We must do something. This is something, therefore we must do it. This is a seductive fallacy, especially when the problem is as dire as climate change. Nonetheless, not all climate change policies are created equal. A simple carbon tax combined with a reduction in personal and corporate income taxes would be a good idea. On the other hand, subsidies for the production of alternative energy sources or a cap-and-trade system would not.
Subsidies for the production of alternative energy sources essentially mean that governments decide for their citizens which technologies are best. The experience of western governments picking winners and losers among new businesses and technologies over the last century has been disappointing at best. It is nearly impossible for any one person to understand all of the information that is relevant to weighing the costs and benefits of every possible technology. Any decision by a centralized decision maker is therefore unlikely to be the optimal decision for every conceivable situation.
The decentralized decision-making process of the marketplace, however, does not suffer from this starting problem. If there were a simple, transparent carbon tax, all individuals and businesses would be forced to take account the costs and benefits of their own decisions. Their own self-interest would lead them to choose the technologies that represented the optimal decisions in their specific situations.
While a carbon tax would raise revenue that could then be used to reduce other taxes, new alternative energy subsidies would require the overall level of taxation to be raised. This not only creates a political problem — the voters generally prefer lower taxes to higher taxes — but also an economic one. Current taxes on labor and investment income cause economic inefficiencies because they discourage work effort and saving, making society as a whole worse off. Thus, the true costs of a carbon tax would be lower — and the true costs of further subsidies would be higher — than the above-mentioned numbers once the deadweight losses caused by other forms of taxation are factored in.
Far more important than economic theory, though, is basic political reality. Public policy must take into account not only market failures — in this case the fact that anyone can currently dump greenhouse gas pollutants into the atmosphere for free — but also government failures. Unlike private individuals or companies, governments can exercise coercive powers over others. As such, special interest groups often seek to use these coercive powers towards their own ends.
Farm groups and energy companies — both renewable and non-renewable — give significant campaign contributions to both political parties. In return, they have been handsomely rewarded by the federal government in the form of various subsidies. Even if the “wise men” in government could efficiently allocate resources and the deadweight losses of taxation were negligible, the special interest groups that benefit from government subsidies have inevitably corrupted attempts to encourage “good” energy sources through these subsidies.
The same political problem applies to cap-and-trade. If permits were auctioned off, a cap-and-trade system would be little different from a carbon tax. But the European Union Emissions Trading Scheme, which started in 2005, and the cap-and-trade bill proposed in Congress did not auction of the permits. Instead, the permits were handed out for free to politically well-connected companies. Given this political reality, cap-and-trade represents the largest corporate welfare scheme in history.
A carbon tax would be much more difficult for special interest groups to hijack. Voters don’t seem to have a problem with coal companies receiving free cap-and-trade permits. On the other hand, how many people would tolerate a coal company being exempt from having to pay a carbon tax? Thus, not only is a carbon tax more efficient than renewable-energy subsidies, but it is much more difficult for special interest groups to hijack than subsidies or a cap-and-trade system. Ultimately, those who are concerned about climate change should argue for a carbon tax.