Archive for the ‘Energy’ Category

Climate change is hot. From the pope’s encyclical to the upcoming United Nations conference in Paris, leaders are debating how to slow and eventually stop the warming of our planet.

We economists think we have an answer: put a price on carbon dioxide and the other gases driving climate change. When emissions are free, businesses, consumers, and governments pollute without thinking. But put a price on that pollution and watch how clean they become.

That’s the theory. And it’s a good one. But translating it from the economist’s whiteboard to reality is challenging. A carbon price that works well in principle may stumble in practice. A real carbon price will inevitably fall short of the theoretical ideal. Practical design challenges thus deserve close attention.

To help policymakers, analysts, and the public address those challenges, Eric Toder, Lydia Austin, and I have published a new report, “Taxing Carbon: What, Why, and How,” on putting a price on carbon.

Some highlights:

  • Lawmakers could put a price on carbon either by levying a tax or by setting a limit on emissions and allowing trading of emission rights. These approaches have much in common. Politically, however, a carbon tax is on the upswing. Cap and trade failed in 2010, while interest in taxing carbon is growing, including three bills in Congress and endorsements from analysts of diverse ideological stripes.
  • Carbon prices already exist. At least 15 governments tax carbon outright, and more than 25 have emissions trading systems. Those efforts have demonstrated that the economists’ logic holds. If you put a price on carbon, people emit less.
  • Figuring out the appropriate tax rate is hard. The Obama administration estimates that the “social cost of carbon” is currently about $42 per metric ton. But the right figure could easily be double that, or half. That uncertainty is not a reason to not tax carbon. But it does mean we should maintain flexibility to revisit the price as new evidence arrives.
  • Taxing carbon could reduce the need for regulations, tax breaks, and other subsidies that currently encourage cleaner energy. Rolling back those policies, in particular EPA regulations for existing power plants, may make policy sense and will likely be essential to the politics of enacting a carbon tax. But the details matter. Rolling back existing policies makes more sense with a carbon tax that’s high and broad, than with one that’s low and narrow.
  • By itself, a carbon tax would be regressive: low-income families would bear a greater burden, relative to their incomes, than would high-income families. We can reduce that burden, or even reverse it, by recycling some carbon revenue into refundable tax credits or other tax cuts focused on low-income families.
  • By itself, a carbon tax would weaken the overall economy, at least for several decades. That too can be reduced, and perhaps even reversed, by recycling some carbon revenue into offsetting tax cuts, such as to corporate income taxes.
  • Unfortunately, there’s a tradeoff. The most progressive recycling options do the least to help economic growth. And the recycling options that do the most for growth would leave the tax system less progressive.
  • A global agreement on carbon reductions would be preferable to the United States acting alone.  Given the nation’s size and contribution to global emissions, a unilateral tax would make a difference, but would damage the competitiveness of some US industries. Special relief for these sectors could reduce the benefits of the tax, but may be necessary both practically and politically.

A carbon tax won’t be perfect. Done well, however, it could efficiently reduce the emissions that cause climate change and encourage innovation in cleaner technologies. The resulting revenue could finance tax reductions, spending priorities, or deficit reduction—policies that could offset the tax’s distributional and economic burdens, improve the environment, or otherwise lift Americans’ well-being.

The challenge is designing a carbon tax that delivers on that potential. We hope our new report helps elevate what will surely be a heated debate.

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The Department of Energy snookered the media last week with a report that seems to show that its clean energy lending programs are profitable. “Remember Solyndra? Those loans are making money,” went a typical headline.

Unfortunately, that’s not true. Taxpayers are losing money on DOE lending. Less than originally expected, and less than you would expect given media coverage of Solyndra, Fisker, and a few other failed loans. But smaller losses are still losses, not profits.

To understand DOE’s spin, consider a simple example. Suppose your spouse borrows $10,000 from a bank at 5 percent interest over 10 years so that you can lend it to your friend Bob on the same terms.

Everything goes well in the first year. Bob pays you, and your spouse pays the bank.

If your aunt asks how the deal is going, what would you say? A good answer would be, “We are breaking even; let’s hope Bob keeps paying us back.” You and your spouse are in this together, the loans from the bank and to Bob offset one another, and your best hope is for that to continue.

If DOE were asked, however, it apparently would say, “Things are great; Bob paid me $500 in interest, and I am on track to earn $5,000.” DOE takes credit for the interest that companies pay on their loans, but it doesn’t subtract—or even report—the interest costs that taxpayers pay to finance those loans. That’s like claiming profits on your loan to Bob, while ignoring the interest your spouse pays the bank.

ELO Report

DOE’s report does not address this issue, except in a footnote in a table (cut and pasted above) revealing that its $810 million of “interest earned” was “calculated without respect to Treasury’s borrowing cost.” In other words, DOE reports gross interest received, not the net interest taxpayers have earned after subtracting Treasury borrowing costs. The incomplete figures in the table seem to suggest that DOE has eked out a $30 million profit on its lending ($810 million in interest less $780 million in loan losses). But when we account for Treasury borrowing costs, taxpayers are actually well behind.

The report does not allow us to say just how far behind. We do know, however, that DOE loans are typically made at small, sometimes zero, spreads above Treasury rates. So a large portion of DOE’s “interest earned” must have been offset by borrowing costs. That puts taxpayer losses in the hundreds of millions of dollars.

The same concern applies to DOE’s statement that interest payments on these loans will eventually top $5 billion. Some media outlets are reporting that as $5 billion of profit. It’s not. That $5 billion does not include the cost of Treasury financing or of any defaults. DOE’s $5 billion figure is like claiming your loan to Bob is scheduled to bring in $5,000 in interest; it’s technically true, but tells you nothing about profits. Indeed, the Obama administration still predicts that DOE’s loans will lose money over their lifetimes.

DOE’s lending programs should not be evaluated solely or even primarily based on their profitability or lack thereof. What matters is their overall social impact. How much are they advancing new technologies? How much are they reducing future pollution? Have they created jobs and economic growth? And are any gains worth the taxpayer subsidies? Those are the questions we should be trying to answer.

If DOE wants to play the profitability card, however, it should do so in an accurate and transparent way. Last week’s report falls woefully short. DOE owes taxpayers an honest accounting of the financial performance of its lending programs.

P.S. In recent work, I raised concerns about how the government budgets for lending programs. One issue is whether we should measure profitability against Treasury borrowing rates (as currently done) or against market rates (which the government could earn by unsubsidized lending). I expected that issue to arise in DOE’s accounting. Instead, the agency ignored the cost of capital entirely. Budget policymakers eliminated that ploy more than two decades ago, so it is stunning DOE would resurrect it.

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Case Western Law Professor Jonathan Adler just released an interesting paper setting out a conservative case for environmental protection. Here’s his abstract:

The existing environmental regulatory architecture, largely erected in the 1970s, is outdated and ill-suited to address contemporary environmental concerns. Any debate on the future of environmental protection, if it is to be meaningful, must span the political spectrum. Yet there is little engagement in the substance of environmental policy from the political right. Conservatives have largely failed to consider how the nation’s environmental goals may be best achieved. Perhaps as a consequence, the general premises underlying existing environmental laws have gone unchallenged and few meaningful reforms have proposed, let alone adopted. This essay, prepared for the Duke Law School conference on “Conservative Visions of Our Environmental Future,” represents a small effort to fill this void. Specifically, this essay briefly outlines a conservative alternative to the conventional environmental paradigm. After surveying contemporary conservative approaches to environmental policies, it briefly sketches some problems with the conventional environmental paradigm, particularly its emphasis on prescriptive regulation and the centralization of regulatory authority in the hands of the federal government. The essay then concludes with a summary of several environmental principles that could provide the basis for a conservative alternative to conventional environmental policies.

One example of what he thinks ought to be a conservative approach to resource protection: property rights in fisheries (footnotes omitted):

The benefits of property rights at promoting both economic efficiency and environmental stewardship can be seen in the context of fisheries. For decades, fishery economists have argued that the creation of property rights in ocean fisheries, such as through the recognition of “catch-shares,” would eliminate the tragedy of the commons and avoid the pathologies of traditional fishery regulation. The imposition of limits on entry, gear, total catches, or fishing seasons has not proven particularly effective. Property-based management systems, on the other hand, have been shown to increase the efficiency and sustainability of the fisheries by aligning the interests of fishers with the underlying resource. A recent study in Science, for example, looked at over 11,000 fisheries over a fifty-year period and found clear evidence that the adoption of property-based management regimes prevents fishery collapse. Other research has confirmed both the economic and ecological benefits of property-based fishery management. The recognition of property rights in marine resources can also make it easier to adopt additional conservation measures. For instance, the adoption of catch-shares can reduce the incremental burden from the imposition of by-catch limits or the creation of marine reserves. A shift to catch-shares would have fiscal benefits as well. Yet in recent years, the greatest opposition to the adoption of such property-based management regimes has not come from progressive environmentalist groups, but from Republicans in Congress.

He also endorses a carbon tax, which combines responsibility (the polluter pays principle) with a move toward consumption taxation.

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Here’s a good laugh line if you find yourself in a policy meeting about how to reduce gasoline use: suggest increasing the gasoline tax. During my time in the White House, I attended several meetings on this topic, and inevitably someone (sometimes me) would offer that simple idea. Everyone would then chuckle at its political insanity, and the conversation would turn to Washington’s policy of choice, increasing fuel efficiency standards for autos and cars.

Those standards certainly can reduce future gasoline usage. But they are an incredibly inefficient way to do so. For some new evidence of just how inefficient, let’s turn the microphone over to the aptly-named Valerie Karplus, an MIT researcher, writing in the New York Times:

Politicians of both parties understandably fear that raising the gas tax would enrage voters. It certainly wouldn’t make lives easier for struggling families. But the gasoline tax is a tool of energy and transportation policy, not social policy, like the minimum wage.

Instead of penalizing gasoline use, however, the Obama administration chose a familiar and politically easier path: raising fuel-efficiency standards for cars and light trucks. The White House said last year that the gas savings would be comparable to lowering the price of gasoline by $1 a gallon by 2025. But it will have no effect on the 230 million passenger vehicles now on the road.

Greater efficiency packs less of a psychological punch because consumers pay more only when they buy a new car. In contrast, motorists are reminded regularly of the price at the pump. But the new fuel-efficiency standards are far less efficient than raising gasoline prices.

In a paper published online this week in the journal Energy Economics, I and other scientists at the Massachusetts Institute of Technology estimate that the new standards will cost the economy on the whole — for the same reduction in gas use — at least six times more than a federal gas tax of roughly 45 cents per dollar of gasoline. That is because a gas tax provides immediate, direct incentives for drivers to reduce gasoline use, while the efficiency standards must squeeze the reduction out of new vehicles only. The new standards also encourage more driving, not less. (Emphasis added.)

A gas tax wouldn’t be a win-win all around, of course. People would pay more in taxes immediately. So you might well want to pair the tax with other policies (e.g., offsetting tax reductions) to ameliorate that hit. (The same concern applies to carbon taxes.)

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Two great tastes often taste great together. Chocolate and peanut butter. Oreos and milk. Popcorn and butter. Could the same be true of carbon taxes and corporate tax reform? Done right, each could be flavorful. But would they be even tastier together?

My Tax Policy Center colleague Eric Toder and I explore that question in a new paper. We find that using a carbon tax to help pay for corporate tax reform has several attractions and one big drawback. A well-designed tax swap could combat climate change, make our corporate tax system more competitive, and reduce long-term deficits, but would be quite regressive, increasing tax burdens on most Americans while cutting them on those with the highest incomes.

Let’s start with the good news. Putting a price on carbon dioxide and other greenhouse gases would be an efficient way to reduce future emissions, encourage greener technologies, and reduce future risks of climate change. A carbon tax would make real the adage that you should tax things that you don’t want–like pollution–rather than things you do.

A carbon tax could also raise substantial revenue. One common proposal, a $20 per ton tax rising at 5.6 percent annually, would raise north of $1 trillion over ten years. That money could help reduce future deficits, pay for offsetting tax cuts, or a combination of both.

Which brings us to corporate reform. Just about everyone wants to cut America’s corporate tax rate, now the highest in the developed world. President Obama wants to lower the federal rate from 35 percent to 28 percent. Many Republicans, including House Ways and Means Chairman Dave Camp, hope to get down to 25 percent or even lower. But they are all having a hard time finding a way to pay for such rate cuts. It’s easy to talk about closing “loopholes” and “special interest” tax breaks in the abstract, but in practice it’s difficult to cut back enough to make such large rate cuts.

Enter the carbon tax. A reasonable levy could easily pay for cutting the corporate tax rate to 28 percent or even lower. In fact, such rate cuts would require only a fraction of carbon revenues if lawmakers also identify some significant tax breaks to go after. The remaining carbon revenues could then finance deficit reduction or other policies.

Cutting the corporate tax rate would boost the U.S. economy, reduce many distortions in our existing code, and weaken multinationals’ incentives to play accounting games to avoid U.S. taxes. The resulting economic gains might even be enough to offset the economic costs of the carbon tax. That’s a tasty recipe.

Except for one missing ingredient: fairness. Like other consumption taxes, a carbon tax would fall disproportionately on low-income families. Cutting corporate income taxes, on the other hand, would disproportionately benefit those with higher incomes. A carbon-for-corporate tax swap would thus be quite regressive.

Eric and I used TPC’s tax model to measure this regressivity for a stylized carbon tax that would raise revenues equal to 1 percent of American’s pre-tax income. As illustrated by the light blue bars in the chart below, that carbon tax would boost taxes by more than 1 percent of pre-tax income for households in the bottom four income quintiles—1.8 percent, for example, in the lowest fifth of the income distribution. The increase would be smaller at higher incomes. Folks with the highest incomes would bear a significantly lower relative burden—just 0.75 percent of their pre-tax income, for the top 20 percent of households.


Pairing a carbon tax with an offsetting cut in corporate taxes would make things more regressive (dark blue bars). Lower corporate rates would benefit taxpayers at all income levels, workers and investors alike. But the biggest savings would go to high-income households. Cutting corporate taxes offsets less than a third of carbon tax burden for households in the first three income quintiles, but more than offsets the carbon tax burden in the highest-income group. The net effect would be a tax cut for high-income taxpayers, and tax increases for everyone else.

That regressivity is a serious concern. A carbon-for-corporate tax swap may be a recipe for environmental and economic improvement, but it isn’t a complete one. As Eric and I discuss in the paper, lawmakers should therefore consider other policy ingredients—per capita credits, for example—that could help protect low-income households and potentially make a carbon-for-corporate tax swap a more balanced policy option.

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Tom Toles - Carbon Tax - December 2012

Artist/Source: Tom Toles at Go Comics

h/t: Greg Mankiw, A Cartoon for the Pigou Club

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Twenty years ago, world leaders gathered in Rio de Janeiro to grapple with climate change, biological diversity, and other environmental challenges. Today they are back again, but with much less fanfare. If my Twitter feed is any indication, Rio+20 is getting much less attention that the original Earth Summit.

One item that deserves attention is greater emphasis on getting business involved in protecting the environment. For example, two dozen leading businesses–from Alcoa to Xerox–teamed up with The Nature Conservancy on a vision for The New Business Imperative: Valuing Natural Capital (interactive, pdf).

The report lays out the business case that natural resources have real economic value, even if they aren’t traded in markets, and that protecting them can sometimes reduce costs, maintain supplies, soften the blow of future regulation, and build goodwill with customers, communities, and workers. All kind of obvious, at one level, but nonetheless useful to see in print with examples and commitments.

One item that caught my eye is the potential for “green” infrastructure to replace “gray”:

Strong, reliable manmade (“gray”) infrastructure undergirds a healthy marketplace, and most companies depend heavily on it to operate effectively and efficiently. Yet increasingly, companies are seeing the enormous potential for “natural infrastructure” in the form of wetlands and forests, watersheds and coastal habitats to perform many of the same tasks as gray infrastructure — sometimes better and more cheaply.

For instance, investing in protection of coral reefs and mangroves can provide a stronger barrier to protect coastal operations against flooding and storm surge during extreme weather, while inland flooding can be reduced by strategic investments in catchment forests, vegetation and marshes. Forests are also crucial for maintaining usable freshwater sources, as well as for naturally regulating water flow.

Putting funds into maintaining a wetland near a processing or manufacturing plant can be a more cost- effective way of meeting regulatory requirements than building a wastewater treatment facility, as evidenced by the Dow Chemical Seadrift, Texas facility, where a 110-acre constructed wetland provides tertiary wastewater treatment of five million gallons a day. While the cost of a traditional “gray”treatment installation averages >$40 million, Dow’s up-front costs were just $1.4 million.

For companies reliant on agricultural systems, improved land management of forests and ecosystems along field edges and streams, along with the introduction of more diversified and resilient sustainable agriculture systems, can minimize dependency on external inputs like artificial fertilizers, pesticides and blue irrigation water.

To encourage such investments, where they make sense, lawmakers and regulators need to focus on performance–is the wastewater getting clean?–rather than the use of specific technologies or construction.

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