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New status quo in climate policy

In climate change policy discussions, for years there has been debate about which types of regulations should be used to reduce emissions. The technocratic crowd claims carbon pricing is the best policy, a view that is supported by pretty basic economics. “Best” in their view means cost-optimal; using cap-and-trade or a carbon tax ensures that the market finds the path of lowest cost.

Conversely, the climate advocacy/activist crowd has for years been pointing out that this theory has not matched reality. Some point out simply that real world implementations tend to perform poorly compared to more rigid regulations, while others go as far to say carbon pricing is bad even in principle. This attitude has often been dismissed as being uninformed, including by people like me.

There is now a book that lends academic and theoretical legitimacy to the idea that carbon pricing is not in fact the most important policy lever. A few months ago, professors Danny Cullenward and David G. Victor published a short policy book [here] that seems to legitimize and formalize the complaints of the advocacy crowd.

Cullenward and Victor have feet in both academic research and in sausage making, having advised large governments on how to design climate-related laws that are actually able to get majority votes in legislatures. Their conclusion is that, though the economic theory of carbon pricing is sound, its implementation is limited by political forces that are virtually impossible to overcome.

Here is the main concept. When economists consider the world, they create models of demand, supply, costs, etc. Within that model, the optimal path is carbon pricing, without question. However, if you expand that model so that it includes (a) voters, (b) lobbying from big industrial emitters, (c) politic influence of the nascent green industry, (d) advocates and civil society, and (e) the incentive-based behavior of politicians, you end up with much different conclusions about which regulations we should spend time pursuing.

Because I was always taught (in graduate courses as well as from accepted wisdom of most academics) that carbon taxes must rule the day, this was a eyebrow-raising read for me. Reading this book has changed my mind on several points.

Here is a summary of some of the book’s conclusions. See if some of them contradict what you have been taught about climate politics.

++ For political reasons, carbon prices almost always end up staying much lower than they need to be (rare exceptions include Scandinavian countries). Their political model suggests that this might always be the case, once one takes into account voting behavior and the political power of entrenched industries, among other factors.

++ If one does choose to implement a carbon price, a simple direct carbon tax is best. This is because, unlike in complicated cap-and-trade programs, it is difficult to sneak in loopholes that destroy the program’s effectiveness. In fact, though jurisdictions with cap-and-trade have seen emissions reductions, most of this has apparently been achieved by regulations other than carbon markets---this is a situation the authors refer to as “Potemkin markets” [link].

++ Carbon pricing should be constrained to stay within a single sector (e.g. transportation, electricity, heavy industry), and we should not shy away from setting different prices for different sectors. A standard example is transportation. Because gasoline prices have high “visibility”---people notice them more immediately---politicians face negative consequences if they support anything that increases fuel prices. But citizens tend to complain less about the electricity sector, partly because they don’t have to drive by a sign that screams the electricity price. Because there is less political backlash, electricity-related carbon emissions can be taxed at a higher rate than fuels.

++ Carbon offsets have almost entirely failed [link]. They are too easy to game, too difficult to verify, and introduce awful incentives. As a separate point, the authors also discuss offsets’ “knife’s-edge incentives,” an intriguing concept that was new to me. Basically: the purpose of an offsets market is to allow polluters to purchase carbon reductions as cheaply as possible. Theoretically, this is good for the economy; more resources can be spent on something other than carbon reductions (healthcare, schools, whatever). But if the offset is very cheap, then the question is, wouldn’t the action have been likely to have happened anyway, through legislation? It has apparently been shown [link] that the difficulty of achieving and verifying “additionality” is even worse than many of us thought.

++ One of their more interesting points has to do with revenue spending, i.e. how to use the money from carbon taxes or other programs. A typical economist might say that it doesn’t matter how the money is spent. After all, everyone agrees the main purpose of carbon pricing is to influence the demand side. But the authors argue that it is politically easier to spend such money for green purposes than to find the money elsewhere. If we accept this, the next question is whether it is better to spend green revenue on (a) Citizen Climate Lobby’s fee-and-dividend idea than on (b) R&D, rebates for EVs and solar, or subsidies for utility-scale clean energy. Based on the existing data, they argue that the first type of spending simply doesn’t move public opinion as much as many thought it would. Millions of dollars divided equally among citizens will not actually receive much notice, whereas millions of dollars spent on wind power of EV rebates will make a significant dent on the energy transition. Ergo, in general, carbon tax revenues should be spent on accelerating the energy transition.

These are useful heuristics for climate advocates to remember, especially those of us who interact regularly with legislators at the city level up to the federal level. (Any world citizen can pressure legislators---just pick up the phone!)

Though on the whole this is an incalculably useful and well-argued book, I am not comfortable with every part of their narrative. Mainly I worry that they are codifying what is “politically feasible” before we really know these limits. For example, though I accept the notion that high carbon taxes have been consistently unfeasible in most jurisdictions, I’m unconvinced that this would never change. If Sweden and Norway have been sustaining high carbon prices, why are we so sure that a few other large nations (say Korea or Spain) wouldn’t be able to pull off a greater-than-$100/ton price as well? My concern is that this book may negatively influence politicians to stop fighting on certain fronts, by setting in stone and formalizing the notion that some policies are “impossible.” In some areas, Cullenward and Victor may be giving up the fight too early.

If you’ve been following climate politics as a professional or amateur, Cullenward and Victor will change how you think. I recommend the book. It is less than 200 pages and pretty readable (for a policy book). It makes a compelling case that listening only to the economists---who model only supply and demand, plus technology cost trends---is a mistake, and that our conceptual model for fighting climate change needs to include politics, crony capitalism, voters’ perceptions, and behavioral economics.


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