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The real costs of the greens' carbon tax
Gerard Jackson
The same mentality that gave us the ethanol scam and food riots is the same one that is trying to foist a disastrous carbon tax on us. One aspect of the carbon tax that is rarely mentioned in the public arena concerns the use of discounting. We naturally value present goods more highly than future goods. This phenomenon is called discounting. It also explains the existence of interest.
If we did not discount then $100 ten years hence would have the same value as $100 in the hand. This also means that future expenditures are discounted by the rate of interest to give us an estimate of their present value. At an interest rate of 10 per cent $100 in a year’s time is worth $91 today. Obviously, the higher the interest rate the lower the present value of a future good. Take land as an example: if its value was not discounted it could never be bought or sold.
When a firm appraises a potential investment it is the practice to calculate its internal rate of return. If the internal rate exceeds the rate at which the firm can borrow, the investment is profitable. (This, of course, is a great simplification of the investment process). Therefore discounting is used by firms to measure and compare future flows of benefits and costs in terms of money. This is basically what most economic models are trying to do when they attempt to compare the costs of cutting CO2 with the apparent benefits. But this approach also brings into play the economic concept of cost.
Every economist knows that the real cost of anything is not its money price but displaced values: those things that must be sacrificed to obtain the desired good. Economists aptly call these sacrifices opportunity costs. Thus the real cost of buying a car is all the other goods and services that would have otherwise have been bought. To a firm, its costs would be alternative revenue flows.
The effect, and intention, of reducing Co2 emissions is to burden the economy with higher production costs. Thus the costs of these green policies to society as a whole will be lower productivity, more premature deaths, fewer opportunities for more productive technologies, especially energy intensive ones, fewer resources for schools and hospitals, the loss of investments yielding more and more better paid jobs, etc. And no amount of discounting or fiddling with incomes taxes can make these costs disappear.
If we focus on the firm for a moment we see that when it considers a potential project it will discount the anticipated stream of earnings and costs and compare them with each other. Should the costs exceed anticipated earnings then obviously the project will be rejected. A crude way of applying the same principle to an economy would be to try and calculate the alleged future costs to the economy of Co2 emissions, then discount these alleged costs at a certain rate of interest, divide the result by the population to get a per capita figure and then subtract the figure from per capita GDP.
If the per capita GDP figure is $30,000 and the per capita cost is $10,000 then the loss of income is significant. (The figures are arbitrary and chosen for reasons of exposition). Of course, it will be argued that it’s still worth the cost and it’s only a one-off sum anyway that doesn’t have to be paid at once. The problem is that it’s not a one-off sum — none of these figures are one-offs. The following explanation should suffice to make my point clear.
A permanent increase in energy costs will force firms to restrict output by eventually changing their factor combinations in a way that will bring operating costs into line with a lower level of output. Thus, if a carbon tax is used to destroy the profitably of coal-fuelled power stations in favour of grossly inefficient wind and solar power the social and economic consequences for the country would be calamitous
To argue otherwise is to assert that rising production costs do not affect output. If this were so, then an immediate doubling of wage rates would not affect output or employment. It clearly follows that the reduction in output becomes a permanent feature. Now a non-green economist could argue that there need not be a permanent fall in living standards or any fall whatever, merely a reduction in the rate of increase in consumption. This amounts to saying that part of those savings that would have gone into increased production will be directed into reducing Co2 emissions. In other words, instead of having a 4 per cent growth rate we only get 1 per cent1.
This argument ignores the fact that the policy would only slowdown CO2 emissions, which would cause green fanatics and gullible politicians to demand even more stringent reductions. This is because the greens' goal is to use 'greenhouse' taxes to reduce production in absolute terms and not just the rate of output. In any case, it's ridiculous to claim that deliberately slowing down capital accumulation is not a cost to society. (The Centre for Independent Studies, so-called free market, recently defended this absurd claim2).
Any government action that forcibly reduces investment and consumption is attacking its citizens' living standards. Moreover, the idea of blanket energy taxes and aggregate discounting for the economy are questionable approaches, falling into the trap of what I call the tyranny of aggregates. By concentrating on discounting for the economy these neglected the key role that the market rate of interest plays in not only equating the supply of capital with the demand for capital but of allocating capital through time.
Production takes time, a fact that few should feel the need to dispute3. The question is: How much time? This is where interest reveals its vital hand. If the rate of interest falls naturally, i.e. people are saving more, from 5 percent to 3 per cent then this will signal to entrepreneurs that more capital is available. By definition this means that the discount rate also falls. Many highly productive projects that were ignored because the previous rate of interest made them unprofitable because of their highly time-consuming nature now become profitable at the lower rate of interest. Therefore the effect of the fall in the rate of interest is to lengthen the production structure by adding more time-consuming but highly productive stages to it. (This is what is meant by allocating capital through time).
Imagine the economy expressed as a right-angled triangle with a number of rectangles going through it, with each rectangle representing a stage of production. As the triangle gets longer and wider more and more time-consuming complex stages are added to it, which eventually increases the flow of consumer goods and services. Now take two identical triangles and then have one expand at 5 percent a year and the other at 1 percent. The one expanding at 5 percent will double in size in about 14 years while the other will take about 72 years. We can see that after 14 years of growth the differences in size would be gigantic.
Let us now superimpose the slow growing triangle A on the fast growing one B. The area outside A but still within B is what B would have had to sacrifice if its growth rate had been cut to 2 per cent. As B is now a far richer economy than A because it has a longer production structure it can allocate more resources to fighting whatever environmental problems it comes to face. This means that instead of imposing an energy tax on production economy B can pay for the environment out of general revenue. In addition, its rapid growth also means that advances in technology would be embodied in its capital structure. On the other hand, the cost to A of fighting environmental problems will be far greater.
Greens can argue that there is no time to lose; impending doom in the form of global warming calls for measures now. And that the economic benefits from cutting C02 emissions will greatly exceed the costs. No and No. In fact, the evidence against the existence of man-made global warming is mounting. Antarctica is getting colder and accumulating more ice, and sea levels are not rising.
The IPPC has conceded that the warming up to 1940 was the result of solar activity during the early part of the century. So the ice caps are not melting and polar bears are not disappearing. Moreover, there has been no increase in warming during the last 10 years. Some scientists are now warning of an impending and significant drop in global temperatures.
The Medieval Warm period — which was much warmer than today — and the Little Ice Age happened independently of human activity. This strongly indicates that even severe weather fluctuations are a natural part of global weather patterns.
In other words — don't panic.
Considering the amount of anti-warming evidence that is accumulating, I think people are entitled to question the motives of those who are using hysterical language to try and bulldoze us into adopting policies that would savage our living standards while simultaneously increasing government control over our lives.
1. Economic growth is the process of capital accumulation. Once again, this is another concept that is more complex than it at first appears.
Economic growth is the only way to raise living standards and conserve resources
Carbon taxes versus living standards
Why a carbon tax would hit living standards
Why is the Centre for Independent Studies supporting the destructive carbon tax?
2. How the Laffer curve really works: This article demonstrates how the tax cuts raise living standards.
3. There are those economists who adhere to the Clark-Knight treatment of capital that views it as a permanent and self-maintaining fund. They also assume that production and consumption occur simultaneously instead of occurring through time. (John Bates Clark Essentials of Economic Theory, The Macmillan Company, 1924, pp. 18-19 and p. 29).
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 28 April 2008