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.

A new study on the economic impacts of Cantwell-Collins’ proposed “CLEAR Act” – the cap-and-dividend climate regulation that I wrote about a few weeks ago – shows that, in every state, the average household will come out ahead. Their extra costs in energy bills will be more than made up for by an annual dividend check. Some states, however, would have a greater net benefit than others: Oregon and Vermont would receive the biggest net benefits; Indiana and Delaware, the smallest.

This is one of the key obstacles to making a cap-and-dividend bill palatable to majorities in Congress. Somehow it’s not enough that working- and middle-class families stand to benefit from this climate policy – the idea that some states would benefit more could turn out to be a deal breaker.

Authors Jim Boyce and Matt Riddle present an innovative solution to this disparity: state-specific dividends calculated to give the median household in each state the same net benefit. Under this plan, the per capita annual dividend check would be $262 in Oregon and $352 in Indiana, but the net benefit to the median household in each would be $65, due to differences in energy consumption between the two states. With any luck, that could be just enough sugar (for Congress) to make the medicine go down.

A policy of tailoring dividends to energy consumption, however, should probably stop there, or it risks sliding down a slippery slope. Some readers may wonder, why not a specific dividend for every income class in every state? How about for every household (so nobody loses out due to the new policy)? Making a dividend check that matches each household’s cost from climate legislation would entirely negate its effectiveness. The idea is supposed to be that households will choose to use less fuel and buy less energy-intensive products because these things will cost more under a carbon tax or tradable permit system. But if each household were given a check for exactly its added costs, nobody’s purchasing behavior would change at all.

In order for a “market-based” climate policy to work, we all have to respond to price signals that tell us it’s worthwhile to conserve energy. Too much tailoring of any climate regulation could weaken those signals.

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.

In response to my recent post about the EPA’s little-known social cost of carbon (SCC) value and its importance in setting the stringency of U.S. emission reductions measures, one reader posted this comment:

… It seems to me that the social cost of carbon is whatever it is. The issue is how close EPA gets their estimate to the true value…

Perhaps, but the EPA’s current efforts at calculating the SCC – with its strong bias towards the lower end of estimations from the climate economics literature – is unlikely to arrive at that putative “true value.”

Here’s another way to calculate the SCC: We could ask ourselves, in general terms, what payment would we accept in exchange for our permission to allow greenhouse gas emissions to continue to grow, and to accept a drastically changed climate and all the social and economic damages that would come with it?

Before you answer, here’s something to consider: If we allow emissions to continue, we know that the climatic changes will be profound and the damages serious, but we don’t really know how profound and how serious.

This is what climate scientists and economists call the “problem of uncertainty.” We have a good idea of what the most likely damages will be, and even a good idea about their lower bound (best case). But the upper bound (worst case) is almost impossible to imagine, let alone quantify, with any confidence. In other words, it’s a big gamble: What would you accept in exchange for my assurance that the damages probably will be difficult but not devastating?

If your answer is some variation on “not for all the money in the world!” then for you (and for me) the SCC is infinite.

The SCC answers the question: What’s the damage done by one more ton of CO2 emitted into the atmosphere? Or, what benefit would make it worth it to you to allow the damage caused by that one additional ton? An infinite SCC tells us that future damages are so great that any additional emissions are simply unacceptable.

For anyone out there who likes to think graphically: The idea presented here is that part of the SCC curve is vertical. For a somewhat technical discussion of these issues see my critique of the now-defunct British method of calculating the SCC.

I hate to bring this up for fear of adding, in whatever small way, to the hype, but … the 2007 IPCC report has not, I repeat, has not been discredited as riddled with errors. Not even a little bit. Not even close.

Yes, two small errors have been found, one about the rate at which Himalayan glaciers are melting and the other about the share of the Netherlands that is currently below sea level. Allowing these errors into the final text of the report certainly represents a failure in the IPCC’s reviewing and proofreading process.

Here’s what’s getting missed when Fox News and even NPR talk about the errors: The IPCC report is thousands of pages long. The results of each volume are summarized, and those summaries are again summarized ad nauseam until the whole thing is distilled into a 20-page policymaker summary report. That summary report is further digested into the one or two numbers that make it into the media, usually the expected average annual temperature change and sea-level rise by 2100.

Some of the information in the full IPCC reports is fundamental, an enormous set of facts and modeling assumptions that come together in these final media-friendly results. But most of the information in the IPCC report is not fundamental, and changing any part of it would have no effect on those final results.

The errors about Himalayan glaciers and Netherlands geography are problems of this latter type: They are not fundamental, and they do not affect the policymaker summary report or the few facts that reach a wider public audience.

For a clear and detailed accounting of errors, real and imagined, in the IPCC report, see this post on RealClimate. For a lighter explanation, try Tom Toles.