Climate Policy Lesson From Liz Truss’s Resignation: Beware Of Budget Deficits

Sustainability Climate Policy Lesson From Liz Truss’s Resignation: Beware Of Budget Deficits Nives Dolsak and Aseem Prakash Contributor Opinions expressed by Forbes Contributors are their own. We write on environmental issues, climate politics and NGOs. Following New! Follow this author to stay notified about their latest stories.

Got it! Oct 22, 2022, 02:22pm EDT | New! Click on the conversation bubble to join the conversation Got it! Share to Facebook Share to Twitter Share to Linkedin Britain’s Prime Minister Liz Truss reacts as she delivers a speech outside of 10 Downing Street in . . .

[+] central London on October 20, 2022 to announce her resignation. – (Photo by DANIEL LEAL/AFP via Getty Images) AFP via Getty Images British Prime Minister Liz Truss has resigned just 45 days after being sworn in. The proximate cause was the mini-budget outlined by Truss’s Chancellor of the Exchequer, Kwasi Kwarteng (who she eventually fired), which reflected Truss’s agenda in the campaign for Tory leadership.

Typically, politicians tend to walk back from the extreme positions they take during campaigns. Initially Truss did not, perhaps imagining herself as a modern-day Margaret Thatcher devoted to supply-side economics. Once the public and stock market reactions were in full display, Truss fired Kwarteng.

Although his successor Jeremy Hunt rescinded critical aspects of the mini-budget, Truss could not recover politically and had to quit. The mini-budget sought to cut taxes for high-income individuals and corporations, and finance the government budget by borrowing . The logic was that tax cuts would stimulate the economy and eventually government revenues would rise.

Although Truss also instituted a cap on household energy expenditures, much of the attention focused on tax cuts. By some estimates , individuals earning £1m a year would have gained £55,220 while those earning £20,000 would have received £157. This looked bad for the party that promised to reduce economic disparities .

Public opinion polls showed Tories facing a sharp drop in public support . The real disapproval came from the stock markets; as Quinn Slobodian put it, “Truss believed in markets but the markets did not believe in her. ” Stock markets deemed the deficit-financed tax cuts to be inflationary and the pound started sinking.

The Bank of England intervened by raising interest rates, and economic chaos followed. Larry Summers quipped, “UK is behaving a bit like an emerging market turning itself into a submerging market. ” Liz Truss’s resignation provides an important lesson for the climate movement: decarbonization should be accomplished without inflation and budgetary deficits.

Across the world, inflation is causing domestic upheaval; commenting on the Global Progress/YouGov data from 11 democratic countries John Halpin terms it a “political wrecking ball. ” In addition, inflationary policies invite stock market punishment. Inflation is caused by several factors but two, in particular, are relevant to the climate debate: a rise in energy prices and government deficits to provide climate subsidies.

Political Challenges of Carbon Taxes The climate movement advocates for including the social cost of carbon in policy and regulatory decisions. The rationale is that fossil fuel use drives greenhouse gas emissions, which harm society. Because the costs of such harms are not incorporated in fuel prices, an externality problem, fossil fuels are overconsumed.

Carbon pricing via carbon taxes or cap-and-trade could incorporate the social cost of carbon in the fuel price. As fuel prices rise, firms and consumers are motivated to decarbonize by finding substitutes or developing new technologies. Of course, the carbon tax needs to be high enough to cause a discernible price increase because without pain, behavioral changes are unlikely.

MORE FOR YOU Juan Soto Contract Rejection Could Make Orioles A Better Buy Than Nationals Recovery Year: Inside Chet Holmgren’s Season From The Sideline Jamal Musiala: Is The Bayern Munich Star The Best In The Bundesliga? But carbon taxes pose a political challenge. In addition to citizens’ aversion to new taxes, rising energy prices lead to inflation. Higher prices hurt low-income households and invite political opposition (recall the “Yellow Vests” protests or the two successive defeats of carbon tax initiatives in the liberal state of Washington).

Although the political acceptability of a carbon tax can be enhanced by revenue recycling (such as providing subsidies to low-income households), a rise in energy prices (whether due to the Ukraine invasion or a carbon tax) is politically sensitive . Protesters in France are upset about inflation and a rise in living costs. Germany is addressing rising prices by introducing a cap on household energy bills (ironically, Truss tried a similar approach as well).

The Biden administration seems to have dropped the idea of a federal carbon tax or cap and trade. In fact, many countries and U. S.

states (including California and New York) have announced new energy subsidies or suspension of gas taxes . What About Subsidies for Pro-Climate Technologies? Demand-side interventions could work via another route: instead of punishing climate “bads” via carbon pricing, they could encourage “good” activities by subsidizing climate-friendly products and technologies. This is the dominant logic of the Inflation Reduction Act (IRA).

Subsidies are politically attractive but raise a different problem: who will pay for them? Given the rising budgetary problems across the world, how viable are the subsidy-based demand side interventions as a tool for climate policy? This brings us back to the question of budgetary deficits and inflation. Until recently, the political left maintained that running budgetary deficits (to finance climate-friendly policies among other things) will not lead to inflation . In February 2021, Paul Krugman hailed Joe Biden as “ the big spender America wants,” and wrote : “the only coherent objections to the Biden plan seem to be coming from some center-left economists who worry that it will lead to economic overheating.

Many, perhaps most other economists, myself included, disagree. . .

” But now, Krugman acknowledges that deficits lead to inflation. And inflation gets punished by stock markets and citizens. Opinion polls suggest that concerns of inflation are driving the Republican rebound in the generic November Congressional ballot.

In sum, Liz Truss’s resignation has important lessons for the climate movement: watch out for deficits and inflation. Climate subsidies have a political appeal, but governments should not finance them by running deficits. The implication is that governments will need to look for revenue elsewhere, or cutback on non-climate programs, both with political consequences.

With a looming recession, which will decrease tax revenue and increase spending on social safety nets, government budgets will be strained. Thus, the climate movement will need to explore new ways to finance climate infrastructure. Moreover, regulations, as opposed to budgetary support, should return to the decarbonization policy agenda.

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