Common Tragedies

Thoughts on Environmental Economics

Common conflations and great expectations

Posted by Daniel Hall on October 3, 2007

Ryan Avent wonders whether Americans understand a carbon tax; Megan McArdle claims that they do. My sense is that Ryan and Megan more or less agree about how Americans understand a carbon tax; the problem is that this understanding is a kind of misunderstanding.

Ryan says that:

I think opposition can be explained almost entirely by lack of public understanding and by a real absence of any marketing of the idea. …while wonks love carbon taxes, few politicians have embraced the policy, so few people are out there publicly making the case for such a tax. Of the Democratic presidential contenders, only Mike Gravel has really stood up for higher gas taxes….

Thinking about it a bit more, though, I think that opposition also stems from the fact that most Americans can’t respond all that well to higher gas prices.

Megan says that:

I’d say they understand it all too well: a tax will make it more expensive for them to drive, forcing them to do less of it. If they didn’t like driving right now, they wouldn’t be doing so much of it.

Note that these statements are two ways of saying the same thing: if you raise gas taxes a little bit, people don’t respond much and emissions aren’t cut; if you raise gas taxes enough to substantively cut emissions, it will be expensive and painful. In other words, demand for driving (and gas) is relatively inelastic. This point is uncontroversial. Part of the misunderstanding, I would say, is the all-too-common conflation of a carbon tax and a gas tax.

A carbon tax would implicitly be a gas tax; it would also be a tax on all other sources of carbon in the economy, including coal and natural gas. It would not just affect the transport sector (about one-third of U.S. greenhouse gas (GHG) emissions) but also the electric power sector (another third of U.S. GHGs), the industrial sector (~20%), and everything else. And emissions in some of these other sectors — particularly electric power — would be less expensive and painful to cut than emissions from cars.*

The other misunderstanding comes from thinking about static versus dynamic effects, or the short- versus the long-term. Utilities will make very different capital investment decisions if coal power plants start costing, say, 30% more to operate overnight. Wind or nuclear or other low-carbon generation will become much more relatively attractive. Of course these investments will take time to come online and start making a difference in emissions. The basic point, however, is that while end-users may not be tremendously price responsive in the short-term to changes in energy prices, it’s the long-term compositional effects in the economy that are the primary reason that carbon taxes would produce changes in emissions.

This is very good news, because climate change is a not — to my mind anyway — an immediate problem that requires drastic and expensive action right now. It is a long-term problem that will ultimately require deep structural changes in how we produce and use energy. What we are doing 50 years from now will matter far more than what we are doing today. This means that rather than slapping a $100 per tonne of CO2 tax on carbon today and leaving it there, we could get more bang for our buck by placing a much more modest charge on carbon in the near-term — say anywhere from $3 to $20 per tonne of CO2 — along with a firm, credible, and public commitment that this price will rise steadily and predictably over time (eventually to a price possibly much higher than $100/tonne CO2).

In fact, expectations of what the carbon price will be in the future would drive many compositional changes even without any carbon price at all for the next few years. If American companies knew with absolute certainty that the government was going to impose a $50 per tonne CO2 charge starting in 2020, they would start making very different investment decisions today. In many ways this scenario would work itself out as if we already had a carbon tax now, at a level that was discounted from that future price. The concept is akin to what economists call shadow prices, where the future scarcity of a resource — in this case the ability to emit GHGs without restriction — is accounted for in the current price of that resource.

This is not to imply that a carbon tax — or some other policy for putting a price on emissions — will be simple or inexpensive. But it highlights the features that a good emissions policy should have: it should cover as many sources as possible — so the cheapest emissions can be found out and reduced first — it should start modestly and grow through time, and it should have as much stability and credibility over the long-term as it can. The first feature (coverage) is a political challenge; the second may be less of a problem, but it is tied to the third, which is the real stickler. Can governments create and maintain credible systems for a decadal (or even generational) approach to a centuries-scale problem? This seems a major challenge even within a single country, where administrations will change every few years; the challenge gets much larger when you extend it to the entire international community. It’s a problem I expect we’ll be trying to solve for a long time yet.

*Potentially a carbon tax — or some other emissions pricing policy, say, cap-and-trade — would also include other GHGs based on their global warming potential, measured in carbon dioxide equivalent. Many of these emissions are projected to be the cheapest to reduce of all.

2 Responses to “Common conflations and great expectations”

  1. Your point that “climate change is not an immediate problem that requires drastic and expensive action right now” is to my mind as well – very salient. A carbon tax is unlikely to do any real good and only reallocate resources that will be required to address the “total commons”. The problem is the sense of urgency that we as a society are increasingly placing on “global warming”.
    I recently attended a lecture by Peter Barnes at Middlebury College on a “carbon cap and rebate” proposal, dubbed “Sky Trust Carbon Cap” and have commented on it at Vermont Confidential . Relevant links to the “proposal” can be found there. While I applaud the desire to “take action now”, I am concerned that selling these various plans will do more harm than good with poorly thought out metrics and false expectations.

  2. Sorry, a direct link to the specific post is here .

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