Sticks and Stones or Prices and Quantities?
The role of economics in future environmental regulation.
We are all breathing into paper bags. What is at stake in Tuesday’s election is beyond measure. If you do not feel like reading any economics, I give you a calming picture of our new kitty. Go vote if you have not done so already.
I have been contemplating what environmental and energy regulation may look like post January 20th. In a second Trump administration, even with a Democratic majority in the senate, we would likely see further aggressive measures to undo the legacy of 50 years of innovative environmental regulation, which has taken economic principles seriously and saved millions of lives worldwide. On top of this comes a significantly more conservative supreme court, which makes me worry about Massachusetts versus EPA, the case that gave the EPA the authority to regulate greenhouse gases as air pollution under the Clean Air Act.
(Mis)using Costs and Benefits
At the heart of regulating environmental externalities lies the application of benefit-cost analysis in many settings, which requires that the benefits from a proposed rule/regulation be greater than its costs. There are of course some settings where courts explicitly prohibited taking economic considerations into account. Yes, in practice, studying individual benefit-cost analyses is about as much fun as seeing a cat part ways with a hairball. It is often cringe worthy, because agencies have to come up with estimates of benefits and costs of regulation very quickly and much of the information required is simply not available. Even with my inflated ego, I could not do better. Hence there is lots of uncertainty around the true costs and benefit numbers. It’s a number sausage made partially with economic mystery meat. But, if the butcher can be trusted, the sausage is usually pretty good.
The Trump administration has used this apparatus and snuck leaded wood chips into the mix to get its way. And that sausage will literally kill tens of thousands of Americans from the resulting deterioration of air and water quality as well as climate change.
But what about a future Biden administration? The Biden climate plan is the most aggressive climate (and energy) plan put forth by any major candidate running in the general election. I think this is truly exciting, and there is so much to love in this plan. I especially like the idea of coupling economic recovery and transformation of the energy economy. Instead of building more highways to generate jobs, let’s build the infrastructure required to get us to that promised land where green electrons flow like wine and windmills flock like the salmon of the Capistrano.
Holding onto “Least Cost”
But I am worried that once we get to the point of actually making and implementing policies to get us there at the federal and state level, the basic premise of achieving a goal at least cost will be in danger. There is a strong movement building, which calls into question whether carbon pricing has worked and whether it should be used in the future. These arguments are made by some scholars I admire, though I disagree with quite strongly.
It has always been difficult to explain why incentive-based policies like carbon taxes and cap and trade markets are so desirable. If implemented wisely, they achieve a stated goal at least cost, which is desirable since environmental policy should be cost effective! We have written about this ad nauseum on this blog since its beginning and EI Alumna explained this again in a most entertaining fashion. (For a more entertaining explanation, please check out Catie Hausman’s explanation). While many of my more hardcore friends would like to see carbon pricing be the sole tool adopted to meet the challenge of climate change, many of us think it should be part of a broader policy portfolio.
There are certain settings where standards (that is, mandating what people and firms do what to in terms of the technology or inputs they use) make sense. When talking local air pollution, mandating the catalytic converter was an amazing success story! So have been standards in lighting, cooling, heating to name but a few. These are just a few examples of settings where the “rational consumer” left alone may not make the right decision. If you still believe in the completely rational consumer, read “Thinking Fast and Slow”, or go to Trader Joe’s hungry.
But what I am worried about is a storyline where carbon pricing (and pollution pricing more generally) has been declared a failure and that in the name of a net zero target we should abandon it in favor of standards, fines, and massive technology subsidies. The so-called proof that has been waived in our faces is the fact that carbon prices are low in places where it is priced (here and here) and hence they have failed. I think that is dangerous rhetoric, which if taken seriously will lead us to race to net zero at the price of a Bugatti, when the we could have gotten 20X the reductions for the same price (or the same reductions at the cost of a Honda Accord!). .
Weaving a False Tale about Carbon Pricing
Prices for Carbon are low for two simple reasons. For one, no place has implemented carbon pricing with drastic reductions in GHGs during the trading window. If there is political support for drastically tightening the cap, prices will rise! Or in plain English, if you go on an extremely serious diet, you’ll feel hungry very quickly. Right now, we’ve just cut out the mid-morning snack.
Second, we have implemented carbon pricing alongside a massive portfolio of complementary policies – almost all of which are sticks and stones (standards). In California we have the low carbon fuel standard, the renewable portfolio standard, building codes, appliance standards, and kale for breakfast requirements. These are expensive! Even the regulators say so. If you dig into some appendices of the renewal of the cap and trade program in California, you can see that some sticks and stones policies are estimated to reduce CO2 at a cost of more than $200 a ton (and some close to $1000!).
The story that carbon pricing has failed because prices are low is not a finding of failure of carbon pricing, but a failure to be serious about going to net zero (or wherever you want to go). Need evidence? My friends Severin, Jim, Frank and Matt have a paper in a top journal that talks about this very point. Price can pop quickly in a cap and trade when the belt tightens. It is for this and many other reasons, that I have always favored a meaningful carbon tax over a complex cap and trade. But that is for another day.
So my hope for 2021 is that we get serious about setting the US economy on a path to massive reductions of greenhouse gas emissions, while at the same time fueling economic recovery. Yet I hope we will adopt an approach that incorporates a hundred years of economic insights in how to achieve that goal in a cost effective manner – especially during a time when the world is facing a massive economic recession. We share a common goal and should talk and work together to get us there.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Auffhammer, Maximilian. “Sticks and Stones or Prices and Quantities?” Energy Institute Blog, UC Berkeley, November 1, 2020, https://energyathaas.wordpress.com/2020/11/02/sticks-and-stones-or-prices-and-quantities/
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Maximilian Auffhammer View All
Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.
Energy Institute Blog 
Another criticism of carbon pricing is that it isn’t politically palatable because it is a tax and a tax implies that people would have to pay more for the same service (e.g., lead to an increase in fuel prices). Standards are more palatable because the costs associated with them aren’t apparent and that is why we should thus focus on them. Leah Stokes’ article talks about this as well.
I wonder whether the public would (over time) figure out that there are significant costs associated with implementing these standards. And then the they may turn against these standards… thus dealing a blow to the political will to reduce carbon. Is this plausible? Have you seen any evidence of this?
So, your “solution” is to disguise price hikes that only serve to hurt the poor. How Orwellian of you.
The alternative, of course, is to acknowledge that none of these totalitarian power grabs (pun intended) do a thing to help “the climate,” which is about to start getting colder now that the grand minimum has begun. By the time the grand minimum ends, fossil fuels used for energy production will be effectively over for the same reasons people stopped buying horses and steam engines (NOT because nanny governments made us), and Global Greening will be happily gobbling up the additional CO2 for free.
“It is for this and many other reasons, that I have always favored a meaningful carbon tax over a complex cap and trade. But that is for another day.”
Agree Maximilian – seems the effectiveness of carbon policy is directly correlated with its simplicity/transparency; that complexity is a red flag for handouts to special interests.
Probably no other academic in climate science has more disdain for complexity than climatologist James Hansen. Climate conferences? Unenforceable pablum. Cap and trade? A leaky boat, half full of water. Hansen advocates for a revenue-neutral carbon tax, aka “fee and dividend”, with the simplest of terms: fees collected on all sources of fossil carbon entering a jurisdiction are split into equal shares and returned to taxpayers in that jurisdiction at the end of each month (after payment of administrative expenses). Those who are responsible for more than their share of CO2 end up net-negative; those responsible for less actually make money. Carrot / stick. The tax is revenue-neutral, so no one gets a payout who doesn’t deserve it.
Though British Columbia has enacted a reasonably successful version, passing the bill required some handouts to special interests. Even though they were “good” special interests (education, healthcare), B.C.’s version became a target of tax hawks. Ideally, all money is returned to taxpayers in a jurisdiction – which is probably why, after getting high marks from U.S. representatives on both sides of the aisle, several promising bills have been shelved in committee.
Seems the effectiveness of carbon policy is inversely correlated with its chances of becoming law.
Fossil fuels and refined petrochemicals will be with us a very long time. Because, unlike the (faux)renewables of wind and solar, they actually work. And petrochemicals are completely important to every aspect of life today. Denying that is to deny science.
CO2 has been, is and will be a highly overblown issue. Denying that is to ignore the data and believe scare mongering narratives.
Bringing rational analysis to any policy decision only makes it better. President Trump has done just that.
Implying the last 60 years of enviro regs have been an unalloyed success is silly.
As is pretending that wood chip regulations are going to kill “10s of thousands of Americans.”
Unfortunately, you have well illustrated the fantasy land that too many people live in. The evidence shows that the negative consequences of climate change are upon us even sooner than forecasted. But even so, to pretend that there is no underlying risk whatsoever of climate change is the ultimate foolishness. We cannot diversity away the ultimate systemic risk posed by climate change, so pretending that we have alternatives if climate change is actually happening is more foolishness.
Thanks for addressing this growing and misleading narrative that the carbon tax is old news and “all of the above” regulation, subsidies and mandates are the real deal.
The most recent example is the House Select Committee on the Climate Crisis Report which contains between 400 and 500 proposed laws and recommendations. In the current Congress since January 2019 they have passed a total of 164 Bills on all topics. Characterized as a roadmap, the Report is anything but without priorities and cost/ton estimates. It reflects the California model with regulations pre-eminent and carbon pricing a very minor player.
A sound climate policy set is one with a carbon tax at its center with truly complementary regulations, subsidies and mandates. Why a carbon tax? Because EU ETS, RGGI and California cap and trade programs cum regulation show that regulatory programs covering the same emitters as cap and trade are contradictory and not complementary. (For another time is the canard that cap and trade and a carbon tax are showing essentially no difference.)
There are market and non-market impediments that can impede pricing impacts. These account for the fact that a carbon price may have limited or no impact on a source of emissions.
So how does one identify truly complementary regulatory programs? The following three criteria can guide policy makers (and economists) to a sound policy set with the carbon tax at its center (thanks to the Ecofiscal Commission of Canada):
(i) No Impact: Where a carbon tax does not impact a source of emissions e.g., forest and agriculture sequestration;
(ii) Inadequate Impact: Where the impact of a carbon tax is inadequate e.g., rental apartments where misaligned incentives between owner and tenant (principal agent problem) justify supplementary policies like building codes and energy efficiency programs;
(iii) Co-Benefits: Where a policy may bring only incremental emissions reductions but provide significant co-benefits e.g., improved health.
In summary, a steadily increasing carbon tax will have a huge impact on the electricity sector transition, significant impact on industrial investment, some impact on transportation and buildings where complementary measures may be justified, and no impact on forest and agricultural sequestration. Some current regulations and subsidies can be phased out.
Finally, a carbon tax provides the opportunity for economists to show their equity bona fides by supporting the use of the carbon tax revenues for equal household dividends thereby holding harmless the bottom 2/3 of households. Note that the Economists Statement (econstatement.org), spearheaded by Janet Yellen and others, comes down on the side of equity and not efficiency which would call for offsetting cuts in corporate and payroll taxes. (Also, it seems time to highlight once again the “Distributional Impacts of U.S. Clean Energy Tax Credits” by Severin B. and Lucas D.)
Terrific essay … but I have a question. You referred to good regulations (your example was catalytic converters) and more expensive, less justifiable regulations (e.g., you mentioned building codes). Where’s the “Field Guide To the Regulations” that tells us whether some proposed regulation is sensible or not?
Thanks for the calming photo of the kitty !!!
Pure unadulterated hyperventilating bunk.
I’ve watched for over 60 years as leftists interminably seek newer and more specious rationalizations for their endless nuisance suits to make money for yet more nuisance suits. They’ve even given their new approach to political insurgency a name – “lawfare”. It has nothing at all to do with the good of humanity and everything to do with political ambition and raw greed.
In the 70s, we had acid rain and other true pollution issues. That was actual pollution, and people came together overcoming partisanship to address it. As a result our air and water are cleaner today than in the 60s. As with every other actual human induced problem in history, we invented our way out of it. We are doing the same thing with fossil fuels, and will be done with them by about 2050 no matter what governments say for the same reasons we stopped buying horses, steam engines, and typewriters – at which point Global Greening will be mopping up the extra CO2 for free.
Enough with the breathless histrionics and pointless hand waving. Replace your “woke” coma lunacy with actual wakefulness.
In the 1960s are rivers were catching on fire and our children were crying from the air pollution. Private industry was doing NOTHING to solve these problems until government regulations forced them change how they produced goods–not “the market” because no one could effectively demand individually a change in those goods. The record of environmental successes from such government regulation is stunning. (BTW, improvements in worker safety came about the same way.) Government represents “us” and allows us to collectively make a decision to improve our situation.
Nice to agree with you here, Richard. I remember what polluted rivers and lakes looked like (nothing in the U.S. today comes close), I was there at the first Earth Day (1970) protesting government inaction. Richard Nixon’s EPA showed what’s possible when two opposing parties work together to solve a common problem.
In the 1960s Republicans were leading the charge to limit ACTUAL pollutants. Most people who were “against” the rules were either simply unaware of the magnitude of the problem and naturally (and wisely) suspicious of government intervention, or they were one of the handfuls of businesspeople of both political parties who stood to lose profits.
CO2 on the other hand is not only NOT a pollutant, but is actually beneficial at any level we will ever see before it ends up right back where it was without our ever lifting a finger. For over 30 years NASA satellites have accurately observed and recorded Global Greening – the ONLY prediction of AGW which ever accurately matched to the predictions. Just as we did in the 1960s, we are “inventing our way out” of fossil fuels by getting the prices for solar plus batteries less than energy from fossil fuels – which pundits are now saying will happen even sooner that 2028, whic was the earlier prediction. And, surprise, surprise, most of the innovation has come from private industry because thousands of greedy scientists funded by millions of greedy investors want to reap the profits from billions of greedy consumers who all want something cleaner and cheaper than fossil fuels.
Now, I know thes facts will make you sad because they don’t follow your political propaganda talking points, but the fact of the matter is that the Climate Change predictions of Armageddon have been cancelled.
A few years back Johnathan Adler had a post entitled: “The fable of the burning River” that said this …”The problem with the story of the 1969 Cuyahoga River fire is that so much of what we think we know about this story just is not so. Start with the famous image published by Time magazine referenced above.”
http://www.washingtonpost.com/news/volokh-conspiracy/wp/2014/06/22/the-fable-of-the-burning-river-45-years-later/