The 'green' car tax grabs that don't add up

By the Stern count, prices should fall 12p per litre

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Budget Comment Alistair Darling has missed his big chance to show that he's both serious about climate change and that he understands the arguments. He's delayed the previously announced 2p per litre rise in fuel duty and then added that it will rise 0.5 p per litre each year thereafter. This simply isn't acceptable, it's putting us all at risk, for what he should have done is cut fuel duty by 12p per litre.

No, I'm being serious, not some fruticake or swivel eyed loonie (although I can be both of those at times). The outcome of the Stern Review (ie, the advice the Government commissioned to tell them what to do about climate change) was that there is a correct level of taxation upon carbon emissions: the slightly alarming thing being that this correct level is lower than the price we already pay.

Start from the point that Stern, the IPCC, the "scientific consensus", are all correct. No, we're not claiming that it's all sunspots, that climate change isn't happening and we're not to blame. Yes, it is, we're causing it and it's going to impose some pretty big costs in the future. At this point what we really want to know is how big are those costs going to be?

So let's throw in the value of Bangladesh before it sinks below the waves, the polar bears, Tuvalu too. The change in weather patterns, the moving northwards of the malaria belt, let's tot it all up and we'll get to some gargantuan number. Let us also look at how many tonnes of carbon dioxide (strictly speaking, carbon dioxide equivalent, CO2-e, to convert methane, NOx and so on to one unit) emitted will lead us to that cost. Divide one by the other and we have the damage that one tonne of CO2 will do.

That's really at the heart of what the Stern Review did (and there are others who have done similar exercises, William Nordhaus amongst them). Stern even went so far as to consider the possibility that we'll all be wiped out by an asteroid strike before Greenland melts in 2500 AD or so. Now there are concerns with the exact numbers, for Stern got to $85 per tonne CO2-e, while Nordhaus has at times said $2.50.

But Stern is supposedly the guy the UK government is listening to, so we'll use his numbers. Stern also said that this number leads us to a simple solution, the employment of Pigou (or Pigouvian) taxation and on this point, despite concerns about the $ number, economists from Greg Mankiw through Nordhaus to Richard Tol (that last actually part of the IPCC process) are agreed: damn good idea. Stick $85 per tonne on each and every emission of CO2-e and you've solved the problem.

No, we don't know how many emissions that will stop, no, we don't know what the cumulative effect will be in terms of temperature, Tuvalu, polar bears or Bangladesh. However, we do know that we've got the right balance: for, you see, we don't actually want to stop climate change, we just want the right amount of climate change.

Yes, the likely changes will impose costs. But so will trying to stop those changes impose costs. We could, for example, shoot anyone who uses fossil fuels after 4pm next Tuesday. Millions would die imposing such a regime and billions shortly thereafter if it were successful. We tend to think that this is too high a price to stop Weymouth becoming waterlogged in a few centuries' time.

So what is the correct price that we should be willing to spend to reduce the future damages? Well, obviously, the cost of those very damages. We don't want to spend more to solve the problem than the problem will cost, after all: no one pays £100 to insure a £90 problem, do they (with the possible exception of extended warranties on electrical items)? And spending less would mean that we are imposing our costs upon those to come in the future, something really not very nice to do.

So, we have our number for the costs, $85 per tonne CO2-e. As long as everyone pays this on their emissions, as long as this externality is incorporated into market prices, we've solved our problem. We now will get the correct amount of climate change, the socially optimal amount, as people will only emit if the benefits of doing so are greater than the costs.

No, it doesn't matter what the taxes are spent on either: that the polluter is paying the costs of her actions in using the Chelsea Tractor to drop diddikins off is sufficient. And do remember that this is all very much mainstream in the economics of climate change. This is exactly the advice that the Government has received.

So if we have our emissions price, and all we need to do is add it to the things that emit, what does this mean for the price of petrol? It's trivial to calculate that $85/tonne CO2-e gets you into the 10-12p (depends upon your exchange rate) region per litre. In order for drivers to pay the costs of their driving they should pay that sum per litre on their petrol: no higher bands for higher emitting cars are needed, no £25 a day rate in London's congestion zone, just that 11p (ish) on a litre.

However, this doesn't mean that it should be 11p higher than now: we've already had the (intermittent) fuel duty escalator for 15 years now. This was introduced in 1993, just after the Earth Summit, the UNFCCC and all that which led to the Kyoto Protocol.

Quite specifically, fuel duty was raised so as to make drivers carry the costs of their CO2 emissions. By 1997, it had added 11p: so, job done, problem solved. However, between then and now, another 12p has been added. (For those who are going to bring up the inflation objection, Stern's calculations were in a later year than these tax rises. Thus that 1997 11p is higher than Stern's required 11p in real terms.)

So in order to have the correct amount of taxation, the correct internalisation of externalities and thus the right amount of climate change in the future, fuel duty should be cut by 12 pence on the litre: further, all other taxes on higher emitting cars should be abolished. For at the moment, we're paying more in tax than the problem itself will cost in the future and that just isn't sensible, nor is it in agreement with all of the advice that the Government has been receiving, even the advice that it itself commissioned.

Not that this is an entirely unusual state of affairs you understand. This is the pesky little problem with any logical argument which leads to the identification of an optimal or perfect level of tax. Such rationality all too often leads to the answer, that perfect rate, being lower than the one necessary to feed the politicians' appetites to waste our money. ®

Tim Worstall knows more about rare metals than most might think wise, and writes for himself at timworstall.com, and for The Business, among others. He is a Fellow of the Adam Smith Institute.

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