The big news this month was Joe Biden’s climate pledge. The president says the U.S. will reduce emissions 50 to 52 percent from 2005 levels by 2030. David Roberts at Vox calls the new pledge “an ambitious target that would require sweeping changes across U.S. society, on which Biden’s infrastructure plan would be a mere down payment.”
The pledge comes with many question marks. How will the president make it happen given the challenges presented by a narrowly-divided Senate? Does the carbon tax factor into these plans? Would we be better off if it did?
With this month’s recap, we’ll look at two parallel conversations that, I think, tell us quite a bit about the future of a carbon tax.
March 31, 2021:
Recently, the American Petroleum Institute has come out as the latest in a long line of energy-intensive industry stakeholders to endorse a price on carbon. Pessimists may view this as a greenwashing attempt to avoid more damaging regulations in the future, but the truth is that—as the R Street Institute has stated before—there is considerable economic wisdom in using pricing rather than regulation to abate emissions. If implemented wisely, carbon pricing in lieu of regulations and subsidies can be a far more potent policy tool for climate progress. Alternatively, poorly implemented carbon pricing risks a lot of economic pain without much benefit.
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It is not surprising that industry participants that are already facing government intervention in their businesses have started to come out in support of carbon pricing, but the policy fundamentals are unchanged. A carbon price that is revenue neutral, focuses on moving the tax code to something better—rather than worse—than the current state, and preempts costlier regulation makes sense. However, a carbon price by any means that uses revenues to expand government would be bad policy. As more and more groups are becoming open to the idea of carbon pricing, they must not forget that conditionality is key, and there is distinction in good ways and bad ways to implement tax policy.
IER’s Take
Philip Rossetti presents here what is probably the best political case to entice right-of-center types to the carbon tax: using the price mechanism is a more efficient, market-oriented way to effect emissions reductions than central planning. The problem with Rossetti’s post is that it doesn’t deliver on the promise of its title, “Return of the Carbon Tax: Why It’s So Popular with Industry Lately”.
Why at this moment has API made the switch?
In my recent op-ed at the American Spectator, I make the case that API’s carbon tax endorsement is a clear effort to reduce public pressure on the industry.
Here’s an excerpt from my AmSpec piece:
“This move comes two short months after the inauguration of a president who calls the far-more-restrictive Green New Deal ‘a crucial framework’ and deems climate one of ‘four existential crises’ demanding an ‘all-of-government’ response. One could speculate—indeed many have— that political heat, rather than atmospheric heat, prompted the API carbon tax switch.
Louisiana Congressman Garret Graves called this a plan to appease the radical left. The problem with Graves’ framing, however, is that the radical left hates the carbon tax as much as it hates Big Oil. Kassie Siegel, director of the Center for Biological Diversity’s Climate Law Institute, told the Washington Post the endorsement was ‘self-serving greenwashing’ and that ‘nobody should fall for the oil industry’s new PR ploy, which will do nothing to fight the climate emergency.’
Kate Aronoff, staff writer at the progressive New Republic, called the carbon tax endorsement a red herring. ‘(C)orporations,’ she writes, ‘are more than capable of expressing theoretical support for a climate policy while working behind the scenes to sabotage it.’ Aronoff is onto something. Viewed through the cynic’s lens, API is endorsing a policy that it knows doesn’t stand a chance of getting signed into law.
API specifically communicates that it will not endorse a tax on top of the existing thicket of regulations. While that does align with what’s sometimes called the economic case for a carbon tax, it’s out of step with today’s politics. The reigning party in Washington wants nothing to do with a tax swap.”
No new point in favor of a carbon tax has emerged in 2021 except for that the alternative suddenly looks much scarier.
April 13, 2021:
If there is one climate economist who is respected above all others, it’s William Nordhaus of Yale, who won the Econ Nobel in 2018 “for integrating climate change into long-run macroeconomic analysis.” The prize specifically cited Nordhaus’ creation of an “integrated assessment model” for analyzing the costs of climate change. The most famous of these is the DICE Model, used by the Environmental Protection Agency.
But the DICE Model, or at least the version we’ve been using for years, is obviously bananas. As climate writer David Roberts noted in 2018, according to the standard version of Nordhaus’ model, the economic cost of a 6°C increase in global temperatures would only be 10% of GDP. As Roberts notes, climate scientists believe that that level of temperature increase would make the Earth basically unlivable. An unlivable Earth is going to cost a lot more than 10% of GDP.
Nordhaus’ models recommend a ceiling of of 3.5°C, which is higher than what the world is on track for at the end of the century if we don’t make any further changes; in other words, a Nobel-winning climate economics model recommends that the economic cost of doing anything more than we’re already doing to stop climate change is too high.
That’s obviously bananapants…
IER’s Take
Judging by the eight times he used the word in this Substack post, Noah Smith seems to think the whole endeavor of climate economics is obvious.
It’s obvious that immeasurable effects should be included. It’s obvious that we discount unethically. It’s obvious, he ultimately thinks, that climate damages will be so large as to merit almost any policy action put forward.
This is now the dominant left-of-center position. Any measured interpretation of climate change, climate damages, and climate policy is evidence that the interpreter doesn’t understand the scope of the problem, Smith implies.
Those in the political center and to its right who advocate for a carbon tax must reckon with this. Philip Rossetti and company offer some reasonable arguments for a carbon tax, but if those arguments don’t even appeal to the center-left, where Smith resides, how does the tax Rossetti proposes stand any chance?
April 13, 2021:
One obvious problem with DICE models, or at least with the numbers Nordhaus plugged into his DICE models, is that they assume a high discount rate. The discount rate is the degree to which we don’t care about the future — the higher the discount rate, the more we disregard what happens in 20 or 50 years. DICE models get their discount rate from interest rates, which represent how much the investors who are currently alive and investing in the market care about the future. If investors’ bond purchases don’t reflect concerns about whether their great-grandchildren live in an infernal hellscape, DICE doesn’t care about it either.
It turns out that most economists think that this isn’t a good way to select discount rates. In 2016, David Roberts reported the results of a survey of economists who mostly supported using a lower discount rate than the market rate, based on ethical concerns about the future of humanity. This is obviously the right thing to do, and economists know it, yet somehow the most popular climate model for years was one that ignored the welfare of future generations.
IER’s Take
In this eyebrow-raising passage, Smith says William Nordhaus’s use of discounting is obviously wrong. That it wasn’t obviously wrong in the eyes of the Royal Swedish Academy of Sciences might give some commenters pause, but not the, er, confident Smith.
While there is some intuitive appeal to the framing of the low or near-zero discount rate supported by Smith and Nicholas Stern as giving equal valuation to future generations, there are very good reasons why a higher, market-reflecting rate makes sense.
As my colleague David Kreutzer has taught me, discounting is an opportunity cost exercise.
What Dr. Kreuzter points out is that if we ignore the rate of return in the market, we run the risk of making future generations poorer by missing out on wealth creation. “(Discounting),” he writes, “does not compare the relative worth of people in different periods or what inflation does or how incomes grow. It simply says how much you would have to invest, elsewhere, today, to get that future value later.”
As Nordhaus writes in one of his papers Smith cites here, “This specification used in the DICE model is sometimes called the descriptive approach’ to discounting. The alternative approach, used in The Stern Review and elsewhere, is called the ‘prescriptive discount rate.’ (Stern 2007) Under this second approach, the discount rate is assumed on a normative basis and determined largely independently of actual market returns on investments.”
Put colloquially, this is the difference between how people tend to behave in a market versus how academics would like them to.
To show that the informed opinion favors a lower, prescriptive discount rate, Smith cites a survey (via Vox’s David Roberts) conducted by the Institute for Policy Integrity (IPI). The IPI survey included 365 economics-PhD-holding participants who have published articles related to climate change in leading economics, environmental economics, and development economics journals.
Narrowing in on one Smith claim, he wrote in his Substack post that the participants “mostly supported using a lower discount rate than the market rate, based on ethical concerns about the future of humanity.”
That isn’t quite true.
Of the 365 participants, only 44 percent said discounting should be “calibrated using ethical parameters.” The remaining 56 percent either favored discounting “calibrated using market rates” (26 percent), didn’t offer an opinion on that question (16 percent), or would support another approach altogether (14 percent).
The survey doesn’t show what Smith says it shows. But even if it did, would that be meaningful? To raise an obvious question, what exactly gives economists special insight into what those ethical parameters ought to be?
