Paul L. Caron

Tuesday, August 23, 2022

Weekly SSRN Tax Article Review And Roundup: Roberts Reviews Carbon Pricing And The Elasticity Of Co2 Emissions

This week, Tracey Roberts (Cumberland; Google Scholar) reviews Ryan Rafaty (Oxford; Google Scholar), Geoffroy Dolphin (Cambridge) & Felix Pretis (Victoria; Google Scholar), Carbon Pricing and the Elasticity of Co2 Emissions, (Aug. 12, 2022).

Roberts (2020)

In December of 2014, at the 21st Conference of the Parties to the Framework Convention on Climate Change in Paris, nearly 200 countries agreed to hold “the increase in the global average temperature to well below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C.” These temperature goals are designed to avoid the extraordinary economic, social, and ecological damage likely to occur if we fail to address climate change in an effective way. To meet these goals, all countries will need to transform their economies to change their power generation and transmission systems, transportation systems, their industrial processes, their built environments, including heating and cooling systems, and land use policies for timberlands, grasslands, and farms. It will also require that we change our consumption habits. The next question was: “How can we do all of that?”

One solution, very popular with economists, has been to price carbon dioxide and other greenhouse gas emissions. When fossil fuels are burned, pollution is emitted. In addition to well-known pollutants, such as sulfur dioxides and nitrous oxide, carbon dioxide is released and aggregates in the atmosphere. The stock of greenhouse gases are warming the planet and destabilizing the climate. The costs and risks of this pollution have been shifted to the public. By putting a price on those emissions, we can require emitters to pay for their pollution. The two ways to price greenhouse gas emissions are by taxing them or by capping emissions and requiring polluters to buy emissions permits. A carbon price increases the costs of production of goods produced with fossil fuel energy (“polluting goods”), producers raise the prices of those polluting goods to reflect their increased costs, and consumers are incentivized to reduce their consumption of polluting goods by the higher prices. If the tax (or the price of the emissions permits) is set at the right level, consumers will alter their consumption habits to seek non-polluting goods and businesses will change their energy consumption practices to reflect that preference.

To set the right carbon price, some economists have estimated the “social cost of carbon,” the damage associated with emitting an additional ton of CO2. Because the scope, extent, and the timing of damage are uncertain, the estimates have varied wildly, ranging between US$10 and $1,000 per ton of CO2.  Other economists have used models to identify the right carbon price, focusing on minimizing the costs of achieving the required reduction of CO2 in the atmosphere. However, timing is important. We have delayed in taking major action for 30 years, so the stock of greenhouse gases in the atmosphere is much greater now. Not only must we reach net zero emissions by 2050, but we must also remove CO2 from the atmosphere to stabilize the climate. Natural carbon capture and storage systems are limited, technological removal is still speculative, and coordinating emissions reductions across the world remains a political challenge.

In the face of these challenges, Rafaty, Dolphin, and Pretis have taken a novel empirical approach to determine the appropriate carbon price needed (as a stand-alone policy) to avoid catastrophe. They assembled a new dataset comparing emissions data for two groups of countries based on their average (emissions-weighted) carbon prices. The first group included 39 countries that implemented a carbon price across five sectors between 1990 and 2016, and the second group included the 164 other countries that did not implement a carbon price during this period. This was quite a feat in and of itself, given the fragmented evidence, the differences in carbon pricing schemes, and the varying economic conditions over this period. By disaggregating the effects of introducing a carbon price from the effects of increasing a carbon price, they were able to reach several conclusions.

First, the mere introduction of an explicit carbon price had a statistically significant effect on the growth of emissions, regardless of the level of the carbon price. Emissions declined by an average of 1.5 percentage points relative to their anticipated business-as-usual upward trajectory. In the electricity and heat sector, emissions declined by 2.5 percentage points relative to their anticipated growth. One caveat to this conclusion is that the initial response may been the result of a credible threat of more stringent regulation and a broader shift away from fossil fuels in the foreseeable future. Second, later increases in carbon prices did not necessarily lead to greater reductions in emissions. The analysis suggested that when existing programs raised their carbon prices, the benefits were marginal. Carbon lock-in may be one of several possible reasons for this inelastic response to carbon price increases; owners and investors in existing fossil fuel-intensive systems and the policy-makers that favor them continue to perpetuate those systems by delaying and blocking the transition to low-carbon alternatives. Third, the authors conclude that introducing a modest carbon price in countries and on sectors that are not currently subject to carbon pricing, would be a more effective policy response than to increase carbon prices in the locations where such programs already exist. Finally, the authors found that at this late stage carbon pricing cannot, as a stand-alone policy, provide a feasible pathway to reduce carbon emissions in time to stabilize the climate. 

Currently, the World Bank estimates worldwide emissions are priced at less than $10/tCO2. The average (emissions-weighted) carbon price is around $3/tCO2. The authors estimate this to be the equivalent to an increase in the US excise tax on gasoline of only US$0.03 per gallon, which is very low. The authors ran several simulations based on a variety of carbon price paths between now and 2050. They concluded that carbon prices at existing and higher, but plausible, levels will not be effective to meet the Paris climate targets and avoid catastrophe. Instead, if we rely solely on carbon pricing to address climate change, the carbon price would need to be $250 per ton of CO2, nearly 100% of global emissions would need to be subject to that price, and virtually all countries would need to participate. Clearly, this cannot be achieved as a political matter, and it would be ill-advised as a policy, based on the harsh distributive impacts throughout the U.S. and the world. The authors conclude that, even with a feasible carbon price, complementary policies and substantial public investment will be necessary if we are to stabilize the climate.

Nearly two decades ago, Princeton scientists Steven Pacala and Robert Sokolow clarified that there was no panacea that would prevent climate disaster. Instead, looking at projected growth of emissions, they concluded many complementary policies and many more investments are needed, with each supplying a wedge of emissions reduction. The remarkable study undertaken by Rafaty, Dolphin, and Pretis suggests that the recent passage of the Inflation Reduction Act of 2022 in the United States and Europe’s implementation of the Green Deal in 2021 were not only important, but necessary responses to address climate change. The Inflation Reduction Act provides such a wedge by expanding and extending clean energy tax credits, investing in clean energy technologies, removing barriers to community solar, electrifying government vehicle fleets, reinstating the Superfund Tax to ensure that polluters pay for their cleanup costs, preserving old growth forests, supporting farmers in the transition to more sustainable agricultural practices, and subsidizing home solar, energy efficiency upgrades, and electric vehicles through the income tax system.

Here’s the rest of this week’s SSRN Tax Roundup:

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