How Come Carbon Taxes are Good for the Economy?

Two of the cities I have lived in are in areas with a carbon tax regime: Vancouver and Stockholm. British Columbia implemented a carbon tax starting in 2008, at a level reaching C$30 per metric ton of CO2, under the right-wing BC Liberals, who favored the carbon tax as a market-friendlier approach than the left-wing NDP’s proposal for cap-and-trade. The tax was revenue-neutral, offsetting other taxes, and is seen as a success; the NDP has since won power and announced a hike in the tax to C$50/t by 2021.

Sweden’s carbon tax is higher and older. It was implemented by the Social Democrats in 1991, at a rate of 24/t for home use, such as fuel, and 6/t for industrial use; it has been subsequently hiked multiple times, reaching 88/t for home use by 2004, and Löfven’s coalition of Social Democrats and Greens has increased it to 114/t for both home and industrial use. Our World in Data cites it as a success too, linking it to high levels of political trust and low corruption levels in Sweden as well as in other European countries with carbon taxes, such as Switzerland.

The question of interest is, how come these carbon taxes are good not just for reducing greenhouse gas emissions, but also for the economy? British Columbia’s economy has grown somewhat faster than that of the rest of Canada. Sweden has had high economic growth since the 1990s as well – see for example World Bank data from 1990 to 2018, in which Sweden’s growth in GDP per capita only behind that of Norway and the Netherlands, both by very small margins. What gives? How come this is apparently good for raw economic growth, when it’s supposed to be an economic distortion that reduces living standards if one ignores long-term environmental benefits?

Negative carbon taxes

There is an array of policies that act as negative carbon taxes – that is, taxes on green activity, or subsidies to polluting activity. The construction of highways is one example – the negative effects of cars include not just climate change but also local air pollution, noise, and car accidents. There are various policies counteracting these effects, such as fuel taxes and mandatory insurance, but they are not enough. For example, in British Columbia the minimum insurance requirement is $200,000 in personal injury plus $300,000 in medical expenses and smaller sums for related torts like funeral costs, but the insurance value of human life is measured in the millions.

To the extent non-carbon taxes on cars are too low, the addition of a carbon tax should move the tax level closer to the true level of the negative externality even ignoring long-term climate change. Carbon taxes should not by themselves improve economic growth on a 30-year horizon, let alone a 10-year one, but lower levels of air pollution, fewer car crashes, and less traffic congestion would.

Another aspect is development. Various zoning laws, such as single-family residential zones in much of Vancouver and restrictions on high-rises in Central Stockholm, encourage people to live and work in lower-density areas. This is simultaneously a negative carbon tax of a sort and a drag on economic productivity. A carbon tax is no substitute for reforms making it easier to add housing – and thankfully, both Stockholm and Vancouver already have fast housing construction, unlike (say) New York – but it does help countermand the subsidies to suburbanization implicit in restrictive zoning.

Climate science vs. arbitrary rule

The economic reasoning behind why special fees on various activities are inferior to broad taxes on income, property, and consumption has to do with incentives and rule of law. Taxing a specific activity incentivizes people and corporations to find creative ways to shift apparent activity elsewhere, creating economic distortions. It also sends everyone a message, “spend more money on lobbying politicians to keep your sector’s taxes lower than those of other sectors.” Broad-based taxes don’t do that, first because the only way to avoid an income tax is to be poorer, and second because there are fewer moving parts to an income or sales tax.

However, carbon taxes are not your run-of-the-mill tax on an activity some politician does not like. Yes, there is a definitive political movement calling for restraining greenhouse gas emissions, but the reasoning behind it is telegraphed years and even decades in advance, and is based on a scientific consensus. Lobbyists can try to fight for exemptions, as they can from income taxes, but the tax itself is based on a process that is transparent to informed economic actors.

In green democracy as in social democracy, the role of the state is not to side with the interest groups that voted for the party in power, unlike in populism. Social democracy holds that the state has an expansive role to play in the economy, but this role is not based on arbitrary exceptions but rather on budgetary and regulatory priorities that have been largely stable for generations: income compression, labor unions, health care, education, child care, infrastructure, housing. It’s not a coincidence that the part of the world with the strongest social-democratic institutions, the Nordic countries, also has more or less the lowest corruption levels.

Green democracy has a different set of priorities from social democracy, but they too are well-known, especially when it comes to the transition away from greenhouse gases. There’s a lot of lobbying concerning specific spending priorities, but the point of a carbon tax is that it adjudicates how to prioritize different aspects of the transition apolitically.

Carbon taxes and good government

The World in Data’s praise of Sweden’s carbon tax regime talks about the necessity for low corruption and high trust levels for a carbon tax to work. But does the causation really run in that direction? What if the causation is different? It’s likely that a carbon tax could politically work in a wide variety of countries, but only in states with high levels of political transparency do politicians prefer it to opaque schemes that reward cronies and favored interest groups.

In other words, once British Columbia enacted its carbon tax the results were positive even without unusually low corruption for a rich country. But for the most part, governments without much transparency or rule of law such as much of the United States do not like the simplicity of a carbon tax. Politicians who call themselves green prefer schemes that either directly subsidize favored groups or at least politically empower them (“Green New Deal”), and that specifically ream difficulties on groups they do not favor (real estate developers, the nuclear industry, etc.).

But that American politicians do not like carbon taxation does not mean carbon taxation could not work in an American context. It does in a Canadian one, without any of the negative economic effects that people who take perverse joy in environmental destruction predicted. The private economy can and does adapt to changes in relative prices, as fuel becomes much more expensive and other products become cheaper to compensate – and judging by the experience of Sweden in particular, even a fairly high tax is compatible with fast economic growth for a mature economy. All it takes is someone willing to spend short-term political capital on the long-term green transition.

40 comments

  1. Oreg

    Funny that in Canada the right favored a carbon tax and the left cap-and-trade whereas in Germany it’s the other way around. The Germans recently plumped for cap-and-trade as the CDU prevailed over the SPD.

    • Herbert

      We’ll see what Bundeskanzler Jens Spahn will introduce at the head of a Black Blue coalition…

      Or Bundeskanzler Robert Habeck at the head of a green black coalition

    • Brendan Dawe

      It’s worth noting that specifically the Gordon Campbell era BC Liberals favored a carbon tax. The typical response of the right in Canada has been somewhere between climate-denialism, climate-change-is-good-because-canada-is-too-cold-anyway-ism, canada-is-only-1.8%-of-global-emissions-so-why-bother-ism, or if they’re put on the spot, vapour-ware-sector-by-sector-regulation-ism.

  2. Herbert

    What about the argument that a carbon tax would lead to goods and services with high carbon footprints simply being produced elsewhere.

    For example the “if we shut down nukes, that means importing worse nuclear energy from the east”

    • ASL

      That already happens in Canada to some extent. Cement, with high GHG on manufacture, is made elsewhere and imported by sea since that is cheaper than domestic manufacture with a carbon tax. Cement is heavy relative to value so at some point inland transport costs will outweigh the carbon tax savings. Other groups promote increased export of raw bitumen from the oil sands which, mostly unstated, is a way to export the eventual GHG emissions associated with upgrading.

    • Alon Levy

      The problem with that argument is that purely domestic consumption is down, too. Check the link re BC – fuel consumption fell 18%, and only 1-2% of that fall can be attributed to people crossing to the US to buy cheaper gas there. In Sweden, too, transportation emissions since 1990 are flat, whereas they’re up elsewhere in Europe.

    • gcitytimes

      A carbon tax is a market mechanism, so it depends how industries respond to carbon taxes in the countries, states, and provinces, where they are implemented and enforced. A steep, blanket carbon tax for industries that pollute is more likely to have a deterrent effect to polluters, although technically with all carbon taxes, polluters can just pay the tax and continue to pollute. It is likely that a steep carbon tax universally adopted by all governments worldwide would be likely to serve as enough of a deterrent to polluters to significantly help to reduce greenhouse gas emissions, and help global governments meet the 2015 Paris Climate Accord goals. The likelihood of carbon taxes being adopted by a significant enough amount of governments globally to make a serious dent in worldwide GHG emissions is a global challenge; although mandates passed by some governments through Northern Europe, especially Scandinavia, as in the article here, represent signs of progress to policy makers worldwide.Other signs of progress include carbon pricing mandates (including carbon taxes or emission trading systems) passed by governments in other pasts of the world including provinces in Canada and Australia, and in the EU ETS. For more on carbon pricing mandates throughout the world, you might like to read: https://www.greencitytimes.com/carbon-cap-and-trade-putting-a-price-on-carbon/

  3. Jonathan Salmans

    “the negative effects of cars include not just climate change but also local air pollution, noise, and car accidents.”

    There are more efficient ways to deal with these than carbon taxes.

    For example with car accidents, a carbon tax would hit someone who chronically runs red lights the same way as someone who buys the safest car on the market and obeys all traffic laws. Someone who drives a Tesla would get a discount even though they’re no safer than a sedan with an internal combustion engine.

    A policy that mandated insurance payouts that more accurately covered the damage caused by a crash would be better. There should be at least a required $10 million payout to victims families for every automotive fatality, and $200k for pain and suffering for every serious injury. Insurance premiums would go up, discouraging driving, but other programs that promoted safer driving would be developed. For instance there would be more of a financial incentive to buy a safer car. Drivers would probably accept electronic monitoring of their driving habits to get an insurance discount.

    Banning motor vehicles capable of speeds above 15 mph should be considered in more spaces to make them particularly safe for pedestrians and children.

    Similarly for congestion, tolls one interstate highways that are set to the lowest level that prevents congestion would be the most efficient way to address congestion. A Tesla contributes to congestion just as much as a hummer.

    On local streets, this should be addressed by fixing the zoning code and giving mass transit dedicated rights of way.

    Pollutants that cause health problems when inhaled could also be taxed directly. This would favor gasoline over diesel even though gasoline is more carbon intensive. It would end coal use in favor of natural gas, nuclear and to a limited extent (absent a technological breakthrough on grid-scale energy storage) renewables.

    • Alon Levy

      (Petrol is not actually more carbon-intensive than diesel, the two fuels are equivalent when it comes to carbon emissions per km driven – diesel just has higher energy density per unit weight.)

      Yes, but given that none of these various ways of dealing with other negative effects of cars is enacted, a carbon tax approximates these ways. High taxes on diesel specifically due to its contribution to pollution, road tolls to curb congestion, and mandatory insurance requirements in the millions rather than hundreds of thousands as in Canada or tens of thousands as in the US, are all valuable, but in their absence, a fuel tax helps mitigate negative externalities.

      • Herbert

        Plus it reduces the negative externality of funding Saudi and Iranian crimes against humanity

      • Mikel

        Petrol is not actually more carbon-intensive than diesel

        Are you sure? I just checked a few popular models from three European automakers (Renault, Fiat, Seat) and there seems to be a small but consistent difference in favor of diesel. In fact I think I read that since the 90s the EU tried to favor diesel cars over petrol because of the lower CO2 emissions, until we learned that the difference between them is not worth choking in NOx and particulates.

      • Reedman Bassoon

        (My memory of taking classical thermodynamics decades ago …) The efficiency of an internal combustion piston engine is increased by increasing the compression ratio. Gasoline engines run at lower compression ratio’s than diesel engines, hence, diesel engines are typically more efficient. There are other internal combustion engines that have other characteristics — gas turbines are more efficient that piston engines, but only at maximum power/load [reference the experimental 1963 Chrysler Turbine car]. There are more complex gasoline engines that are more efficient than the classic Otto cycle — the Atkinson cycle (used in the Prius) is more efficient because it has an expansion ratio different than the compression ratio (mechanically more complex and lower power density). The high compression ratio of the diesel is what causes the nitrogen in the atmosphere to react during combustion and produce higher NOx.

        Your mileage may vary.

        • michaelrjames

          Partly it’s about what the chemical structure of the fuel is. Diesel yields about 13% more energy than petrol (gasoline) on a weight basis. Given that all the weight is in the carbon atoms then this means for diesel there will be fewer carbon atoms per energy released, thus less CO2 released in burning it.
          A diesel engine may also turn more of the energy released into useful work. If I’m reading this (link below) correctly a diesel direct-injection heavy-duty engine could be as much as 20% more thermally efficient than petrol.
          https://www1.eere.energy.gov/vehiclesandfuels/pdfs/deer_2002/session1/2002_deer_eberhardt.pdf

      • Jonathan Salmans

        Taxes on transportation fuel are a good second best, and better than nothing to reduce congestion and local pollution, and improve safety. Since carbon taxes are not common either, consideration should be given to which approach is more politically practical, and it is not clear to me that carbon taxes are more politically likely than the solutions I mentioned.

        I doubt the benefits of a carbon tax in transportation are enough to fully offset the dead weight loss in other sectors like industry, construction and agriculture, so I think your title ‘carbon taxes are good for the economy’ overstates things.

  4. adirondacker12800

    Correlation is not causation. they would have had good economies without the carbon tax too. At this moment in time, a quick glance at gasbuddy.com, gasoline is $1.40 to $1.50 a liter in Vancouver and $1.10-ish in Toronto. Not much of a price difference.

    • Matthew Hutton

      I think 30% more is a fair amount!

      The issue is that often driving is the only viable solution.

        • Mikel

          Do gas taxes vary between the Länder?

          Such a price difference can be relevant in long-distance transport. Near the Spanish-French border you can sometimes see queues of truckers and motorists filling up their tanks in the last Spanish gas station. I’m not sure if the French-side locals do the same, but they do drive over the border to stock up on cheap cigarettes and booze sometimes. A small boon to the local economy! 😛

          • Alon Levy

            At the French/Italian border, people drive over from France to Ventimiglia to buy cigarettes and people drive over from Italy to Menton to fill up their fuel tanks.

          • Mikel

            I guess that’s what we get for having a customs union without a fiscal union. Do you think an EU-wide carbon tax would be politically feasible in the short term? (i.e. before the 2024 election)

          • Alon Levy

            That’s why the EU sets minimum excise taxes. It just so happens that Italy chooses to set its fuel tax well above the EU-mandated minimum.

          • adirondacker12800

            Just like they spent 45 minutes and toll from Staten Island to buy gas in New Jersey, before New Jersey raised taxes. A really quick search says the average price per liter in France is 1.65 Euro and 1.73 in Italy. Yeah right, unless they have some reason to be on the other side of the border they aren’t driving over there much. Which is why on Google Streetview there are petrol stations in Ventimiglia. Which we went over the last time you recounted the urban legend.

          • Alon Levy

            Yeah, so nobody drives 45 minutes across the border for this, but there are long lines of people buying cigarettes at the border on the Ventimiglia side and long lines of people buying gas at the nearest gas station to the border in Menton.

          • Herbert

            No, there’s only a federal gas tax. But I don’t know whether the Länder could introduce one if they wanted to.

            Cities are currently not legally allowed to tax or toll things it’d be in their best interest to tax or toll

          • adirondacker12800

            If they aren’t driving long distances there aren’t very many of them.

      • adirondacker12800

        The price of gas has gone up 25 percent around here, in the past year or so. Not even a ripple of difference that I can see. New Jerseyans got whacked with a big tax increase recently, doesn’t seem to have affected them much.

    • myb6

      +1 Not only could both phenomena be downstream (high-trust, low-corruption, compressed-hierarchy economies outperform over the long-run, and would also have an easier time getting buy-in on a policy that risks creating internal “winners” and “losers”) but causation could also run economic->green (well-performing economies would have the surplus).

      • Alon Levy

        But Sweden was specifically not particularly high-performing in the early 1990s – quite to the contrary, it was in an economic crisis, which led to an Alliance government and a bunch of right-wing economic reforms. The carbon tax itself was passed in a package with an income tax cut as the Social Democrats relied on center-to-center-right support to stay in power, and soon they’d be booted in favor of a fully center-right coalition.

      • Gok (@Gok)

        Free allocation is temporary, and based on benchmarks that are easily predictable. It’s entirely equivalent to different carbon tax rates for differently benchmarked industries.

        • Herbert

          Those benchmarks are set too low and intransparent to the voter. It’s easy to sell whichever outcome as just “the market”. But taxing one ton of carbon dioxide at a different rate as another will immediately be obvious and called out

  5. RossB

    Makes sense to me. I notice you don’t quote any sources, though, which makes me think the subject hasn’t been studied in any great depth. My guess is someone could earn their PhD in economics, or maybe geography by doing a real study. At first glance, charging more for anything would be a drag on the economy. My own theory is that it does, but other things make up for it. First is that the government, hopefully, is spending the money wisely (spreading it around). A less obvious reason is that it helps make the local economy less dependent on an item that widely fluctuates in value.

    As someone who grew up in the U. S. during the stagflation, oil-crisis period, it all sounds rather obvious. Japan, for example, had expensive oil after the war. The U. S. did not. So Japan spent money building things that don’t use oil, while the U. S. built things that did. The U. S. built big cars, big roads, and big houses next to those big roads. Japan built tiny cars, and focused on industries that weren’t so energy dependent (electronics, for example). When OPEC raised the price of oil (dramatically) the U. S. was in deep trouble. To quote the Kinks, (captain) America was falling. Japan, on the other hand, was thriving. The only reason this happened was because Japan had, in effect, inoculated itself against a resource shock.

    Countries that have high gas taxes have all done this. Their economies are focused on things that aren’t going to fall apart, just because someone blows up an oil rig in the Middle East (which happens every so often).

    • Alon Levy

      Hmmm, yeah, the reduced exposure to commodity shocks is a great explanation. But I will caution that it can’t be the only thing – Sweden is not really more insulated from commodity shocks than France or Germany, and France has not had great growth in the last generation. That said, the proximate reason for the Gilets Jaunes riots was not the hike in the diesel tax, which had been announced months before, but an increase in the global price of oil that the rioters then connected to the still-not-in-effect tax hike…

      • RossB

        Yeah, there are probably a bunch of different reasons. I’m guessing another factor is health related. The U. S. got rid of lead in their gasoline, and crime went down. Oil in general is very dirty, and contributes to a lot of health problems. Countries that use less, probably have fewer health problems as a result (all other things being equal).

  6. plct

    Do you have real evidence that a carbon tax is good for the economy? Vancouver and Stockholm both having carbon taxes and having good growth is… bad evidence at best? e.g. I’m pretty sure Guangzhou doesn’t have a carbon tax.

    Before claiming causation, I’d like to know the correlation is actually there.

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