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close this bookThe Costs of Climate Protection: A Guide for the Perplexed (WRI, 1997, 60 pages)
View the document(introduction...)
View the documentACKNOWLEDGMENTS
View the documentFOREWORD
View the documentINTRODUCTION
Open this folder and view contents3. MORE DETAIL ON THE KEY ASSUMPTIONS
Open this folder and view contents4. TRADE AND EQUITY ISSUES
View the documentREFERENCES
View the documentANNEX
View the documentABOUT THE AUTHORS
View the documentBOARD OF DIRECTORS


Despite the wide range of predicted economic impacts of CO2 abatement, two areas of policy agreement among the underlying economic models stand out. First, the economic impacts will be much more favorable if revenue-raising policy instruments are used to control CO2 emissions and the revenues are used to reduce other burdensome tax rates. As explained above, the two principal revenue-raising policy instruments are carbon taxes and tradable permits that are auctioned off by the government rather than given away. Both instruments imply that carbon-based fuels will become more expensive to the users, raising costs throughout the economy. However, using the revenues to lower taxes on labor and capital would offset some of these higher costs and improve the economic impacts.

Giving permits away to energy users and sellers or using regulations to force industries to reduce their CO2 emissions are alternative policy approaches that forgo potential revenues. These approaches would also make fossil fuels more expensive to the users, raising costs throughout the economy. But, they would have quite different economic implications because they create no opportunities to generate offsetting efficiency gains by reducing the marginal rates of distorting taxes.

Instead, the potential revenues from auctioning off permits to burn fossil fuels remain with the firms that received free permits or regulatory permission. Conceding these permits to firms may be politically advantageous because it awards a valuable right to certain firms and industries that might otherwise oppose any climate protection policy. However, economic models agree that this political advantage would be bought at a high economic price. Income and economic growth would be lower if this approach were adopted, just as they would be if revenues from a carbon tax were recycled through lump-sum rebates.

Similarly, forgoing carbon tax revenues would limit the government's opportunities to finance offsetting tax cuts and other programs to cushion the distributive burden of higher energy prices on lower-income households and other vulnerable groups. Instead, those companies permitted to sell or use the limited quantities of carbon fuels available would obtain windfall profits. For both equity and efficiency reasons, the U.S. Government should base its climate protection plans on policy instruments such as a carbon tax or auctioned-off carbon permits that yield revenues to finance tax reductions. Moreover, climate protection plans should be revenue-neutral. They should include explicit proposals for offsetting cuts in distorting taxes on labor and investment incomes. Identifying these tax cuts in advance and ensuring that the government's spending and deficit are unchanged should help allay economic concerns about climate protection.

Climate protection plans should be revenue-neutral. They should include explicit proposals for offsetting cuts in distorting taxes on labor and investment incomes.

The second area of agreement among economic models that have examined the issue is that joint implementation will reduce the overall costs of achieving carbon abatement targets. Emissions trading among domestic U.S. firms and facilities has already proven to be cost-effective in reducing conventional air pollutants. The gains from international joint implementation of CO2 abatement programs should be even larger because the costs of reducing fossil fuel use vary so widely among nations. International joint implementation is compatible both with a U.S. carbon tax and with a carbon permit trading system. The United States has consistently favored joint implementation in principle as a cost-effective market-based policy approach. Ironically, many countries with emerging market economies have not approved the principle of such implementation even though they would benefit significantly from the infusion of technology and investment that it would bring. The U.S. Government should continue to consult and negotiate with other nations to gain international acceptance for joint implementation among nations adopting CO2 reduction commitments, and to promote joint implementation through pilot projects and institutional development.

Aside from the effects of these two policy choices, the remaining variation in the predicted economic impacts of climate protection stems from differences in underlying assumptions built into economic simulation models. Predictions that a carbon tax or a cap-and-trade policy to reduce CO2 emissions would seriously harm the economy are unrealistic. They stem from worst-case modeling assumptions. Under more reasonable assumptions and preferable policy approaches, a carbon tax is a cost-effective way of reducing the risks of climate change and would do no damage to the economy. More likely, taking the environmental effects into account, it would bring long-term benefits.

This point is likely to be obscured as the debate over U.S. climate policy becomes increasingly intense and politicized as international negotiations proceed. Various interests will tout their preferred predictions and experts. The media, on the principle that controversy generates interest, will highlight the divergent predictions rather than informing the public about the underlying sources of disagreement. The public may become confused, disillusioned, or indifferent.

Many emerging market economies have not approved the principle of joint implementation even though they would benefit significantly from the infusion of technology and investment that it would bring.

To counter this, it is important that when the administration finalizes its proposed climate policy it issues a public statement incorporating its best predictions of the impacts these proposed measures would have on the economy, making clear the assumptions and models on which these estimates are based. When Congress holds televised hearings on this issue, expert witnesses and administration officials should be questioned closely on the assumptions underlying their predictions regarding the effects of climate protection on the economy. The press and other media can contribute significantly to public understanding and debate of this important policy issue by in-depth reporting and analysis that goes beyond the formulaic juxtaposition of opposing viewpoints.

The real issues that need resolution are how to cushion the impacts on those few industries, regions, and communities that would be adversely affected and how to negotiate international agreements that will bring about coordinated actions by all major economic powers. In addition, an overall tax restructuring agenda is needed that would incorporate a phased-in carbon tax or auctioned-off tradable carbon permits and equivalent reductions in other taxes to achieve equity and economic objectives.