One possible policy approach to global warming is to outlaw dumping of CO2 into the air where it affects neighbors, just as we outlaw dumping human waste onto a neighbor’s lawn. This is not a favored policy approach for now; Dr. Alley knows of no serious proposals to outlaw most CO2 emissions in the short term. However, some of the proposals in President Obama’s plan involve laws or regulations that reduce emissions, through actions such as requiring that trucks travel more miles per gallon of diesel fuel, or that power plants emit less CO2 per kilowatt-hour of electric generation. In some sense, this is outlawing a small fraction of CO2 emissions.
Economists generally recognize the utility of at least some regulations, such as those prohibiting dumping of human waste on a neighbor’s lawn. (Although, the British publication The Economist editorialized against sewers in 1848, as reported by S. Halliday in The Great Stink of London, 1999.) But, there is fairly broad support among economists for using “price signals” instead of regulations where practicable.
For example, instead of outlawing CO2 emissions, governments could set a limit on how much CO2 could be emitted, and sell or give away permits to emit that much CO2. Then, the people holding those permits could actually emit that CO2, or sell (trade) those permits to other people who wanted to emit the CO2. This process is often called cap and trade. By reducing the permitted emissions over time, or raising the price of the permits, total emissions could be reduced.
At any time, the trading of permits allows the economy to reduce emissions at the lowest possible price. If CO2 is reduced by regulations rather than price signals, those regulations might be written with an eye toward political expediency rather than economic optimization, and so might end up cutting emissions in rather expensive ways. By letting markets achieve the reductions, more-efficient ways are likely to be found. At the time of this writing, cap and trade was being used in Europe to address CO2, in the US to reduce acid rain, and in other ways around the globe. Some danger typically exists that political considerations will cause caps to be set so high that there is little practical effect of the policies. However, with appropriately set caps and sufficiently well-regulated and monitored markets and emissions, this approach can work, and has done so in some cases.
In the broadest sense, cap-and-trade with permits sold by the government is a complex way to levy a tax on CO2 emissions. In part because of the complexity, many economists argue that it would be much more efficient to just tax CO2 emissions directly.
Now, a bit of a highly relevant detour. Governments levy taxes to raise funds so the governments can function, but those taxes always have impacts in addition to the fund-raising. In the United States, governments tax tobacco to raise money and reduce smoking. Governments tax alcohol to raise money and reduce drinking. And, governments tax the wages of workers to raise money… and reduce working?
Reducing the value of work does reduce working. For example, suppose Dr. Alley has $100 to get help with some task. Compare two options: he offers some students $100 to help, or, he offers the students $50 to help, and the government gets the other $50. Which is more likely to convince the students to change their plans and go help Dr. Alley? The answer should be clear.
Just as taxing tobacco, alcohol and wages tends to reduce smoking, drinking and working, respectively, taxing our fossil fuels would reduce their use, as well as promoting substitutes that now are more expensive than the fossil fuels. And, because energy use powers the economy, this would reduce economic activity unless certain other actions were taken.
If a tax (or a cap-and-trade program) were developed to reduce CO2 emissions, the economic impacts would depend hugely on what was done with the money raised. Some political campaigns in the US recently featured advertisements using numbers assuming that money collected from a cap-and-trade system was then run through a shredder, disappearing completely from the economy. This makes the cap-and-trade program sound very expensive, which may be politically useful. But, in our experience, governments that get money tend to spend it rather than shredding it.
Probably the most frequently discussed policy option is to place a tax on carbon emissions, and use the money in a “tax swap” to reduce the tax on wages, or to reduce other taxes that especially reduce economic growth. (Other options include giving the money back to people directly, or using the money to stimulate research—the funds would be available for anything that money can be spent on.) In 2013, the US Congressional Budget Office summarized available research showing that if we ignore all of the benefits of reducing fossil-fuel emissions and avoiding global warming, a properly designed tax swap would have little impact on the economy as a whole—it might slow growth a little, or speed growth a little, but without too much change (Effects of a Carbon Tax on the Economy and the Environment, 2013 [1]). Earlier, the US EPA had conducted a similar study and found a slightly overall increase in household consumption over the next 30 years in response to a price on carbon—a stronger economy from putting a price on carbon emissions and using the money to reduce the tax on work. (U.S. Environmental Protection Agency, Office of Atmospheric Programs, 2009, Revenue recycling to reduce labor taxes, in Supplemental EPA Analysis of the American Clean Energy and Security Act of 2009 [2]H.R. 2454 in the 111th Congress, p. 23, scenario 16.) You might think of this as arising from the fact that replacing fossil fuels is difficult, and taxing fossil fuels causes inefficiency in the economy, but replacing workers is about as difficult and perhaps even more difficult, and taxing their wages causes about as much and may be even more inefficiency in the economy.
Such studies also show that it is possible for governments to raise taxes on carbon and then use the resulting money in ways that are not as helpful to the economy so that the carbon tax really does reduce economic growth significantly. (The worst example of this might be taking the money and shredding it!) But, used appropriately, there is little economic cost and possibly economic gain from a carbon tax even if you ignore the benefits of reducing CO2 emissions. And, as noted in the previous chapter, a cost on carbon emissions is strongly justified if the costs of global warming are included.
One objection to a carbon tax, even if implemented efficiently with a tax swap, is that it takes relatively more money from poor people than from the wealthy; such a policy is often called regressive. In contrast, income taxes tend to be designed in a progressive manner, so that wealthier people pay relatively more. However, other policies can be designed to address such issues if they are deemed important.
In his 2008 book, A Question of Balance, the Yale economist William Nordhaus (we met him in Module 10) devoted a whole chapter to “The many advantages of carbon taxes”. Three days after the Obama administration’s 21-page sketch of policy actions, economist Henry Jacoby of MIT told National Public Radio’s David Kestenbaum (Morning Edition, June 28, 2013) that economists could solve the problem with a one-page bill. Kestenbaum’s analysis in the interview says “This is why economists love a carbon tax: One change to the tax code and the entire economy shifts to reduce carbon emissions. If you do it right, a carbon tax can be nearly painless for the economy as a whole.” (And, again, this ignores the benefits of reducing global warming, which make the carbon tax more favorable.)
A carbon tax (or cap and trade, or regulations, or any other serious attempt to reduce CO2 emissions, probably including carbon capture and sequestration) is likely to have unfavorable impacts on some groups, and favorable impacts on others. In particular, coal miners are likely to lose. One of the short-term responses to reductions in greenhouse gases is likely to be a switch to natural gas for generating electricity—gas emits about half as much CO2 as coal for a given amount of electric generation, and the greater ability of gas turbines than coal-fired boilers to change their output quickly means that more renewables can be used easily in an energy system that has more gas-fired and less coal-fired generation.
PRESENTER: This photograph, from the US Library of Congress, shows a coal miner from 1942 from the Pittsburgh, Pennsylvania area, the Montour Number 4 mine of the Pittsburgh Coal Company. We don't even know the miner's name. We do know that a lot of miners have done very difficult jobs to help their families, to help their communities, to help their countries. No one likes going around firing coal miners.
Coal, right now, is under a lot of pressure. Some of it does come from government regulations. Probably, more of it is coming from natural gas being cheaper, although you'll find an argument on that.
The economically optimal path for dealing with CO2 involves starting very slowly to deal with the problem, and making changes over decades, with the idea, in part, that coal miners, who made honest decisions to be coal miners, will retire in their jobs, coal investors will get their money back, but future generations will do something else. If we ignore the science and the economics, for now, we let another generation coal miners get started, then the economically optimal path will involve much faster changes, with a greater likelihood of firing coal miners. So in some sense, if you really hate the idea of firing coal miners, you want to put our knowledge into the decision-making now.
There is a fascinating issue here, which overlaps with ethics in the next module. The economically efficient path puts a small price on carbon now, and then raises that price slowly but steadily, by perhaps 2-4% per year, so that in a few decades the price becomes high. A person who already decided to be a coal miner, obtaining the education, mortgage, and other things that go with that choice, has a good chance on the economically optimal path to retire as a coal miner, with future generations doing something else (or else with future generations mining coal and then capturing and sequestering the carbon). If someone invested in a coal-fired power plant, they likely will get their investment back on the optimal path.
But, the social cost of carbon is projected to climb rapidly as temperatures and damages rise. If we notably delay starting our response, so that a new generation of people become coal miners or coal-plant investors, the higher social cost of carbon in the future will mean that an optimal path starting in the future involves faster changes, which will make it much harder for those new “coal” people to complete their careers or recoup their investments. If you really are ethically opposed to the general act of firing coal miners or hurting the investors in coal plants, starting now to deal with climate change is probably better than delaying, because of the likelihood that delay now will lead to more coal miners being fired later. (The biggest danger to coal-mine jobs and investors in the US now may be the recent drop in gas prices as fracking has increased gas supply; the free market does not adopt 30-year plans to minimize impacts on coal miners. And, as noted below, the fracking boom involves commercialization of research that in significant part was paid for by the US government, so in that sense government policies have caused trouble for coal miners. Notice, though, as described in the Enrichment linked below, that even if the main danger to coal-mine jobs comes from the free-market influence of gas, the public communications may paint a very different picture.)
Want to learn more?
Read the Enrichment titled Coal Mining Jobs.