Brookings: Projects - Climate and Energy Economics Project

CO2 Emission Permit Prices Plunge In Europe: What's Up?

Adele Morris — Fri, 17 May 2013 13:47:00 -0400

Recent headlines proclaim "deep trouble" in the European cap-and-trade system for greenhouse gases, evidenced by the decline in allowance spot prices from over $25 per metric ton of carbon dioxide in June 2008 to about $3 this month. Although many press articles have referred to an "oversupply" of emissions permits, suggesting some kind of intrinsic imbalance, the markets are clearing just fine. It's just that the price is lower than forecast.

Whether this represents trouble or not depends on what you think the goal of the program should be. If the goal is to ensure that emissions in the covered industrial sectors are no higher than the emissions caps, then the program has worked just fine. It just didn't have to work very hard since much of the decline in emissions relative to projections was driven by the multi-year economic crisis. A sputtering EU economy lowered industrial activity and consumer energy demand, and this drove down allowance demand and prices. This makes compliance easier for the remaining emitters just at the time business and consumers are suffering most. This counter-cyclical property might be seen by some as a feature, not a bug.

On the other hand, if you think the goal of climate policy should be to provide stable cost effective long-run incentives to lower emissions relative to what would otherwise occur, then the ETS price plunge is a cautionary tale. First, it illustrates the importance of the design details of the carbon market. The ETS law included no provision to restrict automatically the number of allowances when prices get low. Efforts to withhold allowances failed when, not surprisingly, coal-dependent states balked at the proposed stringency in an economic downturn.

Second, the price volatility shows that the ETS hasn't really fixed the market failure in which fossil energy prices don't reflect their full social costs, including environmental damages. Economists widely advocate a price signal on carbon that would include those external costs, as best we can estimate them, in fuel prices through a carbon tax or a cap-and-trade system. The ETS illustrates one key drawback of a poorly designed cap-and-trade system: fluctuating allowance prices and abatement incentives. Price volatility makes no sense if you're trying to internalize an external cost because there's no reason to think the social cost of carbon fluctuates over the short run, much less drops by 90 percent over five years.

Third, the ETS illustrates the potential for laxity in one carbon market to erode abatement incentives abroad. For example, the Australians plan to convert their carbon tax to an ETS-linked permit program in July 2015. The prospect of linkage to the ETS lowers the expected Australian carbon price well below the current tax of about $25 per ton of CO2. To be sure, low prices in the ETS just amplify the investment-depressing effect of the broader uncertainty around a policy so incompetent one wonders if they'll go through with it.

Finally, the ETS experience reveals the limitations of framing the environmental success of a climate policy solely in terms of emissions levels. Many environmentalists are more comfortable with an emissions cap than a carbon tax because the cap provides more environmental certainty. However, the lower-than-predicted ETS allowance price has made it unexpectedly easy for utilities to fire up coal-powered plants and delay investments in cleaner natural gas and renewables, and this could set back climate efforts in the EU for years.

The fits and starts of the EU carbon market suggest the potential advantage of an enduring and credible incentive to reduce emissions through a carbon tax. Even if the EU had set a tax at the lesser of the estimated damages from emissions and the public's willingness to pay, it would surely have been greater than the current ETS price, suggesting that the policy with the greater environmental certainty has foregone the opportunity for greater environmental benefits.

Policymakers should expect the unexpected and do what they can to establish a climate policy that is robust to changing economic conditions at home and abroad. Compared to the EU's current approach, a modest predictable tax would be more robust to shocks, solidify the payoffs of investments in new technologies and emissions reductions, cost less (especially if the revenue is used wisely), and ultimately do more to protect the planet.

Authors

Adele Morris

Publication: Real Clear Markets

Image Source: © Alessandro Garofalo / Reuters

China’s Carbon Tax Proposal Highlights the Need for a New Track of Climate Talks

Adele Morris, Warwick J. McKibbin and Peter J. Wilcoxen — Fri, 15 Mar 2013 00:00:00 -0400

China’s Ministry of Finance recently announced a carbon tax. Although the statement was vague about the timetable and the tax rate, the mere prospect of China pricing carbon should have prompted swift laudatory international responses, especially by countries that have long hectored China to take stronger action on climate. China’s announcement, and the underwhelming response of the international community, shows that it’s time to start an international conversation about pricing carbon and invite anyone who’s interested aboard. A Carbon Pricing Consultation (CPC) would allow China and other countries that want to price carbon (via a carbon tax, cap-and-trade system or a hybrid approach) to learn more about it, exchange views, find out what other countries are considering, and potentially coordinate their policies.

In a recent paper we proposed a CPC process that would lead to detailed, pragmatic, and ongoing international discussion of the implementation details of domestic carbon pricing approaches, policies that economists widely agree could address the climate problem cost effectively. A domestic carbon price creates broad, efficient incentives to reduce greenhouse gas emissions. Done well, it would gradually shift consumer demand, production methods, new investment, and technology development towards less emissions-intensive goods and services without unduly burdening poor households. Pricing carbon can also raise revenue to fund government programs or cut distortionary taxes. Finally, a carbon price can promote economic growth by replacing less efficient regulatory and spending policies.

Accordingly, we think parties should embrace carbon pricing as a key low-carbon growth strategy and establish a venue to discuss it. Disparate carbon prices across different countries can shift emissions, production, investment, and trade patterns, and mutual understanding of these cross-border effects is of interest to all. Several countries have adopted or are implementing carbon pricing policies, so there is increasing experience to discuss. And the vehement opposition to the EU’s efforts to price carbon in aviation fuels suggests that unilateral approaches to carbon pricing can undermine progress.

This moment to begin a CPC process is opportune. Climate talks in December 2012 in Doha, Qatar, resolved contentious questions about the future of the Kyoto Protocol and finally retired the constraints of the Bali agenda. Now negotiators will turn to developing a new agreement under the United Nations Framework Convention on Climate Change to cover the post-2020 period. At the same time, the Major Economies Forum (MEF) needs a new thrust of engagement, having developed the Clean Energy Ministerial into an enduring venue for technology discussions. A CPC would fit nicely within the MEF, or possibly the G20.

This new line of discussion would address a glaring gap in climate talks to date. Negotiations have tackled emissions targets, temperature targets, technology transfer, financial assistance to poor countries, forest preservation, and many other topics, but not the practical design of cost-effective domestic mitigation policy. Indeed, few countries include their finance and trade ministries in climate talks outside of discussions of finance. This vacuum of economic expertise and leadership leaves parties prone to commitments, such as a two degree maximum global mean temperature increase, that imply implausibly stringent global efforts and fail to identify concrete solutions.

The CPC, unlike existing clean energy and climate consultations, would be led by finance and trade ministries (not the environment and energy ministries). It would focus exclusively on the practical administrative and technical aspects of responsible mitigation policy. One advantage of this pragmatic approach is that parties could sidestep divisive issues such as who bears responsibility for collective mitigation goals, who should compensate whom for what, and whose approach is more ethical. However justifiable, these debates have done little to promote real emissions mitigation.

The CPC would focus on the technical and administrative aspects of the policies, such as options to identify taxable or regulated entities and sources and methods to track revenue, minimize administrative costs, and ensure compliance. Parties could also discuss the role of international offsets and the interplay between carbon pricing and other domestic climate and energy policies. Countries could discuss ways to predict the effects of alternative tax trajectories, and they could discuss how to distribute and manage markets of allowances and tax revenue. Other topics could include the design of border carbon adjustments and other trade-related issues. The CPC could also steer existing resources to assist developing countries in reducing fossil fuel subsidies and pricing carbon.

One impediment to climate policy in the United States is the concern that without meaningful action by developing countries, pricing carbon will harm the US economy with little overall environmental benefit. A move towards transparent price-based policies give all major emitters comfort they are moving forward in concert with others. The first step is to discuss how to do it.

Authors

Publication: East Asia Forum

Image Source: © Darley Shen / Reuters

American Energy Security and Innovation

Ted Gayer — Tue, 26 Feb 2013 00:00:00 -0500

Chairman Whitfield, Congressman Rush, and Members of the Subcommittee, I appreciate the opportunity to appear here today. My comments will cover the market incentives for energy efficiency innovation, the most cost-effective means of reducing pollution stemming from energy use, and the limitations and problems associated with government energy-efficiency mandates.

Many of the points I will make come from a Mercatus working paper I co-authored with W. Kip Viscusi of Vanderbilt University, which I have submitted along with my testimony. A revised version of the paper is forthcoming in the Journal of Regulatory Economics.

Market prices convey information about the strength of consumer demand for a good and the scarcity of supply for that good, allowing for a balancing of buyers’ and sellers’ interests. In the market for appliances, prices reflect how consumers value features such as energy efficiency and convenience. If the price of energy increases, consumers will be willing to pay more for more efficient appliances, providing a clear incentive to suppliers to respond. The response, in turn, depends on the constraints on production, such as the state of technology. Economists agree that this flow of information between producers and consumers is better achieved through the price mechanism than through government oversight. One important benefit of the market process is that consumers with different preferences can find appliances that best suit their needs. For example, a consumer who lives in a region where energy is inexpensive may prefer appliances that emphasize convenience over energy efficiency compared to a consumer who lives in a region with expensive energy. In short, there is no uniformly “right” amount of energy efficiency in an appliance any more than there is a “right” variety of apple.

However, market prices can provide misleading signals to the extent that they do not account for the pollution costs stemming from energy use. In other words, the price that shows up on one’s electric bill accounts for the private cost of energy, but it does not include the additional environmental damages that impact others due to one’s energy use. Economists refer to these latter costs as “negative externalities.” The best approach to addressing this problem of negative externalities is for the government to price these pollution costs directly. Consumers and firms would then face the full cost of energy use, and markets would respond through some combination of new technologies, alternative fuels, and conservation.

There are a number of reasons why the market-oriented approach of setting a price on pollution is more cost-effective than regulations such as energy efficiency mandates. First, the one-size-fits-all energy efficiency mandates ignore the substantial diversity of preferences, financial resources, and personal situations that consumers and firms must align in order to make their decisions. Second, unlike a price set for pollution, energy efficiency mandates do not promote conservation. Indeed, they lower the cost of using an appliance, reversing some of the energy savings. For example, an energy efficiency standard for air conditioners increases the incentive to run the air conditioners longer. Third, energy efficiency standards apply only to new products, which can create incentives for consumers and firms to retain older (and thus less energy-efficient) products.

Kip Viscusi and I examined a number of recent government regulations that mandate energy efficiency standards for vehicles and appliances. Despite the fact that these regulations are frequently touted as pollution-reducing initiatives, the agencies’ own estimates confirm that the environmental benefits are negligible and are often dwarfed by the societal costs they impose.

In order to justify these expensive regulations, the agencies assert that consumers and firms are making irrational purchase choices and that they therefore benefit if product choices are restricted to those that meet the agencies’ mandated standards. Dismissing consumer preferences as irrational is a significant departure from well-established tenets for conducting cost-benefit analyses set forth in the economics literature and by the administration’s Office of Management and Budget.

By claiming regulatory benefits from the correction of so-called “consumer irrationality,” agencies are shifting regulatory priorities from the important goal of reducing the harm individuals impose on others (through pollution) towards the nebulous and unsupported goal of reducing harm individuals cause to themselves by purchasing purportedly uneconomic products. This shift from environmental protection to consumer protection results in a host of costly regulations that are far less effective than a government policy that simply sets a price for pollution. It also establishes a dangerous precedent: If agencies can justify regulations on the unsubstantiated premise that consumers and firms (but not regulators) are irrational, then they can justify the expansive use of regulatory powers to control and constrain virtually all choices consumers and firms make.

To summarize: I believe that markets generally work well to provide incentives for energy efficiency and to satisfy consumers’ diverse tastes. To the extent that energy prices fail to incorporate the environmental cost of energy use, the most sensible government response is to price the pollution costs directly, and then allow consumers and businesses to respond to the higher prices. Regulations and mandates are inferior policies, but still may be better than doing nothing if the benefits exceed the costs. Unfortunately, by the agencies’ own estimates, energy efficiency mandates frequently lead to minimal environmental benefits that are far less than the costs. In an effort to justify these uneconomic regulations, the agencies have deviated from well-established economic tenets by asserting that consumers and firms are “irrational” and that they therefore benefit from government mandates that restrict choice. The evidence for this view is weak, and assuming that citizens are not capable of making sensible decisions that affect their own pocketbooks is not the right way to advance the important goal of enhancing the quality of our environment.

Authors

Ted Gayer

Publication: Subcommittee on Energy and Power, Committee on Energy and Commerce

Image Source: © Lucy Nicholson / Reuters

A Climate Diplomacy Proposal: Carbon Pricing Consultations

Adele Morris, Warwick J. McKibbin and Peter J. Wilcoxen — Fri, 08 Feb 2013 10:19:00 -0500

I. Introduction

Climate talks in December 2012 in Doha, Qatar, wrapped up lines of negotiation that were begun years before in Bali. Negotiators resolved contentious questions about the future of the Kyoto Protocol and finally put the constraints of the Bali agenda behind them. Now they will turn to developing by 2015 a new agreement under the United Nations Framework Convention on Climate Change (UNFCCC) to cover the post-2020 period. At the same time, the Major Economics Forum (MEF) needs a new thrust of engagement, having developed the Clean Energy Ministerial into an enduring venue for technology discussions.[1] This momentary opening for new agenda items offers an excellent opportunity to expand the dialogue to include technical aspects of the one policy approach that would actually address the climate problem cost effectively: pricing carbon and other greenhouse gases (GHGs).

Negotiators should take this opportunity to establish a Carbon Pricing Consultation (CPC) process: a detailed, pragmatic, and ongoing discussion of the implementation details of domestic cap-and-trade and GHG taxes. A CPC process would address a glaring gap in climate talks to date. Negotiations have tackled national emissions targets, global temperature targets, technology transfer, assistance to poor countries for adaptation and mitigation (a.k.a. “finance”), clean energy, forest preservation, compensation for countries affected economically by mitigation measures, and many other topics. Carbon pricing, however, has received little multilateral attention. It has generally been considered to be a national-level policy—to be adopted at the discretion of individual governments—and therefore outside the purview of international talks. However, much could be gained by bringing countries together to discuss carbon pricing. A CPC process would provide an opportunity for negotiators, as well as the administrators of national pricing policies, to discuss how to induce, practically and efficiently, the broad economic shifts required to de-couple emissions and economic activity.

Why focus on carbon pricing? A carbon price, arising either via a cap-and-trade market or a carbon tax, creates broad, efficient incentives to reduce greenhouse gas emissions. Done well, it would gradually shift consumer demand, production methods, new investment, and technology development towards less emissions-intensive goods and services without unduly burdening poor households. A carbon tax or auctioned cap-and-trade allowances can also raise revenue to fund government outlays or reduce other, more distortionary, taxes. Finally, a carbon price can promote economic growth by replacing less efficient tax, regulatory, and spending policies. For these reasons, there is nearly universal agreement among economists that a price on carbon is a highly desirable step for reducing the risk of climatic disruption. Most would also agree that to be effective in the long run, any significant carbon policy will have to involve a price signal.

Why international consultations? First, outside of finance issues, few countries have sufficiently included their finance and trade ministries in climate negotiations. Thus the perspectives and expertise most familiar with the economics of market-based emissions approaches have been missing in the talks. Second, many countries have recently adopted carbon pricing policies, so there is increasing experience to analyze and discuss. Third, some countries that have not yet adopted carbon prices, such as the U.S., have considerable expertise in efficient administration of excise taxes and could provide valuable advice. Fourth, talks to date have focused on emissions targets, both collectively and by country, divorcing the dialogue from the economic realities of achieving those commitments. It is much easier to reach consensus on the goal of containing global mean temperature increases to 2 degrees centigrade than to grapple with the potentially high price signals on carbon that would may necessary globally to achieve the goal. Until negotiators directly address the levels of economic effort involved and how to minimize the cost, collective commitments to stabilization targets will remain both theoretical and infeasible, however compelling they may be scientifically. Fifth, disparate carbon prices across different countries can shift emissions, production, investment, and trade patterns, and mutual understanding of these cross-border effects is of interest to all parties. Finally, the vehement opposition to the EU’s efforts to price carbon in aviation fuels suggests that unilateral approaches to carbon pricing can undermine cooperation and climate policy progress. Not least, it shows the critical relationship between carbon pricing and international commerce and bolsters the case that this topic is a natural basis for a new climate diplomacy.

II. Towards Carbon Pricing Consultations

The international community should establish a CPC to provide a much needed place to discuss, laud, and understand efforts by countries to price greenhouse gases. It would differ from most talks under the United Nations Framework Convention on Climate Change (UNFCCC) in that the agenda would focus specifically on administrative, economic, and trade-related aspects of policies that price carbon and other GHGs. For example, discussions could include an exchange of countries’ views, experience, and methodologies related to:

how cap-and-trade and/or carbon tax systems work administratively;
administration of excise taxes on carbon content of fuels, including ways to identify taxable entities, establish a tax base (emissions and sources), set reporting requirements for firms, track revenue, minimize administrative costs, and ensure compliance;
ways to harmonize tax administration across countries to foster compliance by multi-national firms and prevent tax gaps and double-taxation;
the potential economic benefits to developing countries of carbon pricing as a low carbon growth strategy and efficient revenue instrument;
the environmental and economic effects of alternative carbon tax levels and tax trajectories;
mechanisms for managing allowance markets and registries, and distributing allowances or allowance auction proceeds;
the design and implementation of border carbon adjustments;
approaches to taxing carbon in bunker fuels;
the feasibility of including non-CO₂ gases, agriculture- and forest-related emissions, and process-related CO₂ emissions in a carbon pricing system;
the role of sub-national approaches;
the macroeconomic and trade impacts of carbon pricing;
the distributional effects of a price on carbon, such as effects on poor households or disproportional regional effects, and how to address them;
approaches to pricing carbon in imported and exported fossil fuels and closely-related products;
experience with the environmental performance of carbon pricing;
other fiscal reforms made in conjunction with carbon pricing (such as budget deficit reductions or reductions in other taxes), and their impacts;
approaches to fiscal cushioning (such as reducing other energy taxes while establishing a price on carbon);
how to report on carbon pricing policies so that measures can be compared across countries;
the relationship between carbon pricing and other policies, such as energy efficiency standards and renewable energy subsidies; and
efficient implementation of carbon pricing in large, complex, federalist systems.

The goal of these international discussions would be to build mutual comfort and confidence in carbon pricing, share views, prevent disputes and trade disruptions, identify and replicate successful approaches, learn from one another’s mistakes, build institutional capacity, and generally promote mutual cooperation on serious, economically efficient, measures to mitigate emissions.

The CPC could also consider how to guide resources and activities of existing bilateral consultations, multi-lateral development banks, the Green Climate Fund, other institutions, and private sector entities towards efficient carbon pricing. One particular option could be to find ways to assist developing countries in their efforts to reduce fossil fuel subsidies and adopt a carbon tax or cap-and-trade program for greenhouse gases. For example, the U.S. Environmental Protection Agency already works with China’s Ministry of Environmental Protection to build the institutions and infrastructure for sulphur dioxide cap-and-trade programs.[2] And the Asian Development Bank currently assists its member countries in establishing and enforcing value-added taxes. The CPC could discuss whether multilateral technical support, either directly through member agencies or through regional development banks, could assist developing countries with similar measures for greenhouse gas emissions trading and carbon excise taxes.

The CPC could also consider ways to enlist existing institutions for analytical support related to carbon pricing. For example, the International Monetary Fund recently issued a report on fiscal policy approaches to mitigate climate change that can help policymakers in its member countries think through the potential for a carbon tax.[3] Likewise, the OECD has prepared an illuminating cross-country comparison of energy and carbon pricing approaches.[4] The CPC could consider ways to expand or target efforts by these institutions to facilitate cooperation on climate change.

It may be possible—and it is desirable—to embed the CPC within the Major Economies Forum, the G-20, or other existing forums as much as feasible. The defining characteristic of the CPC, distinguishing it from existing clean energy and climate consultations, would be that the finance and trade ministries (not the environment and energy ministries) would take the lead. These are the ministries charged with international economic relationships, tax administration, and general macroeconomic stewardship. Of course, to the extent that environment or energy ministries oversee domestic carbon tax or cap-and-trade systems, they would play a role. However, the focus of the discussions would be on the technical, administrative, and economic cooperation aspects of carbon pricing policies, with minimal attention to whether any particular country’s approach would achieve any particular emissions target or other goal. To that end, the typical level of engagement within the CPC may best lie below that of the ministerial level, and it should include those with technical expertise.

One advantage of this approach is that it would separate the work of the CPC, i.e. the pragmatic details of carbon pricing, from divisive issues such as who bears what responsibility for collective mitigation goals, who should compensate whom for what, and whose approach is more ambitious or moral. These debates, however important, have contributed little to global emissions mitigation. Subsequent or parallel efforts can review the adequacy of the price signals and seek to increase and/or harmonize them; the CPC should center on relatively low-profile but critically important administrative and technical policy exchanges by interested countries. An underlying premise is that most major emitters have a mutual interest in effective policy machinery to price carbon.

One useful outcome of the CPC dialogue could be to shape negotiations under the UNFCCC so that countries can supplement their emissions targets with commitments in the form of carbon pricing, allowing compliance by either achieving their emissions targets or by demonstrating significant effort through imposing agreed price signals.[5] Price-based commitments would reduce the risk of inadvertent stringency or laxity, help achieve and document compliance, and allow Parties to compare their efforts transparently.

III. Why a CPC is in the interests of the United States

Consultations around mutual efforts to price carbon are clearly in the interests of countries that have already adopted or are seriously considering adopting such policies. However, even though the U.S. does not currently price carbon at the Federal level, it would also benefit from carbon pricing consultations.

First, an increasing number of US trading partners are adopting carbon pricing, and it is in the US interest to follow these developments closely. Carbon taxes have been adopted in Sweden, Australia, Finland, Ireland, Norway, and South Africa, and the EU has a major CO₂ emissions trading system. As mentioned above, India has a small tax on coal, and China is experimenting with cap-and-trade measures at the local and regional level for possible expansion nationwide. Canada also has several sub-national carbon pricing systems.

To be sure, the magnitude of the price signals and the scope of emissions to which they apply vary significantly across and within countries. But gradually more global fossil fuel consumption is falling under some sort of carbon pricing policy. The United States should welcome a venue in which it can learn from other countries’ efforts, discuss potential economic spillovers and effects on international commerce, and foster discussions that could prevent international incidents such as the dispute over the EU aviation tax.

Second, the United States has considerable tax administration and cap-and-trade expertise that could highlight potentially successful approaches. Although this experience is not climate-related, the United States deploys an efficient and highly compliant excise tax system, and it could assist developing country efforts to build their own capacity to tax carbon. For example, the United States missed an opportunity to applaud and support India’s recent adoption of a small tax on coal. The United States could offer to share its experience in administering its similar coal excise tax, which it collects under the Black Lung Benefits Act of 1977. The United States also has long experience with cap-and-trade systems for criteria air pollutants, much of which is transferable to greenhouse gas emissions trading.

Finally, one key impediment to carbon pricing in the United States is the concern that if the United States prices carbon and other major emitters don’t, then U.S. climate efforts will harm its economy to little environmental benefit. An international venue to discuss carbon pricing policies among major emitters could fruitfully evolve into a place to address such concerns and coordinate, if not fully harmonize, carbon price signals.

IV. Next Steps

As a way forward, we recommend that at their next meeting this spring in Washington, MEF members discuss their preliminary views around the potential for carbon pricing consultations and options for CPC agenda items for future MEF meetings. Australia, given its experience in carbon pricing design, could also propose a CPC agenda item for the G-20 meetings that it will host in Brisbane next year. Discussions within the MEF and G20 could explore whether members believe a CPC agenda item would be productive within the UNFCCC process.

[1] The 17 major economies participating in the MEF are: Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, South Africa, the United Kingdom, and the United States.

[2] For more, see EPA’s Clean Air Markets website: http://www.epa.gov/airmarkt/international/china/index.html

[3] Fiscal Policy to Mitigate Climate Change: A Guide for Policymakers, edited by Ian W.H. Parry, Ruud de Mooij, and Michael Keen, International Monetary Fund, 2012.

[4] Taxing Energy Use: A Graphical Analysis, OECD Publication, January 28, 2013.

[5] McKibbin, Morris, and Wilcoxen (2012) outline just such an approach. http://www.brookings.edu/research/papers/2012/07/carbon-tax-mckibbin-morris-wilcoxen.

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Authors

Image Source: © Stringer Shanghai / Reuters

Want a Pro-Growth Pro-Environment Plan? Economists Agree: Tax Carbon.

Adele Morris — Thu, 07 Feb 2013 16:03:00 -0500

In his recent inaugural address, President Obama promised that “we will respond to the threat of climate change, knowing that the failure to do so would betray our children and future generations. Some may still deny the overwhelming judgment of science, but none can avoid the devastating impact of raging fires, and crippling drought, and more powerful storms. The path towards sustainable energy sources will be long and sometimes difficult. But America cannot resist this transition; we must lead it. We cannot cede to other nations the technology that will power new jobs and new industries – we must claim its promise. That is how we will maintain our economic vitality and our national treasure – our forests and waterways; our croplands and snowcapped peaks. That is how we will preserve our planet…” When pressed on the specifics of what the president means to do on climate, his spokesperson replied: “We have not proposed and have no intention of proposing a carbon tax.”

The president has a problem, and he’s not alone. Many policymakers who are compelled by the consensus of scientists on the risk of global climate disruption seem willfully oblivious to the peer-reviewed economic research on what to do about it. Indeed, they completely ignore the remarkable consensus of economists – a group that often isn’t unanimous on important policy options, as memorialized by President Harry Truman’s famous request for a “one-armed economist.” In this case, though, economists nearly universally agree that, while basic energy research and development remain an important role of government, a price on carbon would minimize the cost of steering economic activity away from the greenhouse gas emissions that threaten the climate. Disagreements can and do arise around the details, such the appropriate level of the carbon price signal and the relative merits of various flavors of the carbon taxes and cap-and-trade programs that could impose it. Nonetheless, there’s as close to a universal consensus among economists as there is on any topic that pricing carbon should be a central feature of climate policy worldwide.

In fact, in a survey of about 40 prominent economists from across the profession, 90% agreed with this statement: “A tax on the carbon content of fuels would be a less expensive way to reduce carbon-dioxide emissions than would a collection of policies such as ‘corporate average fuel economy’ requirements for automobiles.”[1] When weighted by the level confidence the respondents had in their answers, the agreement rose to 95%.

Another survey of the same prominent economists referred to a Brookings Institution description of a U.S. carbon tax of $20 per ton, increasing at 4% per year, which would raise an estimated $150 billion per year in federal revenues over the next decade.[2] A remarkable 98% of the surveyed economists, again weighted by confidence, agreed with this statement: “Given the negative externalities created by carbon dioxide emissions, a federal carbon tax at this rate would involve fewer harmful net distortions to the U.S. economy than a tax increase that generated the same revenue by raising marginal tax rates on labor income across the board.”[3] In other words, using a carbon tax to reduce the budget deficit or reduce other, more burdensome, taxes makes all the economic sense in the world.

For example, consider an excise tax on the carbon content of fossil fuels, imposed where they enter the economy. If it starts next year at just $16 per ton of CO₂ (the equivalent of about $0.16 per gallon of gasoline) and rises at 4% per year over inflation, it would bring in enough revenue over the next ten years to reduce the marginal U.S. corporate income tax rate from a near-global high of 35% to 28%, preserve $115 billion in safety net spending for the poorest households, and still reduce the federal budget deficit by $200 billion over the decade. Such a tax would also reduce emissions by over a third by mid-century.[4] This pro-growth, pro-environment strategy would also obviate more costly regulations, subsidies, and mandates to reduce emissions and give the United States standing to call for equivalent measures abroad.

Notwithstanding the president’s speech, economists are highly skeptical that clean energy subsidies and mandates will create jobs on net over the long run. New technology that involves more jobs than the technology it replaces is likely to be more expensive. So in the absence of a tax on carbon emissions, cleaner alternatives to fossil fuels will require persistent federal subsidies, money that has to come from somewhere. And even if energy technologies become export strengths of the United States, international trade tends to reallocate rather than add or subtract overall jobs in the economy. The real reason to care about clean energy is that it’s clean. A carbon tax naturally promotes the cleanest and cheapest technologies so they don’t need a subsidy to compete.

In his State of the Union speech, the president will likely confirm his intention to issue Clean Air Act regulations to control greenhouse gas emissions from existing power plants, and he’ll probably promote the latest tax credits for clean energy manufacturers. I hope the president uses these inefficient approaches to prompt new authority from Congress to tax carbon and to use the proceeds to reform our creaky corporate tax system, protect the poor, and reduce the deficit that also risks betraying our children.

The president and others should recognize the strong consensus of experts whose life’s work is to understand markets: the best way to reduce greenhouse gas emissions is through a permanent and predictable price on carbon and responsible management of the revenue. Policymakers globally should not deny the overwhelming judgment of economists, even as they respect the overwhelming judgment of climate scientists. On this issue, we’re nearly all one-handed.

[1] http://www.igmchicago.org/igm-economic-experts-panel/poll-results?SurveyID=SV_9Rezb430SESUA4Y

[2] The Brookings paper is here (http://www.brookings.edu/research/papers/2012/11/13-carbon-tax), and its numbers derive from the MIT study here (http://globalchange.mit.edu/research/publications/2328).

[3] http://www.igmchicago.org/igm-economic-experts-panel/poll-results?SurveyID=SV_8oABK2TolkGluV7

[4] My colleagues Warwick McKibbin and Pete Wilcoxen and I analyze a similar policy here: http://www.brookings.edu/research/papers/2012/07/carbon-tax-mckibbin-morris-wilcoxen.

Authors

Adele Morris

Image Source: © Gene Blevins / Reuters

Distributional Effects of a Carbon Tax in the Context of Broader Fiscal Reform

Aparna Mathur and Adele Morris — Fri, 14 Dec 2012 00:00:00 -0500

EXECUTIVE SUMMARY

This paper analyzes the distributional implications of an illustrative $15 carbon tax imposed in 2010 on carbon in fossil fuels. We analyze its incidence across income classes and regions, both in isolation and when combined with measures that apply the carbon tax revenue to lowering other distortionary taxes in the economy. The analysis first uses an input-output table approach to estimate the effect of the carbon tax on consumer prices, assuming that the tax is passed through fully to retail prices. Then, using Consumer Expenditure Survey data on consumption patterns, we estimate the burdens across households, assuming no behavioral response to the new prices.

Consistent with earlier findings, we find that a carbon tax is regressive. Taking into account both direct and indirect energy costs, the carbon tax burden would comprise 3.5 percent of the income of the poorest decile of households and only 0.6 percent of the income of the highest decile. In the consumption approach, the carbon tax is substantially less regressive, with the ratio of average taxes paid by the bottom and top deciles equal to about 1.7.

In the tax swap simulations, we subtract the burden of other taxes that the carbon tax revenue could displace, such as the corporate and personal income taxes, and compute the net effect on households. We analyze revenue-neutral tax shifts under three assumptions about how those other taxes lower households’ capital and labor income: all borne by labor, all borne by capital, and a 50/50 split. Although all of the tax swaps lower the overall burden of the carbon tax (as a share of household income) on the poorest two deciles, tax swaps also exacerbate the regressivity of the carbon tax on the high end. This means that the benefit to the highest income households of the reduction in other taxes is greater than their share of the burden of the carbon tax.

Results suggest that if policymakers direct about 11 percent of the tax revenue towards the poorest two deciles, for example through greater spending on social safety net programs than would otherwise occur, then on average those households would be no worse off after the carbon tax than they were before.

The degree of variation in the carbon tax incidence across regions (with no offsetting tax decreases) is modest; the maximum difference in the average rate across regions is 0.45 percentage points of income. Of the tax swaps, the labor tax swap results in the least variation in net burdens across regions, with a maximum difference across regions of 0.5 percentage points of income. In contrast, the capital tax swap produces a maximum difference across regions of 1.66 percentage points. This suggests that capital incomes are more unevenly distributed across regions than labor incomes.

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Distributional Effects of a Carbon Tax in Broader U.S. Fiscal Reform

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Aparna Mathur
Adele Morris

Image Source: © Bret Hartman / Reuters

Bridging The Gap: Integrating Price Mechanisms Into International Climate Negotiations

Warwick J. McKibbin, Adele Morris and Peter J. Wilcoxen — Mon, 03 Dec 2012 15:34:00 -0500

EXECUTIVE SUMMARY

The Parties to the United Nations Framework Convention on Climate Change (UNFCCC) continue their efforts to forge a new binding international agreement by 2015. The negotiations face daunting odds, but the 2009 Copenhagen Accord’s shift towards heterogeneous national commitments was a positive step forward for climate policy. The prior presumption that binding commitments could only take the form of a percentage reduction relative to historical levels alienated rapidly industrializing countries and led to unproductive disputes over base years and other issues of target formulation. However, the disparate approaches now under discussion complicate comparing the likely emissions reductions and economic efforts required to achieve the commitments.

This paper makes two points. First, we offer good reasons and ways to adapt international negotiations to allow for price-based commitments. The economic uncertainty surrounding target-only commitments is enormous. Combining a clear cumulative emissions target with limits on the cost associated with achieving the target would balance the environmental objective with the need to ensure that commitments remain feasible. This economic insurance could foster greater participation in the agreement and more ambitious commitments. Specifically, we suggest that in addition to their cumulative emissions targets for the 2013 to 2020 period, major economies could agree to a "price collar" on greenhouse gas emissions in their domestic economies. This would include starting floor and ceiling prices on a ton of CO2 and a schedule for real increases in those prices. All major parties would need to show at least a minimum level of effort regardless of whether they achieve their emissions target, and they would be allowed to exceed their target if they are unable to achieve it in spite of undertaking a high level of effort. The paper provides an example of how a price collar would work in the U.S. context under a cap-and-trade system.

Second, analyzing proposed climate commitments in terms of their implied economic stringency, as measured by the implied price on carbon necessary to achieve the targets, offers transparent and verifiable assurance of the comparability of effort across countries. It possible to calculate "carbon price equivalents" of climate commitments in a conceptually similar way to the tariff equivalents used in international trade negotiations.

In sum, the lack of transparency in the level of effort involved in achieving particular emissions targets highlights the potential value of allowing for price-based commitments and argues for greater economic transparency in the international negotiation process.

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Bridging The Gap: Integrating Price Mechanisms Into International Climate Negotiations

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Pricing Carbon in the U.S.: A Model-Based Analysis of Power Sector Only Approaches

Warwick J. McKibbin, Adele Morris and Peter J. Wilcoxen — Wed, 10 Oct 2012 12:25:00 -0400

EXECUTIVE SUMMARY

In June 2010, as the prospects in the U.S. Senate for an economy-wide cap-and-trade bill dimmed, some proponents of climate policy began to push for an approach more limited in scope. One proposed way to limit the scope of the bill was to apply the cap-and-trade program only to the carbon dioxide (CO2) emissions from electricity generation. This paper uses an intertemporal computable general equilibrium (CGE) model of the world economy called G-Cubed to compare a power-sector-only climate policy with economy-wide measures that either place the same price on carbon or achieve the same cumulative emissions reduction as the program limited to the power sector.

We first model a power-sector-only scenario (the Core Scenario) that broadly represents the emissions reduction ambition of a proposal offered by Senator Bingaman in July 2010. We calculate a linearly declining series of emissions caps for U.S. electricity generation from 2012 to 2030 that fall to 17 percent below 2005 levels in 2020 and 42 percent below 2005 levels in 2030. We calculate the CO2 price path that rises at the real interest rate that achieves cumulative emissions equal to the sum of the caps. The price rises at the real interest rate to 2030 and is constant thereafter. We assume that all tax revenues are distributed lump sum back to U.S. households. We then model a second scenario (the Same Price Scenario) in which the carbon price from the first scenario is applied to all fossil CO2 emissions in the US economy, not just CO2 from the power sector. Comparing this with the Core Scenario shows the incremental emissions reductions and other effects of expanding the policy from the power sector to the entire economy. The third scenario (the Same Emissions Scenario) calculates the increasing CO2 price path that if applied to all fossil energy CO2 achieves the same cumulative reductions as the Core Scenario through 2030. Comparing it with the Core Scenario shows the consequences, for both carbon prices and other effects, of using a narrow rather than a broad-based policy. To isolate the effects of U.S. policy, we assume the U.S. alone adopts these climate policies, with no comparable efforts abroad.

As might be expected, the Core Scenario results in a carbon price in the power sector that is almost twice the economy-wide price that achieves the same cumulative emissions. In particular, the power-sector-only approach requires a price on CO2 that begins at $23 in 2012 and rises to $46 in 2030, whereas the economy-wide price begins at $13 in 2012 and rises to $25 in 2030. We find that a price on carbon only in the power-sector does not produce offsetting increases in emissions in other sectors. Rather, we find that carbon emissions outside the power sector fall slightly relative to baseline. This is because of the economic linkages between sectors and the consequences of higher electricity prices on overall economic activity. Global emissions leakage is negligible as the price of oil in other currencies changes little.

All three policies have modest (less than one percent) negative effects on employment in the first decade and little effect thereafter. The policies that price carbon in oil, the Same Price and Same Emissions scenarios, produce much more revenue than the Core scenario.

We find that GDP grows in all of the scenarios at a rate slightly below the reference average in the first decade, but then remains close to reference thereafter. The most environmentally effective policy, the Same Price scenario, also produces the largest short run negative effect on GDP growth and long run negative effect on investment and consumption levels.

We find that all three policy scenarios reduce investment in the capital-intensive energy sector, which lowers imports of durable goods and strengthens the U.S. terms of trade. Thus we find trade consequences of climate policy even in the power-sector-only scenario, which one might think would have relatively low effects on terms of trade given that the U.S. electricity sector uses mostly non-traded fuels. All of the policy scenarios produce an overall decrease in consumption and investment in the U.S. relative to baseline. For consumption, the positive effect from relatively lower price of imported goods is offset by the declines due to higher embodied energy prices.

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Pricing Carbon in the U.S.: A Model-Based Analysis of Power Sector Only Approaches

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Combet’s Carbon Incompetence

Warwick J. McKibbin — Thu, 30 Aug 2012 00:00:00 -0400

The federal government’s announcement that the proposed floor price on carbon would be replaced by a deal to be part of the European emissions trading system in 2015 is astounding.

It shows a complete lack of understanding of what good climate policy should be and what is in Australia’s national interest.

Worse, it raises the economic costs of the existing carbon pricing policy because it creates even greater uncertainty about the price of carbon in future years. It also creates real concern about whether the government knows what it is doing, which adds to sovereign risk.

A minority government, seeking longevity by making whatever concessions are required to whatever sectional interest presses hardest, is clearly the basis for present policy design in Australia.

Vested interests have been allowed to chip away at the carbon price scheme just as they have at most other good ideas, and in the end most Australians are worse off.

It is one thing to make large-scale economic errors when the world economy is giving Australia several per cent of gross domestic product in extra revenue each year. It is another to plan errors for future years when the global economy is looking decidedly uncertain.

In the case of carbon pricing, the idea the Australian scheme should be linked to the European carbon trading scheme is equivalent to the idea the Australian dollar should join the euro zone.

This might be appealing to the government. After all, Australia ratified the Kyoto Protocol just as it was to become redundant and many countries were planning to announce their inability to achieve Kyoto targets at the Copenhagen climate conference. Australia is joining the European carbon scheme just as it has been demonstrated to being one of many policy failures in Europe.

Surely now is not the time to subject Australia to economic shocks out of Europe through an additional channel of the price of carbon. By joining the euro zone, we would complete the trifecta of fundamental policy errors and we could then blame someone else for our economic failures. This may be politically appealing, but it is also appalling public policy.

Carbon rights are like currencies.

The value of a carbon permit depends on the credibility of the government verifying that the carbon right is backed by an emission reduction. Just like money, the only value in an emission permit is the value given to it by a government’s credibility.

The single currency in Europe is under pressure because some governments within the euro zone have not followed policies that support the value of the currency they have created. This lack of credibility not only brings down the economy causing the problem, but it can bring down the entire currency unit because a euro is a euro and its value depends on the credibility of all governments in the system.

The same idea applies to the widespread trading in emissions rights across countries.

The global system is vulnerable to the bad behaviour of a single big player in the carbon permit market. At a time when Europe’s economic judgment is widely questioned, the federal government gives up the right to determine its own carbon price and give that right to Europe. The only case for this is that Europe has greater credibility in policy design and pricing than Australia. This may be true – for now.

The enormous uncertainty over the future of the single currency project in Europe shows why policy design under uncertainty is so important. To expose Australia to the European carbon trading system is a pure cost to the Australian economy. To have a carbon price at $23 a tonne, rising to $29 per tonne in 2015 then falling into a potential abyss, is bad for investment in energy technologies. Yet the solution to climate change will largely be driven by investment in such technologies.

If joining the European trading mechanism is such a good idea in 2015, why not join now? One reason is that the government made an error in providing compensation based on estimated revenue so that whatever happens to the carbon pricing system, the compensation will still need to be paid. Another error is in understanding that the world is highly uncertain and policy should not be made based on a punt about the future. Policy should be robust to different futures.

Australia’s climate policy design has been a farce – and it keeps getting worse.

Authors

Warwick J. McKibbin

Publication: Australian Financial Review

The Potential Role of a Carbon Tax in U.S. Fiscal Reform

Warwick J. McKibbin, Adele Morris and Peter J. Wilcoxen — Tue, 24 Jul 2012 16:15:00 -0400

Executive Summary

This paper examines fiscal reform options in the United States with an intertemporal computable general equilibrium model of the world economy called G-Cubed. Six policy scenarios explore two overarching issues: (1) the effects of a carbon tax under alternative assumptions about the use of the resulting revenue, and (2) the effects of alternative measures that could be used to reduce the budget deficit. We examine a simple excise tax on the carbon content of fossil fuels in the U.S. energy sector starting immediately at $15 per metric ton of carbon dioxide (CO2) and rising at 4 percent above inflation each year through 2050. We investigate policies that allow the revenue from the illustrative carbon tax to reduce the long run federal budget deficit or the marginal tax rates on labor and capital income. We also compare the carbon tax to other means of reducing the deficit by the same amount.

We find that the carbon tax will raise considerable revenue: $80 billion at the outset, rising to $170 billion in 2030 and $310 billion by 2050. It also significantly reduces U.S. CO2 emissions by an amount that is largely independent of the use of the revenue. By 2050, annual CO2 emissions fall by 2.5 billion metric tons (BMT), or 34 percent, relative to baseline, and cumulative emissions fall by 40 BMT through 2050.

The use of the revenue affects both broad economic impacts and the composition of GDP across consumption, investment and net exports. In most scenarios, the carbon tax lowers GDP slightly, reduces investment and exports, and increases imports. The effect on consumption varies across policies and can be positive if households receive the revenue as a lump sum transfer. Using the revenue for a capital tax cut, however, is significantly different than the other policies. In that case, investment booms, employment rises, consumption declines slightly, imports increase, and overall GDP rises significantly relative to baseline through about 2040. Thus, a tax reform that uses a carbon tax to reduce capital taxes would achieve two goals: reducing CO2 emissions significantly and expanding short-run employment and the economy.

We examine three ways to reduce the deficit by an equal amount. We find that raising marginal tax rates on labor income has advantages over raising tax rates on capital income or establishing a carbon tax. A labor tax increase leaves GDP close to its baseline, reduces consumption very slightly and expands net exports slightly. Investment remains essentially unchanged. In contrast, a capital tax increase causes a significant and persistent drop in investment and much larger reductions in GDP. A carbon tax falls between the two: it lowers GDP more than a labor tax increase because it reduces investment. However, its effects on investment and GDP are more moderate than the capital tax increase, and it also significantly reduces CO2 emissions. A carbon tax thus offers a way to help reduce the deficit and improve the environment, and do so with minimal disturbance to overall economic activity.

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The Potential Role of a Carbon Tax in U.S. Fiscal Reform

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Are Pollution Controls Worth Their Costs?

Ted Gayer and W. Kip Viscusi — Thu, 19 Jul 2012 00:00:00 -0400

A recent wave of government regulations mandates the energy efficiency levels of a wide range of consumer and business products, including passenger cars and commercial vehicles, clothes dryers, air conditioners, and light bulbs. The ostensible purpose of these regulations is to reduce pollution, notably greenhouse-gas emissions. But our recent examination of a number of these regulations reveals that, by the agencies’ own analyses, the regulations have only a negligible effect on greenhouse gases, and the environmental benefits are vastly outweighed by the costs of compliance.

The agencies attempt to mask this finding by claiming that the regulations save consumers and firms money, by forcing them to buy more expensive energy-efficient products. By asserting, with little to no supporting evidence, that consumers and firms are making irrational decisions in their purchases of energy-intensive products, the agencies can then claim that energy-efficiency regulations provide private benefits by correcting for this irrationality, and they then use these benefits to justify the expensive regulations that yield minimal environmental gains.

This dismissal of consumer choice deviates from the long-standing methodological practice of cost-benefit analysis—and runs contrary to the guidelines set out by the Office of Management and Budget—in which it is assumed that informed citizens are better able than government bureaucrats at making private purchasing decisions that affect their own bottom line. This is not to say that people are infallible; only that the baseline assumption—supported by much empirical evidence—is that in most contexts consumers with heterogeneous preferences, financial resources and personal situations, are better equipped than analysts and policymakers to make market decisions that affect themselves.

The agencies instead assert consumer and firm irrationality with a generalized appeal to the behavioral economics literature. Behavioral economics seeks to find systematic deviations from rationality and integrate them into economic models, but it does not provide a rationale for taking away consumers’ and firms’ ability to make their own decisions in most market contexts. Rather than just assert irrationality to justify all types of regulations, it is essential for the agencies to document the existence and magnitude of behavioral anomalies in the market they are considering regulating. And where such anomalies are found, the agencies should first resort to less intrusive regulations, such as providing clearer information to consumers and firms in order to help them in their decision-making. Cass Sunstein, the current director of the government office in charge of overseeing the agencies’ regulatory analysis, espoused this policy lesson in his co-authored book called Nudge. To “nudge” is to lightly regulate, primarily through information provision, rather than the current government practice of mandating which products consumers and firms can and cannot purchase.

Perhaps the main failure of rationality is that of the regulators rather than the consumers and firms. Agency officials who have been given a specific substantive mission have a tendency to focus on these concerns to the exclusion of all others. Thus, fuel efficiency and energy efficiency matter, but nothing else does. In effect, government officials are acting as if they are guided by a single mission myopia that leads to the exclusion of all concerns other than their agencies’ mandates.

This agency myopia fosters bad policies. By abandoning the principle of consumer sovereignty, regulatory policy shifts from an appropriate role of mitigating the harm that individuals impose on others through pollution towards a paternalistic emphasis on mitigating the harm individuals impose on themselves. We wind up with more consumer protection (in contexts where there is little to no evidence that it is necessary) and less environmental protection. And if government agencies can justify regulations on the premise that consumers and firms (but not regulators) are irrational, there is no limit to the expansive use of regulatory powers to control and constrain market choices.

Authors

Ted Gayer
W. Kip Viscusi

Publication: Real Clear Markets

Image Source: Shannon Stapleton / Reuters

Energy Efficiency Regulations Set Dangerous Precedent

Ted Gayer — Tue, 17 Jul 2012 11:37:00 -0400

A recent wave of government regulations has mandated energy efficiency standards for products ranging from passenger cars and commercial vehicles, to clothes dryers, air conditioners, and light bulbs. Federal regulators tout these new rules as "greenhouse gas initiatives" with the purported aim of reducing environmental pollutants—especially those that contribute to climate change.

But as the regulatory agencies' own estimates confirm, the environmental benefits of these regulations are negligible, and are often dwarfed by the societal costs they impose.

Read the rest of the op-ed at the US News & World Report website »

Authors

Ted Gayer

Publication: US News & World Report

Image Source: Larry Downing / Reuters

Overriding Consumer Preferences with Energy Regulations

Ted Gayer — Tue, 10 Jul 2012 13:33:00 -0400

Cost-benefit analyses traditionally assume that informed citizens are best able to understand and choose among the available options for the one that best meets their own interests. An individual planning to buy a car, for example, would understand that a large sedan has worse gas mileage than a compact car and would incorporate into her purchase decision the higher expense of gas over the period she expects to own the car. These expected fuel costs would be considered along with all of the car’s other characteristics, including trunk size, comfort, and so on, to make a decision. Thus, regulations that alter consumers’ choices are assumed not to have any private net benefits. A regulation that requires consumers to buy a more expensive, more energy-efficient product, for example, may produce social benefits from reduced pollution, but it will not otherwise make the consumer herself better off.

In a departure from the traditional practices of cost-benefit analyses, recent regulatory analyses have incorporated private benefits under the assumption that consumers have made suboptimal purchasing decisions. In effect, these analyses assume regulations have benefits to consumers because they mandate them to buy products that the government believes make them better off. In a just released working paper co-written with W. Kip Viscusi, we examine a number of recent energy regulations proposed or enacted by the Department of Energy, the Department of Transportation, and the Environmental Protection Agency. Among other things, we find that the preponderance of the benefits associated with these regulations stems from private benefits to consumers of lower energy costs, which is based on the agencies’ poorly-supported assumption that consumers and firms make irrational purchasing decisions. Without these benefits, the regulatory costs greatly exceed the benefits, and the environmental benefits of these regulations are minor.

A link to the paper is available at the Mercatus website (PDF).

Authors

Ted Gayer

Image Source: Lucy Nicholson / Reuters

Clean Energy: Revisiting the Challenges of Industrial Policy

Adele Morris, Pietro S. Nivola and Charles L. Schultze — Mon, 04 Jun 2012 00:00:00 -0400

A peer-reviewed version of this paper appears in the November 2012 edition of Energy Economics and is available for download through ScienceDirect.com (pdf).

“We’re in a competition all around the world, and other countries -- Germany, China, South Korea -- they know that clean energy technology is what is going to help spur job creation and economic growth for years to come. And that's why we’ve got to make sure that we win that competition. I don't want the new breakthrough technologies and the new manufacturing taking place in China and India. I want all those new jobs right here … in the United States of America, with American workers, American know-how, American ingenuity.”
President Barack Obama
May 6, 2011
Remarks at Allison Transmission Headquarters, Indianapolis, Indiana

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Clean Energy Subsidies without a Price On Carbon May Be Money Down a Rat Hole

Governments in most industrial countries have stepped up their promotion of clean energy technology in recent years. No longer a laggard, the U.S. government increased energy subsidies from $17.9 billion in fiscal year (FY) 2007 to $37.2 billion in FY 2010, according to the U.S. Energy Information Administration (EIA).^{^[1]} The total includes a mix of direct expenditures, tax expenditures, the subsidy associated with loan guarantees, and research, development and deployment (RD&D) spending.

The Energy Improvement and Extension Act (EIEA), passed in late 2008, and the American Recovery and Reinvestment Act of 2009 (ARRA) account for much of the increase. The EIEA expanded or extended tax credits for renewable energy, energy-efficient appliances, plug-in electric vehicles, and liquid biofuels. ARRA, a broad fiscal stimulus package, included $35.2 billion to the Department of Energy (DOE) and added $21 billion in energy tax incentives over the life of the legislation.^{^[2]} Using ARRA authority, cumulatively from September 2009 through November 2011, DOE underwrote $35.9 billion in loan guarantees for a range of energy-related technologies.^{^[3]}

Figure 1 displays the U.S. spending stream on energy-related research and development since 1974. The graph shows the dramatic impact of the ARRA package.

Figure 1.^{^[4]}

Public investments of these magnitudes, targeted at specific industries, arguably constitute an industrial policy, albeit a sectoral one, unlike the earlier proposals of the 1980’s —that is, a government strategy to steer resources toward select producers or technologies. The rationale and efficacy of these clean-energy expenditures call for scrutiny.

Proponents offer numerous reasons for scaling up particular energy technologies at the taxpayer’s expense. One set of reasons involves the need to remediate market failures that have not been corrected by other policies. For example, clean-energy technologies are said to emit fewer greenhouse gases than do traditional sources per unit of energy produced. The United States does not have an economy-wide policy to control greenhouse gases, most notably, one that puts a price on CO₂ that reflects the environmental harm associated with use of fossil fuels.

A far more effective policy than subsidies for clean energy research, development and demonstration would be a tax or a cap-and-trade regime that would put an appropriate price on carbon and other greenhouse gases.^{^[5]} Properly implemented, this alternative approach would help level the playing field for greener energy sources, for it would require emitters to pay prices that reflect the costs their emissions impose on society. The enhanced efficiency that would result has been widely recognized by economists.^{^[6]} True costs would flow to purchasers of goods and services that require energy, suitably inducing conservation. Emitters would have incentives to invest in equipment and new production techniques, use alternative fuels, and seek other methods to reduce emissions. And America’s innovators would channel their efforts into inventing, scaling up, and marketing competitive forms of clean energy. However, because existing market signals do not suffice to encourage climate-friendly technologies, carefully targeted federal funding seems warranted. But as we explain later, it is ironically only after incorporating the social costs of energy into market prices that many clean energy subsidies will succeed in deploying new technologies.

Some clean energy technologies, such as electric vehicles and biofuels, are also said to wean the economy from its inordinate dependence on oil, which is both volatile in price and supplied in part from unstable foreign sources. Like environmental damage, the security risks of relying on oil are not fully embedded in its price, and therefore, the argument goes, policies to reduce its use could be efficiency-enhancing.

A second set of reasons for sustaining clean-energy subsidies is less about correcting inefficient market outcomes than about tilting the market toward U.S. interests. In this view, strategic investments in clean energy technologies would increase U.S. firms’ market share of a growing industry and thus help American firms and workers win a larger portion of global business. Although the projected market growth of cleaner energy derives from the international community’s efforts to protect the environment, the objective here is economic. Proponents imply that capturing a larger market share would boost long-term U.S. “competitiveness” and create jobs in American firms that manufacture the exportable products.

Are these justifications sound? And even if convincing in theory, what happens in practice? That is, can the American political process successfully carry out the envisioned strategy? Section 2 of this paper reviews the history of industrial and energy technology policy since the 1970s. Section 3 examines the environmental and energy- independence rationales, and Section 4 analyzes claims about the potential role for government backing of clean energy to ensure U.S. competitiveness and save or create jobs. Section 5 explores the administrative and political challenges of implementing an efficient clean-energy research and development portfolio, and Section 6 sketches our recommendations.

[1] U.S. Energy Information Administration, “Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010,” August 1, 2011. http://www.eia.gov/analysis/requests/subsidy/

[2] $11 billion went to grants to state and local governments for weatherization and other programs and $600 million in new research funding.

[3] U.S. Department of Energy (DOE), Loan Programs Office website, accessed November 29, 2011. https://lpo.energy.gov/?page_id=45. The overall value of loans guaranteed by DOE is much larger than the appropriations necessary to account for the value of the subsidized interest rate on the guaranteed loan.

[4] International Energy Agency, Detailed Country RD&D Budgets. Data downloaded November 29, 2011 from http://wds.iea.org/WDS/ReportFolders/ReportFolders.aspx.

[5] A carbon tax and a cap-and-trade program are theoretically very similar. We favor a carbon tax based on our assessment of the likely actual implementation.

[6] For example: Greenstone, Michael and Adam Looney, A Strategy for America’s Energy Future: Illuminating Energy’s Full Costs, The Hamilton Project, The Brookings Institution, May 2011.

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Clean Energy Subsidies without a Price On Carbon May Be Money Down a Rat Hole

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In Australia, A Carbon Price Over $10 Makes No Sense

Warwick J. McKibbin — Wed, 07 Mar 2012 00:00:00 -0500

The introduction of a carbon price into the Australian economy from July 1 this year is a landmark policy. It will begin the process of changing the incentive to emit carbon in Australia over a very long time scale.

Unfortunately the current policy, unless improved, is likely to cause unnecessary costs to the Australian economy in the short term. What is worse, these costs are likely to be far greater than any expected benefits.

There are many ways that a carbon pricing system can be designed but many fewer ways in which it should be designed, given the nature of the Australian economy and the uncertainty around global climate-change negotiations.

Political compromise and a lack of understanding about the role of uncertainty in designing carbon pricing mechanisms means the Australian approach is likely to be a problem once the time for implementation arrives.

What are the key problems that need urgent attention? First, the idea that the global price of carbon in 2012 or 2015 would be known with any precision when forecast in early 2011 was clearly an exercise in hope over rigour.

The starting price of $23?per tonne of CO2 was partly based on the idea that this would be close to the world price on July 1, 2012. Who knows what that price will actually be on the starting date, less than four months from now, but now the price varies around $6 to $9 per tonne.

Thus Australia is in danger of introducing a carbon price between three and four times the world price.

Second, the policy in 2015 will switch from a fixed carbon price at about $25 per tonne (in 2012 prices) or $28 in 2015 prices to a carbon trading system with a floor price of $15 per tonne in 2015 prices and no effective ceiling price. Most of the economics literature in this area focuses on imposing an effective ceiling price to bind the economic costs close to the expected benefits.

The combination of a floor and ceiling price reduces the volatility and hence the uncertainty in the expected price. Now, consider what happens if the world price in 2015 is below the floor price. Australia will have a carbon price of about $28 on June 30, 2015, which would fall to $15 per tonne on July 1, 2015.

Under this very plausible scenario, the much higher carbon prices paid by Australians between 2012 and 2015 would be unnecessary waste.

More importantly, the value of permits could drop by close to 50?per cent on July 1, 2015. This would cause enormous disruption to carbon abatement policy in Australia – much akin, but on a much larger scale, to the known consequences of stopping various renewable energy subsidies halfway through a scheme.

It is not sound policy to have such wild swings in a carbon price, yet it is a very likely scenario. This type of inconsistency destroys the incentive to invest in carbon abatement activities.

Another argument for a high carbon price in 2012 is the belief that no one will change behaviour at a price below $23 per tonne. This shows a complete lack of understanding of the investment decision process. Companies and individuals making energy production and consumption decisions take into account the expected future price of carbon and the expected volatility in that price over the horizon of the investment project.

A high price today that is expected to collapse because of a faulty design (not to mention the lack of bipartisan support) will merely cause input costs of energy to rise but generate little investment in reducing emissions. A price that is low but expected to rise in future years in a robust system, with the interests of key players aligned through clever allocation of permits, will likely generate a far greater investment response. Uncertainty stifles investment. The current carbon pricing system has too much uncertainty.

Instead of attempting to lead the debate on reducing global emissions in a world losing interest in this debate, the case for a bipartisan carbon price in Australia should be based on our national interest within a realistic assessment of how we can contribute to the global policy debate. The national interest argument is that having no carbon policy generates uncertainty, which inhibits investment in all types of energy systems, which has significant economic costs.

It is in Australia’s national interest to have the price of carbon on July 1 this year starting at closer to $10 per tonne. This price balances the benefits of reducing investment uncertainty against the costs of climate abatement policy.

It appears, as well, that this may be closer to the world price, which helps offset the potential competitiveness problems the current policy creates.

Until the world takes more concrete actions, this is where Australian policy should be focused. When the world takes greater action, the carbon price can be moved up.

The urgent question today is what will the government do between now and July 1 to fix the potential problems created by badly designing the carbon pricing system?

If the government does not realise the potential problems it faces and does nothing to address them, there is a silver lining. A significant carbon price shock will give economists a good set of data to properly evaluate the gross domestic product and employment consequences of this type of policy so we can go back and more accurately recalibrate our models for next time.

Authors

Warwick J. McKibbin

Publication: Australian Financial Review

Reforming Energy Tax Policy

Ted Gayer — Sat, 11 Feb 2012 00:00:00 -0500

This speech was delivered by Ted Gayer at a symposium titled Reforming the U.S. Tax System. The symposium was hosted by the Princeton University Griswold Center for Economic Policy Studies on February 10-11, 2012, and Gayer was invited to speak on the subject of "out of the box" tax reform.

I'm going to start with a critique of existing energy tax policy and then move on to examine how we might re-think energy tax policy within the context of broader tax reform.

Our federal tax code contains a few energy taxes, such as the tax on motor fuels, which is currently 18.4 cents per gallon of gasoline and 24.4 cents per gallon of diesel. But our tax code contains many more energy tax expenditures, which are subsidies granted to items by excluding them from the tax base, such as allowing intangible drilling costs to be fully deductible in the first year rather than depreciated over time.

Already you can see an example of the conflicting nature of our energy policy. We frequently tax an energy source while we simultaneously subsidize it. Or we subsidize an energy source while we also subsidize a substitute energy source. These inconsistencies arise because at different times throughout the last hundred years, we have shifted back and forth across three different, competing goals. And at times, we've even tried to embrace these competing goals within the same energy legislation.

Broadly stated, the goals have been as follows: 1) We should promote domestic energy production; 2) We should raise tax revenue; and 3) We should reduce pollution caused by energy use. It is not the case that these three goals must always contradict each other. For example, the gas tax, which was created in 1932, promotes the goal of pollution reduction and the goal of raising revenue.

But the goals frequently are incompatible. For example, tax subsidies for such things as renewable energy or electric vehicles, are the preferred policy choice for reducing pollution, even though they undermine the goal of raising revenue.

We have also seen conflicts between the goal of reducing pollution and the goal of promoting domestic energy production. So, for example, we have subsidized renewable fuels in an attempt to reduce pollution, while also providing subsidies for oil and gas production, electric utilities, and refineries. The list can go on of energy policies working at competing ends. I'll only note for now that the complexities have increased, as we now have around 50 different energy tax expenditures in our tax code.

So how would I re-consider our three competing goals in a way that would lead to more coherent and efficient energy policies?

First, I would de-emphasize the goal of promoting domestic energy production. The main reason given to justify this goal is that of energy security, which I interpret as a desire to insulate domestic energy prices - especially oil prices - from supply disruptions that can occur in volatile or hostile nations. But because crude oil is traded throughout the world, any supply disruptions in other countries will affect domestic prices even if the U.S. produced all of its oil domestically. So we wind up incurring large costs to shift towards domestic production, we still wind up with the same domestic oil price because the price is set in global markets.

Second, I would emphasize the goal of reducing pollution. The problem with pollution is that it incurs costs on bystanders, and these costs are not considered in the market transaction between producers and consumers. We should enact policies that include these external costs in the market decision, which would lead to a reduction - although not an elimination - of pollution.

The most cost-effective way to reduce pollution is by taxing it, not by subsidizing cleaner energy alternatives. Subsidies are no doubt more politically appealing than taxes; but it is important to remember that such subsidies have real budget costs, which ultimately means they must be financed by increasing other taxes, cutting other spending, or running larger budget deficits. Taxes are also more effective than subsidies, because they send a signal to consumers to conserve energy and they send a signal to producers to innovate and develop low-cost and cleaner alternatives.

Subsidies on the other hand require the government to pick the best alternative fuels and technologies, which puts it in the role of venture capitalist - a job it is ill-equipped to perform, especially given the unavoidable political considerations that influence decision-making. The simplest and most efficient way to account for the external costs associated with pollution is with a tax that is designed to raise the price of different energy sources in proportion to the environmental harm they cause.

The final goal to consider is that of raising tax revenue. The description thus far of my preferred energy policy leaves us with many fewer tax expenditures and with a pollution tax. Both of these indeed provide us with more tax revenue. But note that the goal of a pollution tax is not to maximize revenue. A tax that maximizes revenue will lead to economic costs that outweigh the environmental gains from less pollution.

Once you've established a tax, there is a clear economic case for using the revenues to offset existing inefficient taxes or to reduce the deficit. A pollution tax would increase the price of energy and transportation, which in effect would lower real wages. This decrease in real wages would magnify distortions from pre-existing taxes, such as the income tax. This is known as the tax-interaction effect, and it can mean that a tax on pollution can impose substantial economic costs, even in some cases leading to negative net benefits. The way to reduce these costs is by using the pollution tax revenue to offset economically harmful taxes or deficits.

But while there are clear economic gains to using pollution tax revenues efficiently, such revenue can only go so far to reducing our deficits. A tax of similar stringency to the climate cap-and-trade bill that passed the House in 2009 would raise about $60-$80 billion annually in the early years, rising to about $100 billion in about 25 years, before dropping again thereafter. This is a substantial amount of tax revenue, but it would only play a small part in closing our fiscal gap. If one focuses on just the 10-year window, annual tax revenue would be on par with our expected revenue from excise taxes, which amounts to about half a percent of GDP annually. This is slightly smaller than the revenue loss due to the mortgage interest deduction. Over the longer-term, which is when we face our most pressing fiscal problems, we could expect the tax revenue to contribute less to closing our fiscal shortfall, since emission reductions would be likely to outpace increases in the tax rate.

If our goal is to indeed use pollution tax revenues for deficit reduction, then unfortunately our policy track record here has not been good. Our existing sulfur dioxide cap-and-trade program - which is our most successful market-based program - gives away all of the cap allowance value to electric utilities. For climate policy, the bill that passed the House in 2009 called for about 60 percent of the total allowances to be given away over the life of the program. The remaining 40 percent was to be auctioned by the government, but the auction revenue for the most part was not to be used for deficit reduction. Of the total allowance value in 2016, less than one percent was targeted for deficit reduction. The bulk of the value went to such things as subsidizing electric utilities, helping trade-exposed industries, and transfers to low-income consumers.

In the Senate, the climate bill proposed by Senators Kerry and Boxer would have given away 77 percent of the allowances in 2012. Only about 10 percent was targeted for deficit reduction. The bill proposed by Senators Cantwell and Collins auctioned all of the allowances, but then would have allocated 75 percent of the revenue evenly across all U.S. residents and would have allocated 25 percent to fund such things as transition assistance, carbon sequestering projects, and clean energy investments. Nothing was allocated for deficit reduction.

The administration's original cap-and-trade proposal did call for all allowances to be auctioned. However, none of the revenue was targeted for deficit reduction. Instead, about 80 percent of the revenue was to go to permanently extending the Making Work Pay tax credit, and the remainder was to go to subsidizing clean energy technology.

So our limited policy history and proposals with pollution revenue recycling is one in which the revenues are largely either given away to the regulated industry or are used to fund government programs or tax credits, not to fund deficit reduction or tax rate reduction.

But perhaps the pressing fiscal challenges we face today present an opportunity for better policy now. I suspect a political consensus is indeed achievable with respect to tax reform. Our current tax system is economically harmful, complex, unpredictable, and often unfair, which strikes me as thus creating a broad negotiating space for improvement.

But I do think it is correct that the organizers of this meeting placed energy taxes in the "out of the box" category of tax reform. The most likely route towards tax reform would entail changing our existing tax code, rather than creating a new tax, especially one as controversial as a pollution tax on energy sources. Indeed, President Bush's tax reform panel in 2005, and more recently the Simpson-Bowles fiscal commission in 2010, both focused on reforming the current tax code by broadening the base through reducing tax expenditures while lowering marginal tax rates. Neither of these commissions proposed the adoption of new taxes. I should note that the Debt Reduction Task Force co-chaired by Senator Pete Domenici and my colleague Alice Rivlin (and in which Len was a member) did include a new consumption tax, called the Debt Reduction Sales Tax. But I think it would be politically challenging to expand the dimensions of tax reform to include new taxes, especially a pollution tax, rather than focus on reforming the tax system we currently have.

Let me touch on another possible path towards a pollution tax. I think an underexplored opportunity exists to couple a tax with broader environmental policy reform. It is true that one of the points previously used in favor of the climate cap-and-trade bill was that it could substitute for the default policy, which stemming from a Supreme Court ruling is that the EPA will issue emission rules for greenhouse gases under the Clean Air Act. This Clean Air Act approach to climate policy is considerably less cost-effective than a modest, gradually increasing, and predictable tax on emissions.

But I would take this one step further. Not only can a tax substitute for the default policy of imposing inflexible greenhouse gas regulations throughout the economy, it can also substitute for a broader set of other existing environmental and energy regulations. For example, fuel economy standards and energy efficiency standards are largely redundant given a clear and predictable price on emissions. And a pollution tax should yield co-benefit reductions in pollutants that are currently regulated by the EPA, thus obviating the need for some existing, costly regulations.

In the midst of an election campaign, and with the unemployment rate forecasted to be at about eight percent by the end of this year, we are unlikely to soon see a shift in political momentum towards the type of policy I have described here. But the urgent need for fiscal reform, and the political appeal of broader environmental policy reform, could provide an opportunity to achieve a sensible and effective comprehensive energy policy.

Thank you.

Authors

Ted Gayer

Publication: 2012 Spring Symposium, Griswold Center for Economic Policy Studies at Princeton University

Clean Energy: Policy and Priorities

Adele Morris — Wed, 11 Jan 2012 18:13:00 -0500

President Obama said in May 2011, "We're in a competition all around the world, and other countries …know that clean energy technology is what is going to help spur job creation and economic growth for years to come." Federal energy subsidies, fueled mostly by stimulus spending, reflected his priorities by growing from $17.9 billion in FY 2007 to $37.2 billion in FY 2010.¹ The policy mix includes direct expenditures, tax expenditures, and the subsidy associated with loan guarantees. For example, cumulatively from September 2009 through November 2011, the Department of Energy (DOE) underwrote $35.9 billion in loan guarantees for a range of energy-related technologies.²

One rationale for scaling up clean energy technologies at the taxpayer's expense is that they can reduce greenhouse gas emissions, which aren't controlled by other policies. A second rationale is the thought that strategic investments in clean energy technologies can hasten the weak recovery and improve U.S. competitiveness by driving resources toward a fast-growing sector of the world economy. While a case can be made that subsidizing clean energy might reduce pollution, the case for many subsidies may be narrower than some assert, and turning theory into sound practice is no simple feat. The notion that clean energy industrial policy can increase long-run employment and economic growth is more debatable.

Let's take the environmental case for clean energy subsidies first. The evidence is clear that no subsidy policy is a substitute for a price on carbon, for example from a carbon tax or a cap-and-trade system. To illustrate, a recent modeling study estimates that tax credits for energy efficient household capital would produce 1/20 of the carbon emissions reductions that a similar-sized carbon tax would produce.³ This is because unlike a tax credit for new, more energy efficient equipment, a price on carbon incentivizes emissions abatement from all activities quickly, prompts electricity producers to use lower-carbon fuels, and doesn't create savings that households use to purchase more energy. A carbon price would help level the playing field for greener energy sources by requiring emitters to pay prices that reflect the costs their emissions impose on society. Those costs would flow to purchasers of goods and services that require energy, inducing more conservation. Emitters would have incentives to invest in equipment and new production techniques, use alternative fuels, and seek other methods to reduce emissions. And America's innovators would channel their efforts into inventing, scaling up, and marketing competitive forms of clean energy.

However, particularly until Congress imposes a reasonable price on carbon, cleaner substitutes warrant federal investments. The strongest case is in basic research and early development of clean energy and energy-efficient technologies, since firms tend to under-invest in these activities anyway. In the period before an appropriate price on carbon, it might also make sense to encourage investments analogous to those that firms would undertake if carbon were properly priced, i.e. investments in technologies with the lowest expected cost of abatement and highest probability of market penetration. However, current spending doesn't look like that. For example, of the nearly $40 billion in loan guarantees in the stimulus package, over 43 percent went to two sectors that offer some of the highest costs of carbon abatement and the lowest projected market shares: solar power and electric vehicles. Of course the loan guarantee program is only one vehicle in a convoy of spending programs, but it does suggest the potential to reallocate efforts to technologies that might have the strongest prospects under sensible climate policy.

Now let's consider the claim that clean energy policy can help spur job creation and economic growth, as proponents suggest. Of course, energy policies can affect the fortunes and employment levels in individual industries. But some believe strategic policies could enable U.S. firms to get a leg up on foreign competitors, develop intellectual property, and thereby gain the advantage of being a "first mover." Not necessarily. Firms already have the incentive to develop profitable technologies and use patent protection to maximize their payoffs. The question is whether there is a public-policy case for subsidizing these companies. To make sense, the policy would have to render these firms more profitable such that they yield a beneficial economic spillover sufficiently large to justify the subsidies' cost. In theory that might be possible if, thanks to the government's support and intellectual property protection, U.S. companies could capture world markets at the expense of foreign rivals and generate profits or economic activity at home that otherwise wouldn't occur. However, it's not clear that the clean energy market is likely to advantage the first countries that subsidize or mandate the new technologies. It is just as plausible that greater gains derive from following instead of leading. After all, global demand for clean energy (unlike many other sectors that taxpayers could subsidize using the same logic) is a function of fickle environmental policies that spur adoption of what might otherwise be uneconomic technology. Further, pushing home-grown technologies at taxpayers' expense offers no guarantee that the eventual products ultimately won't be manufactured somewhere else, since the global market forces that drive the manufacturing location of other technologies apply to clean energy technology, too. Indeed, the willingness of other nations heavily to subsidize their clean-tech industries, thereby lowering the costs of clean energy, could benefit both the U.S. economy and the environment.

Might promoting green jobs and clean technology spur growth amid the current economic stagnation? In this situation, the relevant question is how spending related to energy stacks up against other forms of fiscal stimulus. It depends on how "timely, targeted, and temporary" the spending is. By these criteria, much clean energy spending falls short. A major energy project requires time for detailed proposals, competitive contract selection, and negotiations over the scope of work. Research and advanced demonstration projects are hard to scale up quickly, in part because they use skilled labor that is already in high demand. The imperative that stimulus spending be temporary (so it doesn't crowd out other economic activity when resources aren't slack) also doesn't fit a well-structured energy policy portfolio. Government should invest in technology development based on the long-range merits, not how it fits in the business cycle. The most effective stimulus spending on energy could be the energy efficient retrofits for low-income households, which can employ laid off construction workers and benefit those with a high marginal propensity to consume.

Even when there is a sound economic case to fund clean energy in principle, it's all but impossible to insulate the investments from political pressures that distort investments that are already risky given volatile commodity markets. The joint vagaries of political whim and market forces have left a trail of expensive policy failures. While policymakers have had some successes, the history of the Department of Energy's (DOE) RD&D projects has been checkered since the early 1970s. After the first Mideast oil shock in 1973, various alternative fuel programs were proposed but proved problematic. For example, President Carter and Congress created the Synthetic Fuels Corporation that was envisaged to spend up to $88 billion ($200 billion in 2007 prices) and to produce an ambitious two million barrels a day by 1992. Some plants were completed at a cost to taxpayers of about $4 billion (2010 dollars), but they never operated commercially. The Clinch River breeder reactor project cost taxpayers $3.9 billion in today's dollars. It was abandoned in 1983, and none of the subsidized reprocessing plants became commercial operations. Some more recent federal efforts to fund energy technology have seen similar failures and false starts. For example, from 2004 to 2008 the federal government sank $1.2 billion into hydrogen vehicle programs that so far have produced no commercial deliverables.⁴

The failure of Solyndra in August 2011 illustrates the continuing array of economic and political challenges. The California solar firm went bankrupt after receiving over $500 billion in federal loan guarantees. Solyndra's market edge, hailed at first by analysts, was that it avoided the need for expensive polysilicon. But when the price of polysilicon plummeted and Chinese subsidies lowered the costs of polysilicon-based photovoltaics by nearly 50 percent, Solyndra was left hanging. Perhaps riling critics most, the Obama Administration subordinated Solyndra's federal debt to other creditors when it doubled down on what turned out to be a bad bet. Despite the fact that the loss on Solyndra is a tiny share of the overall loan portfolio, the appearance of politically motivated investments has created lingering partisan bickering that prevents a reasoned debate on energy technology policy.

So what should policymakers do? First, there's no substitute for a modest but significant price on carbon. Without a price on carbon, clean energy subsidies can only go so far to counteract the market advantage of cheaper fossil incumbents. And with a responsible price on carbon, market demand would drive deployment of the lowest cost abatement strategies so federal spending can concentrate on more basic research and development. Second, inasmuch as DOE remains in the business of energy technology development, it should target dollars to investments with the greatest potential to reduce environmental damages at low cost. This means an explicit focus on intervening where there's a clear case that market outcomes aren't efficient, and otherwise leaving well enough alone. It also means insulating spending decisions from political winds by establishing independent expert panels to review proposals. Finally, DOE should collect and analyze comparable data on the performance of the wide array of its programs to learn what works well and what doesn't, and it should use those results to improve its portfolio.⁵

Footnotes
[1] U.S. Energy Information Administration, "Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010," August 1, 2011. http://www.eia.gov/analysis/requests/subsidy/
[2] U.S. Department of Energy (DOE), Loan Programs Office website, accessed November 29, 2011. https://lpo.energy.gov/?page_id=45. The overall value of loans guaranteed by DOE is much larger than the appropriations necessary to account for the value of the subsidized interest rate on the guaranteed loan.
[3] McKibbin, W., A. Morris. and P. Wilcoxen, "Subsidizing Energy Efficient Household Capital: How Does It Compare to a Carbon Tax?" The Energy Journal. Vol 32. 2011.
[4] Mufson, Steven, "Before Solyndra, a History of Failures," The Washington Post, November 13, 2011, p. B4.
[5] For more discussion on data and program review, see Jaffe, A., R. Newell, and R. Stavins, "A Tale of Two Market Failures: Technology and Environmental Policy," Ecological Economics 54 (2005) pp 164-174.

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Adele Morris