carbon tax

My colleague (and blog contributor) Frank Ackerman has a new article on Grist that explains why the United States can’t afford to settle for the “social cost of carbon” estimate used in the fuel-efficiency and tailpipe emissions standards unveiled April 1.

As we outlined in our recent white paper, “The Social Cost of Carbon” (available on the E3 Network website), the $21-per-ton figure being used by the government as a “central estimate” of the damages caused by carbon dioxide emissions is based on flawed economics and questionable value judgments.

Frank’s article describes how the government came up with that number, and why the SCC is so important: It’s like a “volume dial” that determines how strict environmental standards should be. Even worse, as Congress considers a climate bill, the $21 SCC could be taken as the recommended level for a carbon tax or permit price:

If that happens, there is no way the United States could reach the widely discussed, science-based goal of cutting emissions by 80 percent by 2050, which would require a much higher price on carbon. Given how cost-benefit analyses dominate U.S. policymaking, a $21 SCC could have a devastating impact on environmental legislation.

It’s easy to think of the fuel-efficiency standards as yesterday’s news, and not discuss the SCC again until it comes up in Congress. But in fact, now is the time to do our homework and figure out what the true price of carbon should be – before that, too, is a done deal.

Why would the Obama administration allow new drilling in U.S. coastal areas, and what will it mean for greenhouse gas reductions? My colleague Frank Ackerman has a posting on the TripleCrisis blog today on off-shore drilling, peak oil, and how they relate to a carbon tax:

Solving our energy problems, without a change in direction, will lead to increasingly costly and environmentally destructive production – either deep offshore, or deep in the rocks below existing communities and watersheds. We need a tax (or a fee resulting from an allowance system) on energy, to keep the cost to consumers high enough to encourage conservation, while holding the price for producers low enough to discourage the pursuit of the worst fossil fuel deposits.

This is another way in which the distributional consequences of carbon permit giveaways (i.e., who gets the revenue – see Alejandro Reuss’ Public Goods posting from earlier this week) differ from those of permit auctions. A cap and trade system will increase the price of oil exploration only if businesses have to pay for their permits; if permits are given to the largest polluters for free, there will be no incentive to limit fossil fuel extraction from areas where underground reserves are not very rich and the environmental consequences of extraction are enormous.

The public debate over the possible economic implications of addressing climate change has generated a lot of heat, but not much light. One area of confusion is the difference between the price of a tradable permit under a cap-and-trade system and the overall economic impact of the program. It is true that a cap-and-trade program is one way to put a price on greenhouse gas emissions (call these carbon emissions for shorthand); a carbon tax would be a different approach to achieve the same objective. However, most would agree that ending free pollution by pricing carbon is a necessary part of a comprehensive climate and energy program. Let’s dig into the issue of compliance costs and overall societal costs and benefits.

There are two main aspects of compliance cost under cap-and-trade: the cost of reducing emissions, and the cost of acquiring tradable permits (typically called allowances). To simplify, we’ll leave aside the cost of offsets, another option under cap-and-trade. Also to simplify, assume all allowances are auctioned.

Even if they are working to reduce emissions, most businesses are likely to continue to produce emissions and need allowances to cover them for many years. But the cost of acquiring allowances isn’t a real economic cost; the money spent to pay for them does not disappear. It accumulates as government revenue. The question is what to do with that revenue: It could be returned to regulated firms, but one of the principal insights in climate policy in recent years is that regulated businesses will be able to pass along much of these costs to consumers. For this reason, there is significant momentum to return the revenue from allowances to the people or to make investments that speed and smooth the transition to a low-carbon economy.

If the emissions market is functioning, the price of an allowance should be roughly equal to the cost of the most expensive ton reduced. That’s because if every ton of carbon has a cost, firms are likely to keep paying to reduce emissions, using every option open to them, until the options are so expensive that it is cheaper to buy allowances. But again, businesses will be able to pass along a large share of these costs. And many of the investments needed to reduce emissions will produce important benefits.

Greater reliance on clean, free domestic energy sources such as wind and solar power will mean greater energy security. Less fossil-fuel combustion will mean cleaner air, improved public health, lower health care costs, and improved worker productivity and performance by students in schools. A price on carbon will contribute to progress in clean technology by providing greater incentives for those who innovate, and this in turn will boost the prospects for American business in this rapidly growing global market. And of course, there is the enormous benefit of avoiding the damages, biophysical and economic, that would result from unabated planetary overheating.

Carbon prices do not reflect these broader socioeconomic effects, and they are almost invariably left out of economic modeling of climate policy that forecast future impacts, too. For more on that topic, see my report on economic modeling of California’s global warming law.

Chris Busch, Ph.D., is policy director of the Center for Resource Solutions, a nonprofit in San Francisco that creates policy and market solutions to advance sustainable energy.

I mean, you don’t have to be a socialist, I guess, to believe in global warming. It’s just that almost everyone who does believe in global warming is a socialist.
– Glenn Beck (Jan. 12, 2009)

I’ve been a socialist ever since I was old enough to have serious political opinions, for over 25 years now. For that entire time, living in the United States, I had assumed I was a member of a small minority. So imagine my surprise to find out that the country is veritably crawling with socialists. Millions and millions of socialists. I appreciate the good news. It really makes my day. (Beck’s comment, by the way, is from early last year, but a friend just forwarded it to me today.)

Now, seriously: Glenn Beck is right about one thing. You don’t have to be a socialist to believe in anthropogenic, or human-caused, global warming. You just have to agree that:

1) Increased atmospheric concentrations of carbon dioxide and some other gases trap greater quantities of heat here on planet Earth (the so-called “greenhouse effect”). This leads to overall warming, as well as other, more complex, effects on climate. That’s not a tenet of socialism, but an idea proposed by climate scientists.
2) Combustion of fossil fuels (things like petroleum products and coal) and other activities undertaken on large scales in current industrial economies produce large quantities of carbon dioxide, contributing to climate change. That’s mostly chemistry. At least, my chemistry teacher taught me that when you burn hydrocarbons, the carbon combines with oxygen and forms carbon dioxide. Of course, he might have been a closet socialist.

What really bothers Beck, however, is the idea that government intervention is needed to deal with climate change. “Almost everybody who says, ‘I’ve got a plan to fix it,’ ” he insists, “is a socialist.” (For right-wing bloviators like Beck, virtually any form of government intervention is synonymous with “socialism.”)

Well, to believe that government intervention is appropriate, it helps to think these two additional things:

1) There are substantial harms from climate change. These could include sea-level rise (flooding coastal areas), increased frequency of “extreme weather events” (like hurricanes), the disruption of existing ecosystems (even a modest-looking change in average temperature can make a region uninhabitable for existing flora and fauna), etc. This actually involves political values. Like the idea that people living in coastal areas will be harmed by rising sea levels or more category 5 hurricanes, and that we should care about that.
2) Unregulated markets will not yield desirable results, in general, if people act purely out of self-interest and if their activities have effects, positive or negative, on “third parties” (people who were not party to a particular market transaction). Therefore, government intervention is necessary to change the incentives under which people make decisions.

In economics, such a third-party effect is called a “spillover” or “externality,” and you can read about it in any standard introductory microeconomics textbook. Let’s take the case of a negative externality. Two parties are engaged in a market exchange. One produces and sells a certain good. The other buys and consumes the good. But instead of this exchange (and the associated processes of production and consumption) affecting only them, it inflicts some harm on a third party. (Pollution is the classic example.) This third party is in no position to demand payment from the guilty parties as compensation for the harm. Since those who inflicted this harm do not have to pay for the privilege, they will not take it into account in deciding how much of the good to produce and consume. As a result, more than the optimal quantity is produced. The market result is, in the words of mainstream “neoclassical” economics, “inefficient.”

Virtually every mainstream economics text presents at least one government response to this problem: A tax equal to the amount of the harm inflicted on third parties will provide just the right amount of disincentive to produce the good. But don’t take my word for it. Here’s what the conservative economist Gregory Mankiw writes in his Principles of Economics (2008): This kind of tax “gives buyers and sellers in the market an incentive to take into account the external [third-party] effects of their actions.” Instead of producing too much of that good, “producers would produce the socially optimum quantity.” As a result, this policy “raises the overall economic well-being” (Mankiw, p. 207). A “carbon tax” is exactly the kind of tax described here. It is meant to make people take into account the harm to third parties of emitting carbon dioxide.

So, in this kind of case, neoclassical economics provides all the ammunition necessary to justify some form of government intervention (though this does not mean the climate policies mainstream economists generally support are equal to the task). I guess that makes Greg Mankiw, and just about every other mainstream economist who has ever written an intro textbook, a socialist – rather than the “free market” fanatics and apologists for capitalism I always took them for.

Has anybody told them yet?

Alejandro Reuss teaches at Bunker Hill Community College in Boston. He is a long-time collective member and former editor of Dollars & Sense magazine.