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Tuesday, April 11, 2000

Hot air about the carbon tax


The debate on the carbon tax is heating up again after a lapse of two and a half years. Before the 1997 Kyoto conference on climate change, I proposed that Japan introduce this environmental tax, following Norway, Sweden, Finland, Denmark and the Netherlands. However, the Ministry of International Trade and Industry, the Federation of Economic Organizations (Keidanren) and industries such as steel and petroleum opposed the tax for the following reasons.

First, raising the prices of fossil fuels through the introduction of a carbon tax would not help much to reduce emissions of carbon dioxide because, generally, energy has low price elasticity, or responsiveness to price changes. Second, the rate of economic growth will drop if the carbon tax is introduced. And third, if Japan alone levies it ahead of other major industrialized countries, the export competitiveness of Japanese industries that consume large quantities of energy, such as steel, will decline.

But what if the carbon tax is instituted? The price elasticity of gasoline, for example, might remain low because it will be difficult to find a substitute fuel, and because most drivers will not immediately drive less even if the price is raised. The same thing can be said about heating oil, gas and electricity.

However, this can happen only in the short run, perhaps for two years at most. The story will be different in three to five years because equipment will be replaced over time.

If, as a result of the imposition of the carbon tax, gasoline prices go up permanently, people who trade in an old car for a new one will most likely choose a model that is more fuel-efficient. Of course, not everyone will do so; some will choose a gas-guzzling luxury car in spite of high fuel costs.

Thus there will be certain imbalances in the fuel efficiency (mileage per liter of gasoline) of cars sold in a given period. But average efficiency will increase and, as a result, gasoline consumption will drop. In the long run, over about 10 years, the carbon tax will induce changes in lifestyle, with more people using public transportation, leading to further drops in gasoline use.

The first argument against the carbon tax -- that it will not help much to reduce output of carbon dioxide because of energy's low price elasticity -- is a fallacy stemming from the tax opponents view that looks only at short-term effects.

If the carbon tax is adopted, practically all prices, not just energy prices, will rise (more or less). As a result, domestic demand, notably consumer spending, will shrink across the board, provided income remains constant. If the tax money collected is kept in government coffers, nothing good will come of it. The economy will certainly hit the skids.

If the deficit-laden government uses the revenue in the general-account (operating) budget, but only in ways that trim the deficit, the rate of economic growth will fall, at least in the short term. In the long term, however, deficit reduction will lead to lower interest rates and spur private demand, such as capital investment and residential construction. So, in the long haul, the growth rate is more likely to rise, as the positive and negative effects offset each other.

What if the carbon tax is used specifically to combat global warming by setting up a special account to support energy conservation programs for businesses and consumers? In this case, it is difficult to be certain whether domestic demand will increase or decrease, because energy-saving investment (for individuals, including consumption) will increase. Whichever the case, it can be safely said that the absolute amount of change in domestic demand will be extremely small. In other words, the effect of the carbon tax on the overall economy will be more or less neutral.

The carbon tax is an income transfer from the consumer to the government. As such, it will have little or no macroeconomic impact unless the government makes the wrong use of the tax revenue.

What about a personal income-tax cut equivalent to the carbon tax revenue -- a scheme already in place in North European countries? Tax cuts for individuals increase spendable income and hence consumer spending. We will have to wait to see whether higher spending from tax cuts will offset the spending setback caused by the higher prices that result from the carbon tax. Whatever the actual result, it will be extremely limited in absolute terms. In other words, as I have already described, the macroeconomic effect of the carbon tax most likely will be almost neutral.

There is no question that the carbon tax will cut into the export competitiveness of energy-intensive industries if no countervailing measures are taken. To avoid that, the tax can be refunded at the water's edge; that is, when steel is exported. Conversely, the tax can be levied on steel imports.

The government and industry here -- which were negative about the carbon tax about two and a half years ago -- are beginning to take a positive position on it. Three reasons may be given. First, there is a strong possibility that Germany, France, Italy and France will introduce this tax. Second, except for the carbon tax there are no effective measures against global warming. And third, with various countries setting their sights on trading in emission rights and related schemes, it is necessary to secure funding for antiwarming measures.

I support the carbon tax system, of course. My hope is that rational discussions will be conducted in this country without undue regard for ministerial interests to determine what kind of tax system is desirable to promote efforts against global warming.

Takamitsu Sawa, professor of economics at Kyoto University, is also the director of the university's Economic Research Institute.


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