Carbon tax fuels massive inflation with high energy prices

Carbon taxes, and their functional equivalent disguised in the form of energy taxes, have faced political obstacles and serial failures to take effect ever since the debacle of the 1993 Clinton–Gore “BTU” tax. Now a bipartisan group of American lawmakers has proposed a “border carbon adjustment” tariff intended to reduce society’s use of hydrocarbons and usher in energy innovation. But carbon taxes have failed, so far, for good reason: they’re a bad idea and would do little to cut hydrocarbon use or stimulate productive innovations. And whether framed as a border adjustment or as the broad-based levy that Congress toyed with enacting three years ago, any carbon tax would be inflationary—meaning this latest proposal couldn’t come at a worse time.

It’s easy to ignore the benefits of cheap energy when, well, it’s cheap. Energy is needed for everything that is fabricated, grown, operated, or moved. Since hydrocarbons directly supply 84 percent of the world’s energy and are indirectly embodied in all the rest, the inflationary potential of any carbon tax is clear. In normal times, energy typically accounts for only about 10 percent of the cost of most products and services. But double the spending on energy, and the average overall final price tag for a product or service rises at inflationary levels. With today’s energy prices already doubled, or more, the consequences are apparent. Over half of wheat’s inflation, for example, is a direct result of higher prices for natural gas, the fuel needed to make fertilizer.

The energy-inflation arithmetic is equally clear at the macroeconomic level. Before the runup in global energy costs—a trend that began well before the war in Ukraine—global spending by consumers and businesses on energy accounted for about 10 percent of global GDP. Double energy costs, and you don’t get more GDP: you get inflation.

Advocates claim that a carbon tax is an efficient way to reduce hydrocarbon use because it “disincentivizes” their use by simply raising the price. Whether the mechanism is directly to tax energy to make it more expensive, or indirectly to tax it by making it more expensive to buy imported products built in other more hydrocarbon-intensive countries, both have the stated purpose of raising prices. High energy prices do indeed discourage consumption, but they also debilitate citizens and economies, especially during times of inflation. So carbon-tax advocates propose that some of those collections would flow back to the economically disadvantaged—which would be pretty much everybody if a tax or tariff were high enough to curb energy use meaningfully.

We have some idea of how significant a tax would have to be to deter hydrocarbon use. For example, in the decade leading up to the 2008 recession, world demand for oil kept rising even as prices rose 200 percent. Oil use dropped only when economies collapsed from the financial crisis. Carbon-tax advocates know that political support will require that energy prices go up only slightly. But any paltry tax wouldn’t measurably affect hydrocarbon use and would therefore utterly fail to achieve the ostensible goal.

Carbon-tax proponents also suggest that the higher costs for hydrocarbons would stimulate both innovation in alternative-energy domains and reshoring of energy-intensive industries. Foundational innovations don’t emerge from punitive taxation, but such taxation is a formula for political backlash. It’s equally fictitious to believe that a border-adjustment tax would induce some rush to low-carbon reshoring of manufacturing. Such a managed economy would, intentionally, yield more expensive goods, and at even higher costs if required to use energy from a subsidized green-energy system. This scheme would not only ignite more inflation but also invite fraudulent accounting, cronyism, and kleptocracy. Because America’s economy uses so much energy, even a modest tariff would drain billions of dollars out of the private economy into government coffers, where much of that would flow to those positioned to benefit. And, as history has shown, any new “modest” tax invariably expands over time.