A simpler, more useful way to tax carbon

For most of the 21st century, putting a price on carbon dioxide emissions (either a carbon tax or a cap-and-trade system) has been seen as the serious person’s climate-change policy, preferred by economists, claimed to have bipartisan appeal, and backed relentlessly by tribunes of Beltway conventional wisdom like the Washington Post editorial board.

In the past few years, though, carbon pricing has fallen out of favor with activists. These days, the left has aligned around standards, investments, and justice: sector-specific emissions standards, large-scale public spending on low-carbon infrastructure, and an overarching focus on the most vulnerable and hardest-hit communities.

Nonetheless, it would be wrong to say that the bulk of climate opinion has turned against carbon pricing. Relatively few people think it’s a bad or entirely useless policy. They just see it as one tool in the policy toolbox, a complement to, not a replacement for, the many other policy tools available. Climate campaigners would prefer a carbon price with more modest aspirations, designed as part of a policy portfolio.

Academia has heard this call and, lo, it hath delivered.

The latest issue of the journal Nature Climate Change contains a study that attempts to sketch out a new approach to pricing carbon, one that does not suffer from the arrogance and overreach of previous attempts. (The authors are Noah Kaufman and Peter Marsters of Columbia University’s Center on Global Energy Policy, Wojciech Krawczyk and Haewon McJeon of the University of Maryland, and Alexander R. Barron of Smith College — I’ll just call it the Kaufman paper.)

Rather than the conventional method of determining a carbon price, which involves wildly uncertain far-future climate projections from scientists and a whole range of social value judgments from economists, they advocate for a more modest approach, with prices tied to short-term goals and arrived at through democratic deliberation. It’s a refreshingly practical approach, a way to help policymakers rather than dictating to them.

Let’s look at the details. I’ll start with the big flaw of carbon pricing to date — the problem the authors are trying to solve — and then take a look at how they propose to solve it.

Carbon pricing has been arrogant in its pretensions and its aspirations

Cap-and-trade systems (which cap emissions and create tradable emissions credits) have largely lost their cachet. California’s system is faltering; the Northeast’s Regional Greenhouse Gas Initiative is still running smoothly, but its effects are modest. Policymakers and economists have come to fear that the markets cap-and-trade creates are subject to manipulation and that they can’t ratchet toward zero emissions fast enough.

And so, what carbon-pricing action there is these days is around carbon taxes. (There are several carbon-tax proposals floating around Congress.)

Traditionally, the more enthusiastic carbon tax advocates have leaned on two flawed assumptions. The first is that there is an “optimal” price for carbon, which perfectly captures the balance between the costs of climate damages and the costs of decarbonizing. The second is that, once that price is determined, a tax on carbon is the “first best” and only necessary policy; other carbon-reduction policies will just distort the perfect market balance struck by the price.

The “optimal” carbon price is known in the biz as the “social cost of carbon” (SCC). The pretense of the social cost of carbon is that economists will add up all the projected damages of climate change to determine the all-in marginal cost of an additional ton of emissions. The tax on carbon will be set at that amount, which means we will purchase exactly as much climate mitigation as is “worth it.”

However, economists cooking up an optimal carbon price and presenting it to policymakers as a fait accompli fails to meet the public’s needs in three big ways.

First, determining climate damages is a wildly complex undertaking. It involves models built on a whole panoply of assumptions and inputs, many of which, the Kaufman paper says, are “inherently uncertain, such as the appropriate discount rates, risk aversion levels, issues around inequality, and attempts to assign monetary values to non-economic climate damages.”

Because of the complexity and uncertainties, the range of values produced by economists for the social cost range widely. “Meta-analyses find recent SCC estimates that range from under US$0 per ton of CO2 to over US$2,000 per ton,” the paper writes. Even if the outliers are excluded, estimates still range by hundreds of dollars. That doesn’t give policymakers much to go on.

Second, all of those uncertain variables — equity, the value of future generations, the value of other species — are buried in models, where they are effectively invisible to policymakers. Assigning value to these variables involves social and ethical decisions, but those decisions are being made by economists rather than through democratic deliberation. Policymakers have no real way of knowing what kinds of considerations produce what kinds of prices.

And third, the values for the social cost of carbon spit out by models have no connection to the policy goals they are meant to serve. They are not designed to achieve particular ends and their effects are uncertain, which, again, isn’t very helpful for policymakers.

The social cost produced by this contentious and values-laden process is meant to capture all the damage done by carbon emissions, meaning it is designed to be the principle, even only, carbon-reduction policy. But that assumes that unpriced carbon is the only market distortion that needs addressing, which flies in the face of real-world experience. The best economic and political theory now suggests that a portfolio approach to climate change, a broad package of policies, has the best chances of success.

But a carbon tax designed around the social costs is designed to be totalizing — it offers no guidance for how to craft a carbon price meant to complement other policies.

There’s a better way to design a carbon tax

Kaufman and his co-authors propose an alternative design framework for a carbon tax: a near-term to net zero (NT2NZ) approach.

In a nutshell, rather than asking what the optimal carbon price is in some econo-metaphysical sense, the approach begins by asking: Given other policies in place and a reasonable set of assumptions, what price on carbon is required to drive emissions to net zero on schedule?

This approach has a number of advantages. It doesn’t require any complex calculations about the damages of climate change decades hence, so the biggest uncertainties are taken off the table and it can produce much more precise, actionable price estimates. It puts values-based decisions about social and ethical trade-offs in the hands of policymakers rather than economists. And it is reverse-engineered from specific policy goals, so it doesn’t require any guessing about its effects. In all these ways, it is much more tangibly useful to policymakers.

To see how these advantages play out, let’s look at the four steps the authors lay out for designing a near-term to net-zero carbon tax.

1) Pick a date to hit net zero

The climate situation is simple: either the world reaches net-zero carbon emissions or global temperatures keep rising forever. Every nation must reach net zero; the only choice is how fast. Different countries will move at different speeds depending on their individual circumstances, level of economic development, and risk valuations. These decisions should be made by policymakers, out in the open.

2) Craft an emissions pathway to the net-zero target

As the Kaufman paper notes, “an infinite number of pathways are conceivable between current emissions levels and a future net-zero target.” Some pathways emphasize near-term reductions. Others emphasize R&D aimed at larger reductions later. Some rely on electrification, some include biofuels, some include nuclear power, some include negative emissions. Some are “straight line” reductions, others show a peak and then a decline.

Again, decisions about the appropriate pathway should be made by policymakers, based on national circumstances and values.

3) Determine the carbon price consistent with the emissions pathway in the near term

Energy-economic models can be used to estimate a carbon price that will help meet the desired target. Unlike the models that estimate SCC, energy-economic models can integrate the effects of multiple policies, so they can show a carbon tax how to be a team player.

The models and their projections are built on assumptions about the future trajectory of energy technologies, consumer behavior, and policy. Those things are more difficult to predict the farther out in the future, so these kinds of models are generally most useful when planning for the short term, the next decade or so. Beyond that, the assumptions become educated guesses.

So Kaufman et. al recommend that the models be used to determine near-term carbon prices rather than to guess what prices might need to be in 2050. “Focusing on the near term,” they say, “means that CO2 price estimates should not be unduly influenced by assumptions about the highly uncertain long-term evolution of technologies and behavior.”

In short, they urge that plans be made based on what we can see immediately ahead of us, not hopes for technological miracles decades out.

4) Periodically repeat steps 1-3

Knowledge in the fields of climate, energy, and technology evolves rapidly; policymakers should periodically set new goals and craft new pathways based on the latest science and democratic opinion.

There are a variety of ways to do this kind of “adaptive management.” Carbon prices could be adjusted automatically based on predetermined metrics — boosted if interim emission targets are not being met, or lowered if energy prices rise too high. Or prices could be adjusted every five years through an inclusive stakeholder process.

“Pairing a long-term emissions target with a set of iterative near-term policies is not novel,” the paper says. “The United Kingdom, for example, has adopted a national target of net-zero GHG emissions by 2050 and sets five-year carbon budgets to act as stepping-stones.” This approach fits well with the Paris climate agreement, which requires countries to submit new nationally determined contributions (NDCs, or commitments to reduce greenhouse gases) every five years.

NT2NZ carbon taxes in the US would be high, but not ridiculously high

To illustrate, Kaufman et. al determine near-term to net-zero carbon prices for the US that would yield straight-line emission reductions to a series of net-zero targets.

The chart below tells the tale. On the left, you can see the emission pathways to net-zero in 2040, 2050, and 2060 respectively. On the right, you can see the carbon prices necessary to reach those targets: $32, $52, and $93 per metric ton in 2025, with prices almost double that in 2030.

The black bar lines on the right-hand chart represent the range of carbon tax proposals currently before Congress, revealing that the near-term to net-zero prices are roughly within the range of what lawmakers are discussing.

As the colored bars on the right show, each estimate is actually a fairly wide range. That has to do with the sensitivity of models to a variety of assumptions, from the cost of various energy sources to the rate of innovation to the success of complementary policies. If any of those variables unfold differently than Kaufman et al. have projected, then the carbon price estimates would change accordingly.

The chart below shows how much changes in these variables affect the final price estimates. As you can see, a great deal depends on the price of oil and the success of other policies, both of which are extremely difficult to predict.

Setting near-term to net-zero carbon prices is not easy. It still requires tons of judgment calls about future developments. But at least this approach puts those judgment calls on the table where policymakers can see them.

The politics of the near-term to net-zero approach

The near-term to net-zero model has a great deal to recommend it over the conventional social cost of carbon method. It is a more modest approach to carbon pricing, more iterative, cooperative, transparent, and democratic. It is much more concretely helpful to policymakers than the endless cosmic quest to determine a precise social cost.

In a sense, however, its strengths are also its vulnerabilities. All those value-laden decisions previously made by economists in spreadsheets would be open to public dispute and manipulation. Every time policymakers revisited the tax, it would be a chance for vested interests to make mischief and complicate it with exemptions and conditions.

Basically, the near-term to net-zero approach exposes carbon pricing directly to democracy. Whether you think that’s a good idea or not depends on your assessment of the health of the world’s big democracies. There is certainly a school of thought that says complex decisions like this should be made by experts — something like California’s model, where the state legislature sets broad targets and direction and the Air Resources Board carries them out.

But if the world is truly to reach net zero, all the world’s polities will eventually have to buy into the effort. It can’t be done successfully if driven purely from the top down. When polities and policymakers are ready, they will find a carbon price a helpful tool, and the modest approach is a helpful way of crafting one.

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