because governments aren’t as smart as markets."The question isn't whether given a certain amount of capital $X, the government or the market will do a better job at allocation. That question is irrelevant, because there is no mechanism by which the government can raise capital from the private sector without distorting incentives and incurring a deadweight loss. This is a reality that no one denies, even if there is plenty of quibbling about the size of the loss.You should read up on the relevant literature, especially this primer on the mythical double dividend and this explicit analysis of the costs of implementing emissions taxes without offsetting income taxes. Essentially, by raising the costs of consumption, a carbon tax acts as an implicit tax on income, albeit one that lacks the anti-savings bent of the income tax. In isolation, this is fine. In fact, it's optimal: if you ignore the presence of existing income taxes, you will find that a carbon tax discourages labor exactly to the extent that maximizes efficiency in the economy. (People may work a little less because it's not worth it to shell out for carbon-intensive goods anymore.) This is one of the nice efficiency results that pops out of Environmental Economics 101. We do not, however, live in a world where income taxes are zero, and this significantly complicates the analysis. If a carbon tax effectively decreases the value of income by 2%, but the income tax rate is already 25%, then this "tax interaction effect" moves the effective income tax rate from 25% to 27% rather than from 0% to 2%. This is far more damaging. It can be alleviated by recycling the revenues to lower actual income tax rates, but otherwise the true costs of the emissions-reduction program can go increase by up to several hundred percent, as the analysis linked above estimates.

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  5. Jason D Scorse's avatar

    Jason D Scorse Posted 9:48 am
    14 Aug 2009

    David- you make some sounds points, but unfortunately these are muted by your continued disdain for economists and the economics profession which clouds your thinking. Mankiw is a brilliant guy but he is also an apologist for failed Republican policies and is well-deserving of sufficient scorn. But he is right about taxes being better than cap and trade- even the originator of the cap and trade system says this- as do many influential environmental economists. You are correct that the current bill calls for a majority of permits to be auctioned but do you really think this will make it into the final bill? If this bill even passes the chances of a significant number of auctioned permits is low and this will likely be another corporate giveaway. Cap and trade in theory could work, but it will likely fail, and there are many other significant monitoring problems and implementation issues that make it very difficult to do right. On the other hand, the chances of a greenhouse gas tax are close to nil so what to do? That's the topic of a future post- maybe next week. In the meantine, I suggest that you put aside your hatred of economics; it doesn't serve you or your readers well. Jason

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  6. SallyVCrockett Posted 11:37 am
    14 Aug 2009

    Jason's right that the majority of scientists and economists favor a straightforward tax and it strikes me as the worst kind of hubris that Congress is ignoring that advice.  I disagree vehemently that a carbon tax is a political non-starter, however.  An electorate that understands it will support it, especially if we recycle the revenue back to them with a tax-shift approach.

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  7. Jason D Scorse's avatar

    Jason D Scorse Posted 2:22 pm
    14 Aug 2009

    I hope you're right and that the political will for a greenhouse gas tax (we need more than a carbon tax) could be generated but seeing the healthcare debate descend into such inanity and depravity with the far right lunatics driving the debate doesn't give me much hope. But if the public realized they'd get all the money back, maybe they could be persuaded.....Jason

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    1. SallyVCrockett Posted 10:51 am
      18 Aug 2009

      Sorry about the delay in my response--I agree that if people understand that the revenue will be returned to them, they are much more likely to support it.  In fact, I think that there are some free market Republicans--those not so disingenuous to reject climate change proposals altogether--who could support a carbon tax if given half a chance. 

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      1. David Roberts's avatar

        David Roberts Posted 12:01 pm
        20 Aug 2009

        "I agree that if people understand that the revenue will be returned to them, they are much more likely to support it."I remain positively amazed at how often this is asserted, utterly without evidence. You want us to bet everything -- scrap a policy that's gotten consensus over decades and start anew, with enormous and unpredictable political consequences -- based on your hunch that the American public will think like you do.

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