Aggressive Greenhouse Gas Policies: How They Could Spur Economic Growth

Greer, Mark R., Journal of Economic Issues

Recent years have witnessed increasing concern about the environmental dangers posed by global warming. The buildup of atmospheric carbon dioxide and other greenhouse gases raises the possibility of climate change, including a change in the general circulation of the atmosphere and shifts in precipitation patterns. The environmental consequences of greenhouse gases are as yet uncertain, but they are a cause for concern.(1) Alarm about economic stagnation and unemployment has also gripped the public, as the major Western industrialized economies appear to have entered a period of stagnant growth. Many would undoubtedly agree that these two dangers, one environmental and the other economic, rank among the most important issues we face today.

It is important to understand what effect solutions to the environmental problem may have on the economic problem. Analysis of the economic impact of reducing greenhouse gas emissions has been dominated by neoclassical economics, which claims that any efforts to reduce them will come at the cost of foregone economic output [e.g., Manne and Richels 1990; Nordhaus 1991]. For example, Manne and Richels [1990, 68] state that it would cost the United States $3.6 trillion (discounted present value) to maintain its carbon dioxide emissions at 90 percent of their 1990 level through the year 2100. Claims such as these, coming as they do from professional economists, tend to undermine the political will to reduce greenhouse gas emissions, especially at a time when concerns about employment are foremost on people's minds.

The purpose of this essay is neither to criticize neoclassical analyses of reducing greenhouse gas emissions nor to question the assumptions upon which these analyses are based.(2) Rather, this essay applies an alternative economic framework, that of Keynesian theory, to this public policy issue. Focusing on investment, this essay will demonstrate that, according to Keynesian theory, greenhouse gases can be reduced without adversely impacting economic growth. Once this point has been argued, the essay will examine a possible supply-side objection to the phasing out of fossil fuels, after which a counterargument to this objection will be made.

The essay will then demonstrate that Keynesian theory suffers a shortcoming in that it disregards how product and process innovation are associated with investment. Recognizing that product and process innovation are an integral aspect of economic growth but retaining the Keynesian insight into the relationship between investment and aggregate demand allows one to discern that reducing greenhouse gas emissions would likely stimulate economic growth and employment. The linchpin of this argument, to be presented at the end of the assay, is that reducing greenhouse gas emissions would stimulate investment in alternative energy technologies as firms strive to adopt these new technologies. This increase in investment would in turn stimulate aggregate demand and boost economic growth. Hopefully, by introducing alternatives to the neoclassical approach, this essay will help to engender the "paradigmatic pluralism" that Soderbaum [1990, 482, 486-7] calls for.

In order to keep a manageable focus, this essay examines just one facet of an overall strategy of reducing greenhouse gases: reducing the use of fossil fuels through gradually phased in excise taxes on their production. To be sure, other greenhouse gases, such as methane, pose potential environmental problems. However, since the burning of fossil fuels is the most significant potential cause of global warming [Ogawa 1991, 24], reducing society's use of fossil fuels would be the central component of any policy to alleviate the risk of global warming.

A Keynesian Analysis of the Effect of Phasing Out Fossil Fuels on Economic Growth

The point of departure for the forthcoming analysis is that firms' investment decisions are driven by their expectations of the future, especially their expectations of future demand for their products. The prospective character of the investment decision finds its expression in the Keynesian idea of the marginal efficiency of capital, wherein the future profitability of an investment project under consideration is paramount [Keynes 1964, chap. 11]. Of course, one of the primary determinants of the future profitability of an investment, and thus of whether the investment will be made, is the future extent of demand for the firm's product: the greater is the demand for the firm's product, the greater are the firm's capacity utilization rate and profit rate on the investment, at least up to the point of full utilization of capacity [Levine 1981, 93; Steindl 1952, 110-111].(3) Thus, if one were to assess the impact of imposing excise taxes on fossil fuels, one of the first places one would look is the effect of such a policy on demand for firms' products. To the extent that this policy diminishes demand, it chokes off investment and growth, while to the extent that it stimulates demand, it promotes investment and growth.

Now, an excise tax on fossil fuels, like virtually every other tax, reduces aggregate demand. Therefore, imposing an excise tax on fossil fuels would lead firms to cut back on investment in new productive capacity as they perceive demand for their products falling. Analyzed from a Keynesian perspective, imposing an excise tax on fossil fuels would reduce economic growth. However, this stifling of economic growth could be avoided if the government automatically spent its excise tax collections. Or, if a conservative political environment precludes such a "tax and spend" policy, the adverse effect of the tax could be countered through an offsetting income tax cut, one ideally aimed at people of modest means who tend to spend, rather than save, any tax cut they receive. In this case, the combined policy of imposing an excise tax on fossil fuels and cutting income taxes for low income households would have a negligible effect on aggregate demand. From this point on, this analysis assumes that all excise taxes on fossil fuels are accompanied by an equivalent income tax reduction for low income households.

Additional complexities manifest themselves when one considers how an excise tax on fossil fuels raises firms' costs and how this cost increase, in turn, alters the distribution of income between wages and profits. As Kalecki [1971, 43-62] has demonstrated, the share of profits in national income (i.e., the ratio of total profits to national income) varies positively with the ratio of firms' unit non-labor production costs to their unit labor production costs. Consequently, as firms' ratios of non-labor production costs to labor costs per unit of output increase, the percentage of an economy's income going to profits increases. This happens because, as non-labor production costs increase, output prices rise as firms apply a constant percentage markup to their now increasing prime costs. Increasing product prices, combined with a constant nominal wage rate, shift income distribution from wages to profits. Since an excise tax on fossil fuels would raise firms' non-labor production costs but have no effect on their labor production costs, it would raise the ratio of non-labor production costs to labor production costs, thereby shifting the distribution of income toward profits.(4)

Now, properly conceptualized, profits are a form of saving, not spending; there is no reason whatsoever that a firm's profits are necessarily spent since the determinants of current profits and current investment are largely disjoint [Levine 1981, 90].(5) Since wages are spent and profits are saved, when the profit share of income rises, so does saving as a share of income.(6) In effect, an increase in the profit share of income boosts the overall propensity to save out of income, which chokes off aggregate demand and thus reduces investment, as Foster [1990, 417] has noted.(7) Since excise taxes on fossil fuels shift the distribution of income from wages to profits, they reduce total spending and thus exert downward pressure on economic growth. This would happen even if the excise tax collections were offset by a low income tax cut. Moreover, since taxes on businesses' prime costs reduce the income multiplier [Laramie 1991, 592], an excise tax on fossil fuels, in so far as it amounts to a tax on firms' prime costs, would reduce the income multiplier and thus diminish aggregate income, aggregate demand, and investment.

The adverse distributional consequences of imposing an excise tax on fossil fuels would call for the enactment of redistributional tax …

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Publication information: Article title: Aggressive Greenhouse Gas Policies: How They Could Spur Economic Growth. Contributors: Greer, Mark R. - Author. Journal title: Journal of Economic Issues. Volume: 29. Issue: 4 Publication date: December 1995. Page number: 1045+. © 1999 Association for Evolutionary Economics. COPYRIGHT 1995 Gale Group.

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