Why a Carbon Tax Would Hit Living Standards
Politics / Climate Change Mar 04, 2008 - 01:54 AM GMTBy: Gerard_Jackson
Mr Humphreys complains that I ignored his proposal to offset the costs of a carbon tax by cutting other taxes. It's clear that he overlooked the fact that I made the effort of stressing that his proposal was designed to be "revenue neutral". But one of my major points is that it does not matter whether the carbon tax is "revenue neutral" or not. What matters is the impact of the tax on Australia's capital structure. This is a vital question that Humphreys failed to address.(I should point out that the Centre for Independent Studies — for whom Humphreys' monograph was written — have been as equally remiss).
I have had emails (very polite ones) arguing that surely Humphreys must be right because offsetting the carbon tax with tax cuts merely means payments will be from Australians to other Australians and so aggregate spending will remain unchanged as will the demand for labour. This view contains two very old economic fallacies that the classical economists had demolished:
It is no longer supposed that you can benefit the producer by taking his money, provided you give it to him again in exchange for his goods. (John Stuart Mill, Essays on Economics and Society, University of Toronto Press, 1967, p. 262).
In a nutshell, Mill was saying that if taxes on production are too heavy then output will fall even though other money expenditures have been maintained or even increased. This is because such taxes would force producers to consume their capital. The second fallacy assumes that employment is a function of aggregate spending. It therefore follows that if spending is maintained despite the burden of carbon taxes then unemployment will not rise. In general the classical economists understood
. . . that if by demand for labor be meant the demand by which wages are raised, or the number of laborers in employment increased, demand for commodities does not constitute demand for labor. I conceive that a person who buys commodities and consumes them himself, does no good to the laboring classes; and that it is only by what he abstains from consuming, and expends in direct payments to laborers in exchange for labor, that he benefits the laboring classes, or adds anything to the amount of their employment. (John Stuart Mill, Principles of Political Economy, University of Toronto Press, Routledge & Kegan Paul, 1965, p. 80).
Mill and his contemporaries were fully aware that ultimately only capital accumulation can raise the productivity of labour and hence real wages. They knew that consumption (the "annihilation of value" as Say colourfully put it) comes out of production as does demand. It therefore followed that directing spending to consumer goods could only lead to capital consumption. It was insights like these that caused Hayek to remark:
It may perhaps be mentioned . . . that the classical English economists since Ricardo, and particularly J. S. Mill (the latter probably partly under the influence of J. Rae), were in this sense much more "Austrian" than their successors.(Friedrich von Hayek, The Pure Theory of Capital, The University of Chicago Press, 2007, p. 68).
All I have done is to apply "Austrian" capital theory to the proposed carbon tax. The Austrian school correctly see capital as a heterogeneous structure consisting of complex stages of production with a time dimension. From this they conclude that shortening the structure lowers living standards. This is something that Machlup lived through:
Austria has a most impressive record in five lines: she increased public expenditures, she increased wages, she increased social benefits, she increased wages, she increased bank credits, she increased consumption. After all these achievements she was on the verge of ruin. (Fritz Machlup, The Consumption of Capital in Austria, Review of Economic Statistics, January 15, 1935).
This brings us to the structure of relative prices as well as capital. Increased spending on consumption will tend to shorten the capital structure by directing factors of production from the higher stages to the lower stages of production. As Hayek explained:
An increased supply of money made available directly to consumers would cause an increase in the demand for consumers' goods in relation to producers' goods, and would thus raise the prices of goods of the lower order in relation to those of the higher order, and this would inevitable bring about a shortening in the process of production [italics added]. (Friedrich von Hayek, Prices and Production, Augustus M. Kelly, 1967, p. 134. There is also Hayek's Profits, Interest and Investment, Augustus M. Kelly, 1975, pp. 255-265).
We can now easily see the detrimental effect a carbon would have on the country's capital structure. Defenders of the tax would argue that tax cuts elsewhere would offset any damage done by the carbon tax by making funds available for investment in alternative energy sources that would now be "competitive". These supporters of the carbon tax have a very peculiar notion indeed of the meaning of competitive. These alternative energy technologies can never be competitive in any meaningful sense of the word. The only way they could successfully 'compete' with coal-fired electricity plants is by becoming more efficient. They can never do this because they are strictly limited by the laws of physics — and taxing coal-fired plants, e.g., cutting gross savings, out of production cannot change that fact one iota*.
(Clarification: By more efficient I mean that even if these alternatives were 100 per cent efficient in a technical sense they still could not compete with centralised electricity generation. Therefore, what we are concerned with is economic efficiency, not technical efficiency. The links at the bottom of this page are to articles that explain the natural and insurmountable drawbacks of alternative energy sources. I apologise for any misunderstanding I my wording may have caused).
This means that the end product of a carbon tax would be a massive rise in electricity prices. How this is supposed to make Australian firms more competitive beats me. What I do envision is companies making a beeline to those Asian countries where the idea of crippling their economies with destructive taxes is anathema. Advocates of a carbon tax have also overlooked the simple fact that the tax would destroy some firms' comparative advantage, particularly if they were capital intensive. This is something else classical economists understood:
A new tax too may destroy the comparative advantage which a country before possessed in the manufacture of a particular commodity. (David Ricardo, Principles of Political Economy and Taxation, Penguin Books, 1971, p. 269).
Once we adopt the Austrian approach to capital we also find that Jason Soon's opinion that the carbon tax would allow "the market to adjust its production in the long term to evade the tax" falls to the ground. Production structure analysis reveals that the market cannot "evade the tax", and that Humphreys' assertion that the "costs of a carbon tax will be offset by other tax cuts" are, at best, wishful thinking. What happens is that production is rearranged to the disadvantage of consumers. In other words, living standards must fall. I find it odd that anyone could describe this situation as one of tax evasion. (What is also strange is that those who defend a carbon tax overlook the interrelationship of prices).
Jason also thinks I have based part of my argument on "scepticism about the science". I have done nothing of the kind. I just refuse to substitute wishful thinking for sound economic logic. Now if Jason had said that there exists an unused shelf of technologies that could be employed then he would have been on somewhat firmer ground. But even this more cautious approach would have failed because it in turn raises the question of why these projects have been ignored. The answer is simple: They cannot pay for themselves because of their insurmountable natural limitations that would produce enormous diseconomies of scale*. So what do our carbon tax crusaders offer as a solution? A form of a prohibitive tariff on existing producers.
To suggest, as Jason did, that we should implement a carbon tax because this will somehow force science to eventually find a better solution is not only naïve it is utterly reckless. Jason's logic leads us to conclude that to find a decent substitute for petrol the government need only raise the excise to a prohibitive level.
What do supporters of this line of thought think would have happened to the Industrial Revolution if in 1800 the British government had imposed prohibitive taxes on coal? Do they honestly think that such a policy would have produced an alternative fuel? Of course not. The Industrial Revolution would have been aborted. (Come to think of it, that's exactly what greens are still trying to do). Do they think that if the British government of the time had taxed steam engines out of use electric motors would have quickly replaced them?
In addition, it seems to me that Jason has inadvertently made technical progress largely a function of prices. I suggest that it is very unusual to find an entirely new technology as a product of prices. The car was not the result of high prices for horses just as the radio was not invented because of the price of telephones, and plasma televisions were not developed because ordinary TVs were too expensive, etc. The following quote helps to put this problem in perspective:
One may argue that the shortage of labor brought about by repeated epidemics favored the adoption of labor-saving devices, but a phenomenon by its nature so complex can scarces by reduced to a naïve and simplistic determinism. ( Carlo M. Cipolla Before the Industrial Revolution: European Society and Economy 1000-1700, W. W. Norton & Company, 1994, p. 151. There is also Abbott Payson Usher's very interesting A History of Mechanical Inventions, Dover Publications Inc., 1982).
I'm afraid Jason's opinion amounts to a policy of "Waiting for Godot". It's time that those who think along these learnt that blind faith is for religion, not economics or physics.
A carbon tax is an attack on capital and no amount of abusive language by Mr Humphreys can change that fundamental fact. The least I expected from him was a modicum of civility. Alas, even that miserly effort was too much for him. He accused me of being a "muppet". I don't mind that because I'm rather fond of muppets. However, he then called me a "tool". For his information I am not on the payroll of any corporation or think tank. Brookesnews is completely funded by me and by me alone. To insinuate, as Humphreys did, that I am a tool for some individual or organization is grotesquely misleading and reveals him to be a person whose judgement is not to be trusted. He also made his lack of integrity pretty clear when he falsely accused me of making the following statement:
Mises was better than Hayek (sic)
All I said is "that Hayek reformulated the calculation problem in such away that he inadvertently weakened von Mises' case against central planning". How did Humphreys think he was going to get away with his brazen lie leaves me baffled. Keeping to form he charged me with having "a pig-headed sort of stupidity" and of engaging in "a weird little rant". And for good measure, I am also a fool. If this is so, then the Austrian school consists of nothing but fools. Somehow I don't think that even the abusive Mr Humphreys is prepared to sink that low. I can only hope that his appalling behaviour is not sanctioned by Greg Lindsay who is Executive Director of The Centre for Independent Studies. In the meantime
Humphreys should take the opportunity to learn that abusive language and bluster are not a substitute for sound economic logic.
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Carbon taxes and Keynesian insanity
Why is the Centre for Independent Studies supporting the destructive carbon tax?
Eugen von Bohm-Bawerk Capital and Interest (three volumes), Libertarian Press, 1959
Friedrich von Hayek Prices and Production, Augustus M. Kelly, 1967.
Friedrich von Hayek, The Pure Theory of Capital, The University of Chicago Press, 2007.
Friedrich von Hayek, Profits, Interest and Investment, Augustus M. Kelly, 1975.
Ludwig M. Lachman, Capital and Its Structure, Sheed Andrews and McMeel Inc, 1978.
Ludwig M. Lachman, Capital, Expecations and the Market Process, Sheed Andrews and McMeel Inc, 1977.
Richard von Strigl Capital and Production, Mises Institute, 2000.
Mark Skousen The Structure of Production, New York University Press, 1990.
Roger W. Garrison Time and Money: The Macroeconomics of Capital Structure, Routledge, 2001.
*These links lead to articles that explain the limitations of solar energy and wind.
Windpower, union stupidity and green lies
How the Bracks' Government will cut Victorians' living standards
Green economic illiteracy, money-grubbing CEOs and windmills
Lefty journo pushes green solar scam
Government MPs plan to rip millions off in subsidies for ethanol producers
By Gerard Jackson
BrookesNews.Com
Gerard Jackson is Brookes' economics editor.
Copyright © 2008 Gerard Jackson
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