IMF Helps Make Carbon Pricing the New Normal

June 13, 2012

Europe does it. Australia does it. Even northeastern-situated states do it. Everyone's doing it. Let's do it. Let's tax carbon.For me, that is an important message in IMF Managing Director Christine Lagarde's historic speech yesterday and in the release of a new IMF primer on how to raise the price of greenhouse gas pollution. You don't get much more establishment than the International Monetary Fund. In calling so publicly for taxation of greenhouse gas emissions; in committing to advise governments on how to do it; and in releasing an authoritative review of policy issues and experience to date, I think the IMF is ushering a welcome (if badly overdue) phase in the fight to slow climate change. Using taxes or permit auctions to limit emissions is evolving from a nice-principle-rarely-practiced to the new normal. Just as it is normal for governments to draw up and enforce budgets, to tax income, and to limit the printing of money to avoid hyperinflation---and just as the IMF advises governments on these matters---so will the same increasingly hold for the use of taxes and tradable pollution permits to protect the atmosphere.You might wonder: since when is the IMF an environmental agency? Lagarde took that challenge on squarely in her speech. "The IMF is not an environmental organization." But in the long-term, she argued, the risk of climate instability poses a risk of macroeconomic instability. And carbon pricing (as well as fossil fuel subsidy cuts) can generate billions in revenue that can be used cut other taxes or increase spending. That's fiscal policy. The IMF is therefore relevant twice over---not as a negotiator of treaties nor an enforcer of rules, but as an adviser and a potential source of pressure for reform.I highly recommend the IMF report as a readable, precise, and authoritative review of many issues that an official designing a carbon-pricing policy will confront. Ironically from the point of view of those worrying that the IMF is straying from its core competency, the one weakness I see is that it is very obviously an IMF report, being a bit too conventionally economistic for my taste. Truly this is a quibble, but I believe it is worth mentioning given that the IMF has historically earned a reputation for being high-handed and out of touch with the ethics and politics of the policies it pushes---and how this arguably undercut its effectiveness.Four illustrations:

  • One can argue in two ways for the use of prices to penalize pollution. The IMF argument is that a universal price will cause those for whom pollution is least valuable to abstain while allowing those for whom it is more valuable to pay the price and proceed as before. In this way, the environment will be protected at least cost to society. "Economic efficiency" will be maximized. In the alternate view, the market economy is too flawed and dynamic to achieve, much less settle into, a perfect optimum, but the market economy remains an extraordinary problem-solving machine. Tax pollution and a billion actors---commuters, builders, researchers, venture capitalists---will respond in myriad ways no regulator could plan. Through trial and error, society will find its way to a better integration of economy and ecology. In this view, policymakers should not get too hung up on determining the "optimal" price for emissions. The key is to raise the price, and probably continue raising it for the foreseeable future in order to permanently shift the path of economic evolution. I emphasize this view in The Natural Wealth of Nations, as Tim Harford does in Adapt.
  • In places the report seems to confuse cost with welfare. If the price of electricity goes up by five cents a kilowatt-hour for everyone, the cost per unit of energy is the same for Warren Buffett as it is for an unemployed, single mother of three. According to the conventional reasoning in the IMF report, this is, again, "optimal" or "economically efficient." But the harm is greater for the mother, who might have to choose between heating and eating. Her welfare (or "utility") will go down much more than Buffett's. From the point of view of maximizing welfare, which is actually an orthodox concept in economics, a perfectly uniform tax on electricity, however administratively practical and environmentally protective, is not optimal. In defense of the IMF, the report devotes much space to how to protect that mother by, for example, terracing tariffs or cutting other taxes she pays. But the suggestion lingers of an unavoidable trade-off between economic efficiency and equity. That suggestion is grounded in a conception of efficiency that is not shared by most human beings, and is therefore potentially alienating to them.
  • The report analyzes the economics of taxation and subsidy more than the politics. Listening to Lagarde yesterday, I was struck by her mention of African nations such as Uganda and Ghana that have recently found oil. Here at CGD, the Oil-to-Cash initiative argues that those countries' earnings from oil should flow not into government coffers, but into the pockets of the people, as in Alaska. Governments might then tax back that revenue, at the price of greater demands from taxpayers for accountability. Per-capita disbursement of the money, in other words, would be good for political development. But from the conventional economic point of view, using the revenue this way is a bad idea, for it wastes an opportunity to stimulate growth by cutting conventional taxes on work and investment. Perhaps this is why the IMF has historically opposed such redistribution. A tension emerges between political and economic development. I don't mean to suggest that there's an easy answer here, which is why both aspects deserve their due.
  • It would be good for the IMF to acknowledge more fully the value of non-price policies. Governments influence greenhouse gas emissions through building codes, zoning rules, subsidies for agriculture, renewable portfolio standards... Non-price policies not only matter in themselves; they also affect the costs, benefits, and politics of price-based policies. Imagine if a law required everyone to drive a gas guzzler to work, solo. A carbon tax could still save the planet, but it would have to be so steep as to force most people to quit their jobs. In contrast, policies that shape cities so that driving is less necessary will make the requisite tax lower and more palatable. (They would structurally increase the elasticity of demand for emissions.) The IMF should not get into city planning, but it should avoid devaluing it by omission.
In reviewing such publications, the friction of disagreement is always more interesting. My secondary comments aside, this is a great volume. And the IMF's entry into climate change work, properly founded as it is in solid analysis, is extraordinarily valuable.


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.