Carbon Taxes

As an economist, one of the biggest frustrations of discussions over climate policy is that we know pretty well what to do - tax carbon (or set up a system of tradable permits, which has similar effects), and that doing so will not be harmful to the economy.  People and firms respond to incentives, and a carbon tax will motivate people to find the lowest-cost ways to reduce emissions.  People are clever and the cost of reducing emissions will likely be much less than many envisioned.

Eduardo Porter's column about British Columbia's carbon tax is yet another illustration of this; he writes:

In 2008, the British Columbia Liberal Party, which confoundingly leans right, introduced a tax on the carbon emissions of businesses and families, cars and trucks, factories and homes across the province. The party stuck to the tax even as the left-leaning New Democratic Party challenged it in provincial elections the next year under the slogan Axe the Tax. The conservatives won soundly at the polls.

Their experience shows that cutting carbon emissions enough to make a difference in preventing global warming remains a difficult challenge. But the most important takeaway for American skeptics is that the policy basically worked as advertised.

British Columbia’s economy did not collapse. In fact, the provincial economy grew faster than its neighbors’ even as its greenhouse gas emissions declined.

“It performed better on all fronts than I think any of us expected,” said Mary Polak, the province’s environment minister. “To the extent that the people who modeled it predicted this, I’m not sure that those of us on the policy end of it really believed it.”

Global Warming: Easy Economics but Hard Politics

The Times reports:

While virtually all of the largest developed and developing nations have made domestic commitments toward creating more efficient, renewable sources of energy to cut emissions, none want to take the lead in fighting for significant international emissions reduction targets, lest they be accused at home of selling out future jobs and economic growth.

The negotiations for a new climate change agreement to be signed in Copenhagen in December are badly stalled. With the agreement running more than 200 pages — including what negotiators estimate are a couple of thousand brackets denoting points of differences — diplomats and negotiators fear that the document is too unwieldy to garner a consensus in the coming months.

Sigh. The darn thing is, the costs of dealing with this are likely to be quite low. Further evidence of this comes from estimates by the CBO:

For example, CBO concludes that the cap-and-trade provisions of H.R. 2454, the American Clean Energy and Security Act of 2009, would reduce GDP below what it would otherwise have been—by roughly ¼ to ¾ percent in 2020 and by between 1 and 3½ percent in 2050. By way of comparison, CBO projects that real (that is, inflation-adjusted) GDP will be roughly two and a half times as large in 2050 as it is today, so those changes would be comparatively modest. In the models that CBO reviewed, the long-run cost to households would be smaller than the changes in GDP because consumption falls by less than GDP and because households benefit from more time spent in nonmarket activities. Moreover, these measures of potential costs do not include any benefits of averting climate change.

EconomistMom notes their reluctance to quantify the benefits, which makes the whole "cost benefit" thing a little hard:

What I see as the trouble with CBO–known as the official “scorekeeper” for legislation being considered by Congress–doing a quantitative analysis of the “economic effects” of climate change policy, is that all their qualifying statements about their inability to quantify (in dollar terms) the main point of climate change policy (avoiding environmental damage and what that means for the broader well-being of our society) will be lost on the policymakers, and hence on the public as well. People look for the numbers in a CBO report and will surely use the numbers about what’s bad about climate change policy as a reason not to enact that policy, as long as there are no concrete numbers to support the merits of the policy. In other words, it’s hard for CBO to be the unbiased arbiter on policy evaluation if they’re only “tooled up” on one side of the debate.

Indeed, the expected value is calculated as the probability weighted sum of the various outcomes. If we assign a value of infinity to "avoid complete destruction of human civilization" then, even if the probability is small, the expected benefit is infinite.

Also on the subject of global warming, Mark Thoma points us to this WSJ column by Robert Stavins of Harvard.

Cap and Trade: Bargain Insurance

The Congressional Budget Office (CBO) has estimated the cost of the Waxman-Markey "cap and trade" bill, and found that it is modest - about $22 billion ($175 per capita) in 2020. That is an estimate of gross costs, and does not take into account the benefits of reducing global warming.

The benefits may be quite large. Separately, the CBO has analyzed the likely effects of global warming. Though they do not put a dollar value on it, $175 per year seems like a small price to (partly) avoid this: While there is some imprecision in estimating the exact implications of carbon emissions for the climate and the consequent economic costs, it is rational to pay small costs to reduce the probability of really, really, really bad outcomes. That is, in essence, why we buy insurance. Though I haven't (yet) managed to crash a car, it makes sense for me to write a check to a lovable, British-accented Gecko who will protect me from some the consequences if I ever do. In this case, the potential consequences are far worse than a car accident, and the costs of insurance are considerably less.

Moreover, as Ezra Klein notes, the cost estimates are likely overstated. Along those lines, Paul Krugman reminds us that market economies can adapt to relative price changes; he writes:

The point is that we need to be clear about who are the realists and who are the fantasists here. The realists are actually the climate activists, who understand that if you give people in a market economy the right incentives they will make big changes in their energy use and environmental impact. The fantasists are the burn-baby-burn crowd who hate the idea of using government for good, and therefore insist that doing the right thing is economically impossible.

Global Warming and Investment Demand

Paul Krugman believes the world economy is stabilizing, but it remains to be seen where the demand necessary to output growing again will come from. On a global scale, Krugman notes, it cannot be exports, but it could be investment associated with tougher rules on carbon emissions:

Speaking in UAE, the world's third-largest oil exporter, Krugman said Japan's solution of export-led growth would not work because the downturn has been global.

"In some sense we may be past the worst but there is a big difference between stabilizing and actually making up the lost ground," he said.

"We have averted utter catastrophe, but how do we get real recovery?

"We can't all export our way to recovery. There's no other planet to trade with. So the road Japan took is not available to us all," Krugman said.

Global recovery could come about through more investment by major corporations, the emergence of a major technological innovation to match the IT revolution of the 1990s or government moves on climate change.

"Legislation that will establish a cap-and-trade system for greenhouse gases' emissions is moving forward," he said, referring to the U.S. Congress.

"When the Europeans probably follow suit, and the Japanese, and negotiations begin with developing countries to work them into the system, that will provide enormous incentive for businesses to start investing and prepare for the new regime on emissions... But that's a hope, that's not a certainty."

That's an important point. Critics of meaningful measures to deal with global warming have focused on the costs of dealing with the problem. These costs are often overstated, and the people making this argument seem to underestimate the ability of market economies to adjust to the changes in relative prices that would be induced by cap-and-trade or carbon tax measures. Part of that adjustment will involve replacing some of the capital stock - from air conditioners to power plants - with more efficient equipment. A policy that credibly commits to raising the relative price of carbon in the future therefore could increase demand today. In the Keynesian model, this would shift the investment demand function, which would also shift aggregate demand, and help close the output gap.

Particularly the midst of a global slump, the need to create jobs provides an argument in favor of taking serious action on global warming now.

As for the actual legislation moving through congress, the Waxman-Markey bill, Krugman sees it as a step in the right direction, but The Economist is disappointed.

(Krugman's reference to Japan is to the export growth which helped get it out of its 1990s slump; as I noted recently, its reliance on foreign demand is getting it in trouble again now).

How Much Carbon Does a Dragon Emit?

In his Times column, Paul Krugman argues that if China won't control its carbon emissions, we should impose a tariff:

China’s emissions, which come largely from its coal-burning electricity plants, doubled between 1996 and 2006. That was a much faster pace of growth than in the previous decade. And the trend seems set to continue: In January, China announced that it plans to continue its reliance on coal as its main energy source and that to feed its economic growth it will increase coal production 30 percent by 2015. That’s a decision that, all by itself, will swamp any emission reductions elsewhere.

So what is to be done about the China problem?

Nothing, say the Chinese. Each time I raised the issue during my visit, I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels. After all, they declared, the West faced no similar constraints during its development; while China may be the world’s largest source of carbon-dioxide emissions, its per-capita emissions are still far below American levels; and anyway, the great bulk of the global warming that has already happened is due not to China but to the past carbon emissions of today’s wealthy nations.

And they’re right. It is unfair to expect China to live within constraints that we didn’t have to face when our own economy was on its way up. But that unfairness doesn’t change the fact that letting China match the West’s past profligacy would doom the Earth as we know it.

Historical injustice aside, the Chinese also insisted that they should not be held responsible for the greenhouse gases they emit when producing goods for foreign consumers. But they refused to accept the logical implication of this view — that the burden should fall on those foreign consumers instead, that shoppers who buy Chinese products should pay a “carbon tariff” that reflects the emissions associated with those goods’ production. That, said the Chinese, would violate the principles of free trade.

Sorry, but the climate-change consequences of Chinese production have to be taken into account somewhere.

James Fallows thinks Krugman misreads what's going on in China:

While his conclusion -- that China has to be part of global efforts to control carbon emissions -- is obviously correct and important, his premise -- that no one in China admits this -- does not square with my observation over these past three years.* As it happens, I spent this very day at a conference in Beijing where the first five presentations I heard were about emissions-reductions and sustainability in one specific domestic industry. (Also, I wrote in the magazine, a year ago, about Chinese people and organizations making similar efforts in a variety of other fields.)

If blunt-instrument outside pressure like this column makes it more likely that Chinese authorities will keep making progress, then as a pure matter of power-politics I say: fine. But my guess and observation is that it is just as likely to get their back up -- and encourage the ever-present victimization mentality that makes it less rather than more likely that Chinese authorities will behave "responsibly" on the international stage.

As I've written a million times (most recently here and here and generally here), arguably the most important thing that will happen on Barack Obama's watch is reaching an agreement with China -- or not -- on environmental and climate issues. We'll see what's the best means toward that end.

Tyler Cowen also has objections. Gary Clyde Hufbauer and Jisun Kim discussed the idea of using tariffs as an instrument of climate policy in a Vox post last year.

High Future Energy Prices Now, Please!

The Times reports from the Detroit auto show:

But the return of cheap gasoline has already dampened hybrid sales. Throughout the show, auto executives emphasized that stable fuel prices, or a coherent government energy policy, would help them anticipate what consumers would buy next. Because of wild swings in fuel prices, “Every six months we get called stupid for having the wrong products,” said Robert A. Lutz, G.M.’s vice chairman.

“Far be it for me to be the first auto executive to call for a gas tax,” Mr. Lutz said. “But right now, it’s like fighting obesity by requiring clothing manufacturers to make nothing but small sizes.”

Electric cars did generate the show’s central irony: the models that will most impress Detroit’s new overseers in Washington will also drag down the automakers’ bottom lines for several years.

The Post's Steven Mufson writes:

Goodness knows, President-elect Obama has his legislative hands full. Maybe that explains why he has taken the idea of increasing gasoline taxes off the table, saying that Americans had enough economic burdens at the moment. Nominees like Steven Chu, the Nobel Prize winning physicist who will become Energy Secretary, dutifully echoed Obama's view even though in Chu's case he has long supported higher fuel taxes.

But by failing to raise the gasoline tax, the president-elect risks complicating another problem: Fixing the U.S. automobile industry.

Here's the problem. Obama and leading members of Congress keep saying they want ailing automakers to make more fuel-efficient vehicles. But the automakers in the past made more money on the guzzlers; in the future, they will have trouble charging enough to make money on new cars using costly new technologies for plug-in or hybrid cars. So the car company of the future may be a money-losing operation, just like the car company of the present.

Raising the gasoline tax would increase consumer demand for more fuel-efficient vehicles. That could help automakers charge more for them and make more money on sales of plug-ins, hybrids or more efficient conventional engines. Not surprisingly, Ford and General Motors both belong to the U.S. Climate Action Partnership, which this week proposed a detailed blueprint for a cap-and-trade system for carbon dioxide emissions. Such a system would put a price on carbon and would effectively tax gasoline and all other fossil fuels.

After being burned last summer by sky-high gasoline prices, do Americans really need higher gasoline taxes to get them to buy fuel-efficient cars? Yes, actually. Americans have an astonishingly short memory about gasoline prices. Sales of the Toyota Prius have hit the skids now that gasoline prices are back below $2 a gallon. And sales of SUVs are relatively strong compared to many other models.

(Hat tip: Mankiw). The principle applies more broadly - the best way to induce investments in "green" technology would be policies that credibly ensure that the price of (non-renewable) energy will rise in the future, like a phased-in carbon tax. Done right, this could even have a positive effect on current investment by creating an incentive to replace inefficient equipment before the higher costs kick in. That is, a (future) tax increase could be a stimulus today... not to mention addressing a problem - global warming - that is ultimately far more serious than the recession.

Politically, it isn't an easy sell, but it should be less difficult now, in the wake of a fall in global energy prices, than it will be once they go back up. Chu's comments were not encouraging, but presumably a climate/energy proposal is in the works that will result, perhaps indirectly, in higher costs for transportation fuel. Still, I worry Matthew Yglesias may be right when he says: "my best guess is that Obama’s climate proposals are too ambitious to be enacted and too timid to avert catastrophe."

But if he's wrong, and we get the high energy prices we need, Bob Lutz has got me covered.

Dubious Cap-and-Trade Skepticism

In a Washington Post op-ed, Bjorn "the Skeptical Environmentalist" Lomborg argues that more government funding for research is a better way to reduce carbon emissions than a cap-and-trade system, as in the Lieberman-Warner bill (recently fillibustered by Senate Republicans). He writes:

Politicians favor the cap-and-trade system because it is an indirect tax that disguises the true costs of reducing carbon emissions. It also gives lawmakers an opportunity to control the number and distribution of emissions allowances, and the flow of billions of dollars of subsidies and sweeteners.

Many people believe that everyone has a moral obligation to ask how we can best combat climate change. Attempts to curb carbon emissions along the lines of the bill now pending are a poor answer compared with other options.

Consider that today, solar panels are one-tenth as efficient as the cheapest fossil fuels. Only the very wealthy can afford them. Many "green" approaches do little more than make rich people feel they are helping the planet. We can't avoid climate change by forcing a few more inefficient solar panels onto rooftops.

The answer is to dramatically increase research and development so that solar panels become cheaper than fossil fuels sooner rather than later. Imagine if solar panels became cheaper than fossil fuels by 2050: We would have solved the problem of global warming, because switching to the environmentally friendly option wouldn't be the preserve of rich Westerners.

Lomborg seems to miss the point of a cap-and-trade: by making it more costly to emit carbon, the system would create incentives to develop energy alternatives and increase efficiency (a carbon tax would do the same thing). By changing relative prices, cap-and-trade will create opportunities for firms, entrepreneurs and inventors in the private sector to profit from developing less carbon-intensive methods of producing energy and products that use less energy. It would also give everyone an incentive to be less wasteful by bringing the price of carbon emissions in line with the true cost (i.e. reflecting the private as well as social costs).

Though government research grants might be helpful (as an academic, I can't argue against throwing more money at universities...) using market forces to mobilize the private sector is likely to be a more effective, lower-cost way of getting us to those cheap solar panels.

That logic is standard intermediate microeconomics, but Lomborg - who has a PhD in political science - doesn't appear to get it.

CARMA chameleon

Dani Rodrik's Blog brings to my attention a new website called CARMA (CARbon Monitoring for Action) with data on the carbon emissions of over 50,000 powerplants worldwide. The site has nifty color-coded maps (like my dream, red, gold and green).

Our friendly neighborhood power plant, Duke Energy's plant in North Bend (the one you drive by on the way to the Cincinnati Airport via I-275) emits 7.5 million tons of carbon dioxide per year, 2123 pounds per megawatt hour, earning a red dot.

Energy Deregulation's Hidden Virtue?

The electricity market was once highly regulated (e.g. prices set by government commissions) on the grounds that utilities are natural monopolies. In recent years, a number of states have de-regulated their energy markets.

The result? Higher prices. The NY Times reports:

Retail electricity prices have risen much more in states that adopted competitive pricing than in those that have retained traditional rates set by the government, new studies based on years of price reports show.

Of course, if there are negative externalities associated with electricity consumption - i.e. global warming-causing carbon emissions - higher prices are a good thing! The de-regulation acts like a stealth carbon tax (except no revenue for the government). Ahh... now I realize that all the politicians, "free market" types and energy lobbyists who pushed deregulation were engaged in a conspiracy to help the environment (no wonder Cheney kept those meetings secret!).

The Economist's Free Exchange blog makes a similar point here.

Intermediate Micro (Donkey Edition)

Late in Tuesday's Democratic presidential debate, Brian Williams gave some of the candidates a chance show off their intermediate microeconomics knowledge (or lack thereof).

We learn that Chris Dodd understands externalities (and what to do about them). From the transcript:

MR. WILLIAMS: ...Are you truly prepared to lead on a national scale the kind of sacrifice it would require where it intersects with the environment?

SEN. DODD: Well, I think you've got to -- I find it somewhat startling here that Ronald Reagan's former secretary of State and George Bush's first economic -- chief economic adviser are, frankly, more courageous and bold on energy policy than my fellow competitors here for this job, the presidency.

I've called for a corporate carbon tax. All of us share the same goals here of achieving energy independence, reducing our dependency on fossil fuels and the carbons they emit. But you're not going to achieve that unless you deal with price, quite frankly, here...

The advisor he refers to is Greg Mankiw, who advocates "Pigouvian" taxes.

The next question went to John Edwards, who must have missed the class on moral hazard (perhaps he had a bad hair day):

MR. WILLIAMS: Senator Edwards, should there be a bottomless well of federal dollars for people who knowingly live in areas of this country that are disaster prone to rebuild their homes if lost in a disaster?

MR. EDWARDS: Well, I think that when families are devastated -- and we've lived with this in North Carolina because we've been regularly hit by hurricanes, and I've spent an awful lot of time in New Orleans. When families are hit by natural disasters, I think it is for the national community to be there for them. I think that's our joint responsibility as a national community to be there for them.

I would have been very keen to learn Mike Gravel's views on resale price maintenance, but, alas, he was not invited. Its not the same without him.

Easy as MSB = MSC

There are some things that seem so obvious after intermediate microeconomics, but unfortunately much of the citizenry hasn't had that pleasure... One example is the use of Pigouvian taxes on externalities to equate marginal social costs and benefits. In the NY Times, Greg Mankiw makes the case for a carbon tax:

IN the debate over global climate change, there is a yawning gap that needs to be bridged. The gap is not between environmentalists and industrialists, or between Democrats and Republicans. It is between policy wonks and political consultants.

Among policy wonks like me, there is a broad consensus. The scientists tell us that world temperatures are rising because humans are emitting carbon into the atmosphere. Basic economics tells us that when you tax something, you normally get less of it. So if we want to reduce global emissions of carbon, we need a global carbon tax. Q.E.D.

Mankiw explains why a carbon tax is preferable to fuel economy regulations and cap-and-trade. Politically, its a tough sell. Mankiw offers an idea to make it go down easier:

Yet this natural aversion to carbon taxes can be overcome if the revenue from the tax is used to reduce other taxes. By itself, a carbon tax would raise the tax burden on anyone who drives a car or uses electricity produced with fossil fuels, which means just about everybody. Some might fear this would be particularly hard on the poor and middle class.

But Gilbert Metcalf, a professor of economics at Tufts, has shown how revenue from a carbon tax could be used to reduce payroll taxes in a way that would leave the distribution of total tax burden approximately unchanged. He proposes a tax of $15 per metric ton of carbon dioxide, together with a rebate of the federal payroll tax on the first $3,660 of earnings for each worker.

Eminently sensible, but I'm not holding my breath. Mankiw is advising Mitt Romney's campaign - if he can get Romney to come out for a payroll for carbon tax swap, I will be very impressed, with both of them.