A couple of weeks ago, he wrote,
I have a question on the carbon tax issue.
Assume for the moment that the tax imposed accurately reflected the social cost. By the standard theory of Pigouvian taxes, do we actually care whether emissions go down? As long as everyone incorporates the social costs in to their decisions, we’ve internalized the externality, yes?
If demand isn’t very elastic in the range of the tax, then no reduction in emissions (or too low to measure) is the “correct” result, right?
1. I suspect that the main reason a carbon tax tends to have no effect in practice is that it takes a lot of political will and bureaucratic effort to make it really bite. It’s difficult to avoid grandfathering and other concessions.
2. If you drink the climate-change Kool-Aid, then the social cost of carbon emissions is ginormous. If you also believe that demand is inelastic, then you either have to implement quantity rationing (there is a classic paper by Martin Weitzman on “prices vs. quantities” that would justify this) or go for a very high tax.
3. If you believe that demand is inelastic for a very wide range of price+tax, then it suggests that the social cost of reducing carbon emission is ginormous. Then the policy issue becomes a kind of irresistable force vs. immovable object situation.
So I have this conversation with my wife sometimes. She is from Boston and her family has a Cape House we stay in sometimes. She mentions that everyone expects global warming will cause the entire Cape to sink into the ocean with a generation.
Me:
“If that’s true, then why do people own Cape Houses? Why is there a market for Cape Houses that people buy and sell all the time where the price seems to be tracking the inland real estate market normally.”
Her:
“Well, they plan to sell before sea levels rise.”
Me:
“But who are they planning to sell to? What buyer wants to own a house that is underwater.”
Her:
“Well they plan to sell before it’s obvious to everyone.”
Me:
“So people are buying Cape Houses today under the assumption that within a generation they can time when they can find a bigger sucker to pay full price for an asset that will soon be worthless?”
Her:
*confused* Yeah…
Sometimes I mention how even if you think millions of home buyer suckers are waiting to buy worthless homes, surely the insurance companies that insure these home can’t be suckers in the same way. Anyway, you get the point.
This is what global warming talk is like. It’s happening because…experts say it’s happening. The impact will be huge and we will be unable to adapt…but all the smart people will somehow avoid it at the last minute by dumping their worthless assets on the rubes.
Right. “Betting is a tax on BS,” and prediction markets tell us what people with incentives to become as highly informed and rational as it is feasible and economical to be really believe about these claims. We don’t have good, deep, liquid, and direct prediction markets on global warming “social costs”, but we can infer from other existing competitive markets in assets (or financial contracts like insurance regarding on those assets) which are claimed to be in line to suffer the most from those costs whether market participants really believe in those alarmist estimates or not.
Examples include prices of agricultural land said to be prone to future doughts, fires, diseases, insect infestations, or storms, coastal properties, and real estate on clines that are claimed to be expected to rapidly get either too warm in the south, or just warm enough in the north (swap for the southern hemisphere).
Turns out it’s really hard to extract any meaningful “high expected climate costs” signal from the noise of these prices.
Furthermore, we are simultaneously told how renewables and batteries are getting cheaper and cheaper all the time and will soon not just be competive with, but outperform even the cheapest fossil fuel plants, and without subsidies, any decade now. If that’s the case, then why worry, we’ll all be on renewables with batteries to balance peak loads with back-up supply, and fossil fuels will be used mostly as convenient feedstocks to synthesize chemicals.
You could create a whole field studying the divergenec of past and currest academic or bureaucratic estimates vs. an inferred prediction market estimate, to come up with an overall test of the level of trustworthiness of political quantitative claims, and how much BS is out there all the time. The moral of the “replication crisis” story, on steroids. “90% of the kool-aid out there is poisoned, and now we can prove it. Don’t drink!”
Relevant link from marginal revolution a few days after this came out:
“Homes exposed to sea level rise (SLR) sell for approximately 7% less than observably equivalent unexposed properties equidistant from the beach.”
https://www.sciencedirect.com/science/article/pii/S0304405X19300807
Most of the netherlands is below sea level. The cape people should just build polders
The typical sea rise estimates won’t make Cape Cod disappear, even 100 years from now. In the span of one 30 year mortgage, 2 feet is a commonly discussed possibility. Most people in the current flood plain out to within 15 feet of the high tide mark are managing risks and pricing it in, understanding that the decay happens over multiple decades. Some lots that were more expensive 10 years ago, are less expensive now.
The greater danger is some form of tipping point, where a region must deal with rapid changes to wind or ocean patterns, melting accelerates, or where an ecosystem partially collapses.
This isn’t just about climate change. I think there is a a pretty good economic argument for sunsetting fossil fuels without climate change as a factor.
Ultimately, I think a carbon tax is the wrong way to go. We need send clear long term signals to the market, stop issuing new permitting, and sunset the existing permits over the next 20 years. Its funny how no one seems to notice how much the existing fossil fuel industry asks of us in the way of public accommodation and public subsidization. I guess we’ve gotten used to it, and no longer notice.
No one should be allowed to pay the externalities, because you can’t price for them, really. Fossil fuel use evolved into what it is today because we all allowed for the long term public commitment to the necessary sacrifices required to make it work. Without that commitment, it wouldn’t have worked out very well. No energy market simply emerges from market sources. They all require broad public commitment.
I suspect the correct answer is #3. Fossil fuels are crucial to modern agriculture (both to power machines and for fertilizer) and made the widespread use of metals possible (there wasn’t much steel back when you had to make it with charcoal). Without widespread metals, electricity is rare. Without fossil fuels, the industrial revolution would have plateaued in the 19th century and our population would have peaked at perhaps 1-2 billion (compared to the 7+ billion we have today).
I think the key is that fossil fuel elasticity is high in the short term but lower in the long term. One of the key features of a carbon tax working well is that it would be given a long time to work, with a predicable cost. If major infrastructure has a 50 year life cycle, then it will take at least 50 years for a carbon tax to have it’s full effect (R&D and infrastructure will be driven by expected future costs). This includes things like housing construction, power and transportation, etc. To support this, each year the carbon tax rate should be set for the next year, and a window for the tax rate each year forward will be tightened. (inflation adjusted benchmark). As an example the cost next year might be set at $50/t, the year after at $55 (+/-2%) and 25 years out at 150$ +/- 50% (all in next year dollars). Each year the range for each future year is tightened (I am using 2% per year as an example), with the rule being the tightened range has to fit in the previous range. This lets the future trajectory be steered higher or lower, but with enough predictability to make investment decisions. With the current all over the place, is it in, is it out approach it is to hard to price into the future. This is also why if we started with a moderate tax 30 years ago it would be much easier to lower emissions now, as half the infrastructure built (assuming ~50 year investment cycle) would have been built with these costs in mind.
The issue is centuries long so a long approach is needed.
Pigouvian taxes are bad theory.They ignore the ‘market’ for government spending of the taxes. The Pigouvian taxes in the usa are generally used to subsidize the special political groups, making them immune. In fact, inflation adjustment is just that sort of counter tax, designed so that government contracts are immune from the Pigouvian taxes.
I think you (Arnold) and maybe some of the other commentators should read this book:
https://www.amazon.com/Ends-World-Apocalypses-Understand-Extinctions/dp/0062364812/ref=cm_cr_arp_d_product_top?ie=UTF8
It’s definitely not perfect (the author has sort of a rambling, conversational style that I could see being annoying to some people) but I think it effectively gets across some of these ideas about geologic time (and how the time humanity has been around, esp post industrial revolution, is really just a blip) and geological cycles, and just how humans are influencing them in ways that are unprecedented, and what the (long term) effects might be.
I’d like to think I’m not a partisan on this issue. The last book that influenced my thinking this much on environmental issues was Sabin’s book on the Simon-Ehrlich bet, and it influenced it in the opposite direction. The environmental left really comes well meaning, but hysterical and wrong, prophesiers of doom, particularly when it comes to population issues.
https://www.amazon.com/dp/B00E64EGZQ/ref=dp-kindle-redirect?_encoding=UTF8&btkr=1
I’m still very skeptical of government’s ability to effectively “solve” global warming (mostly because as a libertarian I’m skeptical of the government’s ability to solve big problems in general), and I think the wailing and gnashing of teeth that accompanied the US leaving the Paris Accord was sort of ridiculous given how little it would have done. I’m sure the left also underestimates humanity’s ability to adapt via the price system, technology etc.
But this first book also has made me less optimistic, especially in the (very) long run (although there are visible effects even now — it doesn’t sound like prospects are good for coral reefs, for example, over the next 50-100 years). If the argument is we have other, more pressing problems now and don’t need to worry about problems on geologic timescale, that’s fine, but I don’t think dismissing it as “kool-aid” accurately captures the tagline (upper right corner) of your blog.
There is certainly some chance that there is “climate change” — I’m actually expecting, due to a lack of sunspots (& magnetic flux from the sun), to have a very small Icy Decades, two or three, starting next year.
The damage comes from flood & droughts (plus fire) — but see how the gov’t is already messing up with both of those. Yet tech solutions that hugely mitigate the damages are known and possible.
On carbon taxes, a large number of supporters just want “yet another tax”. This should be resisted. If it was “revenue neutral”, it would be far more popular, perhaps popular enough to pass.
This year, estimate what a low but rising carbon tax would raise in tax revenue. Take that amount and send out tax refunds to all tax filers for that total.
Say it’s $100 billion in tax rev. estimated, with some 100 million tax filers — all get $1000 refund (or 100% of what they paid, if less). (But only if they file on time?) They get that THIS year, yet the gov’t starts collecting the tax next year. Then, next year, they raise the tax a bit (5%?) but they find out they actually got $108 billion, so they expect to get about $113 billion, and send out checks for $1,130.
Keeping it revenue neutral makes it politically feasible.
Raising the money means those who use carbon the most, pay the most.
Each year it goes up, until carbon use comes down to a “low enough” level — or the will to increase the rate goes down.
Economists “like” Pigouvian taxes for the incentive to reduce taxes by reducing the taxed behavior. Loopholes make it too easy to avoid the behavior changes needed to make the tax lower, but it is exactly those behaviors that need to be changed.
If we actually had a sufficiently scalable solution to drought, we wouldn’t have deserts any more. With sufficient irrigation and fertilizer (which we do have), they’d be productive farmland. But we don’t.
Demand for carbon emitting products certainly depends on their prices and on the incomes of the people purchasing. For example, different countries do use different amounts of oil. Lower income countries and countries with high gas taxes use much less oil.
In any case, if demand were actually totally inelastic, then a carbon tax would be the perfect revenue source. You could raise carbon taxes and then lower payroll taxes and boost gdp a lot, or, similarly, you could eliminate the phase-outs for a lot of welfare programs that produce 70% tax rates for the poor.
A carbon tax would likely be very regressive, especially if demand turned out to be totally inelastic.
I’m trying to imagine what ultra higher carbon taxes would mean for a family of 4-5 that has to heat a home and commutes to work from the exurbs. Wasn’t this why the French rioted.
Not to mention the effect on anyone whose employment is tied to the internal combustion engine.
If there is no response to a Pigouvian tax the optimal Pigou tax is zero. (Just draw the standard curves and you’ll see this.) That’s the problem with combining Pigou taxes with revenue taxes. In equilibrium an efficient Pigou tax will generate much less revenue tax over time. An efficient revenue tax is too high to be a good Pigou tax.
I was the aforementioned commenter and I’m flattered to have made it to a top level post. Of course, I’m traveling heavily the week it occurs!
As it happens, I have spent way too much time working through both the warming and impact models. (I have a reasonable degree of training in this area and was curious.)
The issue is that the unbiased professional analyses by people like Nordhaus just aren’t very dire–despite the general “it bleeds, it leads” coverage of climate change in the MSM.
Sure, you can find a lot of papers speculating about catastrophic outcomes. I’m sure that’s great for maximizing future grant dollars. But assertions of likelihood are much rarer. Such assertions that have survived critical examination in the literature, rarer still.
The central estimate of the SCC by the Interagency Working Group on Social Cost of Greenhouse Gases under the Obama administration was $42/MTon for 2020. They use three different, thoroughly reviewed models (one is Nordhaus’), 2 of which are semi-open source so other people have played with them and understand how they work. (https://www.epa.gov/sites/production/files/2016-12/documents/sc_co2_tsd_august_2016.pdf)
That would translate into a tax of 4.2 cents per kwh on coal electricity and 1.7 cents per kwh on gas electricity. The US average price of electricity in December 2018 was 10.3 cents per kwh. A gallon of gas would have a carbon tax of 37 cents per gal. The US average cost per gallon in December 2018 was $2.34.
So I contend that Climate Change is _exactly_ the situation where Pigouvian taxes should do the job. We have an activity that produces large benefits and has some external costs. We need to make a modest adjustment that will result in somewhat less of the activity due to substitution of alternatives in circumstances where they make sense at the margin.
The trouble is that the atmosphere doesn’t care at which particular geographic coordinates CO2 is released.
That means that ideas like single-government taxes or markets that work for polluting emissions with a more “local” or regional impact won’t extend globally without substantial augmentation by other, highly unlikely policies to deal with activities in other, remote, and independently sovereign jurisdictions.
Everybody – even Krugman – knows this, and knows that the political problem is completely intractable and makes most proposals non-starters as utterly futile, and so apparently the polite thing is for the climate wonks to agree to pretend it doesn’t exist and not to mention it.
There is plenty of reason to be skeptical of the SCC analysis, for example, the fact that it relies on laughably precise and long-term global Macroeconomic forecasting, that it is extremely malleable and sensitive to small tweaks in assumptions hard to empirically validate, and that it is also sensitive to political determination, e.g., Obama’s OMB nearly doubled it, having officially stood at only $21 in early 2013, while Trump’s OMB lowered it to $1.
But even if one accepts a high figure for the sake of argument, the line of reasoning above only holds under conditions of open international trade if one also insists that every other country do the same (which requires the prospect of some kind of implausible coordination, treaty, and compliance inspection regime), or the imposition of complex, country-and-particular-business-operations-specific tariffs on every import proportional to the tax on the amount of carbon dioxide one estimates was released during the production of the good or service plus what will be released during its use.
For example, importing cement from certain plants in Canada (where the US gets most of its clinker imports) which use natural gas to heat the lime would have to have a different tariff than its efficient coal-using facilities, which would have to have a different tariff than imports from China which tends to use less efficient coal-based methods. But even import services such as internet services which consume a lot of electricity in their production would have to be taxed at some rate, and there would have to be a whole new tariff-setting and surveillance bureaucracy established to constantly supervise and refine these rates. And then there’s the issue with every other country retaliating with their own tariffs according to their own different policies and analyses.
Otherwise, unilateral imposition of carbon taxes in one country won’t be Pigouvian because they won’t achieve anything but regulatory arbitrage and site switching, or may even have perverse results such as killing off a local industry in favor of offshoring production that could most efficiently be done domestically, but then also adding in additional costs (and emissions!) of transport.
There’s another problem too. Imposing carbon taxes high enough to bite and lower consumption doesn’t just raise the cost of fossil-based energy, it also raises the costs of many renewable energy approaches. It takes a substantial amount of carbon dioxide emissions to smelt silicon and float the glass for solar panels or refine lithium for batteries, or to make cement and steel to anchor wind turbines or to construct and armor nuclear reactors.
I agree with all this. The difference between theory and practice here is vast. My point was that, assuming our serious SCC estimates are in the rough ballpark, a global Pigouvian tax is a good theoretical solution.
This isn’t a useless conclusion. It gives us a point of comparison for any proposed practical solution. And it makes things like electric car subsidies, rooftop solar mandates, etc. look pretty bad in terms of both effectivenesss and deadweight loss.
And just FYI, the latest papers using empirical climate data to constrain the ECS yield SCCs closer to $10 when you plug them into in the IAMs. $5-20/Mton is my personal synthesis. So obviously, I’m not too worried if we don’t find a good practical solution.
That’s cool. On most issues I try to look up the studies/statistics/data and do the work myself. But with climate I know I’m so in over my head I gave up on that. I try to make up my mind based on proxies like market prices, human behavior, common sense. Which basically left me with “it could be happening, but people aren’t treating it like its a disaster. At worst an inconvenience.” Given the political and economic difficulties Handle outlines below, it basically just makes it “this thing you have to live with but its not to bad.” Gas taxes may or may not make sense for other reasons, though now that fracking is so big I get the feeling a lot of pressure has been taken off.