Carbon Taxes: The Problems With the “Externalities” Argument

by Rob Roper

One of the arguments Carbon Tax proponents make to justify placing such a heavy burden on our citizens is that there is a need to add the cost of “negative externalities” to the price of using gasoline, home heating fuel, etc.

A “negative externality” is a cost that is created through the use of a product but is not born by the user or the producer. In the case of gasoline, home heating fuel, etc. this is defined as the cost society has to pay in response to rising CO2 levels. The argument goes that government should add that cost back into the product through a tax, forcing the user and/or producer to pay the “real” cost of the transaction.

Sounds fair at first glance, but, there are a number of reasons to think twice about the “negative externalities” argument.

First, the true cost of a negative externality is a very difficult number to calculate. The market determines the price for gasoline, for example, based on what a customer is willing to pay for a gallon versus what a producer is willing to sell it for. The compromise between those two forces determines the price. What’s the fair price of a negative externality? Especially for something like CO2 and its impact on climate change? The government essentially makes up a number. This is a capricious process that is genuinely ripe for abuse.

Second, many if not all economic activities have “negative externalities.” Building a house impacts the environment by cutting down trees digging up rabbit holes, etc. Planting an apple orchard or a field of corn. Putting up a wind turbine kills birds, bats. This list could go on forever…. But most of the time we don’t have a “negative externalities” tax for these things (though sometimes there are impact fees), and some cases we subsidize them. It’s totally arbitrary, which also makes this ripe for abuse. And do we want to set this as a moral premise for taxation?

And, finally, what about positive externalities? If it is public policy to tax negative externalities, isn’t it only fair to compensate companies for positive externalities – public benefits a product creates for which the company is not compensated. For example, oil helped save the whales, allowed for the reforestation of the continent, and contributed near doubling of the average human life span over the past century and a half. How do you put a price on that? We don’t. Should we?

- Rob Roper is president of the Ethan Allen Institute

{ 1 comment… read it below or add one }

Kyle Sala April 15, 2017 at 3:27 pm

You make some excellent points here about the externalities. This is something I’ve always struggled with.

Consider this example. A business puts in a new plant, upstream from a community. Say the community relied on fishing, or some other resource from the river. The new business dumps into the river, and destroys the livelihood of the community. This is certainly a destructive negative externality. How to solve?

I’ve also thought the best way is to have the smallest size coalition of affect parties reach an agreement. Although the business perhaps doesn’t have much to gain in these negotiations. (The classic example I think of is the Colorado River pact).

I wrote about it here:


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