This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org
This article is from the July/August 2014 issue.
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Primer
Climate Policy as Wealth Creation
A “cap and dividend” policy would embody the principle that we all own the earth’s resources in equal and common measure.
We know that climate change poses a grave threat to the earth and all who live on it. We also know, in the broadest sense, what we need to do to preserve a habitable planet: severely curtail greenhouse gas emissions from fossil fuels. The question of how to cure ourselves of our fossil-fuel dependence, however, has so far proven devilishly difficult. Possibilities like carbon taxes or carbon caps (and limited emissions permits) are widely discussed, but have so far run into political roadblocks: the power of vested interests like oil and coal companies, the attachment to fossil-fuel based ways of life, the fear of the economic costs involved, and the problem of coordinating national policies (and dividing up costs) to address a global problem. Economist James Boyce offers a policy proposal, based on the development of public-property rights over the atmosphere and the sharing of the proceeds from its use, which is both politically feasible and philosophically profound. This article is adapted from a lecture Boyce delivered, on March 31, as part of the “Climate Change Series” at the University of Pittsburgh Honors College. —Eds.
Why Climate Policies That Operate on the Supply Side?
Broadly speaking, there are two types of policies to reduce carbon emissions from fossil-fuel combustion. One set operates on the demand side of the picture, on the need for fossil fuels. These policies include investments in energy efficiency, alternative sources of energy, mass transit, etc.—investments that reduce our demand for fossil fuels at any given price.
I’m going to focus on the complementary set of policies that operate not on the demand side of the equation, but the supply side—policies that raise the prices of fossil fuels, resulting in lower use. Those policies raise prices either by instituting a tax on carbon emissions or, alternatively, by putting a cap on emissions and thereby restricting supply. In the same way that OPEC restricts supply when it wishes to increase the price of oil, a cap works to raise the price, too.
The policies that involve shifts in demand—investments in mass transit, clean and renewable energy, or energy efficiency—take time, possibly decades, to be fully implemented. In the short run, if we want to see immediate reductions in fossil-fuel consumption, we need policies in the mix that operate on the price today, and reduce consumption today. That’s one reason I think that price-based policies can and should be part of the policy mix.
In addition, price-based policies themselves are critical to the reduction in demand. If consumers, households, firms, and public sector institutions know that, over the next decade or two, the price of fossil fuels will inexorably rise due to policies purposely making that happen, they will have an incentive to make investments in energy efficiency and renewable energy sources. They will face price signals to push that investment along.
The easiest way to put a price on carbon emissions is through an “upstream” pricing system, which means that you apply the price where the carbon enters the economy, not where it comes out the tailpipe. So that would mean at the tanker terminals, the pipelines, the coal-mine heads, where fossil fuels are entering the economy. The Congressional Budget Office (CBO) estimates than an upstream system in a cap-and-trade or carbon tax regime would involve 2,000 “compliance entities”—that’s the name for the folks who have to either pay the tax or surrender a permit for each ton of carbon they bring into the economy. If you tax carbon or price carbon upstream, those price increases become part of the price of the fuel and are passed along to business and consumers, thereby creating incentives for investments that reduce emissions over the longer haul.
There are two instruments that one can use to price carbon—one is a tax and the other is a cap. A tax sets the price and allows the quantity of emissions to fluctuate. A cap sets the quantity and allows the price of emissions to fluctuate. Other than that, they’re basically the same thing. You can think of them both as involving permits. A tax says, “Here are permits, as long as you pay the price for them, you can have as many permits as you want.” A cap says, “Here is the fixed number of permits, and we’re going to let their price be determined at an auction or in a market.”
Is Climate Change a “Tragedy of the Commons”?
Ecologist Garret Hardin coined the now-familiar phrase “the tragedy of the commons” in a 1968 article in the journal Science. Hardin argued that people inevitably deplete commonly held resources because they do not pay the full cost of using them. For example, livestock herders have an incentive to overgraze their own animals on common pasture—maximizing the benefits to themselves, while inflicting the costs of the overgrazing on others. Similar arguments have been made about the depletion of fisheries and many other environmental problems, among them climate change: each person enjoys the private benefits of fossil-fuel use, depleting the finite capacity of the atmosphere to absorb and recycle greenhouse gases, and inflicting damages on others. Mainstream economists often seized upon this reasoning to argue that the solution to environmental problems is the division and enclosure of commons into private property, which would mean that each owner would bear the full cost of using his or her own property.
What economists are describing as “the tragedy of the commons,” Boyce argues, would be better described as the “the tragedy of open access.” Open access allows individuals to appropriate resources at no cost, and when these resources are scarce, to inflict the costs of depletion on others. Understanding that a commons, however, can be “regulated through a system of common-property resource management,” recasts the problem—and the solution. Protecting and preserving these resources does not require privatization: it can be achieved thought the development of public-property rights and regulations over their use. —Eds.
If we had a tax to put a price on carbon emissions, I’d be all for it. But since the main policy objective is to hit the quantity target—to reduce the quantity of emissions—it seems to me that targeting the quantity rather than the price makes a lot of sense. We don’t know for sure exactly what the relationship is between quantity and price. We know that a 10% increase in prices results in roughly a 3% reduction in demand in the short run, but that relationship isn’t precise. Moreover, it can change over time, particularly as more technologies are discovered. So if you want to hit the quantity target, it seems to me that setting a cap has advantages over setting a tax.
One way or another, however, what’s important is to get a price on carbon. When we put a price on carbon, what we’re doing is we’re moving from an open-access regime, which is a situation where there are no property rights, to create a set of property rights. Regulations already assert a certain type of property right, the right of the public acting through the government to make rules about how the resource is used. Putting a price on emissions takes that process one step further. It not only sets rules about using the resource, but also charges a price for using that resource. So it moves along the spectrum from a complete absence of property rights towards a more full specification of property rights.
Just How Much Would It Cost?
Back in 2009, the Speaker of the House of Representatives, John Boehner (R-Ohio), claimed in the debate running up to the vote on the American Clean Energy and Security Act—known as the Waxman-Markey bill, after its main sponsors, Henry Waxman (D-Calif.) and Ed Markey (D-Mass.)—that if this bill were passed, it would be the biggest tax increase on working families in American history. Now, that was probably political hyperbole, but Boehner wasn’t entirely wrong. It would be like a tax increase, and it would be substantial. It has to be substantial if it’s going to bring about the changes in consumption of fossil fuels that are needed to push forward the clean-energy transition. We’re talking about big changes: an 80% reduction in our emissions by the year 2050. We’re talking about an energy revolution, and the kinds of price increases that would be ultimately needed to drive that forward are not inconsequential.
What was the Democratic response? “No, no, it’s not a tax, it’s not a big price increase, and it’s really not going to hurt people all that much. It’s equivalent to a postage stamp a day.” Now, that postage-stamp-a-day figure is an estimate of something quite different from the price increases that households would face. This is the estimated cost of abatement: how much it would cost to invest in energy efficiency improvements to reduce fossil fuel consumption to 75% of the current level. That’s not a huge cost because, in fact, there’s a lot of low-hanging fruit out there in terms of investment opportunities.
The consulting firm McKinsey & Company produced a study a few years back that showed there are even investments that would have a negative cost. In other words, if you make that investment to reduce carbon emissions, you actually get money back because it’s so efficient to make those investments. So overall, you can achieve reductions at a fairly modest cost. But what I want to draw your attention to is the price of the emissions we’re not reducing—the 75% that we’re not cutting.
That’s the higher price consumers will be paying for their use of fossil fuels, and that’s the primary reason for the price increases you will see at every gas pump, on every electric bill, and that you will see trickling through into the prices of other commodities in proportion to the use of fossil fuels in their production and distribution.
Let me remind you that gasoline prices are the most politically visible prices in the United States. They’re advertised in 12-inch high numbers on street corners across America. During the 2008 Presidential campaign, when all the major candidates—including Hillary Clinton and John McCain—were talking about global warming and said they were in favor of limiting carbon emissions with a cap-and-trade policy, gas prices went up. And both Clinton and McCain said this was a terrible burden on the American people, we needed to have a federal gas tax holiday for the summer to relieve this burden. Well, the federal gas tax is about 18 cents a gallon—it’s really not that much. Compared to the price increases that we’re going to see if we have a serious climate policy, I hate to tell it to you folks, but 18 cents rounds to about zero.
We’re going to see gas prices going well above $5 a gallon in the first few years of the policy, and ultimately higher than that. How are you going to have a policy that squares the circle between, on the one hand, the need to price those emissions in order to address the problem of climate change and, on the other hand, even those politicians who see climate change as a problem saying “We can’t let the price of gas go up because it’s going to hurt the American family”?
Who Gets the Money?
How much money are we talking about when we put a cap on carbon emissions? What I want to share here are some “back of the envelope” calculations. Don’t take these to the bank, but they’ll give you some idea of the ballpark we’re talking about.
These figures trace the trajectory if we’re going to achieve an 80% cut in emissions by the year 2050. In the first six years of the policy, if we were to have such a policy in 2015, we’d be emitting on average about 6 billion tons of carbon dioxide per year, a little bit less than in the absence of a policy. The price associated with that reduction would probably be in the neighborhood of $15 a ton, so we’d be talking about $90 billion a year, or about $540 billion over those first six years. In the next decade, we’d be ratcheting those emissions down further to about 4.5 billion tons. To do so, the price would have to be about $30 a ton, generating a total cost to consumers and therefore a pot of money of about $135 billion a year, or $1.35 trillion over the decade. In the next decade, the 2030s, getting down to about 3 billion tons of carbon, we’d be raising the price to about $60 a ton, generating about $1.8 trillion over the decade. And the last decade, the 2040s, ratcheting down further to 1.5 billion tons, perhaps somewhat optimistically assuming here that the price needed would be only $120 a ton—this assumes that a lot of R&D has happened, a lot of new technologies come online, investments in public mass transit are online, etc., so you don’t have to push the price through the roof—that would generate another $1.8 trillion.
What Should We Make of the New EPA Rules?
This June, the U.S. Environmental Protection Agency (EPA) announced a new “Clean Power Plan” targeting a 30% reduction of carbon emissions from fossil-fuel-fired electrical power plants, relative to the 2005 level, by the year 2030. While we may think first of motor vehicles when we think about fossil-fuel use, electrical power generation actually accounts for more of our carbon emissions—over 2 billion metric tons, or nearly one-third of the U.S. total, each year. The EPA policy is not a new law (as climate legislation has been blocked in Congress), but a new set of rules that the Obama administration proposes to implement under the authority of the Clean Air Act.
The Clean Power Plan allows states to each develop their own paths to emissions-reduction targets. The EPA describes four ways to achieve reductions: increased efficiency of coal-fired power plants, a shift towards natural gas-fired (away from coal-fired) plants, a shift toward renewables like wind and solar (away from fossil-fuel-based power generation), and increased energy efficiency in consumption. “States can meet their goal using any measures that make sense to them,” the official EPA blog states. “They do not have to use all the measures EPA identified, and they can use other approaches that will work to bring down that carbon intensity rate.”
One approach is to cap power plant emissions and auction the permits to the power companies. Nine northeastern states are already doing this under the Regional Greenhouse Gas Initiative (RGGI), and last year California began doing so under its Global Warming Solutions Act. Auction revenue can be returned to the people as dividends, or used to fund public investments, or some mix of the two as California is now doing. “The Clean Power Plan offers every state the opportunity to institute cap-and-dividend climate policies,” James Boyce observes.
“Earmarking some fraction of the auction revenue for public investment can make sense, too, but folks should understand that once we’ve capped emissions from the power sector, those emissions won’t be reduced any further by public investments since the level has already been set by the cap. The biggest chunk of carbon revenue, I think, can and should be returned to the people as the rightful owners of our atmosphere.” —Eds.
You add it up and over that 35-year period, we’re talking about something to the order of $5.5 trillion. Economists have a technical term for it—“a hell of a lot of money.” The question is: Who owns the atmosphere and, therefore, who will get the money?
One possible answer is the fossil fuel corporations. You could give them the money that consumers pay in higher prices. If you give the permits to the firms for free, on the basis of some allocation formula, then those permits have to be tradable, because some firms end up being able to reduce emissions more cheaply while for others it’s more expensive, so they need to be able to trade permits with each other. This is where the phrase “cap and trade” comes from. Cap and trade is really “cap and giveaway and trade.” If you don’t give away the permits, there’s no need to make them tradable.
Who ultimately gets the resulting windfall profits? Well, they’re distributed to whoever owns the firms, in proportion to stock ownership. Since stock ownership is very unequal and it’s concentrated at the top of the wealth pyramid, most of the returns would go to those households. And some of the money would flow abroad to foreign owners.
A second possibility is cap and spend. It’s analogous to tax and spend. In this case, the government doesn’t give away the permits, but auctions them. There’s an auction held monthly or quarterly. Only so many permits are on the table, and the firms bid for them. If they want to bring carbon into the economy, they need to have enough permits for the next month or the next quarter. The auction revenue is retained by the government, and it can be used to increase government spending on anything you want to imagine: on public education, on environmental improvements, on foreign wars, you name it. It could be used to cut taxes. It could be used to reduce the deficit. All of those are possible uses of the revenue that comes from a cap-and-spend type policy.
The third possibility is what I’m going to call “cap and dividend.” In this case, the money is recycled to the people on an equal per capita basis. In this case, too, permits are auctioned, but a week after the auction—every month or every quarter—you get your share of the money as your dividend. The result is that it protects the purchasing power of working families. The strongest instrumental appeal of a cap-and-dividend policy is that it would make working families whole. It would protect the middle class and working families from impacts of higher fuel prices and thus build in durable support for the climate policy for the decades it will take to achieve the clean-energy transition.
How Would Cap and Dividend Work?
A carbon price is a regressive tax, one that hits the poor harder than the rich, as a proportion of their incomes. Because fuels are a necessity, not a luxury, they account for a bigger share of the family budget for low-income families than they do for middle-income families, and a bigger share for middle-income families than for high-income families. As you go up the income scale, however, you actually have a bigger carbon footprint—you tend to consume more fuels and more things that are produced and distributed using fuels. You consume more of just about everything; that’s what being affluent is all about. So in absolute amounts, if you price carbon, high-income folks are going to pay more than low-income folks.
Under a policy with a carbon price, households’ purchasing power is being eroded by that big price increase. But with cap and dividend, money is coming back to them in the form of the dividend. Because income and expenditures are so skewed towards the wealthy, the mean—the average amount money coming in from the carbon price and being paid back out in equal dividends—is above the median, the amount that the “middle” person pays. So more than 50% of the people would get back more than they pay in under such a policy. As those fuel prices are going up, then, people will say, “I don’t mind because I’m getting my share back in a very visible and concrete fashion.” It’s politically fantastical, I think, to imagine that widespread and durable public support for a climate policy that increases energy prices will succeed in any other way.
There are precedents for doing this kind of thing. The best known is the Alaska Permanent Fund. In the 1970s, the Republican governor of Alaska, Jay Hammond, instituted this policy when North Slope oil production was starting up. What they did in Alaska was impose a royalty payment on every barrel of oil being pumped out. They said that this oil belongs to every Alaskan in equal and common measure—current Alaskans and future generations, too. So what we’re going to do is charge a royalty for extracting our oil, put it in what we’ll call the Permanent Fund, and use that money in three ways: Part will go for long-term investment. Part will be put into financial assets, so that it will always be there, even after the oil is gone, for future Alaskans. And part of it will be paid out in equal per-person dividends to every man, woman, and child in the state of Alaska. That payment has been as much as about $2,000 a year. This way of providing dividends is not a complicated thing to do. It’s not rocket science, folks. It’s dead easy.
Apart from helping to support family incomes, I think that this policy has deep philosophical appeal, because it’s founded on the principle that we all own the earth’s resources, the gifts of creation, in equal and common measure. The planet’s limited carbon absorptive capacity does not belong to corporations. It does not belong to governments. It belongs to all of us. Cap and dividend is a way of implementing that sense of common ownership, rather than abdicating ownership—giving it away for free—which we currently have under the open access regime.
Ask people, not only in this country but around the world, “Who owns the air? Who owns the gifts of creation?” The answer you will hear most often is that we all own them in equal and common measure. I think our challenge in addressing climate change is to translate this very widely held philosophical principle into actual policy by which we, as the owners of these gifts, use them responsibly. In the case of the atmosphere’s ability to absorb carbon dioxide emissions, that means limiting the amount of carbon we put in the atmosphere. That’s what we need to do.
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