Richard Tol on a Global Carbon Tax

Richard Tol, one of the World’s leading economists on climate, has just had published The Structure of the Climate Debate, a paper that makes some very good comments on the gulf between optimal policy and the reality of ineffective policy backed by a great army of bureaucrats, rent-seeking politicians and environmentalists who exaggerate the issues. It is this optimal policy  – a global carbon tax to constrain warming to 2C – that I take issue with. Both economic theory and the empirical evidence contradict this.  The following is a comment posted at cliscep

Richard Tol states in his paper

Only a modest carbon tax is needed to keep atmospheric concentrations below a high target but the required tax rapidly increases with the stringency of the target. If concentrations are to be kept below 450 ppm CO2eq, the global carbon tax should reach some $210/tCO2 in 2020 or so (Tol 2013).

The 450 ppm CO2eq, would produce 2C of warming from pre-industrial levels if a doubling of CO2 on its own produces 3C of warming. The UNFCCC produced a graph for COP21 to illustrate the global emissions pathway needed to ensure 2C limit :-

Whereas even with the all the vague policy proposals fully implemented global emissions will be about 10% higher in 2030 than in 2010, the 2C pathway has emissions 10-30% lower. That means a carbon tax of $210/tCO2 (now £170) would have to turn around the global relentless rise in emissions and have them falling rapidly. I am deeply sceptical that such a global policy would achieve anything like the that difference would be achieved even with an omnipotent, omniscient, and omnipresent planner to impose the tax. The reasons for that scepticism can be found by applying the tax to real world examples.
First let us apply a £170/tCO2 carbon tax to petrol, which produces 2.30kg of CO2 per litre. With 20% VAT applied is equivalent to 47p a litre added to the retail price. (Current excise duties with VAT are equivalent to £300/tCO2, the diesel £250/tCO2). For a car doing 15000 miles at 39mpg, this would generate an additional cost to the owner of £820 per year. Maybe a 15-30% increase in the full costs of running a small car in the UK. There is plenty of empirical visence of the effect of the oil price movements in the last couple of decades (especially in the period 2004-2008 when the price increased) to show that costs increases will have a much smaller effect on demand, whereas for the carbon tax to be effective it would need to have a much greater impact than the percentage cost increase.
Second, let us apply a $210/tCO2 carbon tax to coal-fired power stations. They produce about 400kg of CO2 per megawatt, so the cost would rise by $84MWH. In China, coal-fired electricity will retail at less than $30 MwH. China would rapidly switch to nuclear power. Even so, its power generation emissions might not start falling for at least a decade. Alternatively it might switch to gas, where the carbon tax would be half that of coal.
However, there is another lesson from oil prices, this time over the last three years. A small fall in demand leads to large falls in price, in the short term. That is the market responds by offsetting the cost of the global carbon tax. To use terms of basic economics the demand for fossil fuels is highly inelastic with respect to changes in price, and the supply of fossil fuels in the short term is highly inelastic to changes in demand.  Emissions reductions policies have not just turned out to be pretty useless in practice, they are pretty useless in theory (with real world political constraints removed) as well.

Kevin Marshall

 

Julia Gillard’s Carbon Taxes– An ineffective policy

Jo Nova claims the Australian Prime Minister, Julia Gillard, lied to the Australian public by being circumspect about a carbon taxes, then when in office to introduce a carbon tax to be followed by cap and trade.

Betrayal of promises is to be expected and welcomed if to meet changed circumstances. For instance new taxes to close a deficit brought on by a recession. But in this case nothing has changed. However, there is a much better reason for Australian’s to oppose the policy – it will inflict economic pain and hardship for little or no returns.

The political argument for the introduction of the policy is that we should meet international obligations. OECD countries “need” to cut CO2 emissions by 80% by 2050 to constrain CO2 levels to around 550-600ppm. It is claimed by the IPCC & the Stern Review that this can be achieved by at a cost much less than the costly consequences of global warming. My example below suggests that a gasoline tax of 6.5 cents a litre would be almost totally ineffective. It would only serve to reduce living standards. Yet this is the start of CO2 reduction policies, when there should be some easy wins. It is as bigger inroads are made that reductions in CO2 should become more costly. Unless more effective policies can be devised, the CO2 reduction policies will leave us and future generations worse off than if nothing was done. Therefore, those who believe in the impending climate catastrophe, but are policy realists should join the climate sceptics in opposing the introduction in Australia of a carbon tax and carbon trading.

I try to explore demonstrate the case for climate change mitigation policies graphically here and which the policy will never link

A Carbon Tax on Gasoline

Consider a motorist in Australia who travels high distances in an old, inefficient truck. He travels 30000km a year and consumes a litre every 6km (6km/l or 17mpg in British terms). So the cost of 5000 litres used will increase the fuel bill by AU$325. If there are no gasoline taxes in Australia, fuel prices will be around $1.20 per litre, so the motorist will already be paying $6000 per year for fuel and (if he is lucky) $2000 for insurance, other taxes, maintenance and depreciation. So the tax will add 4% to his motoring costs.

At a more moderate level, consider a British example (in Australian dollars). Somebody has a medium sized car that is three years old, travelling 10,000 miles (16,000km) per year at 40mpg (14km/l). Fuel is $2 (£1.30) per litre , so costs $2280 for 1140 litres. With no serious maintenance issues, tax, depreciation, insurance and servicing cost around $4500 per annum. Total costs (rounded) are $7000 per year. A 6.5 cent carbon tax will add $71.25, or 1% to this bill.

For a newer car the percentage increase will be lower. Upgrade the specification and the percentage will be lower.

As real incomes rise people are able to afford more luxury. Compare the typical car in Australia with say Brazil, or Brazil with an African nation. In Brazil the best-selling cars have mostly one litre capacity and low specification. Many cars new cars still do not have air conditioning or electric windows. A carbon tax will take people in the reverse direction a long way before they will give up the utility of a private vehicle.

Prof Nordhaus forgets some basic Economics

Wattsupwiththat today carries a summary of William D. Nordhaus’s latest paper on climate change policy. The paper “The architecture of climate economics: Designing a global agreement on global warming” is published at the Bulletin for the Atomic Scientists here.

The basic economic fundamental for any policy is to have a net welfare improvement. Therefore in designing this policy, there should be a reasonable expectation that benefits will outweigh the costs. Prof. Nordhaus simply looks at the improvements to be made from switching from cap and trade (per Kyoto Agreement) to a carbon tax. Not just any carbon tax, but one that is uniform throughout the world.

Nordhaus claims that people should face the social costs of their activities. A carbon tax provides four strong incentives:-

First, it provides signals to consumers about what goods and services produce high carbon emissions and should therefore be used more sparingly. Second, it provides signals to producers about which inputs (such as electricity from coal) use more carbon, and which inputs (such as electricity from wind) use less or none. It thereby induces producers to move to low-carbon technologies. Third, high carbon prices provide market signals and financial incentives to inventors and innovators to develop and introduce low-carbon products and processes that can eventually replace the current generation of carbon-intensive technologies. Finally, and most subtle of all, the use of carbon pricing provides simple, straightforward information that market participants need to undertake each of these three tasks. Of course, placing a market price on carbon use will not work magic.

As a means of making consumers use fossil fuels more sparingly, taxes on fuel are highly inefficient. With no close substitute (at least in cost) for fossil fuels (whether for transport, domestic fuel and light, or industry) rises in price are highly inelastic with respect to demand. That is why in the UK, it is a great way of raising tax revenue – you can raise with impunity without major fall-off in demand. Prof Nordhaus can check this out from the effect on demand to the rising price of oil.

As for making producers move to non-carbon sources of power, it is mostly being driven by government policy. The costs of wind and solar power are still far beyond those of fossil fuels and prone to supply problems. For instance, the recent extreme cold in the UK was accompanied by weak sunlight (it is winter with less than 8 hour days) and virtually no wind.

The incentives to producers to switch to alternative energy sources are already there from the high oil price. It has more than tripled in price in less than a decade. The marginal impact of increases energy prices through taxes will be small, if not insignificant.

The fourth is just a combination of the three. It is only a reason if the word “subtle” is replaced by “insignificant”.

The disadvantages of a carbon tax

What Nordhaus does not look at are the disadvantages.

  1. Carbon Tax is regressive within countries. Those who will have to give up cars and foreign holidays and suffer lower heating and lighting in their homes are the poorest. In Britain, where death rates already surge in cold weather, this will be exacerbated.
  2. A carbon tax works by providing a stark choice – you either reduce energy consumption (and reduce your standard of living) or see your living standards fall in other areas. Without
  3. For many in the poorer, but developing countries, aspirations will be dashed. Economic growth is closely related to increase in energy usage per capita. In India and China with rapid economic growth, hundreds of millions of families will be aspiring to cars, foreign travel, washing machines, refrigerators and warmer (or air conditioned) homes. To control CO2 emissions means denying them these opportunities for many years. This is not just making them less affordable. It is also through slowing those high rates of economic growth. For these people – 40% of the world population – this welfare loss will be far greater than anything that runaway global warming can engender.
  4. A uniform tax is ludicrous. In the UK of the £1.23 per litre I last paid for petrol ($7.30 per US gallon of gasoline) over 50% was in taxation. Yesterday the VAT went up 2.5%, adding another 3p per litre. In the USA it is much lower. In Brazil, diesel is restricted to goods vehicles only and carries no tax. In Iran fuel is subsidized. In the UK (and much of Western Europe) a uniform tax would lead to a reduction in tax in an area where you want to reduce emissions most, whilst achieving large emission reductions in some of the poorest, but developing countries.
  5. Society bears the costs of individual consumption externalities. You should compensate the losers whilst punishing the polluters. But to do this efficiently you need to first identify the losers and the gainers from CO2 emissions. Who will lose from the consequences of climate change is purely speculative.

 

Prof Nordhaus’s mistake is only to look at the advantages of a Carbon Tax over Cap and Trade. He does not look at improving the situation on having no policy at all. He ignores the poor, proposing a policy that will deny the aspirations of billions. Further, he does not take into account the political dimension. The democratic and rich countries will not vote for a policy that can only be effective by significantly reducing their living standards. In Western Europe, this is further exacerbated by most studies showing climate change will do little harm, or be of slight benefit. In China, constraint on CO2 emission growth will also strongly constrain economic growth, which will probably cause political turmoil. Yet without China and other emerging economies buying into CO2 constraint, then Western CO2 reductions are in vain. See a talk by Roger Pielke Jr.

However, Prof Nordhaus recognizes that non-participation costs are very high for achieving emissions targets