The problem arises in how the climate policy interacts with the overall tax system. As the president pointed out, a cap-and-trade system is like a carbon tax. The price of carbon allowances will eventually be passed on to consumers in the form of higher prices for carbon-intensive products. But if most of those allowances are handed out rather than auctioned, the government won’t have the resources to cut other taxes and offset that price increase. The result is an increase in the effective tax rates facing most Americans, leading to lower real take-home wages, reduced work incentives and depressed economic activity.
The hard question is whether, on net, such a policy is good or bad. Here you can find policy wonks on both sides. To those who view climate change as an impending catastrophe and the distorting effects of the tax system as a mere annoyance, an imperfect bill is better than none at all. To those not fully convinced of the enormity of global warming but deeply worried about the adverse effects of high current and prospective tax rates, the bill is a step in the wrong direction.
What everyone should agree on is that the legislation making its way through Congress is a missed opportunity. Obama knows what a good climate bill would look like. But despite his immense popularity and personal charisma, he appears unable to persuade Congress to go along.
As for me, I hope the president refuses to sign a bill that fails to auction most of the allowances. Some might say a veto would make the best the enemy of the good. But sometimes good is not good enough.
N. Gregory Mankiw is a professor of economics at Harvard University. He was an adviser to former US president George W. Bush.
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