Solving advantage two decimates solvency for advantage one

If the literature on carbon tax misses hidden benefits of carbon tax, it also misses a hidden danger: the carbon tax generates revenue only if individuals or firms are paying the tax, that is, if they are emitting carbon. To the extent that they are able to bypass the tax by substituting to lower-carbon substitutes—or to the extent that lower-carbon emitting firms drive out higher carbon-emitting firms—revenues from the tax fall. If those revenues have been used to substitute for other taxes, when revenues fall the programs funded with those revenues come under threat.

One study, for example, in analyzing the effect of carbon taxes in Canadian provinces, assumes fixed elasticities of response of fuel use to carbon taxes [33]. But given the immense research and development infrastructure that has been generated around environmental technologies, this assumption of fixed elasticities is questionable, and it may be necessary to model also the elasticity of the elasticity—that is, it may become much easier to improve energy efficiency or substitute renewable fuels than it is now. For example, the price per watt of solar photovoltaic cells has dropped from over $70 in 1977, to under 70 cents today. That kind of non-linear development in technology is common in the rapidly developing green technology sector, but it is not incorporated in the current models. Indeed, the most ambitious countries have aimed to become 100% free of fossil fuel, and in the Nordic countries 63% of electricity already comes from renewable energy [34; see also 30].

Consider McKibbin et al.’s argument for using carbon tax revenues to reduce capital taxation: “In that case, investment rises, employment and wages rise, and overall GDP is significantly above its baseline through year 25” [10]. But what happens when one introduces non-linear technological development, of the kind seen in the development of solar energy, into the model? The environmental benefits would of course be dramatic, but the revenues from the carbon tax would fall, because these newer technologies emit less carbon and thus generate less tax revenue. If capital taxes or other taxes have been cut, then the programs that were supported by the carbon tax revenue can only be financed through deficits, through new taxes, or through cuts in spending, none of which are included in the optimistic model about economic benefits. These developments may reduce some of those economic benefits. Stern and Stiglitz [1] argue that this would only happen over the very long run, but it is hard to be confident of this prediction given the rapid development of clean energy technologies.