On April 15, 2021, Niskanen Center Board Chair Robert Litterman was invited to testify in front of the United States Senate Committee on the Budget about the costs of inaction on climate change. The full hearing page is linked here. In the following post, we reproduce Litterman’s testimony about managing climate risk and the importance of carbon pricing.

Litterman Opening Statement







APRIL 15, 2021


Chairman Sanders, Ranking Member Graham, and members of the Committee: Thank you for inviting me to address the risks that climate change poses to the economy and my suggestions for how to deal with them. The best science shows that damage from climate change is already serious, and could range in the future from severe to catastrophic.  Risk of this magnitude demands an immediate ambitious response, including a price on carbon. Today the world is hopeful for U.S. leadership on climate action, but appropriate management of climate risk requires action by this Congress.

When the stakes are high, as they are with our planetary future, uncertainty often compels more action rather than less. And in the presence of such large risks, delay in responding is costly. We need to act — immediately and forcefully. Thankfully, the solutions we need to manage these risks are at hand; in particular, a clear, strong price signal will let markets function efficiently and effectively to reduce emissions.  A carbon price can be equitable, bipartisan, and the core of effective climate response.


My name is Bob Litterman. I am an economist by training and have spent my career managing financial risk. I worked at Goldman Sachs for 26 years. I was a partner and head of our firmwide risk department. I am now the chair of the risk committee at Kepos Capital, and I sit on several boards for groups that study and propose responses to climate risk, including the Climate Leadership Council, which I co-chair with Kathryn Murdoch; the Niskanen Center, which I chair; Ceres; Climate Central; Resources for the Future; the Stanford Woods Institute for the Environment and the Stanford Natural Capital Project; the Woodwell Climate Research Center; and the World Wildlife Fund.

Section 1: Lessons from Financial Risk Management

Financial risk management has several simple principles that apply to managing climate risk.  Most importantly, risk management requires imagining “worst case” scenarios, by which we really mean scenarios that are extremely bad, but plausible. When I took over risk management at Goldman, we would analyze scenarios where markets would lose half their value overnight. In such an extreme event, would we have enough capital to open in the morning?

Risk managers do not only worry about expected outcomes. Our job is to prevent disasters. This means that we must look at the full distribution of potential future outcomes and evaluate how changes in policy could hedge against bad outcomes. Identifying the worst-case scenario for climate risk is challenging because we are performing this experiment for the first time, it is practically irreversible, the impacts will be felt for many decades to come, and we must make judgements about how society will respond to large physical changes. I am pleased to provide testimony today alongside David Wallace-Wells because he has done exactly that with respect to climate change and done so in remarkably humane terms.  

Another principle of financial risk management, which is perhaps not as obvious, is that our objective is not to minimize risk, but to price risk appropriately. In the private sector, risk managers make sure that risks are identified and only taken when the reward is commensurate. For example, at Goldman Sachs we would charge traders for the risks they took, forcing them to take risks only where the firm would be more than compensated by the expected returns on their trades.

With public policy, the objective is to use prices to incentivize the right level of insurance against bad outcomes. Without pricing, we would either be too cavalier in the face of oncoming disaster, which describes our current approach to climate change, or paralyzed by an inability to accept some risk as the normal course of things. Neither is necessary in this context. I am also pleased to provide testimony alongside Professor Stiglitz, because he is a Nobel laureate in economics, and I am quite sure that he can explain better than I the importance of incentives in directing the flow of capital and why failing to force economic actors – the fossil fuel industry, manufacturers, and consumers – to pay a price for the climate risk to which we are all exposing ourselves is extremely dangerous.

A third principle of risk management is that time is a scarce resource. If we have enough time, we can solve almost any problem. It is when time runs out that a risk becomes a catastrophe.  The risk from climate change is increasing as we fill the atmosphere with greenhouse gases. We do not know how much time we have before we cross a tipping point, or multiple tipping points, after which unmanageable disaster becomes inevitable. This is an extremely urgent matter and the cost of inaction mounts year over year as climate risks loom larger.

Explaining how uncertainty affects risk management decisions in everyday terms, I often use the analogy of cycling in the mountains, one of my favorite forms of exercise. Imagine two scenarios: In the first scenario you are riding down a road you know well. Up ahead you know that there is a dangerous hidden curve with a sharp drop-off. Since you know the road well, you know where to start braking, and how fast you can safely go around the curve. Given this knowledge, you would ease on the brake well ahead of time, using maximum pressure right before you enter the curve.

Now consider a different scenario, in which you have never been down this road before. Because of your uncertainty about the road you realize you need to be more cautious. You have not eased onto the brakes by the time you spot the hidden curve, and you realize you might be going too fast. So you brake hard. The intent is not to stop, but to go into the curve with more control and more options. You may even let up on the brakes as the curve reveals itself. Aware of the curve, but uncertain of its shape, is where we are with respect to climate risk. We have seen the curve ahead and are going too fast.

And with respect to the potential cost of delay, I remember a specific incident from my own experience. Years ago (on December 6, 2014), my wife and I were driving on the freeway when she exclaimed “Oh my God, Bob — watch out!” From her tone, the urgency in her voice, I knew instantly I had to pay attention. She had spotted, across the divider about a quarter of a mile in front of us, an oncoming 18-wheeler, bouncing out of control and spewing flames from the passenger-side wheel well. I remember immediately slamming on the brakes, even before I had realized, as my wife already had, that the truck was careening diagonally right towards us, which terrified her. Five seconds later we narrowly avoided, by a fraction of a second, plowing head on into a gasoline tanker that had exploded right where we would have been. That quick response to my wife’s warning saved our lives because I was able to safely steer our car through the fire and out the other side.

We are today, with respect to climate action, in the same position I was when my wife sounded her warning. A growing chorus of scientists, CEOs, national security experts, and financial experts have all seen climate change barreling toward us. They are shouting “Watch out.”

Q&A: Litterman on the costs of delay

Section 2: The Implications of Climate Risks for the Financial System and Economy

Last year, I had the honor of serving as the chair of the Commodity Futures Trading Commission’s Climate-Related Market Risk advisory subcommittee. The CFTC is responsible for regulating the derivatives markets in the United States to ensure “integrity, resilience, and vibrancy.” Members of the subcommittee included representatives of market participants — banks, institutional investors, non-financial corporations, and a commodity exchange — as well as academics and nonprofit organizations. We focused on the principles of risk management outlined above, and that led to a clarity of vision that allowed us to create, and unanimously support, a detailed road map for managing climate risk in the U.S. financial system.

Q&A: Litterman on specific and systemic risks

That road map focuses on two types of climate-related financial market risks. First are the specific risks, for example to individuals and corporations, from increasingly extreme weather events such as storms, wildfires, and sea-level rise that are expected to increase in number and intensity over the next 50 years. Specific risks are growing over time, but are manageable. The second type of risk, which I will come back to, is systemic risk to society.

Specific risks take many forms. For example, in the Western U.S., scientists have established a link between the area burned by wildfires and climate change, which creates dry and warm conditions amenable to large wildfires. This has clear implications. We have recently seen the Southwest experiencing record wildfire seasons, exacerbated by both land management practices and climate change. The confluence of those factors has real costs. The CFTC report highlights the case of Pacific Gas and Electric in California, which entered bankruptcy because of $30 billion in liability associated with its infrastructure sparking record wildfires. Meanwhile, the effects of climate change loom even larger in the future.

Another example is flooding incidents in coastal regions brought about by sea-level rise. This is a visible and accelerating manifestation of global warming. Higher sea levels increase the risk of damaging floods in coastal areas, whether they are driven by tides, storm surges, or other weather events. Markets are already starting to respond to this increasing risk, with detectable changes in prices due to perceived flooding risk. This portends significant financial risks, as we reported to the CFTC:

Declining real estate values — driven by climate-related impacts or the perception of such impacts in the future — could substan­tially depress economic activity. Some populations and local communities within the United States may ultimately be required to relocate, with potentially significant economic losses for households and investors.

Lastly, scientists in recent years have begun to identify how climate change has affected individual weather extremes. Last January, the American Meteorological Society published its annual update to an ongoing series of reports, Explaining Extreme Events of 2019 from a Climate Perspective, which found climate linkages to large fires in Alaska, the extreme rainfall associated with hurricanes, and heat waves. All of them were from 2019 alone. The report is released each year. As the symptoms of climate change develop, they will continue to increase risks to infrastructure and economic activity.

The distinguishing feature of specific risks is that they can be insured against, and, of course, they should be. Insurers can diversify exposure to specific risks, and they can share them broadly through reinsurance markets. The cost of insuring against climate-related risks will no doubt rise, but in a market economy those increased insurance costs send powerful economic signals that individuals and corporations will be safer if they avoid exposed locations and prepare for extreme weather.

If these specific risks are addressed and meaningfully disclosed with transparent, auditable, decision-useful metrics, investors will be protected. In our road map we have 53 high-level recommendations, most of which addressed specific risks. As an appendix to this testimony, I have included the chapter of that CFTC report that lists those recommendations.

I am pleased to see that many of those recommendations are being taken up. Since we published that report, the Federal Reserve has joined the international Network for Greening the Financial System. The SEC has started soliciting public comment on regulations for climate risk disclosure by firms. And Randal Quarles, Federal Reserve vice chair and chair of the Financial Stability Board, recently wrote that the Financial Stability Board is designing a road map for understanding and managing climate risks for the G20 and central bankers.

Unfortunately, these actions are not enough. There are risks that are so extreme that there is no way to diversify the exposure, they are systemic. This is the second kind of risk we need to manage, and it requires a societal response. No entity, for example, can insure society against an equity market crash, nuclear war, or a global pandemic; and similarly, none can insure society against the systemic exposure created by climate change. This risk requires a systematic, coordinated, and comprehensive national and global policy response.  

Today, when specific risk protections are inadequate because of the scale of the disaster, we depend on the federal government to provide an emergency backstop. But we cannot simply assume that such a backstop will always be there. We need to act decisively today to ensure that more and more federal bailouts will not overwhelm federal coffers in the case where climate change is unmanageable. If we were to find ourselves in that world, domestic disaster response would not be the only challenge. The indirect effects of climate change — new pandemics, threats to national security from failed states or climate-induced mass emigration, economic retraction in some places — will also demand response. In a world where the effects of climate change are severe, society is likely to start removing CO2 from the atmosphere by artificial means to restore lower temperatures, at great expense. In that scenario, every ton we release today is a future liability.

To avoid the worst of these systemic threats, we must transform our economy to stop emissions.  The scale and urgency of that transformation require that financial markets immediately and dramatically increase the flow of capital toward investments that will reduce emissions. Congress plays a critical role in addressing systemic climate risk. Through fiscal policy, and to a lesser degree direct programs, the federal government directs the flow of capital and supports innovation. The CFTC report is clear: Creating these appropriate incentives “is the single most important step to manage climate risk and drive the appropriate allocation of capital.”

Q&A: Litterman on incentives

Section 3: Responding to Climate Risks

To reduce our exposure to systemic climate risk, we must start rapidly decreasing our greenhouse gas emissions year-over-year. The longer we wait, the more severe the climate risk will get. To avoid the worst-case scenarios, we should work quickly and effectively to secure absolute emissions reductions. The commonly accepted goal of keeping global warming within 2 degrees centigrade, or as close to 1.5 degrees centigrade as possible, implies that the global economy should operate with net-zero greenhouse gas emissions by the mid-21st century.

The United States has made significant progress in reducing its greenhouse gas emissions while maintaining economic growth over the past decade and a half. The U.S. EPA reports that in 2019, gross greenhouse gas emissions were 6577 million metric tons of CO2-equivalent (MMT-CO2eq), down nearly 12 percent from their 2007 peak. That reduction was largely the result of changes in the power sector: switching from coal to natural gas and increasing the share of renewables.

Despite our substantial progress in reducing emissions, if we are to meet midcentury targets, we will have to accelerate emission reductions by two to three times. Last month, President Biden proposed The American Jobs Plan, which would spend billions on climate-related infrastructure, technology innovation, and subsidies for clean energy. Many of those investments will help reduce the costs of low-carbon technology and improve the resiliency of our energy systems.

The level of attention the President, members of Congress on both sides of the aisle, and this committee are devoting to climate change is encouraging. But at the end of the day, the effectiveness of such spending measures, in terms of tons of emissions-reduction per dollar spent, could be many times greater if we created the appropriate incentives for the private sector to fully join the effort. As things stand, there is a bug in the tax code. We allow the risks of climate change to go almost unpriced in market transactions. The best fix for this bug is establishing a price on carbon. I and many other economists can tell you how that price can be determined, but we cannot fix the bug on our own.

Why Carbon Pricing is Important

It was the first recommendation of the CFTC subcommittee — unanimously agreed to by more than 30 subcommittee members — that the United States should establish a price on carbon:

Recommendation 1: The United States should establish a price on carbon. It must be fair, economy-wide, and effective in reducing emissions consistent with the Paris Agreement. This is the single most important step to manage climate risk and drive the appropriate allocation of capital. – pp 123

As we wrote in the report:

Without an effective price on carbon, financial markets lack the most efficient incentive mechanism to price climate risks. Therefore, all manner of financial instruments — stocks, bonds, futures, bank loans — do not incorporate those risks in their price. Risk that is not quantified is difficult to manage effectively. Instead, it can build up and eventually cause a disorderly adjustment of prices. – pp 4

A carbon price is an essential incentive for a productive net-zero economy, one where gross greenhouse gas emissions are balanced by intentional removal of carbon dioxide from the atmosphere. The call for a price on carbon was recently echoed in the National Academies report Accelerating Decarbonization of the U.S. Energy System. The report has a host of recommendations for how the U.S. government can act to reduce greenhouse gas emissions and put the country on an effective path to net-zero, including support for new technologies and environmental management. The authors of that report identified an economy-wide carbon price, set at $40 per ton and rising at 5 percent per year above inflation, as one of the key policies for “[establishing] U.S. commitment to a rapid, just, equitable, transition to a net-zero economy.”

With a carbon price, the public will get more for its money when making investments. In the presence of a portfolio of policies, even a modest carbon price would contribute to a portfolio of climate policies by reducing the cost per ton of emissions reductions and driving capital into low-carbon investments. It aligns the incentives felt by businesses and individuals with the low-carbon economy. It will amplify investments in low-carbon infrastructure, complement energy efficiency improvements, and supercharge innovation from the research bench to the factory floor. And as a more primary instrument for emissions reductions, a carbon price can be an effective way to reduce emissions with minimal administrative or legal challenges and can put us on a durable path toward ambitious climate targets.

Risk management allows us to integrate the costs of climate change into economic decisions by establishing prices for risks.  How should we set that price?  Doing so requires applying new models to the problem of climate economics, but illustrates how taking a risk-based approach encourages strong action.

Along with two colleagues, in 2019 I published a new methodology to price climate damages from today’s emissions. We used the same methods that asset managers use to set prices to estimate a price on carbon that would incorporate risk. This improves over previous models, like that created by the Nobel-winning economist William Nordhaus. Nordhaus’ work showed us that acting to reduce emissions leads to substantial net benefits, but in his model that reduction could happen slowly and allow for large temperature increases. When we include risk in these models, including a small probability of a worst-case or “catastrophic” scenario, the findings motivate an ambitious and rapid response.

First, we found that the price of climate risks should be much larger than is commonly assumed, and that it should start high and slowly decrease over time. When risk is included, the value of avoiding the worst-case scenarios increases the value of reducing emissions. This is the pricing version of braking hard. Later in my testimony I will highlight some promising carbon pricing proposals that would help us get started.

Second, our results highlight the costs of delay as unpriced risks mount each year. In our model one year of delay in adequately pricing the risks of climate change reduces future consumption by the equivalent of 2 percent. That cost rises rapidly for longer delays, as does the cost of each additional ton of emissions. A decade of delay in adequately pricing climate risk costs the future the equivalent of about $10 trillion a year, or $100 trillion for the whole decade. Further delays would cost even more, as mounting risks accelerate the costs of each year of delay.

A carbon price would make material improvements to our ability to manage climate risks and living without one is risky business. So how to do it?

Q&A: Litterman on the need to price risks

Proposals to Price Carbon

I would like to briefly pay a tribute to Ted Halstead, an incredibly talented and inspirational leader with the dream of bringing all parties together on this issue. Many of you probably knew Ted and his indefatigable nature. Before his untimely death this past year, Ted was the CEO of the Climate Leadership Council (CLC), which he founded to lead the development of a bipartisan plan to enact a meaningful and durable carbon price in the United States and in major economies around the world.

The CLC, where I serve as board co-chair, has built a large coalition of leading businesses, environmentalists, and luminaries in support of a detailed and actionable proposal to establish a carbon price. The plan that CLC developed and continues to support would allow the U.S. to achieve large emissions reductions while providing direct cash benefits to households in the form of dividend payments, or carbon dividends.

The CLC proposal is built around four pillars: a steadily increasing carbon price, a corresponding household dividend, a border adjustment to enhance the competitiveness of U.S. firms and increase global climate ambition, and a package of regulatory simplification to offer businesses and innovators a more certain investment environment. These pillars work together to create a package that responds to climate risks with the urgency they deserve, provides immediate and visible benefits to American households, allows the best-practices of U.S. manufacturers recognition in markets, and makes industry a partner in climate action. This framework has been endorsed by over 3,500 economists, including four former Fed chairs and 28 Nobel Laureates.

In the CLC plan, the carbon price also starts at $40 per ton (in 2017 U.S. dollars) in 2023 and increases 5 percent each year over inflation. On its own, such a tax could reduce U.S. greenhouse gas emissions to half of their peak values by 2035, nearly 2,000 MMT CO2eq from today’s levels.

Revenue would be sent back to households in a dividend, ensuring the vast majority of households come out ahead financially, despite the new carbon price. Many believe that a carbon price is regressive, but with a carbon dividend policy the benefits are greatest for middle- and low-income households. In every state, the average household in the lowest seven income deciles is better off with the carbon dividends plan than without it. And those benefits are clear before taking account of the positive benefit to these households of reduced climate risk and local air pollution. Through the COVID-19 pandemic, direct transfers have proven an effective means of improving outcomes for low- and middle-class households. They can do same throughout the transition to a low-carbon economy.

Every corner of the economy would be encouraged to innovate and decarbonize. Economic modeling indicates that the council’s plan would unlock $1.4 trillion of private investment in energy innovation and create 1.6 million jobs. A carbon price would accelerate economy-wide electrification, move our electricity grid towards being carbon-free, expand the market for electric vehicles, boost industrial efficiency, secure a future for carbon capture technologies, and make decarbonization itself a competitive advantage. 

Adding a border adjustment will give cleaner U.S. firms an advantage over their less efficient competitors, expand the impact of the U.S. climate action footprint, and induce emissions reductions in other countries. The U.S. economy is 80 percent more carbon-efficient than the global average and at least 300 percent more carbon-efficient than major competitors like China, India, and Russia. Adding a carbon price to imports that generate overseas emissions ratchets up ambition for domestic policy and makes the U.S. market a demand-driver of clean goods. There is no other climate policy that simultaneously addresses the emissions footprint of our supply chains, drives manufacturing investment back onto U.S. soil, and forces foreign manufacturers to compete on the basis of carbon efficiency.

It is remarkable that energy companies like BP, ConocoPhillips, Shell, Exxon Mobil, Exelon, Calpine and Vistra; consumer brands like AT&T, Ford and GM, and Procter & Gamble; NGOs like the World Wildlife Fund, the World Resources Institute, and Conservation International; and leaders from both Republican and Democratic administrations like James Baker, George Shultz, Larry Summers and Ernie Moniz have all come together in support of a plan for using market instruments to reduce greenhouse gas emissions. But given the win-win outcomes, it should not be surprising.

Carbon pricing in the context of the federal budget

As your committee considers the federal budget, I note that an economy-wide carbon price could raise a significant amount of revenue. The CBO reports that a carbon tax starting at just $25 per ton could raise just over $1 trillion in 10 years. The higher carbon price levels imagined by the NAS committee or the CLC could raise approximately $2 trillion dollars over 10 years. That revenue could be used to reduce the budgetary impact of climate action by investing in infrastructure, budgeting for other tax changes, or sending cash back to households as a dividend as with the CLC proposal. Under any of those scenarios, the tax would motivate private-sector investment in low-carbon technology and innovation. But Congress will need to act to make it happen.

As Congress is considering the President’s proposed infrastructure package, there are other proposals that you may want to be aware of. They share many elements with the CLC plan, but differ in broad policy implementations. For example, the Market Choice Act has had bipartisan support in the House of Representatives for the past two Congresses. It is a proposal that would levy a carbon tax to provide funding for infrastructure as a replacement for the federal gas tax. In addition to fully funding the highway trust fund, it would provide revenue for broader infrastructure investment, advanced energy R&D, and rebates to lower-income households.

Modeling of that proposal shows that it could reduce energy-related CO2 emissions by nearly 1900 million metric tons by 2035, while raising about $1.8 trillion for infrastructure and energy R&D spending. Here too rebates, though smaller than a full dividend, could offset increased prices for low-income workers and retirees. This approach shows that a carbon tax can raise revenue to pay for infrastructure investments while accelerating emissions reductions.

The President has proposed to pay for infrastructure spending with increases in the corporate tax rate and other business taxes. That is a decision that is best left to Congress, but I would note that taxing bad activities, like risking the planetary climate, offers both revenue and social benefit.

Beyond these specific proposals, market-based instruments enjoy substantial support from economists and business leaders. Last year, the Business Roundtable called for “a market-based emissions reduction strategy that includes a price on carbon.” Earlier this year, the U.S. Chamber of Commerce wrote climate policy should “support a Market-Based Approach to Accelerate GHG Emissions Reductions Across the U.S. Economy.” And just weeks before this hearing, the American Petroleum Institute endorsed “a carbon price policy to drive economy-wide, market-based solutions.”

Several members of this committee have introduced carbon pricing legislation in the past or actively support it now. The exact policy construction varies among proposals, but there are other experts who can help Congress understand those policy questions and any resulting tradeoffs. I recognize that there are a variety of opinions about carbon pricing and its design, but leadership and compromise can help build strong coalitions of support.

To manage our climate challenge, the key principles are to create a price immediately, set it high enough to meaningfully reflect the risks imposed by greenhouse gas emissions, and apply it broadly throughout the economy (likely by taxing producers).

Q&A: Litterman on Carbon Dividends


Thank you kindly for the invitation to testify today. I hope that this testimony has shown how the tools and insights of financial risk management can be meaningfully applied to the climate problem. When I take this approach, I find compelling reasons to act. We need to take the worst-case scenarios seriously and respond adequately. Because of the nature of climate risks, time is not on our side. There are real costs to waiting. While many of the individual risks from climate change can be managed well by companies, individuals, and governments, the systemic nature of climate risk means we should be doing much more to price it and reduce greenhouse gas emissions.

I and my colleagues at the Climate Leadership Council, the Niskanen Center, and others stand ready to help you deliberate on these policies and do what is best for Americans and the future. Thank you for your attention and I look forward to answering any inquiries you may have.

Photo by Andy Feliciotti on Unsplash