Tax brown energy or subsidize green? The choice is easy

Progressive Democrats assert that the Green New Deal is the best way to reduce global greenhouse gas emissions.

But this claim ignores the fact that subsidizing “green” energy technologies, such as wind and solar, is less effective than taxing the greenhouse gas emissions produced by brown energy sources, such as oil, natural gas and coal.

{mosads}What happens if we subsidize green energy? More green energy will be produced. But there’s no guarantee that there will be less greenhouse gas emissions. Because these subsidies reduce the price of green energy, and brown energy is a substitute for green energy, the demand for brown energy should fall. 

This will lead to lower prices for brown energy, which implies that even larger subsidies are required to spur more investment in green energy.

Subsidizing green energy requires a revenue source. Regardless of the source, the process of raising these revenues destroys economic value. Less of the product or service providing the subsidy is produced and consumed. 

Suppose the subsidies are funded by a payroll tax. This increases the price that firms pay for each hour of labor and reduces the after-tax wage than employees receive. The former causes the firm to hire fewer workers and the latter causes workers to supply less labor.

Similar logic applies to any fee or tax levied to finance these subsidies. The price including the fee rises and the after-fee price falls, both of which reduce amount of the product or service demanded and supplied. 

The larger the subsidies paid, the greater the amount of economic value that must be destroyed to finance them. This is a rarely discussed aspect of subsidizing green technology.

Using our payroll tax example, not only do firms pay more and employees receive less to finance the subsidies, there’s also less employment and ultimately less output sold by firms.

What happens if we tax brown energy? It becomes more expensive to produce greenhouse gas emissions. The higher price of goods and services produced using brown energy provides strong incentives to firms to find the cheapest, least greenhouse-gas-emitting replacement. 

The brown tax also raises a substantial amount of revenues for the government that can be used to reduce other taxes.

Greenhouse gas (GHG) emissions in the United States in 2016, the most recent year of data available, were 6,511 million metric tons. A modest carbon tax of $10 per metric tonne would raise roughly $65 billion annually. 

This revenue could be used to reduce income taxes and payroll taxes, which should increase employment and the wages paid to workers.

Taxing brown has the potential to achieve what economists call the “double dividend” of simultaneously improving environmental quality by reducing greenhouse gas emissions and increasing employment and output because of the reductions in payroll and income taxes enabled by the revenues raised by the carbon tax.

If taxing brown can deliver this win-win outcome for the environment and economy, why it is so unpopular? That’s because everyone dislikes paying a higher price for products made with brown energy. 

Subsidizing green creates a constituency that receives significant economic benefits from the subsidies.   Because the mechanism used to finance the green subsidies is hidden in a complex federal or state tax system or an even more complex retail electricity tariff, most consumers are unaware of the total cost of these subsidies.

What about politicians? Why do they like subsidizing green instead of taxing brown energy? Subsidizing green allows them to hand out the subsidies to their favorite technologies and services in the name of reducing greenhouse gas emission.  

{mossecondads}Taxing brown energy requires everyone to pay for their greenhouse gas emissions and only those technologies and services that are the cheapest way to reduce greenhouse gas emissions realize benefits from taxing brown. Politicians have little, if any, control over who gets these economic benefits.

We have two choices for a Green New Deal. Subsidizing green is expensive and unlikely to reduce emissions as much as taxing brown, which explicitly prices the cost that greenhouse gas emissions impose on the global environment.

The entities producing these emissions bear these costs and the revenues raised can be used to reduce taxes on activities we would like to encourage, like having a job and earning income. 

If we don’t want to burden current and future generations with unnecessary environmental and economic costs to address the global climate challenge, the choice is clear — tax brown.

Frank A. Wolak is a professor of economics and director of the Program on Energy and Sustainable Development at Stanford University.