On Monday, Rep. Sean Casten (D-IL) posted a 31-part mega-thread on Twitter about carbon pricing (CP). I think he and I are on the same side of this issue, for the most part, but a few of his points are problematic. Active Twitter user though I am, I find the platform unwieldy for a topic this complex, so I hope Casten will forgive me for replying in a way that allows a more detailed discussion of those critical points. In what follows, italicized passages starting with #/ are Casten’s original tweets.

5/ Taking the first point: the goal of C-pricing is to reduce GHG emissions. Not to get bipartisan consensus. Not to reduce deficits. Not to help disadvantaged communities. Those are all good things! But if we do those and don’t reduce GHG emissions, the policy is bad.  

We are on the same page here. My view has always been that the cutting edge of any CP policy is the price itself, not what is done with the revenues. For example, although many CP proposals distribute some or all of the revenue to offset the cost to low-income households, there are many ways to do that, some of which leave a good chunk of the revenue for other purposes. The choice among them, in my view, is more an issue of political coalition-building than of economics.

6/ On the second point: we want to use market forces. This is SO important, and so many C-pricing models have completely forgotten that purpose. Command-and-control regulation is easy. Markets are more complicated.

Maybe Casten means that command-and-control regulation is politically easy. If so, I agree. There is a bigger political appetite to regulate than to price. However, writing good command and control regulations with efficient, unbiased effects on various pollution sources is very difficult. It is even harder to keep a succeeding administration from messing them up. The Trump administration’s unraveling of Obama-era regulations is a case in point. Even when Congress gets involved, we may end up with something like the ethanol mandates, which are full of unintended consequences and arguably do more environmental harm than good. From an economic point of view, a carbon price is far more straightforward, as it involves a single price signal delivered uniformly across all sources and technologies.

7/ But we can say one thing generally: For markets to work, the price a buyer pays should be the revenue a seller gets. 

9/ So the way we efficiently allocate private assets for shoe manufacturing is by ensuring that the $120 I paid for my last pair of running shoes = $120 in revenue to the shoe store. 

10/ No one this side of Karl Marx argues that we should instead pay the government $120 and then leave them to allocate that revenue among putative shoe manufacturers and distributors. And yet that is EXACTLY what a carbon tax does.

This is where I start to have a little trouble with Casten’s argument. To me, the running shoe analogy misses the mark. In that case, there is no ambiguity about the fact that the manufacturer owns the shoes, has the right to sell them, and will not produce them unless the revenue covers costs plus a reasonable profit. But who “owns” the right to pollute?

Consider three possibilities:

  1. Pollution victims “own” the right. The standard analogy is that just as you don’t have the right to dump your kitchen garbage on my lawn, you don’t have the right to dump your carbon in my airspace. I could sell you the right to dump your garbage, or your carbon, if you offer me an attractive price, but unless we negotiate a deal, I can go to court to enjoin unauthorized dumping.
  2. The polluter “owns” the right to emit carbon as the “first user” or “homesteader.” Steel mills and power plants were spewing carbon long before anyone objected or felt harmed by it. Therefore, those who feel harmed must go to the polluters and offer to pay them to cut their emissions.
  3. The government “owns” the air rights and manages them as an agent for citizens. One way to do that is for the government to set a price for carbon emissions and collect the revenue. In turn, through the political process, it would determine how to spend the revenue in a way that best benefits its principals, the citizens.

These alternative assignments of property rights have been debated endlessly on philosophical grounds, but I don’t see much point in revisiting those arguments here. (A search of Niskanen archives will reveal discussions of each in turn: common law, compensation, and pricing). Instead, I would like to focus on some pragmatic issues that lead us to carbon pricing.

From a practical point of view, the problem with assigning air rights to individuals, including the right to seek injunctive relief for pollution under theories of nuisance or trespass, is that it would quickly become impossible for anyone to emit any carbon pollution whatsoever. Each carbon source would have to negotiate a compensation agreement with each victim anywhere in the world. If procedural standards and burdens of proof were structured to favor plaintiffs, any one dissatisfied victim could sue for an injunction to close the source down entirely. Industry and commerce would grind to a halt, and the courts would be clogged with lawsuits for minor infringements or imagined damages. The result would be a world with too little pollution and not enough goods and services. To prevent that outcome, the burden of proof and other legal requirements could be tilted in favor of polluters, as Murray Rothbard noted in a well-known paper. It would be much more difficult for victims to obtain relief in court for unauthorized emissions, despite their supposed property rights, but the result would be a world with too much pollution.

If, instead, the emission rights were assigned to polluters under a homesteading or first-use theory, a different set of problems would arise. In that case, pollution victims would have to negotiate with polluters to pay them to cut back on emissions. That “Coasean” approach sometimes works when there are just a few victims and one or a few sources of pollution. However, in the case of carbon emissions, where victims and sources are scattered not only across states but across the world, such negotiations would have scant chance of success. The Coasean approach, like the Rothbardian one, would lead to a world of excessive emissions.

The argument in favor of assigning emission rights to the government—where it acts as an agent for the citizenry—is that it provides the best hope of balancing the costs and benefits of various levels of pollution. Writers who advocate for carbon pricing argue that such a system offers a practical way of implementing a balanced policy. If so, it would be entirely in keeping with market principles for CP payments to be made to the government, which would then determine how best to use them through democratic procedures—debt reduction, investment subsidies, compensation of low-income households, or whatever.

Turning back now to the running shoe analogy, here is one more point: The manufacturer is not only the seller of the shoes, but their producer. If the seller does not get an appropriate price for the product, the shoes will not come into existence. In contrast, regardless of to whom we assign emission rights, the atmosphere’s capacity to absorb carbon emissions is not “produced” by anyone. It is a naturally occurring resource that can be used up, but it cannot be increased or decreased by human action. Therefore, unlike the case of running shoes, there is no need to compensate the seller for the cost of bringing this resource into existence.

12/ But there’s a second point about markets that is equally or more important: almost any asset we build to lower GHG emissions has a lower marginal operating cost BEFORE factoring in C-pricing than the dirtier asset it replaces.

13/ It’s cheaper to drive an EV than it is to drive a gasoline ICE. It’s cheaper to operate a solar panel than a coal plant. Making your house more energy efficient saves you money every hour. The existence of a C-price doesn’t change that calculus.

These statements are provisionally true, but they do not tell the whole story. Except in the very short-run (e.g., the situation where you already have a Tesla sitting in your garage ready to hit the road), the marginal cost of operation is not the only thing that matters. What matters is the cost over the whole life cycle of the technology in question. For example, the choice between buying a Tesla or an equivalent internal-combustion Audi has to be based on the purchase price plus the operating cost over the life of the vehicle. It is not yet always true that the life-cycle cost is lower for the low-emission alternative.

15/ That matters because even setting aside the anti-capitalist flaws in a carbon tax, a tax on your competitor doesn’t impact your investment decision. The fines Wells Fargo paid last year did not affect the interest rates you earn at Citibank.

16/ In the same way, putting a tax on CO2 emissions at a coal plant doesn’t have any impact on the investment thesis faced by a putative wind farm investor. They don’t know whether the coal owners will absorb the cost or pass it on, or how their long-term revenue will change.

I respectfully disagree. A carbon tax on your competitor most definitely would affect your investment decision. A tax on electricity produced by coal reduces the degree to which a coal-fired plant can undercut its wind competition over the life cycle of the respective generating capacity. Accordingly, it will stimulate investment in wind. The same would be true in the banking example. If Wells Fargo were subject to an ongoing tax (not just a one-off, retrospective fine, which would be treated as a sunk cost), then Citibank could afford to pay higher deposit rates than Wells Fargo and would, accordingly, be able to expand its market share.

18/ So let’s make it three things that proper carbon pricing must do: (a) lower GHG emissions; (b) use market forces to do so, and (c) drive new capital investment in clean energy assets.

Good. We are back on the same page here.

19/ A carbon tax is the second worst way to do that, because it only penalizes emission and then depends on the wisdom of the government to redistribute that money back to those who would invest in GHG reduction.

20/ The worst way though is tax & dividend, which by design distributes the proceeds to people OTHER than those who would invest in GHG reduction. It is designed to guarantee that money isn’t used to reduce GHG emissions.

I get the point Casten is trying to make here, but I would frame it differently to emphasize that carbon pricing and investment subsidies are two separate policies, each with pros and cons.

A carbon price by itself does incentivize green investment, through its effects on relative prices, as explained above. It has the further advantage, which investment subsidies do not, of incentivizing conservation by users of energy, cement, and other carbon-intensive goods. But a stand-alone carbon tax with enough punch to reach any given set of climate goals might have to be quite high, perhaps higher than is politically tolerable. The longer we wait to get moving and the shorter the time frame left to lower GHG emissions, the more credible that concern becomes.

Investment subsidies have the distinct disadvantage of doing nothing to promote conservation. Once the grid is 100 percent green, that won’t matter, but in the meantime, when it is half fossil and half renewable, it matters a great deal. However, subsidies could well play a role in accelerating the rate of green investment, if backed up by a carbon price. (See here for some ideas on how subsidies and carbon prices can be combined to maximize welfare gains.) It is understandable that the more urgently one views the task, the more attractive it is to add investment subsidies to the mix, as Casten proposes. 

Given the urgency of climate change, I understand why Casten would like to take part in any carbon tax revenue and channel it into direct investment subsidies. As I said at the outset, the issue of how to use the income from a carbon tax is as much a matter of political coalition-building as economics. With his seat in the House, Casten is in an excellent position to judge the best way forward. If he wants both a belt and suspenders, I have no objection.

24/ So what should C-pricing do? Simply ensure that carrots = negative sticks. If a solar investor lowers GHGs by 1 ton a year, they should get a revenue stream exactly equal to the payment stream that a coal plant gets from emitting that same ton.

25/ That will change the investment thesis of the clean asset, create a penalty for the dirty asset, and bring clean assets into the market that will out-compete their dirty predecessors. And use markets!

Yes, that is what a carbon tax would do, although I would word it differently. The gain to the solar investor should be equal to the cost borne by the coal plan for emitting the ton of carbon—not the “payment stream” that the coal plan “gets,” but the stream of tax payments it has to pay out. 

For example, suppose without the tax, a coal plant breaks even at $50 per MWh and emits 1 ton of carbon. Its solar competitor has a cost of $60 per MWh. If it tried to sell into the same market at a competitive rate, it would lose $10/MWh. Add a carbon tax of $25 per ton. The coal plant now has to sell at $75 per MWh to break even. The solar plant can now raise its price to $75 and make a $15 profit. So the “carrot” for the solar investor is the $25 added revenue that moves it from a $10 loss to a $15 profit, while the “stick” to the coal plant is the $25 it forks out in taxes. In this way, clean assets will be attracted to the market, just as they should be.

30/ That doesn’t mean carbon-pricing doesn’t work – just that it has to be seen as complementary to other tax and practice-based policies.

31/ But it is an amazingly powerful tool, so long as we make sure to use it as a way to lever private markets to lower GHG emissions… and leave it at that. /fin

Yep. In the end, I think Casten and I share the same goals and see carbon pricing as a powerful part, if not the whole, of the solution. The next step is to move this forward from theory to policy!