I was skimming through Mankiw's blog and came across a post on McCain and Obama's positions on carbon auctions. I mentioned the importance of the carbon auctions in my previous post as a lesson that the US is learning from the mistakes in the EU - i.e. giving away carbon credits in many cases actually serves as a subsidy. Mankiw's point is that you have to go with a full auction system because it most closely resembles a Pigovian Tax, which apparently is the optimal policy response to externalities.
A Pigovian Tax is basically just a tax levied to counter negative externalities in a market. If you give away carbon credits for free, there's no price and no incentive to improve. Instead, you have to put a price on the externality and make people pay for it. And then theoretically the revenue that's generated from the tax could be used on research or projects to mitigate the impact of the externalities.
I also read an article recently about what's called a "cap-and-dividend" system. The basic idea is that instead of the revenue from carbon taxes (or the auction of carbon credits) going to the federal government, the revenue would be returned directly to taxpayers. With any Pigovian tax, the additional price of the externalities that have been "internalized" so to speak will be reflected in the total price of the product. That means higher prices for consumers that continue buying products with heavy externalities (e.g. driving to work in your SUV vs. taking an electric train). For those people that don't buy those products, they are saving money and avoiding the tax. The idea with cap-and-dividend, though, is that you then return all of that money back to taxpayers equally. So, if you're buying the taxed products, you get a little bit of money back - although you don't break even. If you're not buying the taxed products, you are actually making money!
The main thing that's interesting about this idea is that it brings attention to the issue. The size of the problem (and the tax) isn't hidden away in prices. It also ensures that the government doesn't become dependent on what should be a temporary source of revenue.
But wouldn't you be better off if you used the money for research and development? As long as the tax revenues can only legally be used for projects that mitigate the externality, I think that's a better solution (albeit not as provacative). But what often happens is that the revenue goes into a slush fund that can be used for anything - e.g. covering budget shortfalls.
A Pigovian Tax is basically just a tax levied to counter negative externalities in a market. If you give away carbon credits for free, there's no price and no incentive to improve. Instead, you have to put a price on the externality and make people pay for it. And then theoretically the revenue that's generated from the tax could be used on research or projects to mitigate the impact of the externalities.
I also read an article recently about what's called a "cap-and-dividend" system. The basic idea is that instead of the revenue from carbon taxes (or the auction of carbon credits) going to the federal government, the revenue would be returned directly to taxpayers. With any Pigovian tax, the additional price of the externalities that have been "internalized" so to speak will be reflected in the total price of the product. That means higher prices for consumers that continue buying products with heavy externalities (e.g. driving to work in your SUV vs. taking an electric train). For those people that don't buy those products, they are saving money and avoiding the tax. The idea with cap-and-dividend, though, is that you then return all of that money back to taxpayers equally. So, if you're buying the taxed products, you get a little bit of money back - although you don't break even. If you're not buying the taxed products, you are actually making money!
The main thing that's interesting about this idea is that it brings attention to the issue. The size of the problem (and the tax) isn't hidden away in prices. It also ensures that the government doesn't become dependent on what should be a temporary source of revenue.
But wouldn't you be better off if you used the money for research and development? As long as the tax revenues can only legally be used for projects that mitigate the externality, I think that's a better solution (albeit not as provacative). But what often happens is that the revenue goes into a slush fund that can be used for anything - e.g. covering budget shortfalls.
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