Would it be possible to design a carbon tax that the public would enthusiastically support? That would be progressive, rather than regressive, imposing greater costs on the rich than the poor? Is it politically possible to strictly limit the total amount of carbon emitted, without rewarding past polluters with windfall emissions permits? Yes, it is. And it's fun! Politicians — Here's an opportunity to give money to your constituents, and save the world too! It works like this:

First, enact a carbon tax. Nothing fancy here, just your usual I'm-Greg-Mankiw-Wanna-Join-My-Club? "Pigouvian" carbon tax. Embedded in what drivers pay at the pump, added as yet another surcharge to heat and utility bills, would be a new Federal tax on carbon sold or used as fuel. That was easy.

Unfortunately, a carbon tax is regressive. It imposes disproportionate burden on the poor, as the higher cost of driving to work and heating a home takes a much bigger bite out of a burger-flipper's paycheck than a hedge-fund manager's "capital gain".

But, here's a trick. Just as flattish taxes are regressive, flattish subsidies are progressive. So, when we enact the carbon tax, we grant citizens the right to a refund of the tax on a fixed quantity of carbon consumed. We distribute those refunds equally among all taxpaying US citizens annually. And, we permit citizens to sell any refunds they won't need to use.

Suppose, in the beginning, we set the amount of refunds to be equal to the total expected carbon tax, given 2007 US carbon consumption. This seems dumb, right? In the aggregate, we've just created a system whereby the government collects a tax and sends it right back out again, exacting a net cost of zero from the private sector for its profligate use of carbon. All the government has done is caused transfers within the private sector. Yes. But from whom to whom? Light users of carbon end up receiving cash, from the excess permits they sell, while gas-guzzle-monsters pay up! That's likely to mean that most poorer people earn cash from their allotment, paid for by the people whose Hummers they can't see over. Moreover, note that our refunds are distributed only to taxpaying humans, not to businesses, but businesses are still subject to the tax, and can purchase refunds. That means that on net, the government will have underwritten a transfer from businesses to voters households. The vast majority of human beings will see ka-ching positive net wealth from this scheme, without any cost to the government. People who conserve more will earn more, people who conserve less will earn less, or even have to pay. Businesses will buy refunds from households, so long as the cost of the refund is less than the cost of the tax. When there are no more refunds left to buy — when aggregate carbon consumption exceeds the refund allotted — some users will have to pay the tax outright, at whatever rate the government has set.

Now of course a tax on business is indirectly a tax on households. But this is a tax businesses can minimize, by reducing their carbon footprint. That is, after all, the point, to change behavior. Plus, taxing indirectly via businesses, rather than taxing households directly, increases the progressiveness of a tax. Not all costs are passed on to consumers. Some costs take a bite out of profits, harming relatively well-off capital-owners disproportionately. (That's why we have things like corporate taxes.)

The political economy of this scheme is interesting. Since this is a tax that creates an income for most voters (earned, of course, via parsimonious use of carbon), voters might be expected to support increases in the level of the carbon tax, as this increases the value of their refunds. Increasing the tax level faster than the refund allotment makes most voters richer, and helps save the world. It also creates strong incentives for businesses to conserve carbon. As the tax level gradually grows very large, the scheme converges to a cap-and-trade, because it becomes prohibitively expensive for anyone to pay the unrefunded tax.

Would this scheme be hard to implement? Not terribly. Remember, we begin with a simple carbon tax, and we start small and build gradually, so that the refund infrastructure has time to evolve. For a while, lots of refunds would go unused. (They needn't expire quickly.) The government maintains a system of accounts, linked to taxpayer IDs, and encourages private-sector actors to implement trading systems. Carbon consumers claim refunds by submitting proof of taxes paid (bills and receipts), which the government reimburses with a deduction from the claimant's refund account. The process would be quite analogous to the value-added tax reimbursements of businesses apply for in many countries. Consumers who are too busy or disorganized to deal with the paperwork can just sell their refunds and pay the taxes (though they lose some by doing this). Initially, a small industry would spring up to ease the process of claiming refunds, in exchange for a cut. Eventually businesses would find competitive advantage in automating the process. Gas stations, for example, would have every incentive to electronically submit claims on behalf of customers, so that customers see a discount right at the pump. Fraud would be an issue, as it always is. There would be problems, scandals, and solutions.

There's been a lot of debate among the pious, which is more godly, carbon tax, or cap-and-trade? Here's a scheme that starts as a carbon tax and evolves into a cap-and-trade, that creates incentives for consumers, businesses, and politicians to reduce carbon use, that can be implemented gradually, that doesn't reward past polluters, and that leans just a little bit against inequality. What do you think?

Update: For a similar but much simpler idea, see Softening the Impact of Carbon Taxes. The paper proposes a fixed cash rebate of carbon taxes collected, rather than tradable refunds. Thanks to commenter (and author) Dan for pointing this out.

This idea was inspired by Martin Feldstein's Tradeable Gas Rights proposal, via Mark Thoma. I first suggested something like this as a comment to Mark's post.

Free exchange, The Economist's new web log, has an awful piece about globalization and employment security. Mark Thoma does a good job, in his gentle and collegial way, of ripping it a new one.

The basic claim of The Economist piece is that unemployment is low and measures of job security have not fallen, despite the fears of antiglobalists that outsourcing would put them out of work. Mark points out that the research is not so unambiguously cheerful, and that The Economist's anonymous author doesn't have all his facts straight.

But let's be generous. Let's presume (though it isn't true) that "unemployment hit 4.1% in America, the lowest level the nation has seen in thirty years", that "there is little evidence that job security has declined in the last twenty-five years", and "[o]verall, globalisation doesn't seem to have had much effect on job security".

The magazine is called The Economist right? And doesn't economics teach us that it is meaningless to talk about the quantity demanded without also talking about the price?

What has happened to the price of labor over the last several years in the United States? Productivity adjusted, the price of labor has been falling. A dollar's worth of labor produces something between 8% and 12% more output than it did six years ago. So the quantity of labor demanded should be increasing, if the demand schedule for labor has not changed. Instead, the broadest measure of employment, employment to population ratio, has unambiguously fallen.

It's the mystery of the dog that didn't bark. If The Economist is right, then job security has remained stable despite a growing economy and falling output-adjusted labor costs. But job security ought to be improving under these conditions, dramatically. Labor has grown cheaper in the US, and fewer people are working. The last thing those who do have a job right now should have to worry about is losing it!

It's a complicated world. There is a supply-side to consider as well as a demand side. The population is aging. People may prefer education, hobbies, or leisure to employment. But these factors can't account for what we're seeing. During an alleged economic expansion, broad employment in the United States is falling. Where there ought to be labor shortages and firms bidding up the price of labor, the output-adjusted price of labor has fallen. If the explanation for the drop in employment were an increase in retirements relative to new entrants to the labor pool, or of it were a matter of people opting out, that would provoke bidding wars and higher wages for remaining workers.

Something else must be going on to explain these facts. Either the supply of labor must be increasing, or the demand for labor must be decreasing, or the bargaining power of labor must be falling. Now we can't say for sure, but it's reasonable to suspect that the ongoing infusion of around 2 billion new workers into the global market economy would have all these effects: The supply of labor available to firms (quantity at a given price) increases; The demand for domestic labor (quantity at price) diminishes, as firms can outsource; and the bargaining power of domestic labor falls as capital can look elsewhere to meet its manpower needs.

There may be other explanations. But if Sherlock Holmes were alive today (and if he were, like, real), I think he would pronounce globalization the culprit in this, the mystery of the labor boom that wasn't.

Chris Dillow asks, "Why is protectionism popular? The answer is the title, and perhaps I should leave it at that.

But no. I have a reputation for verbosity to protect.

First, the current incarnation of free trade is coming under pressure not because people are stupid, but because people are smart. The publics in countries like the United States and Britain have been remarkably tolerant of free trade over the last two decades, because the policy-relevant public "gets it", has been persuaded by economists from Ricardo on down that free trade is a positive-sum good thing. The arguments for protectionism that Chris catalogs are old tropes that we had almost managed to put behind us.

I've done no study, but here's a conjecture: The countries where protectionism is becoming popular are those with both growing current account deficits and shrinking tradables sectors. A shrinking tradables sector is not the same as a declining industry. Declining industries are normal and good. Even the near extinction of manufactures as a whole is okay. But a shrinking tradables sector is not. A shrinking tradables sector means a decline in nation's capacity to produce goods or services of any sort that citizens of other countries want to buy, at competitive prices.

Free trade is positive sum because of specialization. The idea is that if someone else makes cars better or more cheaply than the UK can, Brits will do some other thing in which they have a comparative advantage, maximizing both overall productivity and the wealth of both nations. But there's a catch to this ancient Ricardian reasoning, a hidden assumption: The other thing that Brits do has to be tradable. If the UK stops building cars, and instead concentrates on home-building and retail sales, then there are no certain gains to trade.

Ricardo probably failed to agonize over this point, because if a country ceases to produce tradables, it stands to reason that it ceases to have the capacity to trade, and the question of whether trade is beneficial or harmful is rendered moot.

But Ricardo is dead, and we live in a brave new world where, at least for a while, some countries are willing to trade persistently for debt not backed expanding (if adjusting) tradables capacity on the part of the debtor. This is not a Ricardian paradise. This is economic terra incognito, and citizens are right to be spooked.

Chris writes:

People lose their minds when they think about national economies. It's obvious that, as individuals, we get rich by specializing in the trade we are least bad at, and buying stuff from others. When I go to work, I'm exporting. When I go to Tescos, I'm importing. No-one thinks of it this way, though.

I think he's wrong. I think that nearly everyone thinks of it this way, both on a personal level and at a national level, and that's precisely why "free trade" is under pressure. At a personal level, when we import by buying stuff at Tescos, but fail to export enough at work to fund our imports, we consider that a problem. When our credit card balances grow large relative to our expected capacity to pay-off or even service our debt, we get very nervous.

So it is, and ought to be, on a national level.

A consumer "importing" more than she is "exporting" has a bunch of alternatives: She can force herself to "import less", by cutting consumption or by turning to imperfect home-made substitites (fire the maid). Or she can increase her capacity to export, by, for example, upgrading her skills and getting a better job. The latter choice is best, both for the consumer herself and for the world as a whole. But if she can't succeed at increasing exports, cutting back on imports is much better than simply letting unfundable liabilities mount.

On a national scale, increasing exports is also better than forcibly cutting imports. But so far, some "rich countries" seem unable to expand exports relative to imports. When the first-best solution to a serious problem proves inaccessible, reasonable people eventually turn to less optimal strategies.

And that's why protectionism is becoming popular again.

Some of the best and brightest econbloggers are having a debate on whether there are negative externalities associated with wealth inequality, and whether these might merit government intervention to remedy. Unfortunately, the debate has gotten lost in a colorful, but unhelpful, discussion of "spite" (on the part of rich people) and "envy" (on the part of the poor). However entertaining this may be, it quite misses the point.

Very large wealth inequality has a huge, tangible negative externally in all existing political systems that has nothing to do with idiosyncratic emotional reactions. Wealth inequality leads to large, utility-destroying errors in public policy.

In the real world, under democratic capitalism, stalinist communism, feudal monarchies, you name it, there is a strong correlation between actual wealth and political power. (Under some systems this might be masked by differing institutions of wealth and property, but facts on the ground proved Comrade Stalin to have a nicer car than Comrade Sven.) Correlation is not causation: In some systems political power precedes wealth, and in others wealth brings with it the capacity to garner influence. Nevertheless, the relationship is strong, everywhere. The wealthy always have disproportionate political power.

Wealthy people — and I mean the best intentioned wealthy people, not the corrupt — make political decisions to improve the world as they see it. The greater the degree of wealth inequality, the greater the difference between the world those at the very top experience and the experience of the vast majority. This leads to errors in judgement, policy changes that improve the world the rich live in while harming the world that the not-so-rich inhabit, and very large utility losses when the not-so-rich are numerous. The best intentioned of the wealthy may try to mitigate this by reading, thinking about the less fortunate, etc. etc. But these exercises are a poor substitute for experiencing the world as most people experience it, and suffering the consequences of poor leadership directly. And power correlates with wealth much more than it correlates with diligence and skill in understanding the world beyond ones own experience.

Utility losses due to misguided generalizations of their own experience by the wealthy and powerful may be inevitable. But quantities matter. A society in which "the wealthy" represent a large fraction of the population who live not to differently from the less wealthy will make fewer and less costly errors than one in which a realtively small, very wealthy group lives very differently from the rest.

From the great spite and envy debate...

• Brad DeLong: Making 'em Feel Small...
• Greg Mankiw: Are the rich spiteful?
• Tyler Cowen: Spite
• Alex Tabarrok: Tax the Envious
• Tyler Cowen: Envy Pollution
• Jane Galt: Should we cut down the tall poppies to give the shorter ones more light?

In a conversation about a recent post of Michael Shedlock's, Eugene Linden likened financial risk to environmental toxins. His very astute observation was that the use of derivatives to disperse risk is much like the strategy of managing toxic chemicals by flushing them to the sea. At first blush, this is eminently sensible, because poisons when sufficiently diluted are not poisonous at all, and may be harmlessly absorbed by the environment. But in fact, the strategy is fraught with peril. Some toxins don't stay dispersed, particular agents accumulate them, and become poisoned and poisonous. In a bay, shellfish might accumulate dangerous levels of heavy metal, and become unfit for human consumption. In the financial world, we know that lots of risk has been created and "dispersed" via derivatives, but we don't have good information on whether all this financial risk is harmlessly diversified, or has concentrated dangerously in the hands of some speculative agents. The accumulation of metals by seabed mollusks does harm not only to the mollusk. Similarly, ill-advised accumulation of risk by hedge funds or investment banks could lead to consequences extending far beyond the risk-accumulator.

I thought this was a particularly good analogy, and have been thinking of other pollution metaphors in finance. "Global imbalance" is a shorthand commonly given for the situation in which some countries — in particular the United States — are spending more than they collectively earn, while others (China, Saudi Arabia, Russia) are selling their goods and services for debt. These habits have become embedded structural facts of various economies, implying changing the pattern — the US builds up debt, China and the oil states — will require "economic adjustment". Economic adjustment is a euphemism for hard times, and this arrangement is not just a private matter between a few countries. In today's interlinked global economy, US consumers provide a great deal of world demand and the US dollar is the global "reserve currency". China's population represents nearly one quarter of the world population, and its political stability depends upon economic growth. If "adjustment" doesn't occur smoothly, there could be a global economic downturn, political instability, resource wars, you name it. These are all improbable events, but they are risks borne by the entire world, and risks that grow with continued unbalanced world growth.

So, in a sense, "global imbalance" is also a lot like pollution. The United States, China, the elites who run the petrostates, are all "getting something" out of the present arrangement. (The US gets to consume inexpensive goods paid for with low-interest IOUs that may never be fully paid; China gets export-led rapid-fire development; and the petrostates get high oil prices without crimping demand, since the US is buying with debt and China is taxing and subsidizing oil consumption.) But, at the same time, they are poluting their own economic and political environment, and that of the rest of the world, with risk. Like polluters generally, "global imbalancers" continue to do what they're doing because in the short-term it's profitable, long-term costs are uncertain and won't be borne solely by the polluter. In economist-speak, global imbalance, like pollution, is an "externality".

Of course, with respect to pollution, industrial societies have been dealing with these problems for a long time. There's no formula for preventing pollution, but one approach that's worked very well both environmentally and politically are so-called "cap and trade" programs. I got to thinking about how we might "cap and trade" global imbalances.

I'm not the brightest bulb on the tree, but Warren Buffett just may be. He proposed a scheme called "import certificates", way back in October 2003. Revisiting it, what does it amount to? It is precisely a cap and trade scheme for global imbalance. I read this way back when, and thought it was kind of loopy. Rereading it now, it seems kind of brilliant. This Buffett guy, he's not so shabby. Why did this proposal get so little notice? It's remarkable in that it permits markets to determine who can most efficiently bear the cost of global rebalancing, and permits gradual application, as the initial "cap" on the US trade imbalance could be set at something like the present level, with a commitment reduce US overspending only gradually. It's financial innovation at its very best. Why hasn't this been done? Why don't we do it now?

Today I'm into nutshells.

Asset markets and central banks are control systems, intended to provide incentives that encourage the effecient use of human and economic resources. I believe these "macro" control systems are malfunctioning, badly. Structural weaknesses in these institutions have permitted some classes of agents to profit from the misallocation and expropriation of resources, creating strong constituencies for the continuation and exacerbation of those structural weaknesses.

Why has nothing really obviously bad happened, if the world's macroeconomic control systems are so out of whack? Economies are big, slow things. They have a lot of intertia — they like to keep doing whatever it is they do. They can be tortured a good bit and bounce back. They have a great diversity of control systems, much more fine-grained, local, and efficient than the large scale capital markets and games played by central banker finance ministers. There are margins for error. But those margins are not infinite. Self-correcting control system failures are okay. Autocatalytic failures, where ineffeciencies promote even greater ineffeciencies, are not. That's where I think we are now.

When describing the problems, they sound very big, central, "macro": currency manipulation, artificial liquidity, leverage, asset bubbles, commodity inflation. But central banks are not the answer to the problems they've helped to create. Reform, when it comes, won't be with a Plaza Accord, an IMF/G-7/OECD initiative. The solution, eventually, will involve changing the definitions of money, corporate stock, and other financial assets, and the structure of the markets on which they trade, to be less prone to self-reinforcing malfunctions, and far more grounded in specific, local, and concrete knowledge. These will be fairly radical changes, though there may be incremental paths to get there. Understanding what more robust and effective market-based control systems would look like, and developing a rich, quantitative theory relating information-work to efficient decision-making, are perhaps the crucial challenges of our time.

The one thing that the current leadership of the United States and the current leadership of Iran have in common is an interest in high oil prices. Iran's government and ruling elite live off of oil revenue. At present, macroeconomic conditions are such that high oil prices lead to a redistrubution of wealth in the US towards the Bush administration's personal and political friends without (so far, so good) damaging the broader economy in any obvious way.

A gentlemanly game of saber-rattling seems to be in the interest of both parties. Perhaps that is why we have one.

A nuclearizing Iran may be a real issue. The world is full of real issues. The current crisis might have come up any time in the past decade, and might have been delayed five years with the smallest amount of fudging and dissembing and rhetorical moderation on Iran's part. Why now?

I'm not alleging a conspiracy here. In a game of two players with a mutual interest, there need be no secret handshake to seal a deal. Nor am I alleging that everything is fabricated. Perhaps the new Iranian President really is driven by domestic power considerations in his boastful cretinism. The Bush Administration probably does want to see regime change in Iran and an end to its nuclear program, and Sy-Hersh-style deniable brinkmanship may be a defensible strategy to get there. But it can't hurt, from either perspective, that the athletes in this little game of nuclear chicken are very, very well paid.

Glenn Reynolds writes...

ARNOLD KLING ON fear of confrontation: "Unfortunately, large segments of American society no longer have the ability to confront real evil. People lack the confidence and moral clarity to stand up to intimidation. . . . One can view Islamic militants as armed versions of unruly teenagers. We should not feel guilty toward them. We should demand reasonable and decent behavior from them, rather than excuse their tantrums or their crimes."

That would require thinking of ourselves as adults, which is unacceptable to many.

I want to think of "us" as the adults. In fact, in the run-up to the Iraq war, which I supported despite the clear disingenuity of the war's justification, I took a similar, explicitly paternalistic view of the world. The Europeans in particular were behaving like petulant teenagers, protesting "the system" while enjoying a vast subsidy, in financial terms and as "moral comfort", by letting America do the dirty work ensuring their security. And I viewed much of the Middle East as locked in a kind of post-Marxist, post-colonial, Che-T-shirt-style adolescent radicalism, which mixed with Islamism and pan-Arab nationalism, and unfortunately real explosives. My view at that time was that the United States was an arbiter of reason and civilation, imperfect but sufficient to enforce certain standards and keep the peace.

But, owing partly to the incompetence which with Iraq's reconstruction has been managed, but primarly to the fact the United States has allowed the soundness of its own economy to become badly undermined, I no longer believe we are credible adults. My estimation of the Europeans and the Islamic world have not changed. I've little flattering to say about either. But now the United States reminds me of an alcoholic parent trying to keep its delinquent kids in check. Tipsy, blustering America might be well-intentioned, it might in fact know better what's right and what's wrong, but its constant bumbling, its ability to throw tantrums but incapacity to lead or to guide, and its self-destructive partying on cheap capital render it an ineffective role model. The US is in for a bad financial hangover from its subsidized home-equity binging. While I have complete faith in America's ability to take a cold shower and figure out how to right itself economically, that will take several years, and those will be years in which the US will be weakened, and manifestly in crisis. America's security burdens will weigh heavily in an era of financial pain at home and escalating US dollar prices for anything and everything in foreign lands. I'm afraid we may not have the wherewithal to carry the load.

And then I am haunted by Osama Bin Laden's tale of the weak horse and the strong horse. In a world where America is weakened and Europe is senescent, let's hope that it is India, or the Pacific Rim, or even Red China itself that rides tall for a while, and not some destructive amalgam of religion, nationalism, and fascism.

Public pension systems should offer tiered benefits explicitly contingent upon the number of children a couple has had, but with the extra benefits not kicking-in until at least 20 years after a child was born. Lots of variations on this theme are possible (extra benefits to parents of the educationally successful, etc.), though there is a slippery slope to overintrusive social engineering.

This idea has the advantage that it offers an incentive to reproduce that is likely to disproportionally affect those well prepared to raise a child. An impulsive teen whose failure to use birth control leads to a pregnancy is unlikely to be swayed in her choice of whether to have the child by an incentive 40 years distant. But a distant incentive may well affect the decision of successful couples, already socking away funds in their IRAs an 401-Ks, and whose decision to have very few children is related to conscientiousness in managing their finances.

Aside from addressing broad perverse incentives against childrearing, fecundity-indexed public pensions would help counter the growing insolvency of social insurance programs. Any private pension manager knows that it is important to match the assets and liabilities of her fund, in terms of both quantity and timing of payoff. A private pension manager buys bonds as long-term, liability matching assets. But with a social insurance programs, owing to their scales, financial assets may become meaningless. If a society fails to produce real assets sufficent to support the aged, any bonds the social insurance program has become claims on stale air. The real asset that social insurance programs rely on is productive young workers. A social insurance program that wants to match assets to its liabilities ought to be encouraging the reproduction of successful wealth creators.