Tim found this update from Greg Mankiw:
Update: Responding to my post, John Whitehead writes, "The standard textbook treatment of a Pigouvian tax is agnostic on what happens to the revenue."
He is right, of course. So let me clarify. I was trying to make a point not about textbook economics but about practical politics. Here are two propositions:
1. The tax system should be shifted in a Pigovian direction.
2. Government should be larger.
These are largely unrelated claims. Logically, one can believe both, neither, or only one of them. In my view, it much easier to make the case to many voters, especially those on the right, for proposition 1 than for proposition 2. As a result, if you strongly believe in proposition 1 and are trying to put together a coalition to make it happen, marrying it to proposition 2 is not the best move.
I'm no expert in practical politics. Indeed, I have no idea how I would advise a politician how to answer this Republican debate question: “I want to know if any of [the candidates] have received a word from God on what they should do and take care of first?” When a word from God is an important issue isn't it a little bit ridiculous to wonder what God would advise on Pigouvian tax revenue?
But I'll take a stab at broadening the menu of practical political options. First, I'd say that presenting your counter argument with the vague "Government should be larger" and a "carbon tax needs to be evaluated on its own merits and should not be a stalking horse for a broader, big-government agenda" is not a signal that you are an unbiased advocate for more efficient environmental policy. Here is how Wikipedia explains big government:
Big government is a term generally used by conservatives and libertarians to describe a government or public sector that they consider to be excessively large, corrupt and inefficient, or inappropriately involved in certain areas of public policy or the private sector.
So, we might assume that to Mankiw "big government" is a pejorative term. In other words, an increase in government revenue is a bad thing. I don't think that this is necessarily the case. There are at least two situations that I can think of that might be inconsistent with increased government revenue being a bad thing. The first is that the U.S. government is currently running a budget deficit. Increased revenue could be used to fund the existing size of government and shrink the deficit. Even Mankiw (in 2006) mentioned that increased revenue would be a good thing (however, the notion was gone in 2007).
The second situation is when increased revenue is used to fund an efficient increase in a public good (when the benefits of the increase exceed the costs). I'm thinking, for example, that maybe an increase in the gas tax could be used to fund transportation system maintenance. It could be possible to build a political coalition around higher gas taxes and safer roads and bridges, right? The Pigou Club's Wikipedia page even mentions that some of the "elite" members are in favor of this option:
The Pigou Club is described by its creator, economist and blogger N. Gregory Mankiw, as "an elite group of economists and pundits with the good sense to have publicly advocated higher Pigovian taxes, such as gasoline taxes or carbon taxes." These pundits and economists often advocate lowering other taxes to keep the total amount of taxes collected the same, though many have also proposed dedicating the revenue to other worthwhile projects.
Second, Pigouvian taxes are not the only way to achieve an efficient regulatory outcome. An alternative is cap and trade:
... both a carbon tax and carbon cap-and-trade will achieve the same level of increased efficiency by achieving the optimal abatement level at the minimum cost. The only difference is the distributional implications. The cost to the firm is lower for carbon cap-and-trade. The government receives tax revenue with a carbon tax. Both policies are preferred over techological or output standards (i.e., command and control regulation).
It seems to me that one could put a coalition together around cap and trade with freely distributed permits. In that situation, rents would accrue to many low abatement cost firms while high abatement cost firms would suffer. As a practical political matter, it might be good to get the big money people on your side before you make the case to the voter-peons, right? You would think that this sort of efficient environmental policy plus practical politics would be favored by Mankiw, but no such luck. This is because they don't raise revenue:
But the history of cap-and-trade systems suggests that the allowances would probably be handed out to power companies and other carbon emitters, which would then be free to use them or sell them at market prices. In this case, the prices of energy products would rise as they would under a carbon tax, but the government would collect no revenue to reduce other taxes and compensate consumers.
Nat Keohane at EDF has a critique of Mankiw's argument against cap and trade so I'll just say that there is an alternative opinion. A here is an excerpt from a good summary of the practical political considerations from 2007, right before both presidential candidates Obama and McCain both came out in favor of cap and trade:
In theory, both approaches aim to achieve the same result: by making it more costly to emit carbon into the atmosphere, the government would discourage the burning of fossil fuels, encourage producers to find alternative energy from renewable sources and prod consumers into using energy more efficiently. Each side can make a compelling case. So what’s the argument?
Many economists line up behind a carbon tax. They argue that it is the most cost-effective way to limit global warming emissions, that it provides a more predictable long-term price for energy producers of all kinds and that emissions trading schemes would be subject to manipulation by special interests. ...
Indeed, most politicians favor cap-and-trade, in part because it obscures the full cost of curbing carbon emissions. ...
Supporters of a cap-and-trade program argue that explictly raising carbon taxes high enough to make a serious dent in the output of global warming gases would be politically impossible.
But environmental advocates make a further argument. While they agree that cap-and-trade programs will lead to higher prices, too, they say that the only way to achieve support for an ambitious global warming agenda from both the general public and those within the energy industry is to guarantee that emissions will fall. ...
In just the last few weeks, the debate has heated up, so to speak, as both sides recognize that with both Republicans and Democrats agreeing that something needs to be done, their shared goal may be within grasp. That makes winning support for the right approach, as each side sees it, even more important.
So, considering the political atmosphere in 2007 and given the current state of affairs, that cutting income taxes is considered by many people as a panacea for many problems, I'm not convinced that Mankiw's Pigouvian tax and lower income tax coupling is an effort to build a political coalition. I think it is great that Mankiw is such a great proponent of Pigouvian taxes. I just wish he would lighten up on the persistent coupling.
For the record, I would be in favor of either a carbon tax or cap and trade as an efficient approach to climate policy. I'm agnostic on what happens to the potential revenue because (1) there are three potentially efficient approaches and (2) we can get bogged down into mostly distributional issues and economists don't have a monopoly on their understanding of fairness.