Saturday, July 26, 2014

Why Does Politics Keep Getting in the Way of Pricing Carbon?

Willingness to Pay for Climate Mitigation [Credit: Jenkins (2014)] Click to enlarge.
  • While a carbon price is every economists' favorite climate plan, real-world political constraints get in the way (just ask Australia!)
  • In a new paper in Energy Policy, I examine a variety of political economy constraints that limit the environmental efficacy and economic efficiency of real-world carbon pricing policies.
  • Households in the United States appear willing to pay just $80-200 per year to combat climate change, equivalent to a carbon tax of roughly $2-8 per ton.  In contrast, estimates of the full social cost of carbon -- the level of carbon tax envisioned by economists -- are an order of magnitude or two larger, ranging from roughly $15-150 per ton (and rising steadily over time).
  • Climate policy makers ignore political economy constraints at their peril--and part two in this series (coming tomorrow) will explore what can be done to seize the opportunity space for improvement in climate policy design.
Ask an economist how to combat climate change, and you're likely to get a pretty simple answer: put a price on carbon.

"If you let the economists write the [climate] legislation, it could be quite simple," MIT business school economist Henry Jacoby told NPR last year, implying that the whole plan to curb greenhouse gas emissions could "fit on one page."

In economics-speak, climate change is "an externality" -- a set of costs (e.g., climate change-related damages) that are external to current market transactions, since no one has to pay for the costs associated with their CO2 emissions.

As such, the traditional economic prescription for climate externalities involves establishing a "Pigouvian fee" on the sources of GHG emissions that corrects for the un-priced externality, either via a tax on carbon dioxide (CO2) and other GHGs (a "carbon tax") or via a market-based emissions cap and permit trading mechanism ("cap-and-trade"). There's a lot of debate about which approach -- tax or cap-and-trade -- is better, but both rest on a common economic foundation, and I'll refer to both collectively as "carbon pricing policies."

If these instruments successfully establish a carbon price equal to the full climate change-related external costs associated with emissions of CO2 and other GHGs (the so-called "social cost of carbon"), they will equalize the marginal social and private costs of GHG emitting activities, restoring an economically efficient of emissions (economists call this "a Pareto optimal level").

There's only one hitch: people generally want their energy to be cheaper, not more expensive!

Last week, Australia repealed it's carbon tax, ending a brutal, decade-long fight over climate policy.  The repeal is just the latest and most glaring example of the extremely up-hill political battle facing any effort to put a hefty price on carbon--i.e., a price sufficient to fully internalize the social costs of CO2 emissions and substantially reduce greenhouse gas emissions.

Why Does Politics Keep Getting in the Way of Pricing Carbon?

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