Climate change and the American economy

The 3rd National Climate Assessment (NCA) was released earlier this month, painting a frightening picture of the spiraling costs of climate disruption to America and highlighting the need to price carbon dioxide (CO2) emissions.  While President Obama has pledged action and the electricity industry nervously awaits new EPA regulations for power plant emissions, the most appropriate action remains politically impossible: carbon taxes, cap and trade and carbon pricing are all consistently used as divisive issues to excite the conservative base of the GOP.

This is exactly backwards.  If you believe in American capitalism and free markets then you believe in a price on greenhouse gas emissions. The only question is what that price should be.

A properly functioning market-based economy creates a real and accurate price for a product, supporting rational consumer behavior. In a market-based economy, businesses are rewarded for efficiency, because lower cost motivates consumers. This is why American capitalism has been so successful – a very clear reward exists for developing efficiencies or innovation, and that reward is market share. This reward is a fundamental principle on which American excellence was built.

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Rather than being included in the price of energy, the external price of our CO2 emissions has been, and will continue to be, socialized across current and future populations through the costs and taxes that will pay for damage to property and human health. 

Here is what we know:

  • The Intergovernmental Panel on Climate Change’s Fifth Assessment Report said with nearly unanimous certainty CO2 emissions are accelerating global warming and causing increasing climate disruption. 
  • The costs of climate change are, and will continue to be (with virtual certainty) almost unimaginable - at the very least TRILLIONS of dollars over coming decades.
  • The current price paid by consumers associated with the release of CO2 during conversion of energy for his or her use is at or near zero, even as the NCA found climate change already costing the U.S. economy billions every year.
  • No avenues exist today for a consumer to reasonably include the cost of climate disruption into their choices about energy use or energy source.

We should be pricing CO2 emissions today – and we should be pricing them regardless of whether the link between CO2 emissions and climate change could someday be proven incorrect.  The price of carbon emissions should simply include an uncertainty discount to account for any doubts about the cause and cost of climate disruption.   

Tobacco use and prices provide an excellent example of how this should work.  Since humans began smoking tobacco (as early as 5000 BC) societies have borne the burden of the disease for both smokers and those exposed to second-hand smoke. During the mid to late 20th century, the U.S. recognized the costs tobacco use put on society as a whole, especially the huge burden that illnesses likely caused by tobacco use put on the heath-care system.  While exact costs were uncertain, it was clear some portion of the cost of an individual’s choice to smoke was being socialized across the broader population. 

Painful and inexact as the exercise may have been, we decided to put a price on those socialized costs (in the form of direct taxes and settlement payments placed on tobacco products), then discounted the cost to reflect uncertainties, and added that adjusted amount to the price of a cigarette. You’re free to smoke; you’re just not free to smoke without paying at least some of the broader social costs for smoking.  Smokers now make decisions about smoking based on prices that better approximate the true cost of their actions – the market functions more correctly.

These same principles can and should be applied to greenhouse gas emissions.  You should be free to emit CO2, but you should pay a price for those emissions that reflects the total societal costs.

Markets fail when specific costs are socialized across a broad population. Socialized costs artificially lower a product’s cost, not because the product is actually better or cheaper, but because someone other than the consumer is paying some portion of the cost.  Individual consumers of the product are attracted to the relatively less expensive product and not properly incentivized to conserve or select an alternative source.

This, unfortunately, is exactly how our current energy market functions.  CO2 emissions are not captured in the cost of each unit of energy used.  The consumer does not pay the real cost for energy, because these costs are socialized, and will be paid by property owners and taxpayers. Forcing taxpayers to carry the cost of CO2 emissions, rather than individual users based on actual usage, undermines the market basis for American growth and innovation. This distortion undermines our ability to make the best decisions about how we will harness the energy necessary for future generations to realize the same opportunities and promise that allowed America to be nation it is today. 

Critics say carbon markets don’t work, but they couldn’t be more wrong. The World Bank has identified more than 60 carbon markets round the globe, in both developed and developing nations, either operating or in development.  Here in the U.S., two carbon markets, one in the Northeast U.S. and one in California, have cut emissions and returned billions to energy consumers.

The National Climate Assessment makes it clear that the cost of inaction is severe, and the world around us shows solutions exist.  Rather than hoping for the President to act alone by executive order or through EPA regulations, Congress must realize that our current approach of socializing greenhouse gas emissions isn’t supporting the free-market.  A price on CO2 is exactly the right way to support the American market-based economy.

Hinckley is the head of global energy finance for Sullivan & Worcester. He is also an adjunct professor of energy policy at Georgetown University and writes a regular column on energy finance.

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