Two views on carbon pricing

2009-04-12

in Economics, The environment

Brick arch and river

The basic idea of carbon pricing is to force people to take into account more of the consequences of their own actions. This is essentially a response to market failures; while there is an incentive to overfish from a commonly-accessible lake, it doesn’t make sense to overfish your own pond. That being said, there do seem to be two possible philosophies for setting the price. One approach is to approximate the total level of harm your actions cause, then set the price at that level. But turning the suffering of others into your suffering, you are given the incentive to minimize the harm, and avoid actions that have more harmful than beneficial consequences. In the context of climate change, however, the overriding task is not simply to emit less, but rather to build a society where people live carbon-neutral lives. Arguably, then, the level of the carbon price should be set so as to make that transition maximally easy, while making sure it happens fast enough to avoid abrupt or catastrophic change.

In the end, this distinction is largely academic, given the uncertainties involved. (There is also the matter of choosing a discount rate, which has enormous effects on your estimate of the net present value of harms that occur in the future.) Since the transition to a carbon neutral society will be a one-off change, we will probably never have the information required to know for certain whether it could have been done more quickly or efficiently. Once the risks associated with inaction are taken into account, it seems clear that we need to establish a carbon price that spurs rapid action and a sustained commitment to economic transformation.

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{ 17 comments… read them below or add one }

Tristan April 12, 2009 at 2:56 pm

“By turning the suffering of others into your suffering, you are given the incentive to minimize the harm, and avoid actions that have more harmful than beneficial consequences.”

I think a better way of saying this would be, “by making you pay for the cost of their suffering, the parato optimal solution in which they are compensated for their loss out of your benefit is at least formally possible”

Milan April 12, 2009 at 3:08 pm

Pareto optimality (even potential pareto optimality) doesn’t seem like the right metric here, for several reasons. For one, you are not engaged in a voluntary exchange with the other parties affected by your decisions. Pareto optimality is a kind of thought experiment, based on the equilibrium reached between partners with different assets and preferences, engaging in voluntary exchange. Secondly, the number of counterparties is large and uncertain. It is easier to quantify the harm you do to people fifty years out, but the consequences of today’s emissions will be felt by people living millions of years from now, provided the race endures.

Carbon pricing is about encouraging right behaviour, not about compensating the victims of harmful behaviour. That is especially true when you are looking at systems like the former Liberal Green Shift – where revenues from a carbon pricing scheme would be used to offset tax cuts elsewhere.

Tristan April 13, 2009 at 11:52 am

You might be right, but not for the reasons you give. Pareto Optimality is not only valid in cases of voluntary exchange – the whole notion of cost-benefit policy validation contravenes this. The idea, at least as I understood it, has always been “could those who benefit theoretically recompense those who lose out”, and not “can we get those who benefit to recompense…” Although, if you want to just reject this as completely violating autonomy, I’d be amenable to that – the way I’m talking about pareto optimality sounds like acting such that it might be possible for you to treat others as ends and not means, and this very possibility validates treating them as mere means.

. April 13, 2009 at 12:01 pm

Kaldor-Hicks efficiency
From Wikipedia, the free encyclopedia

Kaldor-Hicks efficiency (named for Nicholas Kaldor and John Hicks) is a measure of economic efficiency that captures some of the intuitive appeal of Pareto efficiency, but has less stringent criteria and is hence applicable to more circumstances. Under Kaldor-Hicks efficiency, an outcome is considered more efficient if a Pareto optimal outcome can be reached by arranging some compensation from those that are made better off to those that are made worse off.

. April 13, 2009 at 12:07 pm
Milan April 13, 2009 at 1:11 pm

Pareto optimality requires that the exchanges are voluntary, and possibly that they are immediate and happen in relatively quick succession until equilibrium is reached. Potentail Pareto optimality (Kaldor Hicks) just requires that overall utility rises enough to compensate the losers in theory: a far more problematic ethical stance. It lets you steal Bill Gates’ Ferrari, because you will have more time than he does to enjoy it.

The ethical position of future generations is somewhat akin to that of a patient in a coma. They are unable to communicate their preferences, and unable to take any action in response to what is done to them. There is also considerable uncertainty over what course of action would have the best possible outcome for them, though the evidence is overwhelming that continuing on our present course of action will be disastrous for them.

Any compensation explicitly set aside for future generations (not something included in any carbon pricing plan I know of) is also somewhat akin to taking something from a store with no cashier and leaving money behind. If the price of the thing is unclear, the compensation may not be adequate. There are also issues of consent, particularly if the action you take will alter the future ability of the shop to operate as it would have without your action.

Tristan April 13, 2009 at 2:32 pm

I don’t disagree with your rejection of Kaldor-Hicks optimality, but I do disagree with how quickly you dismiss it as relevant to the issue of carbon taxes.

“just requires that overall utility rises enough to compensate the losers in theory”

Exactly: but isn’t this exactly how many policy decisions are made? E.g. if I’m a city and I’m determining whether raising taxes to pay for some new services is justified – I look at the overall benefits and losses. I don’t expect everyone who benefits to literally pay the people who lose. For example, when cut and cover rather than tunneling was picked as the construction method for the Canada Line, businesses on Cambie lost out, but the idea is overall there are more benefits. Is implementing a policy that destroys businesses because it increases overall value exactly like stealing Bill Gates’ Ferrari? I don’t know, I wasn’t aware he had a Ferrari.

How are future generations different from business owners on Cambie?

Milan April 13, 2009 at 10:31 pm

One big reason is that there is a potentially infinite number of them. Unless we devise a scheme for ‘discounting’ the utility of future generations, we will be morally bound to avoid harming them in any way (no matter how slight) and investing all the resources of society in improving the lives they will lead.

Tristan April 14, 2009 at 12:14 am

“Unless we devise a scheme for ‘discounting’ the utility of future generations”

We talked about exactly why its appropriate to discount the utility of future generations in foundations 103. Remember the Robinson Crusoe example?

Milan April 14, 2009 at 8:52 am

Discounting may be appropriate – even necessary – but it doesn’t lead to one clear answer of how one current generation could compensate all future generations.

Right now, we are not making the economic transition necessary to stop climate change. As such, doing so plus creating a huge stock of compensation seems even less likely to happen rapidly. Given that, perhaps it makes sense for the explicit aim of carbon pricing to be changing the nature of the economy, not building up funds for compensation.

In this view, the carbon tax need not even necessarily be financial. Since it is an incentive to guide behaviour, it could just as well be a flogging per unit of greenhouse gas emissions, or mandatory labour. Probably, a carbon tax is a better option than either of those things, but the other possibilities illustrate ‘carbon tax as incentive.’

R.K. April 14, 2009 at 10:04 am

Carbon beatings would be much less efficient, since they cannot be traded.

A carbon tax can be implemented at the point of energy import or production, with the effect then spreading through the economy. A flogging, by contrast, would have to be administered to the end user, and would require a complex system of carbon accounting for every person.

Finally, flogging old ladies for warming their houses in winter would probably strengthen public opposition to carbon pricing.

Milan September 29, 2009 at 4:34 pm

James Hansen:

The basic point—the fundamental problem—is that because of government policies, fossil fuels are the cheapest form of energy. They are not made to pay for the damages they do to human health and the environment. As long as fossil fuels are the cheapest form of energy, they are going to be used. That’s why I say you have to address the fundamental problem and that is put a rising price on carbon emissions.”

Note that this suggests the appropriate price for carbon emissions isn’t determined by how much additional harm they cause, but rather by what is required to drive people to alternatives.

This is ethically important, partly because it is always easy for people to assign costs to strangers, rather than accept those costs themselves. Hansen’s sort of pricing would change behaviour more effectively than one where people have the option of offloading harm onto others.

Tristan September 29, 2009 at 4:43 pm

“This is ethically important, partly because it is always easy for people to assign costs to strangers, rather than accept those costs themselves.”

Corporations are after all, by law, externalizing machines.

. September 29, 2009 at 4:59 pm
Milan October 5, 2009 at 9:30 pm

Whether applied to individuals or corporations, this is what Pigouvian taxes are meant to correct. That being said, the standard definition of these taxes is closer to the ‘tax at the level of harm’ approach, rather than the ‘tax at the level that will change things’ approach.

The second is a lot more defensible, especially when there is no actual compensation flowing from actors to their victims.

Milan October 26, 2009 at 1:49 pm

Another point in favour of setting the tax level where it will produce changed behaviour – not where it is equal to harm caused – is the reality of economic growth. As people around the world continue to get richer, it will become easier to pay any particular level of tax. At the same time, the amount of harm additional emissions will cause to future generations will only become larger. To keep the incentives aligned, the tax needs to rise to keep incenting good choices.

. December 30, 2011 at 4:13 pm

The SCC – a calculation of the damage caused by each ton of carbon dioxide (CO2) emitted into the atmosphere – is a sort of “volume dial” for climate policy: The higher the SCC, the tougher (and more expensive) the regulations that policymakers will consider cost-effective. The figure the U.S. government has used since last year, developed by an interagency group, is $21 per ton of CO2.

But that number, this peer-reviewed report shows, is based on fundamentally flawed methodologies and grossly understates the potential impact and uncertainty of climate change.

Making small adjustment to the models to reflect these factors lead to values as high as $893 per ton in 2010 and $1550 in 2050.

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