Legislation


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.

Most economic analyses of “cap-and-trade” policies – under which the government sets a target amount of emissions and then issues tradable permits totaling that amount – take it for granted that it would not make any difference, in the reduction of emissions, if the government were to sell the permits or give them away. A 2008 report on cap-and-trade climate policies from the MIT Center for Energy and Environmental Policy Research puts it like this: “Economic theory suggests that the method of distributing emission allowances, i.e., through grandfathering or auctioning, will not affect an individual source’s output decisions or emissions.”

If firms always make optimal decisions, maximizing their profits, as mainstream “neoclassical” economists assume they do, this conclusion should be correct. It shouldn’t make any difference to a profit-maximizing firm whether, by reducing its emissions, it avoids the cost of buying emissions permits or reaps the benefit of selling permits. Either way, it will reduce emissions as long as the cost of doing so is less than the price of the permit.

But are real-life firms really the perfectly rational profit maximizers of the neoclassical economists’ imagination? Some insights from behavioral economics suggest they may not be, and therefore that they may react differently to a policy that makes them buy emissions permits compared to one that gives them permits for free.

(more…)

It’s nice to win, now and then, in the battle against really bad economics.

Back in 2006, California adopted an ambitious state climate policy, known as AB 32. It will require higher fuel efficiency standards for cars and trucks, better insulation and energy efficiency in homes, and more vigorous promotion of renewable energy. Careful analysis by the state’s Air Resources Board and analysts at the University of California-Berkeley showed that AB 32 will have neutral to slightly positive effects on California jobs and incomes – a conclusion that was unacceptable to some of the bill’s opponents.

Last year, two reports trashing AB 32, and state regulation in general, were released by Sacramento State College business professors Sanjay Varshney and Dennis Tootelian (click here for the first, here for the second).  They projected that AB 32 would reduce the state’s overall income by 10 percent, and that regulation in general would shrink California’s output by one-third. Released with great fanfare, these super-sized critiques started showing up in media discussion of AB 32.

I did a report called “Daydreams of Disaster” for the California Attorney General’s office, evaluating the Varshney-Tootelian (V&T) studies. V&T assumed that all benefits of AB 32 were too speculative to include; in effect, they estimated benefits at exactly zero. The costs caused by AB 32, on the other hand, are treated with expansive generosity. Housing costs surge upward, based on the cost of converting homes to zero net energy consumption (but with no resulting savings on utility bills). The projected fuel savings from new, high-mpg cars are treated as a cost imposed on owners of older cars (but not a savings to new car owners). Food cost increases are estimated in an entirely data-free manner. V&T then multiply everything by 2.8 to account for indirect costs.

Even worse is the V&T critique of regulation in general. They estimate a single equation explaining state GDP, across the 50 states, based on six different rankings of state business climates from Forbes. Those rankings give every state a number from 1 (best) to 50 (worst); in the V&T equation, every one-point increase (worsening) in the “regulatory climate” ranking decreases state GDP by a bit more than $4 billion. California comes in at number 40 in the Forbes scorecard for regulatory climate, so V&T project losses to the state of more than $160 billion. And don’t forget to multiply the result by 2.8!

The worst mistake here, although not the only one, is this: State-by-state differences in the size of the economy are – surprise! – primarily determined by the population of the state, a factor left out by V&T. (Why does California have a bigger economy than Rhode Island? Because California is a bigger state with more people, not because of either state’s business climate or rankings in Forbes.) When I reran V&T’s analysis taking state population into consideration, the Forbes rankings had no correlation with the size of the state economy per capita.

My report was one of three independent evaluations of the V&T work, all reaching entirely negative conclusions. The word is starting to get around: the Legislative Analyst’s Office of the California legislature released its own analysis of the shoddy quality of the V&T reports; the head of Small Business California asked that the studies be removed from public websites, due to “deeply flawed methodologies and useless conclusions”; the story even made the San Francisco Chronicle last Friday, which quoted my summary remarks: “The losses they [V&T] project would be serious economic impacts – if they were real. They are, however, entirely unreal; they should be viewed merely as daydreams of disaster.”

There’s plenty more bad economics out there to do battle with. But it’s gratifying to see that there are some limits to what you can get away with in public debate.

Wait a second, the free carbon permits aren’t going to be given away on an equal per capita basis? Let me get this straight: The plan is to give free permits to pollute to the largest historical polluters? Why? Because otherwise, these most polluting industries will fight to block the climate legislation. Is this how all policy is made? We can’t pass a health bill that doesn’t include a giveaway to insurers? Would an anti-smoking measure have a little something in it for tobacco companies? A gun law with a present for the gun manufacturers? Well, probably this is how all policy is made.

Still, the purpose of climate legislation isn’t to make power companies happy, nor is it to guarantee them a continued stream of profits. Capitalism creates and destroys: There’s no guarantee that what made a profit today will make a profit tomorrow, and there is no obligation on the part of the voting public to shore up business models that are damaging to the public good. The purpose of climate legislation should be twofold, 1) to reduce greenhouse gas emissions, and 2) to do so in a way that promotes equity.

Yes, assuming a particular overall cap on carbon, giving the permits away instead of selling them should end up with the same reduction in emissions. (To get this result, the permits would have to be fungible – that is, after they are given away or bought from the government, they can then be sold again to the highest bidder; this leads to the efficient market solution that neo-classical economists are always yammering about. The companies that can reduce their carbon emissions most cheaply will do so and sell the permits they do not need to companies for whom it would cost more to reduce emissions.)

But here’s what would be different: If the government sells the permits, that revenue can go to reduce taxes, or support green jobs, or send a dividend check to every citizen. If the government gives away the permits to private companies, the value of the right to pollute the atmosphere (which, as I’ve mentioned, belongs to every global citizen on an equal per capita basis) ends up going to the same malefactors that have been getting this windfall for decades.

Personally, I don’t think that having made a profit in the past gives you some sort of “God-given” right to make a profit in the future, whether the public likes your product (or your way of doing business) or not. And I don’t think that U.S. environmental regulations need to be business-friendly in order to be the right thing for our society to do.

The value of a clean, low-carbon-dioxide atmosphere is enormous, and it belongs to all of us, equally. I’d like to think that my Senators (this means you, John Kerry and Scott Brown) won’t be intimidated into giving it away.

This is very exciting news: The Senate’s new climate bill calls for the allocation of free carbon permits!

Now I realize this is controversial, but, personally, I can’t wait to receive mine. I couldn’t be more thrilled to have – in such a tangible form – control over my per capita right to pollute or not to pollute the atmosphere. I know it won’t be much – just one 300 millionth of the U.S. cap on emissions, but it still means a lot to me.

I’ll have to think carefully about how to use it. Naturally, I have a strong inclination to retire the permit (take it out of circulation); maybe I could make it into a nice papier maché art object to hand down to my grandchildren and great-grandchildren. A small souvenir of a good and important choice. I can only imagine that they’ll be grateful.

I suppose that power companies and other big greenhouse gas polluters will soon be knocking on my door wanting to buy my permit. Well, they better be willing to pay top dollar, because it’s going to take a lot (the true social cost of carbon?) to get me to part with it.

* Warning: This blog posting contains sarcasm. The Senate’s free carbon permits are not really for you and me; they’re for power companies. Stay tuned for more on this topic.

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