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Carbon pricing is not a panacea

Pretty well every economist you talk to will agree; if you want to reduce pollution, carbon or otherwise, the most cost-effective way to do so is with a price on the emissions of that which you seek to reduce. They’ll also tell you that, under some basic assumptions, the cost-effectiveness result holds whether you impose that price through a tax or by fixing allowable quantities of emissions, distributing the rights to emit, and making them tradeable – so-called cap-and-trade regimes.  This is taught in most first year economics classes, and you will test it under every conceivable permutation and combination of assumptions if you take an environmental economics class. It truly is economics 101.

Carbon pricing mechanisms generate cost-effective reductions because they make emissions (or emissions reductions) valuable. If you are facing a carbon tax, you can reduce your tax bill by reducing emissions either through changes in actions or changes in technology. The same is true for a cap-and-trade program, although in that case you might be earning revenue from the sale of unused permits or avoiding the need to purchase them.  Regardless, the price on emissions creates a decentralized economic incentive to reduce pollution. We’ve known this since Pigou in 1924 – Pigou suggested that the government could impose “extraordinary restraints – most obviously taxes,” to reduce pollution.

The reason why carbon pricing is not a panacea also goes all the way back to Pigou, if not earlier: stringency matters.  Carbon pricing is cost-effective because it provides people and firms who are affected by the price an incentive to change behaviour or implement new technology if those changes reduce emissions at a cost less than the carbon price.  That’s great, but no one is going to spend $50 to save $25.   In other words, carbon pricing is cost-effective, but not necessarily effective. Effectiveness is a matter of the level of the price and how broadly it’s applied, not the fact that there is one.

If you’re worried about climate change, your first concern should be effective policy (by how much will this reduce emissions?) and not cost-effectiveness (could the same emissions reductions have been generated at lower total cost to society?).  If you believe the International Energy Agency (IEA)’s 2012 World Energy Outlook, to stabilize global GHG concentrations at or about 450ppm, we’re going to need effective policies, and quickly.  By 2035, the IEA models suggest that we’ll need the equivalent of a global carbon price of $120/tonne, along with some complementary regulations. With the exception of implicit prices on carbon on some emissions in Sweden, Japan, and Germany (see yesterday’s OECD report for details), no carbon pricing policy in place today comes close to that type of stringency.  Put another way, despite all the good things about BC’s carbon tax (and it got some laudatory words in the OECD report yesterday), it’s barely stringent enough to fit into the IEA’s 450ppm path and it’s not likely to be stringent enough to see BC’s emissions decrease between now and 2020 (see Table 17).

Your second order concern should likely be political feasibility, and in particular you should ask whether more stringent regulations are more feasible than a stringent price-based policy.  If that’s true, then your regulation will lead to more expensive emissions reductions, but the total benefits to society of a stringent regulation could easily outweigh a weak carbon price.   It’s possible, but by no means guaranteed, that more cost-effective policies will be more politically feasible. If your condition for GHG policy is that you must impose the same price on all sectors of the economy because you want to be cost-effective, that rules out higher prices on some sectors where deep emissions reductions are possible, or lower prices in more politically sensitive areas to ensure you get a policy in place at all. Policies are also most cost-effective when the costs are transparent, but when you see the NRDC campaigning against Keystone XL by telling Americans that their gas prices might go up, you know just how politically palatable a transparent price at the pump will be.  If you want a policy that will actually reduce emissions, it has to be implemented and kept in place by people who face elections every 4 years or less. You might not like it, but that’s a reality.

So, can we all talk a little more about stringency and political feasibility and a little less about prices vs. regulations?


14 responses to “Carbon pricing is not a panacea”

  1. Roundup: More challenges to Justice Nadon’s appointment | Routine Proceedings

    […] Andrew Leach looks at carbon pricing versus regulation of GHGs, and how carbon pricing may actually not be the better way […]

  2. Marc Lee

    A lot of economists primarily emphasize the impact of higher price on decision-making, and to the extent revenues are considered, the favoured approach is tax reductions elsewhere. These latter personal and corporate tax cuts are presumably growth-enhancing, a point for which I am skeptical.

    Better to spend on complementary climate action, in particular investments that lead to structural changes beyond what individuals can do on their own in response to a higher price. For example, increasing rapid transit capacity or new district energy systems.

    My preference is for a rough split on the revenue side: half would fund a broad-based (CCTB-type) benefit that would address regressivity in the incidence of the tax; half would fund green infrastructure projects (transit, high-speed rail, district energy, renewables). These and a few other thoughts on reforming BC’s carbon tax here:

    I think this formulation would greatly reduce the political friction of carbon taxes, as people start getting a cheque in the mail and see jobs being created as we built good things that reduce our emissions and improve quality of life in other ways (co-benefits). People don’t get “revenue neutrality” the way economists think; they may not like paying taxes, but when they do they expect that money to be spent on stuff society needs.

    In terms of efficacy we need to start talking about a carbon budget for Canada, and here the math is pretty painful (at least if we take the 2 degree C target seriously, and we should). It means keeping most fossil fuel reserves in the ground, while being really smart about how we spend our remaining budget. I sketch out the problem here:

  3. Andy Skuce

    First, a minor point on the, to me, irritating title: does anyone seriously claim that carbon pricing is a panacea? I keep hearing that form of argument directed at every proposed solution to emissions reduction and from all sides of the debate: nuclear, CCS, natural gas, efficiency, regulations, smart grids, personal actions, none of them are panaceas. (Rant over.)

    An underreported aspect of BC’s carbon tax is that it is popular, as shown by opinion polls and by the results of the recent provincial election, where the only political party opposing the tax, the BC Conservatives, did not even get 5% of the popular vote. Politicians and pundits elsewhere like to assume that there is an iron law that introducing carbon taxes will lose votes. BC shows that this need not be the case.

    The main reason for this, I think, is because the tax is revenue-neutral and produces low income tax rates. Any politician planning to scrap the tax and keep the budget balanced will have to raise personal and corporate income taxes. Most people in BC pay lower income taxes than they would in other provinces, even Alberta.

    I agree with Marc Lee that spending more of the tax revenues on infrastructure and R&D would probably yield better emissions reductions. I also think that proportionally more needs to be transferred to low income and rural people. However, I have come around to accepting that the current arrangement, which favours tax reductions to the middle class, may well be the optimum from a political standpoint. Better to have a suboptimum tax that is politically resilient than one that reduces emissions more, but that is vulnerable to repeal, as is happening in Australia. In other words, I would trade efficacy for feasibility.

    Of course, there are limits to the stringency of a carbon tax for a small economy, like BC’s, one that relies on trade with other economies that have no (or low) carbon pricing. It would do the climate no good at all if, for example, the BC cement industry closed down and the production moved to Alberta or Washington State.

  4. Andy Skuce

    Yes, people do oversimplify their message to make it short and catchy–and bloggers sometimes do the same with their headlines. ;^)

    On the popularity of the carbon tax in BC, I might add that BC has the advantage of having abundant hydroelectricity, so the carbon tax did not show up on electricity bills (although due to political deferrals of needed BC Hydro investment, big rate increases are coming). For provinces, like Alberta, that rely on coal-based electricity (never mind the oilsands), an economy-wide carbon tax would be a harder sell.

    On your last point, I’m a regular reader of your blog and Tweets (for which I am grateful), so I am well aware that you take a constructive stance on climate policy. When I respond to you, I tend to focus on the bits I don’t agree with, not the majority of it that I accept.

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  6. mcdermottinNYC

    The low cost provided by cap and trade/offsets provides for more political acceptability in the short term and more scope for stringency in the long term — Its all very complimentary.

    Industry and Conservatives know this and that’s why they are so hostile to cap and trade — Indeed, if you don’t want to do anything, just attack the mechanism with the greatest probability of success.

  7. The Alternative for Carbon Taxation: Renewable Green energy | ENV 350: Energy Policy and the Environment

    […] disadvantages about carbon taxation. I firmly agree with Andrew Leach’s statement in his article Carbon pricing is not a panacea, carbon taxation is a cost-effective but not necessarily effective [5]. This is because that carbon […]

  8. Jon Houle

    “If you’re worried about climate change, your first concern should be effective policy (by how much will this reduce emissions?) and not cost-effectiveness (could the same emissions reductions have been generated at lower total cost to society?). ”

    This always bears repeating in conversations of carbon pricing Andrew; thanks for bringing it up. I remember debating a former energy policy professor of mine who stated that a carbon tax alone (at the right levels) would be sufficient in achieving emissions reductions since in theory businesses and people would act rationally to reduce their emissions.

    But, I find this view totally ignorant of what some have called the “institutional momentum” of the world we live in (i.e: reality. We know we don’t all act as rational actors). A few propositions to make my case. 1) Costs borne by businesses are typically passed onto consumers in order to attempt to maintain ROI. 2) It’s much easier for a consumer to shift their spending between discretionary spending and necessities (i.e: beer vs. gas) in the short to mid-term instead of making lifestyle changes. 3) Mass changes in how a nation uses its resources when scarcity isn’t an issue is slow. Especially in an area of relatively ample fossil fuel supplies and tight household income in the face of a struggling economy and rising living costs. 4) Short term failures in systems create a lot of political pressures which can lead to its downfall before dividends can become more transparent to the greater populous.

    Given the above, I believe our policy -if truly aimed at GHG reduction- should be aimed at capping emissions at certain levels (as determined by science). I just don’t see how a tax could achieve that without being extremely politically unpopular with the general public. Granted, in theory, the cost is the same as you alluded to, but the transparency of a tax can make it an extremely easy political target. As we’ve seen with the success of the SOx and NOx cap-and-trade system in the U.S, when properly implemented it can achieve its stated policy purposed and emissions reductions without too much political troubles in the long term since its not a tax that can be cut by politicians to buy votes.

  9. mcdermottinNYC

    Andrew — I thought this “offsets and keystone Summit” would be a great one for you to attend.

    Just think, you can sit around with Tom Steyer’s folks, hold hands, and sing kumbaya: “Hot air it is, my lord, hot air it is…Alberta’s praying, my lord, but hot air it is… Alberta’s crying, my lord, but hot air it is…”

  10. Andrew Patrick

    Thanks for the great post and thread. Lots to think about. The link accompanying this text is dead: “it’s not likely to be stringent enough to see BC’s emissions decrease between now and 2020 (see Table 17).”

    Just wondering if you can point me to the report.

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