My first answer to the question in the headline is, “Of course!” Taxation, especially indirect taxation of the fuel that is used in trucks and equipment used in the construction process, would boost costs that would have to be passed on to consumers. The more honest answer is, “I have no idea, only a guess.” What do the experts say? It’s difficult to tell because after looking around the Internets I found very little in terms of answer the exact question in the headline. Why bring this up? Well, Washington state could be on the verge of passing a carbon tax, especially if Democrats take over the state senate with a win in a hotly contested election on the eastside of Lake Washington, Legislative District 45. What are the questions I’d ask economist on this topic?

(I’m not going to have a discussion about the history of the carbon tax in Washington, but here’s a good post about where things stand currently).

This post is really a think-out-loud post, not a treatise, but I should start by restating my rule of thumb on taxation. Taxes

1. Raise revenue for things considered to be beneficial to the wider community but that the market may not produce efficiently. For example, parks are not likely going to ever be the highest and best use of a piece of urban property. Therefore, we pay taxes to buy and hold that land for the broader benefit of the community.
2. Encourage or discourage behavior. We ought to tax things that we want less of and tax in reverse (subsidize) things we want more of. For example, we want less consumption of scarce resources like fossil fuels that also add to pollution and carbon emissions, but we subsidize, in many ways, homeownership by granting tax exemptions.
3. Redistribute wealth. Taxation can capture and move money around the economy. For example, a single-family homeowner has a lot of wealth in the form of equity in their home. Taxing that equity to support a housing voucher program for a renter with less money is redistributive; so would upzoning the single-family neighborhood to increase supply, although zoning is not taxation.

A carbon tax, therefore, is, in my view, a “good” tax in that it is aimed at reducing the use of a product that contributes to climate change. But back to what it might do to housing prices.

Does taxation lead to inflation?

Here’s a pretty good answer from the Internets:

In Keynesian economics framework, taxes are determinants of aggregate demand. So, increases in taxes lead to lesser demand (as consumers will have less money to spend) and, hence, their impact tend to be deflationary. Similarly, it can be argued that tax cuts will lead to more consumer spending and their impact tend to be inflationary. But aggregate supply remains completely unaffected by changes in taxes.

On the other hand, those who discard the above framework, believe that from a supply side perspective, increases in taxes tend to increase the production cost and the burden is passed on from the producers to the consumers in the form of indirect taxes. So, the prices of goods and services will rise leading to inflation. Therefore there is no perfect equation between taxation and inflation.

I think that says it all. It depends on the assumptions made on how the market will react to a tax; less spending and lower demand, or higher costs passed on through higher prices.

What about indirect taxation?

This question is more complicated, of course. This whole question has a lot to do with elasticity, that is, how high can a price for something go before people just quit buying it. Things that people can’t live without can rise in price a lot before they stop buying it or find substitutes. Milk can probably increase in price a lot before people switch to drinking their coffee black or eating cereal with orange juice. Gasoline and housing really don’t have very many substitutes, but people can take transit or move to an area with lower housing prices.

We do have in the United States from all levels of government, indirect taxes. Europe and other countries have often used a Value Added Tax or VAT. This is a tax that is on the incremental increases in value of the production of a product from raw materials to point of sale to the consumer. Theoretically, these kinds of taxes mean the final price of the product reflects all the taxes paid a long the way. A study by the Bank of Greece looking at whether these taxes contributed to inflation led them to conclude that, “in general, although the importance of indirect taxes as a factor influencing inflation is indisputable.” But they also found that,

The contribution of indirect taxes to inflation for the year 2012 came mainly from the rise in the special consumption tax on heating oil in the last quarter of the year and from the changes in VAT (mostly moves to different rates) carried out in 2011 and fully reflected in prices in 2012. This carry-over effect was 0.19 percentage point from the VAT increase and 0.29 percentage point from SCTs. In total, indirect taxes contributed 0.48 percentage point to inflation

Do carbon taxes boost inflation?

Our neighbor to the north, Canada has a carbon tax, and it has been identified as a cause for an increase in overall inflation:

Canadian inflation spiked to its highest rate in more than two years in January, as new carbon taxes in Alberta and Ontario fuelled a surge in gasoline prices.

Statistics Canada reported that the consumer price index was up 2.1 per cent year over year in January, the fastest pace since October, 2014, and up sharply from 1.5 per cent in December. It said gasoline prices were up 20.6 per cent from a year earlier, the biggest increase since September, 2011. The increase reflected the introduction of a carbon tax in Alberta and a cap-and-trade carbon pricing system in Ontario, both of which came into effect on Jan. 1, as well as higher crude-oil prices, which lifted fuel costs nationwide.

However, the same article offers that

Economists said generally rising inflation numbers reflect the pickup in Canada’s economy over the past six months, although they have been tempered by a generally rising Canadian dollar, which cools costs for imported goods.

So when carbon taxes kick in, they boost fuel prices that contribute to the overall measure of inflation. But that addition to aggregate price increase is a contribution doesn’t mean inflation is attributable to a carbon tax.

Does taxation boost the price of housing?

Well, it’s a complicated and tangled issue because most of the literature considers “housing” almost as the same as “mortgage;” that is, people, even researchers and economists think of housing as single-family housing purchased with a loan as an investment in an appreciating asset, not an apartment paid with a rent check once a month. And our tax code strongly favors mortgages (remember my #2 rule of thumb above). So an analysis by the Brookings Institution found

As capital gains taxes go up, so does the value of the capital gains exclusion on housing. (To put it another way, if capital gains and dividend tax rates were 100 percent, all investors would put their money in tax-favored investments like housing and municipal bonds.) Like the increase in ordinary income tax rates, a higher capital gains rate makes housing more valuable.

This comment is about 7 years old and is looking at a proposal on increase capital gains taxes. But because exemptions on mortgages would be exempt, then people subject to those taxes would push money there. So, the researcher said,

In recent research, I’ve found that increases in rates on both capital gains and ordinary income would boost metropolitan housing prices by between 7 and 10 percent, with larger hikes for cities on the coasts.

That doesn’t help us learn very much about how increased costs of production impact all housing prices, including rentals. It does show how we’ve slanted our tax structure to favor and incentivize ownership of single-family homes.

Conclusion

My guess is that a carbon tax in Washington State would increase overall inflation since the tax will eventually get passed on to the consumer in higher fuel prices, and fuel prices are always part of the calculation of the inflation rate. Producing housing does rely significantly on vehicles and equipment that use fuel, and that means those costs will end up in the price tag of housing. How much additional cost? It’s hard to say. Most carbon tax proposals have provisions to help poorer families with the additional costs associated with the tax. How would this ameliorate higher costs of living associated with a carbon tax? I don’t know.

As of today, my big concern is that along with impact fees, Mandatory Inclusionary Zoning (MIZ), proposed increase to the Real Estate Excise Tax (REET), design review requirements, and the myriad of other fees, regulations, and rules already choking supply, a carbon tax would be yet another log on the inflationary fire. Does that mean the legislature shouldn’t pass a carbon tax? Not necessarily. But it does mean that proponents of more housing supply need to lean on state and local government to stop taxing new housing and slowing its production. Pass a carbon tax, but not before we ensure that we’ve reduced all the other bad taxes that are adding to people’s struggle to make ends meet.