Without Climate Legislation, We Might Get More Regulations!

Filed Under (Environmental Policy, Finance) by Don Fullerton on Oct 22, 2010

On Tuesday October 19, the Center for Business and Public Policy (CBPP) presented a panel of experts on “Environmental Regulation: Building a Low-Carbon Economy.”  It was sponsored by the College of Business and the MBA Program with financial support from State Farm.  This blog may help tie our virtual audience to activities at the “brick and mortar” University, with a few reflections of my own.

Climate legislation recently failed in this Congress, so the U.S. will not soon adopt any cap-and-trade policy.  To provide incentives for Congress to act, however, the Obama Administration had said that otherwise the EPA will act to reduce carbon emissions using other forms of regulation under the Clean Air Act.   The key question here is what can or should be done without climate legislation.  The Panel members were asked to discuss the future of energy use, its role in creating a low carbon economy, and what future energy policies and regulations will be needed.

The first speaker was William A. Von Hoene Jr., the Exelon Corporation’s Executive Vice President for Finance and Legal.  Exelon has 17 nuclear reactors at ten locations, as well as other plants powered by hydro, wind, solar, landfill gas, and fossil fuels.  Their electricity is relatively low in carbon emissions, with 5.4 million customers primarily in Illinois and Pennsylvania.  They favor carbon pricing because it reduces overall abatement costs relative to a patchwork of tax credits for certain technologies and mandates such as “renewable portfolio standards.”   Those policies might not target the cheapest form of abatement, whereas a carbon tax or cap and trade price would provide clear and crisp signals to reduce emissions in any of the cheapest ways.  He also talked about their “Exelon 2020” business strategy of greening their operations, helping customers reduce emissions, and producing more low-emission electricity.

A problem, of course, is that none of these other technologies are very cheap.  Protections for nuclear power may prevent any new plant, and the U.S. has no long term storage plans anyway.  Other renewable options like wind or solar are not cost-effective unless the cost of coal-fired electricity is raised by a carbon dioxide tax of more than $30 per ton.

The second speaker was Mark Brownstein, Deputy Director of the Energy Program for the Environmental Defense Fund.  He talked first about “what went wrong” with climate legislation in Congress.  Divisions were not just by party but by region, since the President’s plans were offset by a coalition of Republicans and coal-state Democrats.  The recession also added to perceptions that markets don’t work, which spills over to carbon permit markets.  He also talked about “what’s next”, including renewed effort to put climate legislation back on track, with eyes on state action and EPA regulations.   Finally, he discussed “what’s the focus” at EDF.  Besides continued discussion of climate policy and EPA, they are interested in energy market reform.  For example, smart grid technology that links various electricity markets can allow more people to buy power from areas that have newer and cleaner production.

The third speaker was Jon Anda, UBS Securities’ Vice Chairman and Head of Environmental Markets.  He also extolled the virtues of carbon pricing, because it would encourage new technology that could help the U.S. compete internationally.  It would “decarbonize” production at the least cost, minimize leakage, and realize various “co-benefits” (reductions in other pollutants).   In particular, he pointed out that a carbon permit system should not apply to utilities only, because reduced emissions among utilities would be offset by increased emissions elsewhere (“leakage”).  It needs to cover all use of all fossil fuels. 

For example, carbon pricing for utilities only would raise the price of electricity, but that could discourage the use of electric vehicles.  Carbon pricing also needs to apply to gasoline, for drivers to make the right tradeoffs between whether to buy an electric car or a fuel-efficient gasoline car.

Why Low-Carbon Technology Innovation is Not Enough

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Mar 19, 2010

Nobody likes new taxes.   When policy wonks like me talk about addressing the problem of global warming by introducing a carbon tax, nobody listens (even though all of the tax revenue could be returned by cutting OTHER distorting taxes on labor or on investment!).  Instead, policymakers like to use the Manhattan Project analogy, essentially saying that we can solve the whole global warming problem just by research and development (R&D), innovation and diffusion of new technology.  We’ll just throw money at the scientists, and they will solve the problem for us.  Policymakers want to subsidize or require wind power, solar power, and other low-carbon technologies.

Here is why that idea will not work, for reasons based on some new research in a book called “Accelerating Innovation in Energy: Insights from Multiple Sectors”, edited by Rebecca Henderson and Richard G. Newell.     To see what might work for energy, they look at technology innovation in all the other sectors where R&D has been successful (the internet, chemicals, agriculture, and semiconductors).  They find that three elements were key in ALL of those success stories: “(1) the substantial, differentiated, end-user demand that enables private firms commercializing the technology to anticipate healthy returns; (2) the sustained funding and effective management of fundamental research; and (3) the development of an institutional environment that includes robust mechanisms to promote the widespread diffusion of both knowledge and technology and that favors vigorous private-sector competition.”

My point is all about #1: there has to be demand in the market for the technology.  No matter how much money Congress throws at the problem of research into new energy technologies, the program will not be successful unless people want to USE those new technologies.  And people will not particularly want to use those new low-carbon technologies, unless they face a carbon tax!  The researchers and developers of new low-carbon technologies might have great ideas, but those ideas will not come to fruition unless people are chomping at the bit to get those new technologies and use them to increase their profits or reduce their carbon tax burden.

My own thinking about this problem relates to the fundamental reasoning for any government policy intervention: the private market works fine unless you can point to a fundamental market failure.  One market failure is the pollution externality from carbon emissions, and that can be addressed by a carbon tax.  A different market failure is that any private firm might not have sufficient incentive to undertake R&D if they don’t capture all the benefits from it.  Patents only last for 17 years, not all ideas can be patented, other firms can see those ideas, and other firms can get similar patents for similar technologies.  These “knowledge spillovers” are a possible justification for government intervention to subsidize basic research, the kind of research that private firms would not undertake sufficiently.

But we still have two different market failures!  Two different market failures require two different policies to address them.  Subsidies for research might help address the knowledge spillover problem, but we still need a carbon tax to get people to want to use those technologies.

That is why we can’t solve the global warming problem by just throwing money into research.

The Glass is Not 90% Empty; It’s 10% Full!

Filed Under (Environmental Policy) by Don Fullerton on Dec 22, 2009

Happy Holidays, everybody.  I’ll keep this short, since we’re all out of school and busy with family.  I just had a few thoughts on the further deliberations about climate change in Copenhagen.

Some observers might be disappointed about how little was achieved there, but I think that such a view would be based on expectations that were entirely unrealistic.  It would seem impossible to get 193 different nations to agree on anything!  The process is long and difficult, and we could not have expected more than a step or two in the right direction.

Certainly we could not expect a major leap into stringent mandatory reductions of all greenhouse gas emissions.   The world does not yet have enough experience with climate policy, in order to know how it works, how expensive it will be, what are the abatement alternatives, and how the permit trading will operate.   Only some of the nations of the world agreed to the Kyoto Protocol in 1998, and that was viewed as a major achievement.  Even that agreement delayed the first major mandatory cuts by ten years, to 2008-2012.  To prepare for that mandatory phase, the European Union instituted a Phase I of permit trading to meet its own voluntary reductions during 2005-2008.  This “emissions trading system” (ETS) became the largest pollution trading market in the world, and it offers several lessons to the rest of us.  It started with only moderate emission reductions, and a price of only 10-15 Euros per ton of carbon dioxide.  The businesses and other institutions gained experience with permit trading and are now ready to participate in Phase II.

Similarly, it would be a great achievement to involve more nations of the world, even with only slightly more stringent emissions reductions, to gain more experience before leaning on the rest of the nations to participate.

Much of the debate is about whether the U.S. should enact legislation unilaterally, without any new international agreement.  It might be dumb to give everybody else a major advantage in term of production costs.  Again, I would point out the difference between initial small steps, as opposed to the large steps that are needed eventually to deal seriously with climate change.  If we all wait until all nations agree to major cuts, it may never happen.  An important and viable alternative is for the U.S. to lead the way with some small steps, even by ourselves – to establish a climate policy, to impose some moderate emissions reduction, to set an example for the rest of the world, and to proceed then to lean on other nations to join an agreement.

I’d recommend reading the blog by Robert Stavins of Harvard.   He provides a very useful summary of the Copenhagen agreement and some analysis of it.  As inducement to click on his link, I’ll paste just his concluding paragraph here:

“The climate change policy process is best viewed as a marathon, not a sprint.  The Copenhagen Accord – depending upon details yet to be worked out – could well turn out to be a sound foundation for a Portfolio of Domestic Commitments, which could be an effective bridge to a longer-term arrangement among the countries of the world.  We may look back upon Copenhagen as an important moment – both because global leaders took the reins of the procedures and brought the negotiations to a fruitful conclusion, and because the foundation was laid for a broad-based coalition of the willing to address effectively the threat of global climate change.  Only time will tell.”

Does a Carbon Tax need a “Border Tax Adjustment”?

Filed Under (Environmental Policy) by Kathy Baylis on Dec 4, 2009

When our colleague Don Fullerton was in Brussels this week speaking at a conference on climate change, he voiced support for border adjustments for carbon policies. This idea was promptly rebuffed with cries of ‘protectionism’, particularly from the business participants. Now, a border adjustment is just a friendly way of saying ‘an import tariff,’ so it’s understandable that people might see them as a harbinger of protectionism. Like most trade economists, I’ve seen many examples of trade policies that were reputedly intended to ‘level the playing field’, e.g. countervailing duties and anti-dumping tariffs, promptly get co-opted and used as a means to protect the loudest domestic industries, so I am sympathetic to this concern. That said, I think there are a number of compelling arguments for introducing some border controls along with a stringent domestic carbon policy.

Think of a carbon tax or cap-and trade system like a Value-Added Tax (or VAT), where border-adjustments are common. Most countries that tax the value-added in production of each good also tax imported goods at the same rate. They do this to ensure that imported goods aren’t given an unfair advantage over the taxed goods produced domestically. The same logic applies to a carbon tax, or a cap-and-trade system on emissions. The idea is that we would like to tax imports at an equivalent rate as domestic production. Thus, we would impose a tax based on the average carbon content of the equivalent domestic product. This approach conforms with the WTO rule of equivalence – that a country doesn’t favor its own producers over producers in another country.

Is designing a border adjustment going to be harder to do for carbon than for a VAT? Definitely, because carbon content is harder to measure than value-added, which is just a price. It also means using domestic carbon content as a proxy for the carbon content in imported goods, which is not going to be accurate. The problem is that the alternative is trying to estimate specific carbon content for all imports, which is not only impossible, but also generates the potential for problems with the WTO.

Now you might well be thinking, you’re suggesting imposing an imperfect, potentially arbitrary tariff on billions of dollars of imports. How can this be a good thing? Let me walk through a few arguments.

1) If you don’t have a border adjustment, other countries have an incentive not to sign on to an international carbon agreement. By imposing a carbon policy domestically, we are raising the marginal cost of production inside the United States, so it gives firms the incentive to move to a lower-cost location as long as they continue to have access to the US domestic market. From the perspective of, say, Indonesia, a US carbon policy might make the US look quite tempting as a potential market. And the last thing they want to do is to get rid of this advantage by imposing a carbon policy themselves.

2) In contrast, a border adjustment means that a country like the US or Europe does not have to wait for an international climate agreement before implementing a carbon policy. In short, because it neutralizes the potential negative trade effects of a carbon policy, it becomes easier for a country to ‘go it alone’ and not have to wait for other developed and developing countries to sign on to a Kyoto-like agreement.

3) Similarly, if you do have a border adjustment, it can be used as an incentive to get other nations to implement a carbon policy, particularly developing countries with a large export base. Only those countries without a carbon policy would be subject to a border adjustment, and the revenue from the border adjustment accrues to the importing country. So an exporting country faces the choice of letting their firms pay the tariff to someone else, or collecting that revenue themselves in the form of a carbon tax or (auctioned) cap and trade permits. So even if the border adjustment is imperfect, one can hope it’s temporary.

I can see my trade colleagues wincing at their computer screens while they read this. Yes, we have had loads of trade measures that were supposed to be temporary that ended up becoming enshrined by the interests that they benefit. So my last argument is for them.

4) Without a border adjustment, import-competing industries will demand special treatment in the form of free permits, or, of more concern, outright exemptions from the carbon policy. Why do I claim this? We’ve seen it in Europe. Under the European Trading System for carbon, each country was allowed to exempt certain industries from the cap-and-trade system, and they particularly targeted those firms in ‘trade-sensitive’ industries. Along with generating concerns about environmental efficiency, such exemptions generate potentially large economic inefficiencies domestically and are incredibly arbitrary. Thus we tend to see the most politically-sensitive industries often identified as the most ‘trade-sensitive’. At least a border adjustment could be designed to be neutral across domestic industries, reducing the potential gains for firms in politically-powerful positions. As an aside, note that industry-specific subsidies could include exemptions to costly general environmental regulations and are subject to countervailing duties (CVD). Thus, I wonder if we might see such exemptions generating a cascade of CVD cases.

OK, I always find it frustrating when people from other disciplines pretend to be economists, so let me be clear that I’m not in any way a trade lawyer, so I can’t speak convincingly on the trade legality of these ideas. That said, we know that border adjustments for VATs are allowed under the WTO. You might also be concerned, however, that any border adjustment policy might spark a trade war, which our anemic global economy certainly does not need. In response, let me note that when the Uruguay round of the GATT was concluded, countries signed on to a ‘peace clause,’ where they agreed not to take trade actions against their fellow countries on agricultural subsidies as long as those subsidies conformed to the Agreement on Agriculture. To facilitate carbon policy, I wonder if there might be the potential to negotiate a similar peace clause for environmental subsidies and/or border adjustments as long as those border adjustments conform to some internationally-agreed upon rules. For example, these rules might try to ensure that countries treat importers no differently than they treat their domestic industries, and that the border adjustments be transparent and apply equally across industries.

In conclusion, border adjustments might help make domestic carbon policy both more palatable and more efficient, and could, in fact, be less harmful to free trade than allowing one-off industry exemptions.

Recognizing the Costs and Benefits of Climate Change Policy

Filed Under (Environmental Policy, Uncategorized) by Jeffrey Brown on Nov 4, 2009

I am posting a day later than usual this week because I spent a good part of yesterday participating in a fascinating discussion about U.S. policy towards climate changes sponsored by the Center for Business and Public Policy, the Institute for Government and Public Affairs, and the Environmental Change Institute (all at the University of Illinois).  Three highly accomplished experts on climate change (Charlie Kolstad, Don Fullerton, and Nat Keohane) discussed the various approaches to tackling this global policy priority.  The conversation was refreshing for its analytical clarity, its recognition of both the benefits and costs of alternative policies, and for the fact that it was good economics set against a backdrop of political realism.  It left me wishing that more of our policymakers in Washington would have such high quality conversations when making their decisions.   

 

In preparing my own thoughts for this event, I read through some of the material from two of the many “sides” in the debate over climate policy legislation – the views of the U.S. Chamber of Commerce and the views of the Obama Administration.  Doing so brought back memories of my own days in the White House (in 2001-02 under President Bush).  Specifically, it made me remember the constant struggle between the economists and policy wonks who want to have honest and nuanced discussions about complex issues, and the “spin masters” whose job it is to effectively communicate to the public in a simple way.  I understand the value of simplicity for communication, but all-too-often, the truth gets “simplified away.”

 

Economics is fundamentally about trade-offs.  Perhaps no phrase is more famous for capturing this idea than “there’s no such thing as a free lunch.”  But to listen to the opponents and proponents of climate change legislation – at least after they have been filtered through the communications shops – one could be forgiven for thinking that our policy makers do not understand this.    

 

Let me give two examples – one from each side.

 

The U.S. Chamber of Commerce has an official position on climate policy that states:

 

“Our position is simple: There should be a comprehensive legislative solution that does not harm the economy, …”

 

What is remarkable about this statement is that they do not say that the legislative solution should be one in which “the benefits clearly outweigh the costs.”  Rather, they are imposing a truly impossible standard – that the solution “does not harm the economy.”  The most straightforward interpretation of this is that they are unwilling to accept any cost or slowdown in economic growth in order to reduce emissions.  Unless you believe that there are no costs to climate change and/or no benefit to any solution, this cannot possibly be an optimal – or even rational – policy.  

 

Proponents of climate change often make equally vacuous statements.  To hear many in the Obama Administration speak of climate change, you would think that environmental regulation is good for the economy rather than a cost.  They focus their attention on the number of “green jobs” that will be created, while largely ignoring the large number of jobs in other industries that will be destroyed.  I’ve yet to see a single study showing that environmental regulation is a NET positive for economic growth or job creation in the U.S. 

 

What we need – on this and so many other issues – is a “grown-up conversation” about the costs and benefits.  Of course we know that reducing emissions levels will be costly.  Of course we know that it will require changes in the way we consume and produce energy.  The question is not whether climate policy can be done at no harm to the economy or can even benefit the economy – the question is whether the benefits of reducing emissions is worth the cost. 

 

Fortunately, even if the “talking heads” are not having these discussions, serious thought leaders like those at our forum yesterday are.  Let’s just hope that policymakers listen.

 

     

 

 

 

 

 

 

 

 

Climate Legislation, the Senate, and International Treaties

Filed Under (Environmental Policy) by Don Fullerton on Nov 1, 2009

This week the Senate began committee hearings on S-1733, the Kerry-Boxer Bill, with a mark-up expected within the next two weeks.  The authors modeled their Senate bill on the House’s Waxman-Markey Bill that passed the lower chamber in June.  The main component of both bills is a cap-and-trade system to limit greenhouse gas (GHG) emissions in the United States.  Although the Congress has a full agenda, legislative action is critically important at this moment due to the upcoming United Nations Climate Change Conference in Copenhagen, to prove the United States is willing to participate in global GHG mitigation.  (For more information visit: http://en.cop15.dk/)

When the U.S. negotiators sent by President Obama return from Copenhagen, any treaty they sign must be ratified by the Senate with a two-thirds vote, before it could take effect.  This check on the power of the Executive branch is enumerated in Article II, section 2, of the U.S. Constitution, which states the President “shall have Power, by and with the Advice and Consent of the Senate, to make Treaties, provided two-thirds of the Senate present concur.”  Thus, a treaty must gain the support of 67 senators in order to take effect, a number unrealistically high for an issue as contentious a climate change.

If any agreement in Copenhagen is not signed or not ratified, however, it does not mean that the U.S. cannot be a partner in a global climate solution.  Indeed, the U.S. can act as a de facto treaty member by passing domestic climate change legislation that can be harmonized with international standards.

To enable harmonization with an international treaty, domestic legislation requires three main features.  First, for fairness and competitiveness, the emission reduction targets must be comparable to those of the other industrialized economies such as those in Western Europe.  Second, to reduce the total cost of GHG reductions, it must allow for the sale and purchase of verifiable allowances across international borders.  Third, it must establish a mechanism for technology or monetary transfers to developing countries, lessening their mitigation burden and hopefully bring countries like China and India into the agreement.

The Senate proposal and the House bill demonstrate to the international community that the U.S. is serious about climate change mitigation.  Indeed, the framework in these bills provides a basis for U.S. negotiations in Copenhagen, and furthermore, any agreement at that international conference will influence the final form of the domestic legislation.

Alternative Policies to Reduce Greenhouse Gas Emissions

Filed Under (Environmental Policy) by Don Fullerton on Oct 11, 2009

I’m a tad late to upload my Friday blog, since it’s already Sunday, and now Charlie Kahn has beaten me to the punch.  I’ll assume it’s better late than never, and still provide what I could have uploaded on Friday.  As I said last week, I was invited to speak about climate policy to the 27 Finance Ministers of the 27 countries in the European Union.  The EU has an “Emissions Trading System”, which is a carbon dioxide cap and trade permit system — an economically efficient way to cut greenhouse gas emissions.  But it only covers electric utilities and certain other industries, only 45 percent of emissions in Europe.  For some reason, they don’t want simply to expand that system to cover the whole economy, as they certainly could.  So the question is what to do in the “non-trading” sector.  Anyway, here is what I told them:

I’m greatly honored to be able to talk to you today, about the choice among policy instruments for pollution abatement.  It is a very difficult but important job you are undertaking, the planning for efforts to reduce emissions of carbon dioxide and other greenhouse gases (GHG).  I cannot help you with the details of policies in Europe, but I hope to be able to clarify a few of the conceptual issues in the choice of policy.

All pollution abatement polices can be grouped into two broad categories.  On the one hand, we have traditional regulations such as technology mandates or performance standards.  Examples include energy efficiency standards, building codes, mandated use of renewable fuels, scrubber requirements, and vehicle fuel efficiency standards.  On the other hand, we have market-based economic incentives that impose a price per ton of emissions.  Examples include a carbon tax or cap-and-trade permit system.

In the comparison among these alternatives, I will focus primarily on cost efficiency, by which I mean the ability to achieve the minimum total cost for any given amount of abatement.   In this regard, all of the policies listed above could achieve the same cost efficiency, if policymakers have full information about all the costs of all the technologies.  With only the use of regulatory mandates, for example, then legislative bodies would have to specify which areas should use wind or solar power, which areas have ready access to natural gas, and which areas have geology that might be favorable for carbon sequestration and storage.  Policymakers would have to identify the cost-effective technologies for each different product or activity.  If all this information were available, and the regulations required only the least-cost ways to cut greenhouse gas emissions, then this approach could be perfectly cost effective.

In contrast, the use of a carbon tax or permit system effectively imposes a price per ton of carbon or other greenhouse gas emissions.  For sulfur dioxide and other pollutants, such pricing requires measuring emissions that actually emerge from each smokestack.  Emissions of carbon dioxide do not have to be measured directly, however, because those emissions are directly related to the carbon content of the fuel being burned.  A tax or permit price can be imposed on each ton of coal at a rate that reflects the carbon content of that coal, and on each barrel of oil at a rate that reflects that carbon content.   In fact, this price is even easier to collect if it is imposed not “downstream” on each of the millions of businesses that burn fossil fuel, but instead “upstream” on the relatively few firms that produce such fuel (that is, at the mine mouth, oil well, or natural gas pipeline).   Either way, it raises the price of fuel that is carbon intensive, and therefore reduces the use of whatever fuel is the most carbon intensive.

So far, the various alternative policies could be roughly equivalent.   If a cap-and-trade system limits the total amount of carbon dioxide and drives the price of a permit up to €16 per ton, then that policy has the same effect as a carbon tax at the rate of €16 per ton.  With full information, the two “market-based” incentive policies are identical.  The difference between them is subtle, and it only arises with uncertainty or imperfect information about the costs of alternative abatement technologies.  In that case, a carbon tax places a clear and certain price per ton of carbon dioxide emissions, and it encourages all of the cheapest forms of abatement, but policymakers cannot be sure about exactly how much abatement will be undertaken.  In contrast, a cap-and-trade system places a clear and certain limit on the total amount of emissions, to achieve a certain amount of abatement, but we cannot be sure exactly what the price is going to be.

Either way, however, a price per ton of emissions achieves cost-efficiency, because it provides incentives to businesses and households to undertake any abatement that costs less than the price per ton of emissions, and it encourages them to forego any form of abatement that costs more than the imposed price per ton of emissions.

This discussion now brings us to the major difference between market-based incentives and the other more traditional forms of regulations like technology mandates or performance standards.  And this difference is large and important, not subtle.  In most cases, policymakers are never going to know the cost of each technology or method of pollution abatement.  That information may be very technical, and it is specific to each firm or each location.  Only the engineers within a firm may be able to figure out what are that firm’s most cost-effective technologies.  Any mandates imposed from outside are unlikely to require the cheapest technologies, and they may require some very expensive technologies.  Only omniscient policymakers could achieve cost-effective abatement.

Because this point is so important, let me elaborate by example.  The sector covered by the permit system includes many kinds of activities with many possible abatement projects, but consider just the six projects shown in the graph.  Each may have a very different cost per ton of abatement.   If a set of mandates were to choose imperfectly, it could require expensive technologies and miss some cheaper options.  With a single price of €16 per ton, however, then the various businesses could choose for themselves, knowing what they know about the costs of their own technologies.  All projects cheaper than €16 per ton are undertaken, and the expensive ones are not.

Now consider the second part of the graph, showing some projects in the sector not covered by the permit trading system.  With no policy in the uncovered sector, then none of these projects may be undertaken by firms there, even cheap projects that cost less than €16 per ton.  Again, policymakers could try to “pick the winners”, but perhaps without the inside information required to know which are really the most cost-effective methods of abatement.  Imperfect mandates could require some expensive options, and skip some of the cheapest ones.  Finally, consider a carbon tax in the uncovered sector.  If the tax is set at a rate of, say, €10 per ton, then the firms have incentive to undertake any project that costs les than €10 per ton of abatement, and not the more expensive ones.  In this case, abatement is cost-effective within the uncovered sector.

Unless the rate of tax in the uncovered sector is the same as the permit price in the covered sector, however, the overall effort is not really efficient.  In the example of the second graph, where the permit price is €16 per ton and the tax is €10 per ton, then the uncovered sector would not undertake the two projects that cost €11-14 per ton, even though those projects cost less than some of the €16 projects undertaken in the covered sector.  In fact, overall efficiency is improved by making the tax rate in the uncovered sector closer to the actual permit price in the covered sector.

An Interview in Sweden

Filed Under (Environmental Policy) by Don Fullerton on Oct 2, 2009

I usually upload a new blog each Friday, but this week I traveled from Illinois to Sweden, where I am honored to be invited to address the collected Finance Ministers of all 27 nations in the European Union.  They are meeting in Sweden, because that nation currently holds the rotating presidency of the European Union.  They are having meetings about the economic downturn and other financial matters, but one of their meetings is about climate policy.  This meeting is intended to prepare for the December negotiations among all the nations in the world in Copenhagen.  Already the European Union has an Emissions Trading System (EU-ETS) that places a price on carbon dioxide emissions in the trading sector, but the trading sector includes only about 45 percent of carbon dioxide emissions.  Thus they wonder what policy could be used to reduce greenhouse gas emissions in the non-trading sector.  As one option, they are considering a carbon tax.  I’ll write more about these policies later, when I’m back in the United States, but meanwhile I thought I would upload a copy of the interview that was published on their website.

“The most important thing is an agreement in Copenhagen”

“The single most important action to reduce carbon dioxide emissions is for all nations of the world to agree to binding emission limits when they meet at the Climate Change Conference in Copenhagen.” So says Professor of Finance Don Fullerton from the University of Illinois, who is one of the speakers at this week’s meeting of finance ministers in Göteborg.

On Thursday and Friday the EU’s finance ministers and governors of central banks will meet in Göteborg. Don Fullerton, an expert on taxation and environmental economics, has been invited to speak about cost-effective policies for reducing carbon dioxide emissions.  “I consider that the sectors not under the EU Emissions Trading System could also be made to face a tax on carbon dioxide emissions. This policy is cost effective because it is expected to provide incentives for businesses to cut emissions by any of the cheapest ways possible”, says Don Fullerton.

Don Fullerton’s work aims to find the cheapest ways to reduce emissions. The cheaper the methods, the more likely that they will be accepted by the public and implemented by policy.

Cheaper to act now

“It is not realistic to believe that we can cut carbon dioxide emissions without any costs at all”, says Don Fullerton.  “But the world still gains by cutting emissions now, because the cost of doing so is less than the cost of global warming if we don’t act.  The longer we wait, the greater the consequences in the form of sea level rise, loss of biodiversity, etc.  The cost of stopping global warming later on will be higher.”

Strength in numbers

In Don Fullerton’s view, all countries of the world must act together to reduce emissions and reach an agreement in Copenhagen.  “A small set of nations cannot do it alone, because one set of emission cuts could be more than offset by increases in carbon dioxide emissions elsewhere. When the governments have reached an agreement in Copenhagen and each nation has to cut emissions, then the most important policy for each nation is to put a price on emissions, either by an emissions trading system or a tax on greenhouse gas emissions”, concludes Don Fullerton.

Speakers

Besides Don Fullerton, a number of other economists are coming to address the finance ministers and governors of central banks at the ministerial meeting in Göteborg. These include Lars Nyberg from the Riksbank (Swedish central bank) who will speak about financial supervision and crisis management, Jean Pisani-Ferry, Director of the think tank Bruegel in Brussels, Francesco Giavazzi, from Bocconi University and MIT, who will speak about ‘exit strategies’, and Stephen Nickell from Nuffield College in Oxford who will speak about employment policy.