Read the full report here.

Economists often find themselves on the defensive in debates over climate policy. Their favorite tools, carbon taxes and emissions trading, are viewed as dangerous political distractions. “Climate economists have blown it pretty comprehensively,” writes one critic. Some of the criticism is deserved. This report identifies several areas in which economists have either missed the point or at the very least failed to make themselves understood. It offers suggestions both for modifying the market-based policies widely favored by economists and for presenting them in a way that is more in tune with the views of the larger climate community.

A good part of the resistance to carbon pricing stems from the “Pigovian” model widely used to explain the policy. That model identifies an optimal carbon price and an optimal rate of emissions by balancing the harms caused by carbon emissions against the costs of abatement. The model views too little pollution as just as big an evil as too much, and depends on the rational self-interest of firms and consumers to achieve an efficient result. However, as critics point out, such a model is only as good as its assumptions. Market imperfections and behavioral issues can undermine the effectiveness of a pricing-only climate policy.

The social cost of carbon (SCC) is another point of contention. Economists define the SCC as the discounted present value of all future harms done by greenhouse gas emissions and make the SCC the carbon-price benchmark. However, measuring the SCC turns out to be more difficult than it might seem. Economic, demographic, technological, and scientific uncertainties mean that it is impossible to make a credible point-estimate of the SCC. At best, models only identify a broad range of plausible values. In addition, several critical steps in measuring the SCC are implicitly or explicitly subjective, rather than scientific. Those include the choice of a discount rate, which is a measure of how much people in the present care about the future; the degree to which policy should focus on unlikely but catastrophic risks; and “equity weighting,” which means determining the relative importance of climate harms to particular people or nations.

To avoid the problems of the SCC, an increasing number of economists advocate a “target-consistent” approach to policy. The idea is first to establish a clear goal, such as holding warming to less than 1.5 degrees above preindustrial levels, and then to work backward to devise a set of cost-effective policies to reach the target. Carbon pricing is a strong candidate for inclusion in such a set of policies. The target-consistent approach is a natural fit when the chosen policy goal is deep decarbonization – achieving net-zero emissions by a chosen date.

The alleged political toxicity of carbon taxes is a final concern of the critics. It is true that carbon pricing proposals meet with considerable political resistance, but so do almost any effective policies. Abandoning pricing in favor of subsidies, performance standards, and regulations does not change the fact that reducing emissions entails real costs. At best, such policies only move the costs around, shifting them from consumers to taxpayers or from one industry to another; at worst, they increase the economic costs of decarbonization without overcoming the political barriers. A strong case can be made that an “all of the above” strategy that includes both market-based and administrative measures represents the best way forward in both economic and political respects. 

Photo credit: iStock