Optimal Carbon Tax

Carbon emissions aren't a negative externality of energy consumption. Global warming isn't a negative externality, either. Warming will have some positive effects, too. It's the damage or harm from global warming that's the negative external effect of energy consumption. But that's not quite right, either. Because it's not clear that all the warming is the effect of human activity. Some warming might have been in the cards anyway, in which case, we're just exacerbating the trend. So in order to estimate the optimal pigouvian tax, we not only need a solid estimate of the net harm of warming, but we also need a good estimate of how much of that is the external effect of human activity. I don't think there exists a good estimate, which I think gives us good reason to worry about proposed carbon taxes. Any tax, unless we are very lucky, will either be too low or too high. If it is too low, we'll get too much carbon emission. But if it's too high, we'll get too little and I think that's likely the more worrying scenario, especially if it slows growth for poor countries. And I worry that harm could turn out be larger than the harm the tax is meant to prevent.
This whole area confuses me a lot because I see a lot of smart people who seem to be acting like they have a good idea about what the optimal tax rate is, but I am pretty certain no one does.

Author: Will Wilkinson

Vice President for Research at the Niskanen Center