A Pigou Club Member Agrees (Basically) With a Climate Change Skeptic

On June 12th, 2007, noted economist and climate change skeptic Ross McKitrick made a proposal in Canada's Financial Post newspaper that I believe has not received the attention it deserves. The article: Call their tax which proposes to tie the carbon tax to levels of warming seems to have gone unnoticed by many, though the magazine The American has a terrific summary - Cutting the Gordian Knot: A new and better carbon tax proposal.

The Carbon Tax Proposal

The carbon tax that McKitrick proposes is powerful, yet simple. As McKitrick describes it:

Second, climate models predict that, if greenhouse gases are driving climate change, there will be a unique fingerprint in the form of a strong warming trend in the tropical troposphere, the region of the atmosphere up to 15 kilometres in altitude, over the tropics, from 20? North to 20? South. The Intergovernmental Panel on Climate Change (IPCC) states that this will be an early and strong signal of anthropogenic warming. Climate changes due to solar variability or other natural factors will not yield this pattern: only sustained greenhouse warming will do it...

Now put those two ideas together. Suppose each country implements something called the T3 tax, whose U.S. dollar rate is set equal to 20 times the three-year moving average of the RSS and UAH estimates of the mean tropical tropospheric temperature anomaly, assessed per tonne of carbon dioxide, updated annually. Based on current data, the tax would be US$4.70 per ton, which is about the median mainstream carbon-dioxide-damage estimate from a major survey published in 2005 by economist Richard Tol. The tax would be implemented on all domestic carbon-dioxide emissions, all the revenues would be recycled into domestic income tax cuts to maintain fiscal neutrality, and there would be no cap on total emissions.

The Benefits of the Plan

Despite being a self-described 'tree-hugging, bird-watching nature lover', I believe McKitrick's proposal has a number of merits, including:

Taking the Politics out of the Rate: Some believe that temperatures will rapidly increase over the next few years and as such the carbon tax rate should be set high. Others believe that anthropogenic climate change is not occuring, so the carbon tax rate should be set at zero. By implementing McKitrick's plan, we do not have to decide a priori who is correct. If the first group is correct, they get the carbon tax rate they want. If the second group's predictions are more accurate, then the carbon tax rate will wind up near zero. Or as McKitrick describes it:

Under the T3 tax, the regulator gets to call everyone's bluff at once, without gambling in advance on who is right. If the tax goes up, it ought to have. If it doesn't go up, it shouldn't have. Either way we get a sensible outcome.

Provide an Incentive for More Accurate Climate Models: Since the tax rate is variable, large-scale emitters of carbon will want to have accurate forecasts of future temperature changes. This tax plan gives incentives for the private sector to develop accurate climate change predictions due to the dollars involved.

Provide an Incentive for the Development of a Climate Futures Market: Since there is so much at stake financially for getting the future level of temperature change correct, there will no doubt develop a future's market in temperature. Futures markets tend to be far more accurate predictors than individuals, so a future market will lead to a more accurate 'consensus' of what the future holds in terms of climate change.

The Carbon Tax Plan's Flaws

The carbon tax is not perfect. If temperatures are increasing due to the burning of fossil fuels, then the tax rate only reflects past activity. That seems a little like buying fire insurance after your house burns down. But since part of the point of this is that we cannot predict the future, the backward-lookingness of the plan seems to be a flaw we must live with.

A more fundamental flaw is the way the tax rate is set. McKitrick writes:

uppose each country implements something called the T3 tax, whose U.S. dollar rate is set equal to 20 times the three-year moving average of the RSS and UAH estimates of the mean tropical tropospheric temperature anomaly, assessed per tonne of carbon dioxide, updated annually.

This presupposes that the damage caused by climate change is proportional to the change in temperature. Is there any reason to believe this is so? It would seem to me that if we are worried about 'run-away' climate change, a 5-fold increase in the temperature anomaly should lead to more than a 5-fold increase in the tax rate. I am not certain what the right functional form is (quadratic? exponential?), but I believe it is unlikely to be linear. Further study would be required to determine the functional form the tax rate should take.

As well, McKitrick's proposal does not consider the non-Pigovian pro-economic growth arguments for increasing the gasoline tax and decrease income taxes. However, increasing general sales taxes on all products (including gasoline) and decrease income and corporate income taxes would achieve the same ends.

Calling McKitrick's Bluff

I suspect Prof. McKitrick believes that those on the climate change could be a serious problem side of the debate will shy away from his proposal. Although I have some reservations on the formula used for the tax rate, I believe McKitrick's proposal has a great deal of merit. After determining the correct formula for the tax rate, I would support his proposal.