As support increases for cap and dividend, it’s time to look under the hood
Posted by Rich Sweeney on June 5, 2008
Today Robert Reich pens his support for cap and dividend. Not too much new here, if you’ve been following the work of Peter Barnes lately. He does pose two caveats I hadn’t heard before though. The first is allocating dividends on a per adult basis, as opposed to per capita. Not sure why this is preferable, but I’m not opposed to it either (I am an adult, technically).
His other suggestion is that checks be distributed monthly, like Social Security. Again, like the per-adult discussion, the cap-and-dividend debate is still nascent enough that there aren’t many strong opinions staked out on this detail. All other things equal, monthly dividends would probably best alleviate the financial burden of increased monthly utility bills. However, I’ve always just assumed the payment would be annual, like a tax refund. In fact, I’ve also come up with a nifty justification for this arbitrary payment schedule. In Nudge, Thaler and Sunstein muse about consumers’ irrational handling of tax returns. In theory, most people should be able to roughly predict how much they’ll get back from the IRS and incorporate this future payment into current consumption. Yet in practice, people tend to treat these transfers as windfall profits, and blow them on luxury goods. Recent research out of the Chicago Fed has found that recepients of earned income tax credits are likely to spend that money on big ticket items, such as automobiles.
So why does this matter? Well, I’d argue that the behavioral evidence I just mentioned suggests that annual transfers would promote more energy efficiency/ conservation than monthly transfers would. Once we put a price on carbon, people’s utility bills are gonna go up. While this is going to be a bit painful, the idea is to induce a decrease in carbon consumption. Households will be forced to recognize the true costs of their energy usage, and will reorder their relative consumption preferences accordingly. If we simultaneously hand out money to offset these expenditure increase, people won’t conserve as much. In econ terms, the income effect of this policy will somewhat offset the intended price effect. For necessities (which are highly inelastic) this might be desirable, especially for low income households. But at the same time, the point of pricing carbon is to reduce emissions, so it’s important that we think about where we expect these reductions to come from. Though my libertarian friends will surely scoff at this idea, I’m suggesting that maybe its possible to help reshape people’s consumption patterns for the better by smartly structuring a cap and dividend program. If the dividends are handed out once a year, people will irrationally discount them, and the price effect of the policy will dominate. Fortunately, the energy efficiency/ conservation literature suggests that after the initial shock, people will adjust just fine to lower household energy consumption (look at Europe). If you believe the folks at McKinsey on the technical side, or people like Richard Layard on the behavioral side, this switch to a lower energy lifestyle could actually be welfare enhancing. On top of that, at the end of the year, people would get a vacation or a new wardrobe as a reward for conserving carbon. You can think of this as a Christmas account for energy conservation.