Thank you for this useful critical appraisal of the fossil fuel subsidy discussion. I agree with you that the distinction between actual monetary outlays and what’s imputed on the basis of estimates of the associated externalities hasn’t been as clear as it should have been. However, conceptually it is correct: not accounting for the externalities (by pricing carbon right) is a subsidy. (To take into account the uncertainty about the social cost of carbon, it would have made sense to present a range of estimates.) Whether you prefer to call it a tax hike on fossil fuels is a question of messaging. In terms of practical policy, nobody is recommending we instantly raise the price of fossil to the SCC: it is clear that it will have to be gradual. And the IMFs recommendation is that this should be done in a revenue neutral way, i.e. the carbon tax proceeds be recycled to the private sector. The point is to induce a substitution effect without the income effect. Which is why it’s economically irrelevant that the subsidies are paid to consumers: they lower the price of fossil fuels and thus increase consumption. The ultimate incidence of the subsidy is with producers, as the consumer spending is profits for them.
Finally, in terms of practical policy the uncertainty about the SCC is a red herring: when the current global price of carbon is - if we’re lucky - 20 dollars, the issue is not whether the SCC is 100, 200, or 300. We know what we need to do: raise the price of carbon! And absolutely, we need to do it in an equitable way.
Thanks for this thoughtful piece though, I will write up my thoughts in a more structured way in my own Substack.
Spyros, many thanks for your very thoughtful comment. A few quick reactions:
Completely agree that accounting for externalities is the right thing to do -- I said as much in the blog. The issue is how we estimate them. And here:
The uncertainty about the social cost of carbon is not a red herring--it defines the magnitude of the problem, the urgency with which we should act and the size of transition costs we should be willing to bear. So it is a crucial issue, which is why I am very uncomfortable with the IMF and others throwing out huge numbers and waving away the massive uncertainty of the estimates.
Calling it a tax hike is not an issue of messaging, it is not semantics. It is a tax hike -- which is why the IMF talks of revenue neutrality.
I doubt governments would follow the revenue neutrality recommendation, given how saddled they are with huge debts, and their unending wishlist for spending. But even if they did, it would not spare a recession if were to engineer the drastic reduction in fossil fuel consumption implicit in removing the 7T subsidies because, as I mentioned, we do not have enough alternative energy.
So again, yes, we have to debate the speed of the transition. Because you and I here agree that the transition as you say should be gradual, but we need an explicit honest debate on what gradual means. Meanwhile the public debate is dominated by apocalyptic predictions and outsized externality estimates that fuel the extinction panic and are not all consistent with gradual action. This creates a dangerous detachment between hype in the public debate and actual progress. Compounded by a stunning hypocrisy and reluctance to discuss openly what kind of transitions costs we might be contemplating, with the result that as soon they are presented with actual higher bills, people balk and policymakers have to rethink their strategies.
With this said, thanks again for the comments, and look forward to reading your Substack post!
Thank you for this useful critical appraisal of the fossil fuel subsidy discussion. I agree with you that the distinction between actual monetary outlays and what’s imputed on the basis of estimates of the associated externalities hasn’t been as clear as it should have been. However, conceptually it is correct: not accounting for the externalities (by pricing carbon right) is a subsidy. (To take into account the uncertainty about the social cost of carbon, it would have made sense to present a range of estimates.) Whether you prefer to call it a tax hike on fossil fuels is a question of messaging. In terms of practical policy, nobody is recommending we instantly raise the price of fossil to the SCC: it is clear that it will have to be gradual. And the IMFs recommendation is that this should be done in a revenue neutral way, i.e. the carbon tax proceeds be recycled to the private sector. The point is to induce a substitution effect without the income effect. Which is why it’s economically irrelevant that the subsidies are paid to consumers: they lower the price of fossil fuels and thus increase consumption. The ultimate incidence of the subsidy is with producers, as the consumer spending is profits for them.
Finally, in terms of practical policy the uncertainty about the SCC is a red herring: when the current global price of carbon is - if we’re lucky - 20 dollars, the issue is not whether the SCC is 100, 200, or 300. We know what we need to do: raise the price of carbon! And absolutely, we need to do it in an equitable way.
Thanks for this thoughtful piece though, I will write up my thoughts in a more structured way in my own Substack.
Spyros, many thanks for your very thoughtful comment. A few quick reactions:
Completely agree that accounting for externalities is the right thing to do -- I said as much in the blog. The issue is how we estimate them. And here:
The uncertainty about the social cost of carbon is not a red herring--it defines the magnitude of the problem, the urgency with which we should act and the size of transition costs we should be willing to bear. So it is a crucial issue, which is why I am very uncomfortable with the IMF and others throwing out huge numbers and waving away the massive uncertainty of the estimates.
Calling it a tax hike is not an issue of messaging, it is not semantics. It is a tax hike -- which is why the IMF talks of revenue neutrality.
I doubt governments would follow the revenue neutrality recommendation, given how saddled they are with huge debts, and their unending wishlist for spending. But even if they did, it would not spare a recession if were to engineer the drastic reduction in fossil fuel consumption implicit in removing the 7T subsidies because, as I mentioned, we do not have enough alternative energy.
So again, yes, we have to debate the speed of the transition. Because you and I here agree that the transition as you say should be gradual, but we need an explicit honest debate on what gradual means. Meanwhile the public debate is dominated by apocalyptic predictions and outsized externality estimates that fuel the extinction panic and are not all consistent with gradual action. This creates a dangerous detachment between hype in the public debate and actual progress. Compounded by a stunning hypocrisy and reluctance to discuss openly what kind of transitions costs we might be contemplating, with the result that as soon they are presented with actual higher bills, people balk and policymakers have to rethink their strategies.
With this said, thanks again for the comments, and look forward to reading your Substack post!