Not a typical outcome.

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Does Pricing Carbon Worsen Inequality? It Doesn't Have To

Christopher Flavelle writes editorials on health care, energy and environment for Bloomberg View. He was a senior policy analyst for Bloomberg Government and chief speechwriter for the leader of the Liberal Party of Canada.
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Faced with a barrage of Democratic policies to combat climate change, Republicans have long sought a non-ridiculous justification for resisting. They haven't quite nailed it.

The earth can't be getting warmer, because some days are cold and here is a snowball. OK, maybe the earth is getting warmer, but certainly not because of humans. (How very pretentious of you to suggest otherwise.) Fine, maybe human behavior has something to do with it -- but a carbon tax can't possibly change people's behavior. (Unlike income and investment taxes, which should be cut because they obviously do change people's behavior. That's different.)

So when Republican Mitch McConnell of Kentucky told the Senate that the Environmental Protection Agency's regulations limiting carbon emissions from power plants would "punish the poor" by increasing the cost of electricity, he wasn't just defending his state's sputtering coal industry. McConnell was also making perhaps the most persuasive argument Republicans have left: Trying to reduce emissions will disproportionately harm the most vulnerable Americans. And aren't we all supposed to be worried about inequality?
QuickTake Income Inequality

That argument, increasingly common among conservatives, is intuitively appealing, and it even has some data to back it up. Poorer households spend a larger share of their income on energy than their wealthier counterparts, and so would bear a heavier burden from any policy that raises the price of electricity or gas. And whether by tax or regulation, there is no meaningful climate policy that won't directly or indirectly raise that cost.

There are three problems with that argument.

First, measuring energy costs as a share of annual income can be misleading. Annual income "is not really a good measure of well-being," said Don Fullerton, a professor of public finance and environmental policy at the University of Illinois. Many households that look poor are actually students, the retired, or people whose incomes swing from year to year.

Fullerton said economists prefer to calculate energy costs as a share of annual spending, which fluctuates less. Looking at spending this way all but wipes out the regressive effect of higher energy costs.

What explains this? Some people with low incomes in a given year may spend more than they take in -- retirees living off savings, perhaps, or students supported by their parents. Another explanation is that households with higher lifetime incomes also tend to have more demand for energy, thanks to more cars, bigger homes and more stuff to put in them.    

Here's a second problem with the argument: It assumes the effect of such a policy will translate entirely into higher consumer costs for carbon-intensive products. But not every company will be able to respond that way.

"Part of what happens when you put a tax on a firm is they put their product prices up," said Nicholas Rivers, a professor at the University of Ottawa who studies climate change. But companies with less pricing power, especially those that export their products, can't do that. Those companies may cut wages instead, Rivers said. 

Those cuts have a greater effect on higher-income households, who unlike the poor get more of their income from wages than from government transfers. So to the degree that companies adjust to carbon pricing by cutting costs, such a policy could reduce inequality rather than exacerbate it. 

Here's a third problem with the argument that pricing carbon worsens inequality: It ignores what happens to the revenue raised. New research in Canada, where the largest provinces use some type of carbon pricing, shows that by giving back less than 15 percent of the money generated by the tax to the poorest 40 percent of households, governments could fully offset the cost those households pay.

QuickTake The Cost of Carbon

"You've got 85 percent of the revenue left to do whatever you want to do," said Chris Ragan, an economics professor at McGill University and chairman of the nonprofit Ecofiscal Commission, which published the research. "If you're only going to look at the tax side, none of this feels very fun."

None of this means conservatives are necessarily wrong. Policies to reduce carbon emissions, if done the wrong way, could still end up falling unevenly on the poor.

Take, for example, cap-and-trade programs, which put a ceiling on emissions, then distribute permits for producing those emissions to individual polluters. If those permits are auctioned off, governments can use the proceeds to help low-income households.

If permits are instead handed out for free -- as California did until recently -- "that could be hugely more regressive," said Fullerton, helping companies while leaving the poor with higher costs.    

Climate policy can also worsen inequality by failing to give poorer households access to low-carbon alternatives. Imagine a carbon tax whose burden was evenly distributed among rich and poor families. Those with more money may still be better off, because they're better able to buy an electric car or a more efficient air conditioner, or put solar panels on their roof. A renter earning minimum wage can do none of those things.

QuickTake Climate Change

But that's not an argument for doing nothing; rather, it illustrates the importance of smart climate policy, which includes expanding people's options. According to work by Ben Leard, a research fellow at Resources for the Future, the gasoline tax is more regressive in states that don’t have much public transportation.  

"If you have a very stable and robust transit system, then lower-income households can use that as opposed to driving to get to work," Leard told me. "The poor, they're more likely to substitute to transit to avoid the increase in the gas tax."

The entreaties by McConnell and others not to punish the poor are a useful reminder: If governments aren't careful, the rush to reduce emissions could make inequality worse. But rising sea levels and other consequences of a changing planet will hurt the poor far more than even the most poorly designed regulations, so stasis isn't the answer either.

If McConnell is really concerned about protecting those on low incomes from ill-conceived efforts to fight climate change, the best thing he could do would be to support a carbon tax whose revenue goes back to the poor. That's probably not the remedy he had in mind. But he makes a very compelling case for it.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Christopher Flavelle at cflavelle@bloomberg.net

To contact the editor responsible for this story:
Brooke Sample at bsample1@bloomberg.net