Changing the Economics of Energy

Changing the Economics of Energy

By Dr. Jonathan Tiemann

This February, a group calling itself the Climate Leadership Council published a paper titled, “The Conservative Case for Carbon Dividends.” The paper’s eight authors constitute sort of a blue-ribbon panel of thoughtful conservatives. They include former senior Republican officials (James A. Baker III, George Schultz, Henry Paulson), prominent economists (Martin Feldstein and N. Gregory Mankiw, who also served in Republican administrations), business leaders (Thomas Stephenson of Sequoia Capital and Rob Walton, a member of the Wal-Mart founding family and board), and the CEO of the Climate Leadership Council, Ted Halstead.[1] The paper begins with a forthright acknowledgement of the seriousness of climate change as an issue. The paper’s main proposal is to impose a tax, initially $40 per ton, on carbon dioxide emissions, using the proceeds to pay every American an annual “carbon dividend,” which they estimate would initially amount to about $2,000 for a family of four. While we would all pay the tax indirectly because taxes generally find their way into consumer prices, the idea is those that choose to make our lives less carbon-intensive would come out ahead, while those that continued to lead carbon-intensive lives would be net payers. The proposal has the merit of articulating a coherent policy approach to greenhouse gas emissions, using a price mechanism to decentralize the day-to-day consumption choices and long-term investment choices, which consumers and businesses must make to effect substantial reductions in those emissions.

The Climate Leadership Council is an interesting group. They’re an explicitly Republican-leaning organization, and their paper cites solidifying Republican leadership in government as one of the objectives of the carbon dividends proposal. As they put it in their paper, “The opposition of many Republicans to meaningfully address climate change reflects poor science and poor economics, and is at odds with the party’s own noble tradition of stewardship. A carbon dividends plan could realign the GOP with that longstanding tradition and with popular opinion.” None of this means that those politically opposed to the Republican Party or the current Administration should dismiss the CLC proposal out of hand. First, the public stance of the party is to deny climate science so strongly that the CLC’s argument that their plan could help solidify Republican power seems (from their point of view) unrealistically optimistic. More important, when the peril is as acute as the danger of climate change, we all have an obligation to evaluate any plausible ideas and embrace the good ones, regardless of their source.

The CLC’s carbon dividend plan has the virtue of simplicity on its side. One of the difficulties of any climate change policy is that it needs to induce, or to force, a wide variety of economic actors to make a wide variety of changes. Real reductions in greenhouse gas emissions require utilities to shift to low- or no-carbon energy sources, households to reduce their use of energy from greenhouse gas-emitting sources, and businesses — particularly energy-intensive ones, like information technology firms that run massive server farms — to shift their energy inputs. Broadly speaking, a policy that sought to generate those outcomes could take three approaches: regulatory mandates, tax incentives such as penalties and credits, or steps to shift the underlying market conditions that inform private decisions. The CLC’s proposal uses a straightforward tax penalty to shift the relative prices of carbon-intensive and carbon-free energy sources, and then leaves private actors to respond voluntarily to the revised market conditions. It also has the potential to provide economic stimulus. The carbon tax would encourage investment in new energy sources and equipment. The carbon dividend could give cash to lower-income households, stimulating consumption and adding to aggregate demand.

For a matter as diffuse and complex as energy production and usage, a market-based approach has important advantages. Consider, for example, regulatory mandates. Suppose Congress decided to pass legislation meant to require a reduction of, say, 50% in greenhouse gas emissions over some period of time. They might try to require that utilities install some amount of renewable power capacity, or impose operating requirements on coal-fired power plants designed to encourage shifts to other fuels. Such rules might be directionally correct, but at best they would produce a crude approximation of the economically optimal way to achieve the policy goal of reducing emissions. The problem is that by the time regulators study the matter, formulate and draft regulations, and then implement them, market conditions may have shifted to such an extent that some other set of measures, in transportation, say, would have been more effective than those in power generation. And once those regulations are in place, they require an infrastructure for compliance and enforcement.

Tax incentives have a similar problem. While tax incentives have been effective in encouraging households and businesses to install solar panels, for instance, it isn’t obvious that the optimal low-carbon energy mix includes precisely the amount of solar that has resulted from the incentives. The trouble is that a renewable energy incentive only addresses the policy goal indirectly, and favors a particular approach to reaching it.

The carbon dividend proposal does involve a tax incentive — a penalty tax on carbon dioxide emissions, applied “at the refinery or the first point where fossil fuels enter the economy, meaning the mine, well or port.” The key is that the tax incentive attacks the policy goal — reducing carbon dioxide emissions — directly. The program would distribute the proceeds of the tax as a dividend to every American. That’s it. If carbon dioxide emissions don’t fall as fast as policymakers would like, all they need to do is increase the tax. The winners would include any consumers using less energy from carbon-intensive sources, and the losers would include producers and consumers of carbon-intensive types of energy. Whether and how economic agents choose to adjust to the pricing of carbon dioxide emissions is entirely up to them.

We can’t predict just what would mix of renewables, nuclear energy, alternative transportation technologies, conservation, and other measures would yield the optimal approach to reducing carbon dioxide emissions. By pricing the emissions and leaving the rest to voluntary action, the proposal removes the need to try to determine that mix and implement it by fiat. It also allows flexibility to implement newly developed technologies and respond to changing pricing of substitute energy sources without requiring a cumbersome process of adjusting targeted regulations or incentives.

One clean energy source that could benefit substantially from the carbon dividend proposal is advanced nuclear energy. The CLC agrees. Their paper says, “Carbon pricing would also encourage domestic nuclear energy, further promoting climate stability and America’s energy independence.” Targeted incentives have emphasized renewables, especially solar and wind, and those certainly have the potential to contribute a great deal toward reducing greenhouse gas emissions. But where those incentives favor a particular type of solution, the carbon dividend plan places all carbon-free energy sources, including nuclear, on an equal footing. If nuclear power enjoys the same advantages as solar and wind, that simplifies the problem of creating a carbon-free power grid with sufficient capacity for both base and peak loads. That, in turn, has the potential to accelerate the necessary shifts away from fossil fuels for applications like transportation and home heating.

The CLC’s carbon dividend proposal offers a straightforward, potentially effective plan to battle climate change by reducing carbon dioxide emissions. By taxing those emissions directly, the proposal encourages a flexible, efficient, market-based approach to determining exactly what steps economic agents will take to use less carbon-intensive energy. That bypasses the delay, lobbying, and controversy of an approach relying on either regulation or targeted incentives. Strikingly, the proposal comes from a blue-ribbon panel composed largely of conservatives from the previous generation. The principal barrier to this proposal is that today’s generation of Republicans show no interest in acknowledging climate change, let alone addressing it.

[1] James A. Baker III, Martin Feldstein, Ted Halstead, N. Gregory Mankiw, Henry M. Paulson, Jr., George P. Schultz, Thomas Stephenson, Rob Walton, The Conservative Case for Carbon Dividends, Climate Leadership Council, February 2017. At https://www.clcouncil.org/wp-content/uploads/2017/02/TheConservativeCaseforCarbonDividends.pdf

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