In 1990, by an overwhelming majority, the US Congress amended the Clean Air Act to establish a market for electric utilities to trade the right to emit sulfur dioxide, a main contributor to acid rain.
The law was based on a simple economic insight. If utilities facing high costs to cut emissions could, instead, buy allowances to pollute from those who could cut emissions for less, reducing overall pollution would be much cheaper. The idea had been successfully used before, during then-US president Ronald Reagan’s administration, to reduce lead in gasoline.
It worked again. By 1996, sulfur dioxide emissions had declined by a fifth. A study published a few years later concluded that trading of pollution permits cut the cost almost by half, saving utilities and their customers billions of dollars.
Illustration: Lance Liu
Here is the not-so-funny punch line: A decade and a half later, when US President Barack Obama proposed using “cap and trade” to cut emissions of greenhouse gases — the biggest environmental threat of our time — lawmakers looked back upon this unquestionable success and said “no.”
Members of Congress have changed, of course. Many Republicans who say that climate change is a myth or believe that the Obama administration is engaged in an unnecessary “war on coal” many have been hoping to block any environmental program. What they achieved, however, was to direct efforts to combat climate change in a much more expensive direction.
“It is a mystery,” said Gilbert Metcalf, an economist at Tufts University specializing in energy and the environment, “why the Republican Party drives environmental policy away from using Adam Smith’s invisible hand.”
There is plenty of evidence of the high cost of regulation. Sebastian Rausch, from the Center for Economic Research at ETH University in Zurich, and Valerie Karplus, from the Massachusetts Institute of Technology, have modeled how a cap-and-trade policy would look compared with a variety of regulatory options — including a federal renewable portfolio standard, a clean energy standard, fuel economy standards and the like.
A standards-based policy, which is what we have now, is generally much more inefficient, delivering only one-fourth the emissions reductions of cap and trade for the same cost.
“The politics are making the administration do things in a much more expensive way than if the Congress had acted to do something about climate change,” Columbia Law School’s Michael Graetz said.
Other research points in the same direction. Last week a New York Times column highlighted an assessment of the federal weatherization program by three top environmental economists. The findings, though heavily criticized by the Energy Department, were nonetheless discouraging. Residential weatherization reduced carbon emissions at a cost of US$329 per tonne, about 10 times as much as the Obama administration’s estimate of the damage that carbon in the atmosphere imposes on society.
By contrast, price-based tools — emissions permits traded on open markets or taxes that provide polluters an incentive to cut emissions — are efficient because they spread the cost of abatement through the economy.
As head of the Harvard Environmental Economics Program Robert Stavins points out, using regulatory standards to limit greenhouse gas emissions from millions of households, factories, farms, cars, trucks — which all face very different abatement costs — would be an implausibly complex task.
“The only way to do this is to send information through markets,” Stavins said.
An economy-wide carbon price, he argues — as does much of the economics profession, including many Republicans — would give all the incentive to reduce emissions at the lowest possible cost.
However, little progress has been made. While carbon is often implicitly priced via excise taxes and other taxes on energy, the price tag is almost always too low to encourage substantial reductions in carbon emissions.
Economists at the Organisation for Economic Co-operation and Development estimated that the effective tax on carbon among the world’s 41 biggest polluting nations, which account for some 84 percent of global carbon emissions from energy, amounted to about US$16.60 per metric tonne of carbon, on average. That is about US$20 less than the estimate of carbon’s social costs.
China, the US, Russia and India, which generate more than half of the world’s greenhouse gas emissions, price carbon dioxide at less than US$5.50 a metric tonne. In Russia, the No. 3 emitter, the implicit tax on carbon from energy use is roughly zero.
What is worse, subsidies to fossil fuels around the world reach into the hundreds of billions of dollars a year, putting a thumb on the scale in the wrong direction. Taxes on coal — the most polluting fuel — are often zero. Across the 41 countries evaluated by the organization it was taxed, on average, at US$1.75 per metric tonne of carbon dioxide.
Can devastating climate change be averted without properly pricing carbon? Probably not.
To be sure, prices cannot do the job alone. The world also needs an intense, concerted investment effort to develop new energy technologies. However, it also needs to put in place a powerful incentive to move away from fossil fuels that avoids being so expensive that it is politically untenable.
Unfortunately, some influential people are pushing the wrong way. Two weeks ago, Pope Francis made a case for aggressive action against climate change but rejected the use of markets to help do the job.
Trading carbon permits “can lead to a new form of speculation, which would not help reduce the emission of polluting gases worldwide,” he wrote. “It may simply become a ploy, which permits maintaining the excessive consumption of some countries and sectors.”
Metcalf worries that the pope’s views could complicate the effort to forge a worldwide climate agreement in Paris in December.
“What we don’t want is the Paris agreement to try to shut down markets,” he said. “There’s a lot of pressure to inject some of the language about their negative aspects.”
Still, for all the skepticism from many quarters, the evidence that prices can do the job better than anything else is starting to sink in. The World Bank tallied eight new carbon markets that opened in 2013. China is experimenting with seven carbon market pilot programs and is expected to start a nationwide trading program next year. Mexico and France introduced new carbon taxes last year. Mexico cut its oil subsidies.
Obama’s clean power plan might lead to more carbon pricing, encouraging states to reduce their emissions by joining regional carbon exchanges.
Even Republicans might be brought on board. Graetz argues there is a good case for a carbon tax as part of a broad fiscal overhaul, using the revenue to offset cuts in payroll taxes.
Taxing carbon, a “bad,” to reduce taxes on wages, a “good,” could improve economic efficiency. And it could disentangle the debate over climate change from the perennial ideological battle over the size of government.
In the end, opposition to effective climate change policies will not stop the fight against climate change, but it can, unfortunately, prevent the fight from being done in the smartest possible way.
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