On Carbon Taxation

# On Carbon Taxation To what end must we pit ourselves against the unstoppable driving force of climate change? Perhaps it is because we sincerely believe that our policies, such as carbon tax, can genuinely help. The reason I ask these questions is because a carbon tax is a big talking point for the 2020 election, and although politics is lowbrow, pointing out flawed economic reasoning is not. And the truth is, for whatever reason you believe a carbon tax is a good idea, you're wrong. And it's not because I'm a climate denier, or don't understand economics, or I'm a rich, old fart with no kids and nothing to lose. I disagree because I care about doing the right thing, not the easy thing. And although a carbon tax seems to be both an easy and good way to path the way towards a green economy, let me show you why it is both very challenging and, not ineffectual, but bad, malicious, counterproductive and possibly even Evil. But let me explain. The theory of taxation is based on the principle of substitution. On the supply side, taxed goods are either substituted or, if there is no more economical alternative, a greater cost of production is incurred. Every taxation scheme presupposes a mapping of products with corresponding taxes. When there are few goods and the tax function is simple this is not hard to achieve. However, for industrial goods that serve as inputs to significant portions of all industry, assigning a cost in proportion to environmental impact is incredibly challenging. Firstly, because low cost correlates well with greater ecological impact, an improper mapping (mispricing taxes for particular goods) will push suppliers to use the cheapest goods relative to their productivity, which will generally have greater impact on the environment. Secondly, because production webs are an incredibly complex network of interrelationships that make establishing even a close approximation of the *real* environmental cost (assuming it exists) cost-prohibitive and virtually impossible. But let's keep going. Let us assume that this mapping is possible—so how would we do it? Suppose we want to tax oil goods, since oil is a fundamental input to our economic system. But how do we price goods? We substitute them with other goods that have already been priced, and evaluate *marginal* differences in productivity, and estimate linear changes with some historical data. The problem is we only know how to price goods relative to other similar goods. Numerical analysis only yields insight about the marginal response of the economic system to higher prices, our predictive powers extend only a few percentage points in either direction. Structural change is dependent on variables that are not available for analysis, from the complex web of interrelationships to the extent that each input used by producers is tied to the taxed good, to the substitutability of each of these, and on and on, one can see that this problem seems infinitely recursive. Merely collecting these data would impose a significant strain on the economic system and, assuming that it is done, would likely yield data with low reliability, figures that are hard or impossible to verify, as every producer providing this information has an incentive to mislead, and quite sparse as relating to the *real* network of interdependence of every produced good. Even [relatively simple goods](https://www.youtube.com/watch?v=67tHtpac5ws) pose intractable computational and data problems. The very foundation of financial theory (time value of money) which is used to find the appropriate tax, is incompatible with this question: > The criterion of maximizing present monetary value causes systematic underestimation of the biophysical requirement of exhaustible resources for future generations.[^5] Now consider oil again, which data suggests has 1) no substitute in key sectors of the economy, 2) is interdependent with nearly everything else, and 3) has nearly 40 trillion in capital investments that are **only productive in an oil regime**[^1]. When there is no substitute for a good with demand, pricing theory assigns it an infinite price. This isn't helpful, so let us consider a scheme that merely extracts the maximum tax revenue to fund a sustainable energy substitution. Suppose you push a profit maximizing initiative for consumers. You're amortizing the replacement cost of 40 trillion worth in capital, as well as the additional cost of building additional capacity for new people being born, as well as the maintenance cost of existing capital until it is replaced, in a regime where most existing capital is [old and unreliable](https://www.infrastructurereportcard.org/) and when it is being tested by climate induced disasters. The best case scenario is one where substitute goods capable of driving the economy the way oil does *actually exist*. This is incredibly optimistic. It also assumes the cost of replacing existing capital will be equal to its current estimated value, which again is optimistic, as we're drawing not on millions of years of accumulated energy (fossil fuels), but on weak, hard to transport, and inconveniently located flows of energy (eolic, solar, geothermal, etc). It is likely the cost is much greater. The data also suggests that energy transitions have been driven by greater quality, power-dense energy sources, and by the development of capital investments and technology needed to produce motive power efficiently. It is not only the exploitation of coal that ushered in the industrial era, but also Watt's steam engine, which wrought a tenfold rise in energy efficiency (from 0.2% all the way to 2%), the blast furnace used to make iron, and many other innovations. The blast furnace works by indirectly heating iron ore with coke, which is coal fired at low oxygen levels to burn off impurities to produce higher-grade fuel that burns at hotter temperatures. Charcoal-fired iron, which benefits from the relative purity and high-grade of charcoal as a fuel, does not imbue iron with impurities that make it weak. Coal, on the other hand, is not surprisingly a much lower-grade fuel that, if substituted into a charcoal-fired iron furnace, produces brittle and useless iron[^2]. This serves as an example of the complex and unexpected ways the energy input of choice profoundly shapes the economic system and invested capital, and how each time there is an energy transition a great amount of invested capital needs to be substituted with generally less efficient results, since each step of production is fine-tuned and developed to be as efficient as possible with their given inputs. This is known as **path dependence**, and it makes any relatively large change to a complex system extremely hard to pull off without great losses in production and efficiency. This strikes a much less than rosy picture for alternative energy sources. Although nuclear power can provide reliable and sustainable electric energy, electricity is itself a poor substitute to oil, as it cannot be easily stored outside of expensive chemical batteries (terrible for the environment), or hydroelectric dams, which convert electric to potential energy by pumping water upstream and releasing it to power electric generators on demand. However, these are not very conveniently located (generally not close to densely populated, energy intense areas), are themselves dependent on access to water (threatened by climate change), and crucially does not substitute hydrocarbons in the transport industry, which accounts for 20% of emissions. Nor does it satisfy agricultural needs, which take ammonia (produced with Haber-Bosch process) and potassium (very much non-renewable) as key inputs as fertilizer, not even counting all sorts of pesticides or the powering of advanced agricultural machinery[^2]. Thus we find that much of the world's *energy* (distinctly not *electricity*, which accounts for a mere 20% of total energy) depends on oil, natural gas, or coal, which are used in ways that are *uniquely dependent on the energy source*, and thus hard or impossible to replace without astronomical investment in R&D and productive capital. Suppose instead we don't extract profit maximizing taxes from the public, to avoid all the terrible problems that would result. First of all, good luck paying for a 40 trillion overhead in infrastructure we must replace in a viable time frame. Second, since we have already outlined the scope of the problem, and we assume there is no taxable amount that can cover the costs and not cause a severe depression, we merely use an appropriate amount to encourage producers and consumers to use environmentally conscious products. This sounds somewhat acceptable, and is probably what politicians talk about when they say they intend to enact a Carbon Tax. Although it appears reasonable appearances are deceptive, as this presupposes many of the impossibly challenging conditions that made our first hypothetical carbon tax fail. First one must make a mapping of goods to their environmental impact that is sufficiently good to avoid a shift to less costly and worse inputs. If eco-friendly goods are taxed and thus have higher prices, participants will just buy cheaper goods that are less regulated or mispriced with respect to their footprint, since nearly every good that is cheaper is also worse for the planet. In this manner an approximate-but-imperfect mapping of tax prices will do more harm than no taxes at all, since it will encourage agents to go for cheaper and likely less eco-friendly goods, while simultaneously straining and negatively impacting companies that self-regulate honestly and effectively. Second, it presupposes that substitutes *exist*, such that this order of taxation will prompt reinvestment and a transition towards more broadly acceptable sources of energy, productive processes, etc. Yet, as we have previously outlined, there are no perfect substitutes for oil, and we must not only replace an energy source, but also one that is portable, very energy dense, liquefiable, storable, and capable of producing high temperatures when burned. We must also replace the chemical processes for which oil is a key ingredient, including all those that produce our complex and also hard-to-substitute medicines, industrial chemicals, plastics, etc. We must also find a way to substitute or reduce our dependence on nonrenewable minerals, since these too will one day run out, and at the same time find a source of nitrogen, potassium, and various other chemicals for use as fertilizers, which account for nearly 70% of global agricultural output. Although this is hardly an exhaustive list, one can easily see that solar panels, wind turbines and nuclear energy are **not solutions to these problems.** Now supposing that the taxation scheme is mathematically perfect, somehow capturing exactly the relative impact of all goods and assigning proportional taxes, what happens? Suppose it is actually enforced across the globe and aggregate demand shifts accordingly in response and somehow a major economic depression is avoided. How will the companies supplying key inputs (image below) to our economies respond? Will they survive and continue filling their unsubstitutable role in our society? Supposing that any failure of these systems would immediately cause a depression, if not total civilization collapse, let's begin by analyzing the response of a (relatively) simple one: energy and resource infrastructure. In general, when we consider a major decrease in production in a globalized economy that is predicated on sustained growth, where each subcomponent expects equal or greater returns to those of the present time, and where strategic capital investment stretches far off into the next few decades, a decrease in the rate of growth is enough to severely impact each and every critical hub in ways that are both unpredictable and threatening to the very mechanisms by which they exist. As output shrinks what happens to the price of oil? Although an increase in price through taxation reduces demand for oil, as quantity consumed starts shrinking and productive capital investment owned by oil companies begin to operate at a deficit, energy companies are forced to take a loss to cover their costs and keep oil wells pumping, since they cannot easily be turned off and on like taps. If they cannot meet short term liabilities or meet fixed costs, the company goes bankrupt and production immediately ends. If government steps in and finances the venture, they lose even more money and the potential to continue with their schemes to replace the infrastructure with something that is *actually* sustainable. A crisis in a single hub is an existential risk to the entire system, by definition, and ameliorating this crisis will be incredibly costly, as alluded to by the 2007 credit crisis. A crisis spanning across *multiple* hubs is likely to bring about a total systemic collapse. In the terms expressed by the goal of a carbon tax—that is, incentivizing a transition to more sustainable inputs for production—the impossibility of pricing a non-substitutable good, and the consequences of enacting a significant taxation scheme cannot cause more good than harm. Therefore, a taxation scheme cannot be implemented to cause a positive impact unless it takes on merely a symbolic role, and even this assumes a perfect map of tax levies to goods, which would otherwise incentivize consumption of goods that are even worse for the environment. Going even further, this ignores the immense burden that a pricing agency would have, as would enforcement of this law and the incredible slowdown that trade would have if goods and their impact had to be recorded and authenticated by all intermediate agents until the final good is produced and consumed. After considering this, one question remains unanswered, what can be done? We are locked in a speeding train with no breaks by design, and one whose tracks end at the edge of a precipice. The train keeps on accelerating, however, and it could be going fast enough that we could attach wings and fly, averting catastrophe. Faith that technological development will save us, that some energy will be discovered and substitute oil perfectly, magically, is the final refuge for those aware of the imminent resource and environmental crisis. Yet even if discovered, it better happen before it's too late. Second, it better be a damn good substitute, because we use oil for the food we eat, the goods that were transported to our hands, for plastics and as part of an immense number of industrial manufacturing processes. In the face of these facts, perhaps all that should be done is invest as much as possible on this project, quietly and without arousing much suspicion for panic would surely hasten our demise. We need something like a Manhattan Project, but—inconveniently—there is no war to win and no cash to go around. Perhaps some billionaire will achieve what decades of half-hearted government action could not, but again, we see ourselves hoping for a miracle. If all we have left is faith, let us all pray together, and pray that the coming decades bring about a tranquil end to civilization—that we vanish, as foretold by T. S. Eliot, not with a bang, but with a whimper. For what better choice do we have? ## Citations [^1]: Piketty, Thomas, and Arthur Goldhammer. "Income and Output." In Capital in the Twenty-First Century, 39-71. Harvard University Press, 2014. Accessed January 19, 2020. [^2]: Smil, Vaclav. "Fossil Fuels, Primary Electricity, and Renewables."*Energy and Civilization: A History*, 225-94. Cambridge, Massachusetts; London, England: MIT Press, 2017. Accessed January 19, 2020. [^3]: Smil, Vaclav. "Energy in World History." *Energy and Civilization: A History*, 385-442. Cambridge, Massachusetts; London, England: MIT Press, 2017. Accessed January 19, 2020. [^4]: Korowicz, David. "Trade off: financial system supply-chain cross-contagion: a study in global systemic collapse." *Metis Risk Consulting, 30th June, revised* (2012). [Link](https://www.feasta.org/wp-content/uploads/2012/06/Trade-Off1.pdf) [^5]: Mayumi, Kozo. "Can the Social Cost of Carbon be Calculated?" In *Contemporary Climate Change Debates: A Student Primer*. Routledge, 2019. Accessed January 19, 2020.