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Carbon Taxes versus Living Standards

Politics / Climate Change Mar 13, 2008 - 12:57 AM GMT

By: Gerard_Jackson


I recently wrote two articles strongly critical of John Humphreys' proposal for a carbon tax. In his rejoinder ( The Gerry chronicles: carbon tax & bad economics ) he completely ignored my fundamental point that a carbon tax is a direct tax on capital and hence Australia's capital structure and the process of capital accumulation.

(The Austrian school defines capital as a heterogeneous structure consisting of complex stages of production with a time dimension. It is within this theoretical framework that my argument against a carbon needs to be understood).

Even though Mr Humphreys admits that his tax "would come at the expense of other investments that have a higher free-market return" he calls me "unhinged" because I pointed out that his proposal is a "more subtle version of the above 'war is good' argument". I fully stand by that statement. For those of you not acquainted with economics, there is an atrocious fallacy about that would have us believe wars and natural disasters are economically beneficial because they encourage new investment.

It follows from this fallacy that any policy that destroys capital combinations with the sole object of creating new but less efficient capital combinations is a first cousin to "the war is good" fallacy. And it is no fault of mine that Mr Humphreys failed to make the connection. Now Austrian capital theory is the only effective counter to this fallacy. Irrespective of Mr Humphreys' protestations, his original article did not make a single reference to capital or to living standards. He his therefore in no position to criticise me for bringing this fact to the attention of readers.

Mr Humphreys claims that I either believe taxes do not change behaviour or that they do, in which case I have no business criticising him "for stating the obvious". This is a gross misrepresentation of my argument and amounts to an attempt to try and stand it on its head. My very point is that the proposed carbon tax would bring changes and that these changes would damage living standards by shortening the capital structure. His response deserves to be quoted in full:

We already have a tax on electricity (the GST) and very high taxes on fuel, and we have escaped catastrophe. I agree that a carbon tax has costs. But the fuel tax and income tax also have costs. If you increase the tax on electricity but decrease the tax on fuel and/or income then there will an economic cost (from the higher electricity tax) and an economic benefit (from the lower fuel and/or income taxes). It is unclear which effect would be larger. Indeed, if a carbon tax replaced a fuel tax (as I suggest in my paper) this is the equivalent of having a lower tax on a broader base' which is generally considered to increase economic efficiency.

From an Austrian perspective this shows that Mr Humphreys has no grasp of the issue. Any Austrian economist would immediately point out that these taxes are not direct taxes on capital, and that different taxes bring about different results. Let me put it another way, Mr Humphreys insists on referring to a tax on electricity while my point is that the carbon tax is a tax on the means of generating electricity. Two entirely different things. Now the one sure-fire way to get less of a product is to raise the cost of producing it. This is exactly how a carbon tax (or a restriction on carbon emissions) would strike at capital accumulation. (The process of how taxes affect savings, investment and consumption is not as straightforward as many people think).

He goes on to state that a carbon tax "does make alternative energies relatively more competitive. This will lead to a change in investments. What exactly is he [Gerry] disagreeing with?" This is terrible nonsense. The tax would not make alternative "investments' more competitive. This could only be achieved by increasing their economic efficiency. A pattern of production brought about by using a tax to destroy efficient capital combinations in order to direct spending to grossly inefficient alternatives cannot by any stretch of the imagination be called competitive. And it is ridiculous to argue otherwise. He then states:

He [Gerry] says that the "revenue-neutral" nature of the tax is not relevant. This says a lot about Gerry. There are two options with a carbon tax. Either you tax and spend. Or you tax and tax-cut. I have argued strongly that the later is better than the former. Gerry can't tell the difference. In his own words "what's so good about revenue neutral". Of course the "revenue-neutral" element is important. As Gerry points out, taxes distort the market allocation of resources (leading to deadweight loss and mal-investment). This isn't just true for a carbon tax. It is equally true for the fuel tax and income tax (and all other taxes). '

The above is just more evidence that he is totally ignorant of Austrian economics. He then implied that I lacked the intelligence to understand the meaning of "revenue-neutral". I made it very clear in my article why "revenue-neutral" is irrelevant and also misleading. Regardless of what Mr Humphreys would have people believe, I never said he "claimed that a carbon tax will be neutral". This is a pure invention on his part. And it was he ' not I ' who said that a carbon tax should "be revenue-neutral, efficiency-neutral, and equity-neutral". He just doesn't understand that Austrian analysis focuses on the impact the tax would have on the country's capital structure. This is the real heart of the matter and the very thing he does not tackle. Once again:

I'll explain it again for the people in the cheap seats' a carbon tax will create an economic cost, but removing other taxes will create an economic benefit. Gerry agrees that a carbon tax creates an economic cost. And as a free-market advocate presumably he understands the economic benefits of tax cuts. So what is he disagreeing about' Your guess is probably as good as his.

He is clearly asserting that tax cuts would offset the costs of a carbon tax. But he can only do so by ignoring the effects of the tax on the capital structure. What needs to be understood here is that capital is a structure with a time dimenstion and anything that servers to shorten it will lower living standards 1 . The Austrian case is clear: you cannot use taxation to make significant changes to the capital intensive stages of the production structure without changing its shape. And this is what Humphreys needs to comprehend. Moreover, his argument implies that by maintaining individual spending through tax cuts living standards will not fall. This is a gross error that the classical economists were fully aware of. As J. S. Mill put it:

. . . 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 was labouring the point that anything that directs spending away from investment does so at the expense of real wages. And that is what Mr Humphreys' proposal does. His response to this insight is to argue that the quote is "absolutely irrelevant". On the contrary, it's clear that Mill's insight is very relevant. Mr Humphreys went to say that Mill stated "that tax & spend is not good for the economy" Actually Mill said nothing of the kind. It is not and never has been a question of "tax and spend". The questions have always been ones of how much taxation there should be and what are the economic and social effects of various taxes.

Mr Humphreys admits that though a carbon tax cannot "make Australian firms more competitive" cutting the fuel tax would. He is obviously assuming that the costs of his tax-induced changes to the capital structure will not offset a reduction in fuel costs. How can he possibly know that, particularly in the case of energy intensive operations' He argues that the tax would bring about "a moderate increase in electricity prices". If this is so, are we then to assume that the tax itself will raise little revenue' If this is the case, where is the price incentive to seek out alternative energy sources?

Taking solar and wind as an example ' and one he used ' we will find that compared with coal-fuelled power stations these alternatives are horribly inefficient. This means that there exists a huge cost gap. So large is this gap that even if these coal-fuelled power stations were taxed out of existence a massive hike in electricity prices would still be needed because of the alternatives' enormous diseconomies of scale.

As Mr Humphreys should know, markets are always forward looking, meaning that any proposed tax on an asset would be factored into its price. This now seems to be happening. The power industry recently warned governments that mandated "emission cuts" (which would basically have the same effect as a carbon tax) could "wipe more than $10 billion off the value of older coal-fired power stations, which are found mainly in NSW and Victoria". (Matthew Warren Compo urged for power firms , The Australian , February 23, 2008). This strongly suggests that Mr Humphreys' optimism is somewhat misplaced.

No one disputes the fact that power stations are assets. If the tax is high enough the asset would be immediately abandoned. However, if the tax is just lower enough to keep these assets in service then they would be gradually consumed. In plain English, a process of capital consumption would be set in motion. Supporters of a carbon tax would be quick to stress that investment would still continue in the form of alternatives. But Austrians point out that these so-called investments are really malinvestments that could not pay for themselves in a truly competitive environment. Therefore, expending money on them does not promote capital formation but the dissipation capital.

(To get a better understanding of the nature of capital see Ludwig M. Lachman's Capital and Its Structure , Sheed Andrews and McMeel Inc., 1978. Incidentally, one of my copies of this book was acquired some years ago from the Centre for Independent Studies).

Mr Humphreys categorically states: "Gerry claims that I refuse to accept limitations on some energy sources". I said no such thing. What I said is that solar and wind have insurmountable natural limitations. Nor did I state that he ever "argued for or against any particular type of alternative energy". Nevertheless, it was he who stated that a carbon tax "would encourage Australia to start shifting away from its reliance on carbon intensive 'dirty' coal". I think any unprejudiced reader would be justified in concluding that Mr Humphreys was arguing against coal-fuelled power stations. Unfortunately inventing quotes and then attributing them to others in an attempt to discredit critics seems to be par for the course with Mr Humphreys.

He accuses me of "technology-pessimism". This is a gross misreading of my article. What I did say is that wind and solar could never be more efficient then centralised power generation. This is an economic fact that no government can legislate out of existence 2 .

In my last article I pointed out that Mr Humphreys was wrong about the development of Austrian economics. He still is. He asserts that "the split is the time when people started self-identifying as 'neo-classical' and 'Austrian' which happened at about the time of the marginal revolution in the late 19th century. This is pure baloney. It is generally agreed among Austrians that the real divorce between the two economic schools happened in the 1920s. As I said in my article: "As proof we need look no further than Knut Wicksell's observation in 1924 that"

Menger' was successful in establishing a school of enthusiastic and highly talented followers, the Austrian School, whose doctrines spread over the whole world, and for a period of fifty years set the course of all work and discussion in theoretical economics, and to some extent in fiscal theory too. (cited in Economics as a Coordination Problem , Gerald O'Driscoll Jr. Sheed, Andrews and McMeel Inc, 1977, p. 6).

Wicksell clearly put the split in the 1920s. Moreover, Walras' work had very little influence until the 1920s and virtually none at the turn of the century at which stage "Walrasian analysis remained on the fringe of what was being taught in most universities". (Frank M. Machovec, Perfect Competition and the Transformation of Economics , Routledge, 1997 p. 97). According to Schumpeter "it was only in the 1920s, that is to say, long after his death, that he [Walras] got his due". (Joseph A. Schumpeter, History of Economic Analysis , Oxford University Press, 1994, p. 829). His Elements of Pure Economics was not even translated into English until 1954. (Mark Skousen Making of Modern Economics: The Lives and Ideas of the Great Thinker , M. E. Sharpe 2001, p. 217).

And then we have Emil Kauder who specifically states that the decline of the Austrian school started with Friedrich von Wieser's death in 1926. (Emil Kauder, A History of Marginal Utility Theory , Princeton University Press, 1967, p. 113). Karen I. Vaughn is of the opinion that

Austrian economics from 1871 until the 1930s was economics developed by Austrians in Austria. It was not even clear that the national distinction reflected any sharp doctrinal differences with neo-classical economics. (Karen I. Vaughn, Austrian Economics in America: The Migration of a Tradition , Cambridge University Press, 1998, p. 10).

And then we have Ludwig von Mises himself who said:

About the time of Menger's demise (1921), one no longer distinguished between an Austrian School and other economics. The appellation "Austrian School" became the name given to an important chapter of the history of economic thought; it was no longer the name of a specific sect with doctrines different from those held by other economists. (Mises The Historical Setting of the Austrian School of Economics , Ludwig von Mises Institute, 1984, p.19).

This decline ? largely due to the rapid acceptance of the concept of perfect competition ? that signalled the emerging domination of the distinct neoclassical school.

[T]he adoption of perfect information modelling as the heart of neoclassical economic transformed the way economists were trained to think about the institution known as the market. (Machovec p. 300).

Hence the actual divorce took place in the 1920s.

Mr Humphreys inadvertently revealed his ignorance of the Austrian school with his hilarious statement that "I consider myself a follower of both [schools]". This makes as much sense as claiming to be a catholic atheist. To make matters worse for himself he is still pushing the lie that I said "Mises was better than Hayek (sic)".

To prove just how informed he is on Austrian economics he categorically denies that Hayek weakened Mises' case against socialism. Anyone who has read von Mises knows he stated without any qualifications the impossibility of socialism. I want to make one thing absolutely clear. I am not suggesting, as some have, that Hayek misrepresented Mises, merely that the unfortunate way in which Hayek reframed the argument weakened Mises' devastating criticism and gave his socialist critics' proposals a credibility that they did not deserve.

Hayek introduced into the calculation debate what some call the "knowledge problem" (very important in itself). Unfortunately this enabled socialists like Oskar Lange to argue that all that was needed to successfully manage a socialist economy was a means of collecting and utilising the necessary knowledge. But Mises' insight was that the real problem of socialism is that it was money prices (not values) that made economic calculation possible, and that these prices could only exist where the institution of private property prevailed. In other words, in a socialist state the information needed for the allocation of resources would not even exist. This led Mises to scornfully remark that:

The paradox of "planning" is that it cannot plan, because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark. There is no question of a rational choice of means for the best possible attainment of the ultimate ends sought. What is called conscious planning is precisely the elimination of conscious purposive action. (Ludwig von Mises Human Action , Henry Regenery Company, 1963, p. 700).

Humphreys stated that "when you have a few words to summerise the early economic development it is quite standard to just stick with Smith and Ricardo (and often J.S.Mill)". The problem here is that the "standard" is wrong. It is impossible to summarise the subject of early economic thought with mere references to just Smith, Ricardo and Mill without grossly misrepresenting the entire subject. Anyone with only a passing knowledge of the subject would know that.

It is now time to turn to Mr Humphreys' style of discourse. There is, of course, nothing wrong with a robust exchange of ideas. However, his deliberate distortions are unforgivable, and his language is one of unremitting personal abuse the violence of which does him and the Centre for Independent Studies little credit.

Postscript: Considering that Greg Lindsay, executive director of the Centre for Independent Studies, sponsored and published Mr Humphreys' monograph I believe, given the seriousness of the topic, that it is incumbent on him to publish an article on capital theory and taxation. May I humbly propose Dr Frank Shostak. Frank is a former professor of economics and an Austrian and is therefore amply qualified to fulfil the task.

The following sites expose man-made global warming as a fraud:

The Carbon Coalition

The Lavoisier Group

Global Warming Politics: A Hot Topic

Errors in IPCC Climate Science

Junk Science

1. Imagine a situation in which a government proposed to levy a 100 per cent profits tax on business while 'offsetting' it with an equivalent cut in taxes on consumer goods and incomes. Does anyone really think that these tax cuts would prevent an economic collapse?

2. These links lead to articles that explain the limitations of solar energy, wind and ethanol.

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

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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