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Tax Policy for a Climate in Crisis


Martha McCluskey (@MarthaMcCluskey) is Professor Emerita at the University at Buffalo, State University of New York, and President of the Association for the Promotion of Political Economy and the Law (APPEAL).

How can a Law and Political Economy approach guide the power of taxation toward democracy, justice, and a livable planet?

As a start, it can help us reorient our understanding of the function of taxation. On the traditional view, taxation is understood as a political intervention in a pre-existing market that maximizes resources through decentralized private transactions. In that frame, taxes function to redistribute resources among private parties, correct market failures, and raise revenue for public goods.

If we accept this view, taxes have little role to play in advancing our most fundamental social goals. Tax policies, viewed as an external deviation from a free market ideal, risk disrupting the market’s power to facilitate individual choices and undercutting its ability to produce the resources on which any reform policies will depend. To reduce such distortions of market processes, according to the common logic, tax policy should address public problems with narrowly tailored solutions designed to minimize downstream market effects. Although contemporary tax scholarship widely qualifies the antecedent market ideal, it nonetheless tends to accept the general premise that taxes should supplement, rather than supplant, the role of private decisions in allocating resources.

As tax policy confronts evidence of impending climate catastrophe, such private market deference is ripe for scrutiny. Far from being merely a system for “redistributing” resources produced through independent economic processes, taxation is part of the legal architecture that constitutes those processes in the first place. Along with other political institutions, taxation contributes to establishing and governing the trustworthy public credit medium – money – on which market exchange depends. By taking account of monetized transactions and selectively withdrawing money from circulation, taxation regulates the power of this liquidity to fuel economic destruction as well as production.

The idea that there is a pre-tax market that is subject to isolated imperfections relies on a misleading picture of money as a neutral medium of private exchange. In reality, the inherently political design of money and finance necessarily sets in motion market incentives that have enormous downstream impact on market choices and on long-term social and economic conditions. Those with favored access to this privileged form of credit will have greater market bargaining power to secure their interests and shift costs or constraints to others. And, in the United States, the power to determine who has access to this government-backed liquidity, for what purposes, and on what terms, has largely been delegated to private banking institutions.  

The limitations of such a system have been known for the better part of a century. Guided by Keynesian macroeconomic theory, twentieth-century economists widely recognized that the income tax can stabilize business cycles by siphoning off rising income as the economy heats up. But Keynes’ macroeconomic vision went beyond regulating the quantity of money in circulation to smooth seemingly apolitical market cycles. Keynes further recognized that highly liquid private investment markets can be ill-suited to developing the relatively illiquid assets on which human communities depend. Investors who can readily withdraw and convert their gains as conditions change, insulated from long-term liability from risk and damage, will tend to steer resources toward short-term, individualized financial gains while leaving society in general (and subordinated communities in particular) with fixed, large scale, and long-term costs.

As one strategy to reduce the perverse incentives of investor liquidity, Keynes advocated using taxation to substantially increase the transaction costs of buying and selling financial assets. Going further, however, Keynes concluded that the inherent mismatch between illiquid productive resources and liquid finance will be best addressed through active public control of investment decisions. Such a conclusion does not depend on the naive belief that government experts can foretell the future with perfect accuracy. Neither public nor private decision makers can predict the full long-term consequences of their particular investment choices. Those consequences will depend on, among other things, how these investment decisions shape near-term economic, legal, and political power to govern which interests get the most protection and which get most exposed as risks emerge under changing conditions. Public oversight of investment decisions, in a government structured for democratic accountability and inclusion, can better direct power toward avoiding inequitable, catastrophic, and irreparable harms.

Viewed in this context, tax policy should address the climate emergency by democratizing the market-shaping power of publicly-backed finance. Currently, investment in fossil fuels is driven by the interests of private bank leaders with outsized discretion to shape the market, and outsized power to insulate their personal gains from larger social and economic crises. Over the last seven years following the Paris Agreement, the world’s 60 largest private banks have invested over $5.5 trillion in the fossil fuel industry, locking in place a physical and political infrastructure that will constrain future options for energy transition and climate justice. U.S. banks have dominated global fossil fuel financing in absolute numbers, so that by 2022 they had provided one quarter of the world’s investments in what can be reasonably considered a system geared to mass destruction of human and environmental assets.

Amplifying this privatized fire hose of liquidity, over $11 billion in federal tax expenditures have been allocated for fossil fuel development in the period between 2019 and 2023. These tax breaks are produced with lavish investments in legal and media experts paid to defend, greenwash, and expand the industry’s continued political economic hold on the future. In 2022, their financial power helped global oil and gas companies generate record-breaking profits, much of which they used to reward investors through stock buy-backs and to reinvest in their core fossil fuel business. Executives as well as shareholders have been amply rewarded for continuing on this destructive path: four of the largest U.S. oil and gas producers and carbon emitters disclosed over $1.8 billion in CEO compensation between 2013 and 2022.

Against this tidal wave of financial power for continued fossil fuel extraction, tax strategies for subsidizing alternative energy or penalizing fossil fuel consumption are important but insufficient. Without strategies that directly disable the revenue-generating capacity of fossil fuel, the industry will further use its near-term power to make energy transition costly and divisive. The fossil fuel industry’s continued tax advantages reflect its hold on politics, and also on law, part of a larger pattern of reinvesting oil and gas wealth to weaken institutions of democracy. That political hold is strengthened by the idea that tax policy should focus on adjusting market prices, rather than on cutting off destructive market power. And that market power comes especially from fiscal policies that keep public and private spending dependent on an ongoing stream of fossil fuel revenue. 

Taxation should be viewed as one of several interrelated strategies for mobilizing the public power of money to re-orient both economy and the state. Redirecting current financial power away from climate disaster and the resulting inequalities will require building political and economic support for combining taxes with broader changes in legal rules, financial governance, and government spending to create interlocking barriers to gains from fossil fuel production.

An LPE approach should affirm the market-shaping power of all these overlapping strategies. 

That means rejecting a view of taxation as a policy tool for surgically fixing market problems while minimizing disruption of existing market forces.

As an example of tax policy’s market-shaping potential, compare traditional cap-and-trade programs with the strong “cap and invest” climate program that has been proposedby a broad coalition of organizations in New York. In the latter model, adopted in various forms by other jurisdictions, producers and distributors of carbon emissions are in effect taxed by being required to buy allowances subject to a cap that declines over time. This tax strategy gradually withdraws the economic power to liquidate the earth’s carbon capacity, while directing the proceeds to fund alternatives to fossil fuel energy or rebates to households to offset energy transition costs.

In contrast to traditional cap-and-trade proposals, the proposed cap-and-invest program would make allowances non-tradeable and non-bankable, with caps applied to each economic sector and each facility rather than in the aggregate. Beyond raising the market price of carbon dependence, this approach potentially removes the legal rights and financial liquidity that reinforces that systemic dependence on fossil fuel infrastructure. Making the allowances unmarketable will help steer the remaining financial value from this destructive infrastructure toward investments in energy transition and energy justice, rather than toward speculative profiteering from the right to pollute. Finally, the coalition proposes that proceeds be dedicated to a Climate and Community Protection Fund for climate-supporting infrastructure, with grants designed to replace the tax revenues local governments lose, to support unionized work and job transition, to give grassroots community organizations control over investments, and to direct 75% of spending to projects in disadvantaged communities.

As this plan recognizes, tax policy involves political struggles over not only the power to redistribute market earnings, but also the power to transform market governance. Drawing down the fossil fuel industry’s existing financial power to gain from climate destruction, and building up countervailing democratic power to promote environmental and social well-being, will be an investment with immense economic as well as political benefits.

This post is adapted from Rethinking Economics for Tax Law and Political Economy 83 OHIO ST. L.J. ONLINE (2022), in response to Jeremy Bearer-Friend, Ari Glogower, Ariel Jurow Kleiman, Clinton G. Wallace, Taxation and Law and Political Economy,  83 Ohio St. L. J. 471 (2022).