Thanks to a particularly odious little troll of a man and to a writer whose two major works the late, great Christopher Hitchens describes as “transcendently awful”, the word “tax” has a nearly obscene connotation.

Nonetheless, it is clear to me that a carbon tax, similar to those implemented in major economies throughout the world, should be broadly implemented here in the United States – the second largest emitter of carbon dioxide in the world.

Figure 1. Source: Wikipedia

Unlike a lot of mush-minded Greenies, I am under no illusion that a tax on carbon emissions will discourage people from burning carbon-based fuel or will serve just retribution on wasteful capitalists. Nor do I think that the taxing authority will use the collected funds for anything other than a typically idiotic boondoggle. In fact, I do not even believe that a carbon tax will do anything to stop the near-term effects of climate change (there is plenty of heat stored in the ocean, and those chickens will take decades to come home to roost).

No. My reasoning is based completely on free market considerations.

Humans do one thing phenomenally well: adapt to obstacles. If there is a mountain in front of us, we’ll climb it, build a tunnel through it, construct a road around it, and throw up a scenic overlook on the side of it.

The pure expression of human adaptability is the free market system.

Before June 2007, no one even realized that not being able to watch their favorite superhero movie while commuting to work was even an obstacle to overcome. Now, try to take a commuter train or subway (or even an elevator) without taking your smart phone out of your pocket.

Figure 2.

A carbon tax will provide economic incentives for entrepreneurs and technologists to adapt to a real obstacle — whether or not most people view the obstacle as important or not.

Let’s say that the federal government enacted a levy of $10 per ton of CO2 emitted — a pittance next to the true, non-externalized cost of carbon.

The fact is that a $10 / ton carbon tax will do nothing or next to nothing to end prices or to the amount of CO2 released into the atmosphere. However, it will release the adaptive creativity of engineers and business people trying to find ways to help companies extract as much profit after the tax is imposed as they did before.

It would be easy. A company – maybe a company like Carbon Engineering, about which I wrote a longer article earlier this month – will come along and find a solution such that the imposition of the $10 has no net effect on client firms’ bottom lines. An entrepreneur becomes wealthy, lawyers charge fees for patent applications, engineers get stock option grants, and someone somewhere gets a decent job building and maintaining whatever contraption the entrepreneur developed.


Then, it will be time to raise that tax to $15 / ton so we can watch the same wealth creating process occur once again.

In fact, the idea forwarded by (fake) Nobel Prize winner Paul Romer in his blog post entitled Conditional Optimism about Progress and Climate is, I think, exactly the right one. In Romer’s words:

One way to achieve this [N.B. set up a tax that would spur innovation] would be to start with a very low tax on greenhouse gases right away and commit that the tax (in dollars per unit of greenhouse gas emitted) will increase gradually but inexorably. Innovators will start investing now in ways to for people to get what they want without paying the tax. They will stop investing in ways to extract more fossil fuels that will be subject to the tax.

After all the fear and hand-wringing, once we commit to this kind of tax, progress will continue but in a slightly different and much better direction. It will still seem to be free.

There is already a model for this type of an innovation-spurring tax in the CAFE standards put in place after the Oil Shock of the early 1970s and refined both legislatively and judicially since that time. The imposition of increasingly stringent fuel economy requirements has spurred innovation in materials science, hybrid and electric engines, and automotive design, while simultaneously making passenger cars better and more reliable.

Figure 3. Observed CAFE by regulatory class

Global Warming is a given. The amazing adaptability of our species will be tested, and hopefully our ingenuity will allow us to avoid the fate of other, less adaptable species. The only way we will be successful in maintaining and improving our aggregate living standards is by unleashing the inventiveness of the free market. The free market thrives on overcoming obstacles, and government policy can easily provide obstacles that will spur innovation rather than prop up regressive and wasteful malinvestment.

Most importantly to investors, allocating capital to companies that will help our species adapt to a new climactic reality is the only vehicle for building and maintaining intergenerational wealth in the 21st century. Intelligent investors take note.