Nullius in Verba

Remember when I said that the Liberal Party’s Green Shift could raise emissions by 7.15 Mt? Well, the Liberals state Economist Jack Mintz, of CD Howe fame is 100% behind the Green Shift since he wrote part of it. But really is he? I’ll show you that from what he actually says he sounds quite dubious, and honestly I doubt his true comprehension of the very complicated work being done in the area of the double dividend. That being said, I do respect him as a renowned economist.

(The Green Shift Raises Emissions by 7.15 Mt [Click Image to Enlarge])

His words 2006:

However, the [carbon] tax approach may achieve little in the way of environmental objectives. The demand for such products as gasoline and heating fuel is less sensitive to price, since the tax also falls on necessary, almost essential, services such as heating and transportation. The carbon tax is also a highly inflexible tool since it cannot be easily adjusted for changing emission levels. Further, governments become reliant on the revenue and are less willing to adjust the tax rates downward when emissions decline. For these reasons, some experts have argued that regulations that limit emissions, including tradable permit regimes, can be more effective and more flexible.

And his words in the National Post 2008:

While the price for carbon is certain under the tax, the ability to achieve targets becomes uncertain as much depends on how households and businesses will respond to the tax. [I show you how households respond with my analysis here - langmann]

Personal tax reductions will provide some relief to all Canadians although the anti-poverty measures tend to support poorer provinces. The benefits of corporate reductions go primarily to Ontario (43%), followed by Alberta (22%) and Quebec (20%).

Where the Liberal proposal is weaker compared to the Conservative plan is that the latter is more directed at reducing carbon. The Liberals should have distributed more of the carbon tax proceeds to fund investment tax credits in new carbon-reducing technologies and less in anti-poverty measures. While it is appropriate to provide relief to low-income Canadians, the broadening of refundable income-tested tax credits could ultimately push up marginal tax rates on some low-income Canadians trying to get ahead. Thus, the Liberal plan is not as successful in improving competitiveness as it could be.

[comments in brackets and bold text is mine - langmann]

Jack Mintz does not sound as supportive of the Liberal Green Shift as the Liberals make him out to be. What I would like to note two things. In terms of the tax itself, Mintz does not seem to think the Green Shift would obtain the targets the Liberals need to obtain to meet the Kyoto Accord. Secondly Mintz seems to think that the Conservative plan is much more effective at the real goal of meeting the targets themselves.

Some criticisms of Mintz however. Number one is that he ignores the entire proposition of the double dividend (the idea that shifting taxes to dirty stuff and reducing taxes on income increases GNP and welfare). Instead he suggests funding industrial upgrades. The evidence from Europe behind the double dividend is not great and in my honest opinion inconclusive with some articles stating that the double dividend is real and others finding no effect. Mintz ignores the only evidence that suggests some benefit and throws the money at industrial upgrades of which no benefits are proven.

The other interesting aspect of the European carbon tax to note is that many industries are exempt from carbon the tax itself and hence still polluting as much as before, and secondly many of the Nordic countries have politically directed energy policies at alternative sources of energy production in the form of Nuclear Power and Hydro. I have not seen any great evidence yet that the carbon tax itself has reduced pollution in Europe, and I am still looking.

(When the Russians Came Only the Fool Was Worried as the Court, in Bliss, Danced)

I have created a graphic to demonstrate how the Green Shift raises CO2 emissions by 7.15 Mega tonnes. The economic evidence I used includes peer reviewed articles from economic journals. This is described in a post that attempts to make it easier for non-economists to understand. The Green Shift II. Stephane Dion likes to refer to the Nordic countries as a carbon tax success, but that is not entirely true as this Wall Street Journal article points out.

(Please read the previous Green Shift article first if you haven’t already)

How the Green Shift Causes More Greenhouse Gas Production and is Worse for the Environment

In the 16th Century St. Paul’s Cathedral garnered the displeasure of much of London’s population, protesting against the control of religion and human rights by a foreign power in Rome, the cathedral was pillaged and nearly destroyed. God Himself made His feelings known when He joined with the mob, and destroyed the tower with a lightening bolt, the awesome display quickly sobering all sides in the debate.

During this time and afterwards, the well protected St. Peter’s also known as Westminster Abbey, had remained untouched, and money donated to that cathedral was siphoned off to pay for the maintenance of St. Paul’s, of which we have just stated caused much unrest and finally resulted in catastrophe.

It is from this situation the old English idiom “Robbing Peter to Pay Paul” came into use.*

The problem, as many have found out the hard way, is that quite often both Peter and Paul lose out when the unintended consequences of the enlighted action lead many and money astray. 

(Stephane Dion Could Not Convert Canadians As Only the “One” Converts St Paul on the Road to Damascus)

As I indicated in the previous article on the Green Shift, an unintended consequence of the shifting may actually result in more production of the supposed greenhouse gasses by consumers. In essence this has to do with the price elasticity of demand as well as the income elasticity of demand. These are influenced by the unfortunate fact that there are no real substitute goods for gasoline or many fossil fuels for that matter, as well as the fact that these substances are involved in almost every human endeavor.

To define it simply, the economic definition of elasticity is the ratio of the percent change in one variable to the percent change in another. The price elasticity of demand is therefore the percent change in quantity demanded divided by the percent change in price. Gasoline is a very inelastic good, meaning that changes in the price of gasoline will have very small effects on the quantity demanded.

In simple terms, the price elasticity of demand defines the percent people will decrease their consumption of a good if the price is increased. The income elasticity of demand is the percent people will increase their consumption of a good if you increase their income.

Alright so lets start with a very basic example. On a simple microeconomic scale, if Peter is spending 100 dollars on fossil fuels and the government taxes it by 20 more dollars, he will reduce his consumption of gasoline by the price elasticity of demand. In layman’s terms he will cut his use of gasoline by a certain amount based upon his budget. If the price elasticity of demand is inelastic because Peter cannot find another fuel source for his car, Peter may end up spending 118 dollars on gasoline with the government pocketing the 18 dollars and Peter reducing his quantity of gasoline by the small amount he can while sacrificing his spending on other more unnecessary things in his budget.

If the government then gives Peter back the 18 dollars it took then Peter may use the extra income to spend some of that money on gasoline depending on his income elasticity of demand. In layman’s terms as his income increases he will spend more of his budget on gasoline for example by making that extra trip to the video store, or out to dinner etc. More than likely he will use the extra money to buy some of the unecessary goods he gave up before the price increase once he has satisfied his gasoline requirements.

Think of what you would do in this simple situation, if you were only buying the amount of gas you absolutely needed before the tax, and then after the tax you got your money back. You will more than likely try and be back where you started. This is why on a micro-economic level, I think the Green Shift is flawed when it comes to greenhouse gas reduction. Soon I will show you the numbers, or the money as they say.

But what happens if the government gives you more money than you started with? This is the situation where you might actually end up buying more greenhouse gas producing products than you ever did before, and also where you might indirectly switch from using friendlier natural gas to deadlier gasoline. 

The problem is that the consumption taxes and income taxes are not directly linked.

Let’s set this up. The Green Shift proposes the impossible, that it will only target non-gasoline fuels for taxation. According to Natural Resources Canada data, residential natural gas contributes to 32.2 Mt of CO2 per year. It is a large segment of of the total residential production of CO2, on par with electricity. Oil is minor with only a 6.8 Mt contribution and will be ignored in this simple estimate. The estimated long run price elasticity of demand of natural gas is -0.36 according to the U.S. Department of Energy. The Green Shift will increase the price of natural gas by ~18.0% at the end of four years. Therefore the reduction in CO2 production is calculated to be 2.09 Mt (18.0%*(-0.36)/100*32.2 Mt).

According to the Green Shift somehow the majority of Canadians are going to get more money back due to income tax reductions. You only have to go to their website to see that somehow you are coming out ahead after playing with their calculator. (The plan implies the wealthy will not but in actual fact it will likely be the poor who suffer most.) Government projections have the revenue from National Personal Income Taxes in four years at roughly 143.375 billion dollars. Increased personal income due to Green Shift, 7.54%**. The income elasticity of demand for gasoline has been calculated to be on average to be 0.88 from a meta analysis by Espey. Natural Resources Canada has greenhouse gas emissions at 89.4 Mt CO2 for gasoline transportation. The increase in CO2 use from the increased income spent on gasoline is 5.93 Mt.  

Income elasticity of demand will also effect the consumption of natural gas. Income elasticities of demand differ between countries widely, and are greater in Europe. Ashe et al. in the Energy Journal show a 1.3 to 6.1 income elasticity of demand for natural gas in the long run between Europeans. I will use a more conservative number calculated by David Brightwell at Texas A.M. of 1.46 as it is likely an underestimate of Canadian elasticity. The increased consumption of natural gas due to increased income is 3.31 Mt ((32.2 - 2.09))*(0.0754*1.46)).

The Green Shift alone results in an increase in CO2 greenhouse gas production by consumers of 7.15 Mt (5.93 + 3.31 - 2.09 Mt).

Limitations to this analysis include the cross price elasticity of coal, oil, natural gas, and gasoline. In simple terms by making one more expensive relative to another there may be a consumer switch to the cheaper fuel. As has been shown by many authors substitution effect between any two is very small if not insignificant, except for the substitution between natural gas and oil, and natural gas and gasoline for some reason. Either way, the cross price elasticity would make the increase in CO2 production from the Green Shift larger if at all. Another obvious limitation is the increase in over-all fossil fuel use due to increasing incomes as GDP rises over the next four years. This would change the numbers somewhat, but more important to note, would increase fossil fuel use overall and greenhouse gas production. It is also important to consider the linearities, in this case the differences in elasticities faced by people with different incomes. People in the low income bracket tend to have a more inelastic price elasticity for necessities and a higher income elasticity. This is due to the fact that the richer you get the less likely you are to spend any more money on gasoline. In essence you reach a point where you are using as much gasoline as you like. Therefore while I have used average elasticities, it is likely that my number is an underestimate as most of the apparent Green Shift income transfers are to the low income bracket who are more likely to buy more fossil fuels than the middle income bracket.

A note to those in British Columbia who face a gasoline tax based carbon tax. It is likely that due to the income elasticity of demand you will also see an increase in greenhouse gas production.  

A Shocking Mystery

There exists a mystery in regards to the Green Shift. No where in the pdf can I find any mention of household increased electricity costs due to their increased tax on coal. Coal plants produce a large share of electricity in North America. Obviously electricity contributes a significant household cost. Considering that with the income tax decrease most Canadians are barely ahead adding the increased cost of electicity would certainly put most Canadians into the red.

Why do Economists Like the Green Shift?

Economists do not necessarily like the Green Shift. Many economists favor a change in our tax strucure from income taxes to consumption taxes. I agree with this but have some reservations, one of which is that the change has not been well studied with real occurances. Basically the theory is that by reducing our focus on income taxes, taxes that cause a negative strain on productivity and employment, we will increase GDP. Moreover by taxing pollution we will account for the negative externalities caused by consumption and increase GDP. This is called the double divident effect. The argument out there is whether this effect is real, weak or strong.

An economist who I respect, Dr. Ross McKitrick, has calculated the GNP rise due to the double dividend in Canada to be positive, (0.6%) with a 21 dollar (1989) per tonne CO2 tax. I don’t know whether he factors in the income elasticities into his reduction of CO2 model or whether he simply accepts a reduction. 

It is also important to note other studies such as by Carraro et al. that show that in the short run the double dividend effect can increase employment, but in the long run has no effect. Dr. Stephen Smith presents a review of the possibilities of the double dividend and its possible negatives and concerns.

Some of my concerns regard the implications of a shift from capital to labor in an open market. If labor is made cheaper relative to capital it may occur that the productivity of labor relative to other countries decreases. Essentially this is due to the disincentives to reinvest in productivity. As productivity falls, so does wages and Canadians may become poorer relative to other countries. Other concerns regard to the increased costs of energy and it’s obvious effects on production, manufacturing, industry, and even the service sector. Fossil fuels are an integral input in almost any good or service.

Many of the people who advocate a Green Shift use Finland and Sweden as an example of success. Fortunately for the Fins and Swedes, they have alternatives or substitutes in the form of nuclear power and hydroelectricity respectively. Finland is expanding its reliance on nuclear power and Sweden has placed its reduction on reliance on nuclear power on hold as they have come to realize the the difficulties of renewable energy. Sweden has 44% of electricity  produced by hydro and 47% by nuclear energy, total 91%. In comparison Canada has 24% of it’s electricity generated by CO2 producing sources, and this doesn’t appear to be changing as provincial governments have no real policies for energy production.

Mt = mega tonnes 

* It is likely that the idiom “Robbing Peter to Pay Paul” has been in the vernacular for much longer, and may indeed hark to the 12th century latin vernacular. However the event must have well suited the expression for those aware and cynical enough to turn it to English.

** It is hard to know, reading the Liberal Green Shift plan, which year the dollars are adjusted for due to inflation. I am assuming 2008 dollars. I hope they thought of inflation.

The English language is one of connotation, and some words like “stupid” should be applied carefully, but when warranted, applied definitively. What Dan Gardner tries to imply in this recent article is that Stephen Harper is stupid, even though he has a degree in Economics, by flogging him with an interview with the renouned Economist, Dr. Greg Mankiw.

Stupid is defined by Websters as acting in an unintelligent or careless manner, or lacking intelligence or reason.

As the old adage suggests, “While leaving the house to call someone stupid, be sure you don’t bang your head into a mirror along the way.”

The MSM is as Stupid as it is Vain

I’m sure no one in this country has missed out on the Liberal Party’s proposed carbon tax, the Green Shift™. While Stephane Dion has been unable to even pronounce it in English, let alone explain it, the mainstream media has done a bang on job of praising this thing whenever or however it can. Still I have yet to hear on the news a basic Economics discussion of the subject, and I have yet to hear from any published peer reviewed literature as well. So when the mainstream media fails us, like it usually does it is time to turn to the blogosphere. And so we being The Green Shift - The Economics Lesson - in Basic for Dan Gardner™. Oh and we’ll include some peer reviewed journal articles as well.

The basic principle of the Green Shift is that by increasing a tax one artificially increases the cost of carbon producing substances or greenhouse gas substances (GGS) so that people consider purchasing substitute goods instead thus lowering the release of greenhouse gasses. Moreover by reducing people’s income taxes by replacing it with the increased tax revenue from GGS one avoids harming people along the way, or causing the much dreaded stagflation. It is worth pausing here, for those of you unfamiliar with economics, in order to read the wikipedia definition of stagflation and note in particular that :

First, stagflation can result when an economy is slowed by an unfavorable supply shock, such as an increase in the price of oil in an oil importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable.^[5][6][7] This type of stagflation presents a policy dilemma because most actions to assist with fighting inflation worsen economic stagnation and vice versa. Second, both stagnation and inflation can result from inappropriate macroeconomic policies. For example, central banks can cause inflation by permitting excessive growth of the money supply,^[8] and the government can cause stagnation by excessive regulation of goods markets and labor markets.

Yep.

Anyway so let us set up a basic economics argument for the Green part of the plan as follows. Here is a supply and demand curve with price (P) increasing to (P’) as we increase or shift the cost or supply curve (S) of gasoline by adding a tax (S’). As you will see the quantity of gasoline demanded decreases from (Q) to (Q’) and the ticker tape ticks, the adding machines add, and all is well in economic pre Christmas land. (D is the demand for gasoline curve)

Ok now let us add the “Shift” into the plan. We’ll give back Canadians this extra revenue in the form of an income tax reduction. So without going into a lot of detail, suffice to state that when one increases the income of a group of people one also shifts up the aggregate demand curve. This is generally because as one has more money in one’s budget one is less constrained by costs. In other words, if we all get an extra $2000 a year in income tax rebates, some of us are going to drive to New York for the weekend like we always wanted to do.

Let’s see the curves shifting.

Whoops! As the demand curve shifts up from (D) to (D’) the quantity of gas consumed increases from (Q’) to (Q). We’re right back where we started! What we have done is simply artificially raised the price of things, but not done a thing to reduce consumption of gasoline or GGS for that matter.

What’s worse is that one has no real idea how these supply and demand curves are going to shift. They could in fact shift in a worse direction than one intended. For example as seen in this graph one could seen the consumption of GGS increase to (Q”) instead. More GGS consumed than before one played God-onomics.

The question comes down to the shape of the real demand curve for GGS. If the demand curve is “inelastic” it is a vertical curve, and this would mean no matter how much you increased the tax, the quantity consumed of GGS will not change as seen below.

Inelastic demand curves are seen when a good has no substitute goods, that is no readily available good with the same function that you can purchase in it’s place. Gasoline is a likely inelastic good as there really is no substitute for your Honda Civic you just bought. It cost $20,000, and unless you are Bill Gates, replacing it with a fusion powered vehicle isn’t going to happen anytime in the near future. Also as North American electricity generation is primarily from GGS, changing to non GGS generation will be a costly step with no immediate realistic substitutes other than Nuclear and Hydro power.

So what does the scientific peer reviewed literature demonstrate in regards to the elasticity of gasoline, the number one GGS? Hughes et. al state that:

We find the short run price elasticity of gasoline demand is significantly more inelastic today than in previous decades.

and

consumers have not significantly altered their gasoline consumption in response to higher gasoline prices.

interestingly

at lower income levels, the amount of travel has already been reduced to the minimum leaving little room for adjustment to higher prices.

In other words the evidence suggests that we’re pretty much locked into buying the gas we need. West et. al suggest that the cross-price elasticity between gasoline and leisure (the optimal tax rate on gasoline without causing external damage) is 35%. This happens to be the current tax rate on gasoline in Canada in most cities already, therefore taxing it more will cause significant burden.

And just how effective is the tax on gasoline at reducing air pollution? Sipes and Mendelsohn demonstrate that:

Our results indicate that if an environmental surcharge is added to gasoline taxes, then the additional tax will decrease gasoline consumption only slightly and, therefore, will have little effect on air pollution.

and more drastically

The results suggest that people with twice the income buy only 10–20% more gasoline. Of course, governments could use the revenues from gas taxes to address equity issues by lowering taxes on poor people or subsidizing services for them. However, in practice, it is not clear that current subsidies for transport actually benefit poor people more than others. Even if the income elasticity estimates in this paper are low, a tax on gasoline would most likely fall most heavily on the poor.

When it is all said and done, the people likely to suffer from the Green Shift are the poor themselves.

Dr. Mankiw is a proponent of the Pigovian Tax, that is a tax on things like GGS which have externalities such as pollution which are proposed to not be included in the price of the good itself. Dan Gardner seems to think that externalities are simply basic economics. They are not. In fact the theory of externalities is extremely complicated, and made more complicated by the question of whether externalities really exist.

At the end of the day, Stephen Harper has to decide a course to take. He doesn’t have the luxury of sitting in an Ivory Tower playing tiddly winks or black board what if’s. We have this Green Shift theory which sounds interesting, but what we don’t have at our finger-tips is the shapes of those curves I drew above. We also don’t really know how much they will shift and where they will equilibriate. The only way to know for sure is to experiment, and the most prudent way would be to experiment slowly, because we really have no idea how things will change - contrary to the apparent thoughts of Dion who thinks we need to act fast to save the planet.

Stephane Dion Uses Sign Language to Describe His Knowledge of Economics

We could easily make greenhouse gas output worse, we could have no effect at all. We could cause a depression, we could cause the worst outcome possible: stagflation. Many of the Canadian banks suggest that Canada is on the brink of a recession, recessions tend to mostly harm the poor, and the journal articles suggest the poor will bear the brunt of a Green Shift.

Therefore seems it would be stupid, Dan, to manipulate the Canadian economy so drastically at this time, that is when one considers the peer reviewed Economic evidence.

(Update: Read part II of the Green Shift)

* The Green Shift plan has no immediate consumer gasoline taxes. However if the plan is to actually reduce GGS it will have to target gasoline in some manner. Gasoline is the number one and major contributor to Canadian GGS. For now they will target producers, who will have to pass some of these taxes onto the consumer, some will be taken out of profits, and some will be taken from the employees of the firms. Once again there are graphs to explain all that, of which we have no idea the slopes etc. In the end gasoline prices will rise, anyone who thinks they won’t is selling you a bridge to nowheresville. 

** It is likely that the effect of Anthropogenic Global Warming caused by GGS on global climate change is low or non-existant as no definitive proof exists, and many peer reviewed articles state there is no evidence.  Moreover it is likely that the current land based data is corrupt.

*** While many economists including myself support a pure consumption tax rather than income tax, all taxes do have harmful effects on the economy and the poor specifically. Consumption taxes have their own side effects and have not been entirely studied.