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Krugman on Waxman-Markey’s Cost: We Hope His Readers Can’t Multiply

Paul Krugman has been on the warpath lately regarding climate change economics. He has devoted his last two NYT columns (here and here) to the subject, as well as back-to-back blog posts (here and here). True to form, Krugman accuses those who disagree with him of abject stupidity and evil intent; for Krugman it is impossible that any decent economist who cares about human beings could actually think the costs of cap-and-trade legislation will be high. But as we’ll see, Krugman’s own figures don’t jibe with the narrative he’s pushing.

In his September 27 blog post, Krugman takes up his familiar theme of denouncing those who dare to say that Waxman-Markey carries a large price tag. After using a diagram to explain the textbook distinction between the compliance costs of a new tax (or mandate), versus the “deadweight loss,” Krugman excoriates economist Martin Feldstein for allegedly spreading lies:

[Feldstein] took the CBO’s estimate of “compliance costs”, which was $1600 per household in an early report (it’s now down to $900, but who’s counting?), and implied that this was the economic cost of the legislation. But “compliance costs” are basically the sum of the blue rectangle and the red triangle; the true economic costs are just the triangle, and are much smaller.

OK now, this is quite simply hilarious, if you can follow me through the argument. I really don’t think Krugman realizes just how much his pants are down on this one.

First off, Krugman is correct that there really is a distinction between the impact of a new tax in terms of paying extra revenues, versus the overall loss to the economy because of distorted incentives. But when the public wants to know “how much will cap-and-trade cost?”, it is quite reasonable for them to wonder, “How much will my electricity bill, or gasoline prices, go up because of this?” Most people do not realize that Krugman & Co. are netting out the gains to the recipients of free allowances and government expenditures when computing the “net burden on U.S. households.”

For an analogy, consider the debate over health care reform. Using Krugman’s approach to cap-and-trade, the proponents of reform could say, “We suggest imposing an extra tax of $1 trillion on upper-income earners, in order to provide insurance to all Americans. But the cost to the economy would be quite minimal. After all, every penny of that trillion dollars would be spent on hospitals, doctors, pharamaceuticals, etc., thus recycling that money right back into the pockets of U.S. households. The true economic cost of the tax hike would only be in the form of reduced incentives to work among the super-wealthy, which I estimate at around $75 billion over a ten-year period, which works out to a Slurpee per day for the average U.S. household.”

Would anybody buy the above argument? Of course not. A $1 trillion tax hike is just that, a $1 trillion tax hike. Of course that money “gets back into” the economy when the government spends it, but so what? The reason people dislike taxes is that it’s no fun to pay them, and they have a lot less control over how politicians spend their money once it’s confiscated. And yet, the above argument that I invented for health care is very analogous to how Krugman is saying we should score the “economic cost” of cap-and-trade.

So what’s the true number, Professor Krugman? But now we’re ready for the really fun part. Krugman is saying that because Feldstein focused on the gross costs of compliance–rather than the net “deadweight loss” in terms of altered incentives–he frightened the American people with the scary number of $1,600 per household. So what is the more accurate number, according to Krugman? In the same blog post he tells us:

Now, the cost to the economy of this limit is the benefit the private sector would have gotten by emitting more than is allowed under the cap. It’s shown in the figure as the red triangle labeled “deadweight loss”. CBO puts these losses under Waxman-Markey at 0.2-0.7 percent of GDP in 2020, 1.1 to 3.4 percent in 2050. These costs have to be set against the environmental benefits.

Well hold on just a second! What if we convert that statistic back into a dollar amount per household? Krugman would have you believe it would be a lot lower than $1,600, right? And yet simple arithmetic shows us that he’s way way off.

Let’s convert the range into a single point estimate: We’ll say that Waxman-Markey will cost 2.2% of GDP by 2050 (a little less than the midway point of the range). If we turned that percentage into a gross dollar amount with current GDP levels (year 2008), it works out to about $315 billion. (Current GDP is $14.3 trillion, so 2.2% of that is $315 billion.) Dividing by 117 million U.S. households, that works out to almost $2,700 per household. So already, we’re way above the allegedly dishonest figure put out by Feldstein.

But wait, it gets much worse. The CBO estimate refers to the cost of Waxman-Markey in the year 2050, when GDP will be much higher. As Krugman explains in one of his recent NYT columns: “[T]he budget office also predicts that real G.D.P. will be about two-and-a-half times larger in 2050 than it is today, so that G.D.P. per person will rise by about 80 percent.” (The interested reader can see the CBO’s actual GDP forecasts in the last tab of this Excel file.)

So assuming that the number of people per household stays roughly constant between now and 2050, we need to increase our figure of $2,700 by 80%, allowing us to conclude: Krugman’s own preferred mid-range estimate of the cost of Waxman-Markey works out to $4,800 per household by the year 2050.

Conclusion. By focusing on the “deadweight loss,” rather than the gross compliance costs, Krugman is minimizing the huge spikes in energy prices that Waxman-Markey would impose on consumers. If such an analysis were used to score a simple tax hike, everyone would recognize the chicanery involved–and this is why the politicians are pushing cap-and-trade, rather than an explicit carbon tax.

However, even on his own terms, Krugman’s own statistics yield a mid-range cost estimate of Waxman-Markey of $4,800 per household by the year 2050. So when Martin Feldstein and others throw around figures like $1,600 or even $3,100, they’re not scaring the public enough! When the caps under Waxman-Markey are squeezed as tightly as they will go, the CBO itself admits that the “deadweight loss”–the measuring rod favored by Krugman–will be in a range with a mid-point value of $4,800 per household.

One final point: It would be misleading to conclude, “Oh, so the CBO says the cost of Waxman-Markey’s cap-and-trade program will be $4,800 per household.” That figure applies to the year 2050, when households will be much richer. This is one of the reasons the CBO and other groups express costs (whether from carbon restrictions or from climate change) in the far-distant future as a fraction of GDP, rather than as a dollar amount. However, even if we looked at the mid-point 2.2% of GDP estimate using 2008 numbers, the per-household cost is $2,700, much higher than Feldstein’s figure of $1,600. What Krugman and other proponents of Waxman-Markey are doing is reporting the dollar-cost per household figures for early years (like 2020), when the emission caps are relatively lenient. But then in the later years (like 2050), when the caps are very tight, Krugman and others report the figure as a % of GDP, which means nothing to most Americans.

8 comments

1 Andrew { 10.02.09 at 10:55 am }

“These costs have to be set against the environmental benefits.”

So, what he is saying is that we need to compare the cost to the benefit. Okay. The benefit is zero. Zip. Zilch. Nada. Nothing. If we are going to go to that step, then it doesn’t matter if people are “exaggerating the cost”-if it isn’t free, the cost exceeds the benefit, since there isn’t any.

2 PaulD { 10.02.09 at 2:55 pm }

I understand the perspective you are presenting and I think it is a valid one to consider. At the same time, I think that Krugman makes a valid point from a different point of view.
I see Krugman arguing that energy markets achieve an efficient outcome only when the full cost of energy is included in its price. By their nature, markets do not include the cost of externalities such as the cost of pollution emissions. He therefore argues that society receives the benefit of a more efficient allocation of resources when the price of energy is adjusted by government policy to reflect its true costs. If this is done with a tax, the cost of the tax to society is directly offset by the harm averted to society by the resulting reduction in CO2 emissions. This is a different argument than suggesting the cost of a general tax is offset by the benefit of government spending financed by it.
Krugman’s theory is basic economics 101. In real world, however, the difficulty is that it is almost impossible to determine the true cost of CO2 emissions and the accompanying level of taxation that results in the most efficient allocation of resources. If the tax is set higher than the real cost of CO2 emissions, then the energy markets will not reflect an efficient allocation of resources and real harm will be done to the general welfare.
It is likely in Krugman’s view that any politically feasible tax will be lower than the true costs of CO2 emissions and will therefore at least move the costs of energy towards a more efficient allocation of resources. Lest I be accused of agreeing with Krugman, I am much more skeptical that the costs of CO2 emissions are higher than their benefits. Accordingly, I while I agree with his theory, I don’t agree with his real world policy advice.

3 Richard W. Fulmer { 10.02.09 at 5:10 pm }

I have two basic issues with Krugman’s analysis:
1. As PaulD points out, the benefits of reducing U.S. CO2 emissions are almost negligible. Even Waxman-Markey proponents admit that. So any cost to the economy is a net loss.
2. It’s a static analysis. If I rob Peter to pay Paul, in a static model, there is no impact on the economy in the aggregate. In the real world, Peter buys locks for his house.

4 Noblesse Oblige { 10.03.09 at 9:50 pm }

Put aside the razzle dazzle. The cost to the economy would be the additional cost of energy systems favored by government, over the cost of systems that would be incurred without government intervention ( presumably mostly based on hydrocarbons). These systems will suck capital out of the rest economy that would have been used to produce real economic progress. Any reasonable set of numbers runs to the trillions for the US alone. And at the end of the day, we will be no better off environmentally than we are now. That is, the ‘externalities’ remain the same, because the whole thing is based on flawed science — if you want to grace it by calling it ‘science.’

5 Cooler Heads Digest 2 October 2009 | GlobalWarming.org { 10.05.09 at 9:07 am }

[...] Paul Krugman Can’t Multiply Robert Murphy, MasterResource.org, 2 October 2009 [...]

6 Celebrity Paycut - Encouraging celebrities all over the world to save us from global warming by taking a paycut. { 10.05.09 at 10:35 am }

[...] Paul Krugman Can’t Multiply Robert Murphy, MasterResource.org, 2 October 2009 [...]

7 David C { 10.05.09 at 10:09 pm }

There’s one big gaping hole in your logic. Martin Feldstein’s $1,600 figure was for 2020, not 2050. From his WSJ article: “The Congressional Budget Office recently estimated that the resulting increases in consumer prices needed to achieve a 15 percent CO2 reduction — slightly less than the Waxman-Markey target — would raise the cost of living of a typical household by $1,600 a year.” That 15% number is slightly below Waxman-Markey’s 2020 target, not its 2050 target. Using your method, Paul Krugman’s 2020 number is then $550 dollar per household, substantially below Martin Feldstein’s number.

8 Robb714 { 11.20.11 at 2:38 pm }

Mr. Krugman and his friends need therapy and to stay out of non-crazy people’s business! His views on everything are wrong now, a hundred years ago and tomorrow. He should start doing stand-up because his thoughts are just laughable, tbh.

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