Americans for Tax Reform

A Free Economics Lesson for Media Matters

This piece was originally written for Americans for Tax Reform’s blog, where I am an Associate (intern):

Every day after ATR posts new state figures on how cap and trade will destroy jobs and increase energy costs, Media Matters Action’s blog responds, like clockwork, that Waxman-Markey would instead create “green jobs”. For example, after Tuesday’s post on Kansas, Media Matters responded that 17,000 green jobs would be created. Because we know that Media Matters is reading our blog, we figured that we should give them a free economics lesson to explain why cap and trade may “create green jobs” but will still hurt the economy. Read on, Media Matters!

Cap and trade works by setting a cap on CO2 emissions – effectively creating a carbon energy quota. Firms bid for permits from the government to contribute toward this quota. The bidding process imposes a de facto excise tax on the carbon-based energy market. This tax causes the supply of carbon-based energy to decrease. The tax increases – and supply decreases – by the amount necessary to create a new supply-demand equilibrium at the level set by the carbon quota. This can be represented graphically.

The above is a standard supply-demand model of the carbon-based energy market. The horizontal axis represents the quantity of energy produced and consumed. The vertical axis is the unit price of energy. The red line D is downward-sloping demand. The blue lines shows supply, which decreases (shifts left) after the imposition of the cap and trade quota. The quota is shown by the green vertical line “capping” carbon-energy at Q2. The vertical distance between the two supply lines shows the size of the excise tax created by cap and trade.

Economists use the concept of “total surplus” to measure the benefits of a market. Roughly explained, total surplus represents the sum of differences between the benefit for each consumed unit (shown by the demand curve) and the cost for each produced unit (shown by the supply curve). On the graph, the total surplus can be seen as the triangular area between the supply (S) and demand (D).

What happens to the total surplus when the government imposes cap and trade? When the de facto tax goes into effect, the cost of each additional unit of production increases by the amount of the tax. Thus, each unit of energy produced and consumed yields less surplus; the unit surplus by the excise tax. Part of this surplus is taken from consumers in the form of a price increase (P2 is higher than P1). The rest of this reduction is felt by lower unit revenues for producers (P2-Tax is lower than P1).

This tax revenue is retained by society in the form of government revenue. This area is shown on the graph as the two green areas. We can think of this tax revenue as the source of “green job” funding. As the graph demonstrates, “green jobs” are created by eating into and displacing pre-existing economic prosperity. Where the government creates “green jobs”, it destroys other jobs or eats into the taxpayer’s wallet.

But worse than arbitrarily distributed government revenue is dead-weight loss. Dead-weight loss represents goods whose benefit exceeds their cost, but are not produced. The energy quota and tax ensures that a certain amount of production will be lost– represented by the two purple areas on the graph. The real production costs of these goods are lower than their benefit to consumers, but taxes put them out of reach. Dead-weight loss is felt as a decrease in consumer wealth and supplier jobs, and these losses do not yield any ameliorating increase in government spending – the wealth simply disappears.

The government cannot “create” jobs. It can only arbitrarily displace one industry with taxes and then replace it with spending. When it does this, it creates dead-weight losses that harm the economy as a whole. When Media Matters writes that the government will “create” green jobs, they really mean that the government is going to rearrange the energy sector for the detriment of all – what we have argued all along!

2 Comments

  • Liz

    Hi Wallace,
    I tripped over your S and D curves. They’re colorful, that’s for sure. It would be helpful if you would consider in your essay your notion (or someone’s) elasticity of demand for carbon-based energy (the slope of the D curve). Remember Economics 202? Generally the more inelastic a good, the less the reduction in Quantity supplied (and therefore, you see, a smaller deadweight loss). You know, the reason these conversations about deadweight loss and tax revenue go on so long is because they’re full of complexity and nuances and scratching of some pretty thoughtful heads.
    On the bright side, your insight in this article may be worth what Media Matters paid for it.
    Cheers,
    Liz

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