Sunday, February 14, 2010

Carbon Tax



Sovereign debt , as a potentially crippling fiscal problem world wide, has risen to the forefront over the past few months. Whether it is the US, Europe, Japan or many other developed and developing countries the sovereign debt watch is on.

The major metrics of a pending sovereign debt crisis that have been in vogue for decades used to be applied only to developing countries. Unfortunately this is no longer the case. The Herculian efforts by governments all over the world; the developed in particular; to avoid a repeat of the debilitating depression of the 1930's has forced these countries to increase substantially their fiscal stimulus programs. In a sense the monetary and fiscal policies adopted by the officials of all of these countries have been very successful. A worst case scenario has been avoided.

But as economics has always taught us, There Ain't No Such Thing AS A Free Lunch; TANSTAAFL. Yes we avoided a deep recession and the top officials can pat themselves on the back for this. But maybe not. Is the cure at least as expensive or maybe even more so than the ailment that it saved us from? That is , currently, the $64,000 question or maybe I should say the $64 billion question?:-)

Often, our efforts at prescribing remedies are counter productive because of what is inherent in problem solving. We always seem to target the symptom rather than the disease. As a result we inevitably move from one crisis to the next as a result of the law of unintended consequences.

In our efforts to save the system and to prevent a major economic depression we proceeded to throw money at the problem in order to generate more final demand and thus put more people to work. What we did not stop to consider is the major question of how are we going to pay back all of these funds that we have borrowed? It seems that we did what we always do, shift the burden onto the future generations. The debt will not come due for some decades ,right? Wrong.Well informed individuals know that more debt implies more taxes in the future and so they take corrective by refusing to own the highly risky debt. Once we find out that the debt service is too large and that we cannot keep on rolling the debt unto the future then we will have no choice but to become deadbeats. That is where we are at the moment. The question is which country is going to go under first? Would it be Greece or would it be one of the other PIIGS? How about the UK, or evn Japan or the US? If any of these countries default would they set up a contagion that will devastate all the current international financial sytem as we know it?

Believe it or not there is a potential mechanism that if adopted could go a long way towards addressing the real cause of this issue and not only the surface phenomenon. The solution that I am about to propose is not new, actually,N.G Mankiw wrote about it in 2007.

"The scientists tell us that world temperatures are rising because humans are emitting carbon into the atmosphere. Basic economics tells us that when you tax something, you normally get less of it. So if we want to reduce global emissions of carbon, we need a global carbon tax. ...

The idea of using taxes to fix problems, rather than merely raise government revenue, has a long history. The British economist Arthur Pigou advocated such corrective taxes to deal with pollution in the early 20th century. In his honor, economics textbooks now call them “Pigovian taxes.”...some taxes align private incentives with social costs and move us toward better outcomes."


I would love to see a carbon tax levied not only in the major industrial countries but all over the globe with all the proceeds dedicated to lowering the sovereign debt. Such a tax could be a first step towards internalizing the negative externalities of all the production inthe world economy. If that leads to less and more efficient production then all of us will be winners.

11 comments:

Caroline Craig said...

It seems that all of this talk about cap and trade and carbon credits is just dancing around the inevitable and seemingly only worthwhile solution: carbon tax.
As for sovereign debt, that subject always fascinates me. I guess it's economics in general- the value of these little pieces of paper and how we can transer that value. I'm still intrigued by my own online banking! How I can simply click "transfer money" and a few more clicks later- i have less monetary value in one account and more in another. It makes it appear like money and value and all that... they're magical. They can be drastically changed and even eliminated simply with the move of a hand. Too bad we all know that isn't true.

Syed Mohsin said...

I was one of those people who thought that, maybe levied taxes could fix problems such as air polllution, industrial waste,water pollution, etc, or atleast, reduce them. After reading this article, I just realized that taxes will not help, we will always find ways to pay the taxes, no matter how high the amount will tend to get. It is human nature to do more of things we like to do, we like extrating resources and expanding our economy. So if high taxes are levied, we will get around it by finding ways to afford the taxes, and in turn, create more pollution, due to the extraction of resources or inputs that are needed to run the economy and generate income; or better yet, that extra amount of levied tax.

Rob Hamilton said...

Looking at the post, there is a issue of treating the symptom rather than the disease. The symptom was the current economic recession and issues in the financial market. What is the deeper problem? Gratification now at the expense of those who are not even around yet?

Going along with this, to address this root problem, there needs to be a fundamental change as to how we live our lives, a broader and more holistic depth to how we operate as a society needs to be refined so the dumping of burden onto the future can be identified as the issue, and not whatever the headline problem of the day is on the local paper.

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