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Who Should Price Carbon?

October 22, 2016
Carbon pricing is more and more important to understand as we adapt for the future. Should the Federal Government, State Governments, or the private sector be responsible for the decision? Either way, increasing volatility and instability makes this debate increasingly important - and a resolution even more urgent.

by Henry Mason

To examine this question, we need to understand the concept of carbon pricing. Greenhouse Gas emission (most notably carbon dioxide) is a natural byproduct of almost all industries worldwide. Even if they are not direct emitters, certain parts of a company’s value chain might be responsible (such as transportation or consumer use). When these industries operate naturally, their associated greenhouse gas emissions cost them nothing other than the price of their inputs (coal, gasoline, oil, natural gas, etc.) Corporations operating with a “business as usual” mentality are internalizing the benefit, in the form of revenue, and externalizing the negative externalities of a changed climate. Carbon pricing charges companies a price roughly equal to the cost that society as a whole incurs from the pollution they produce. The government then spends that money either remediating the pollution, or subsidizing/investing in technologies that will reduce our nation’s carbon footprint into the future. Currently, there is no nationally accepted or enforced public price on carbon. Several states and municipalities enforce one locally [1], but carbon pricing would only become effective with much wider participation. This problem creates the debate that this piece centers on: should the price associated with carbon be dictated by the federal government, the state governments, or even be priced internally by companies themselves?

The federal government recently created a comprehensive formula for calculating the social cost of carbon (SCC) under the Obama Administration’s Clean Power Plan (CPP). The SCC was used to quantify the benefit of reducing our emissions in order to effectively compare it to the cost of the project. This method has become widely accepted and is used by many federal agencies. It factors in, among other things, the potential changes in net agricultural productivity, human health, property damages from increased flood risk, and changes in the cost of energy [2].  It controls for different discount rates going decades into the future [3], and as a result is a very effective tool for policy makers. Yet, the argument over whether American companies and citizens nationwide should be unwillingly subjected to its economic effects is a divisive one. With the current political atmosphere, it would be a monumental endeavor, and the process of passing and enforcing such a law, even if successful, would take years.

Another potential solution is to have individual states mandate their own carbon price. The schemes of different States would vary based on both local industry mixes and political atmosphere, creating a different set of problems. When the power to price carbon becomes de-centralized, there is a tragedy of the commons that results. The states which will be less affected by the impacts of potential climate change have much less incentive to enforce a large, if any, price on carbon. If fact, some may hope to attract immigration from high emissions industries currently based in states with higher carbon pricing. Thus, the states which discourage emissions the most (likely the states that would also suffer the most negatively from a changed climate) would suffer an economic penalty disproportionate to the sanctions that they enforce.

A final option is to place the burden of this decision in the hands of the private sector instead. It is difficult to find a business or industry that would not be affected by climate change. That may be due to their location, the potential changes in cost of their raw materials, or other risks along their value chain.

 

<p>Volatility of the cost of a Gallon of regular grade gasoline over the years. A company which relies heavily on carbon fuels to transport materials from place to place (a part of their value chain) will suffer from uncertainty and major losses as gas prices rise. Source: White House Shareables <a href="#_edn4">[4]</a>.</p>

 

The instability that accompanies these unpredictable changes due to climate change gives companies an incentive to internally price carbon. Additionally, if the government were to introduce widespread measures to reduce carbon emissions in the future, companies that were already doing so would be in a prime position in their industry relative to their competition. There are many benefits to being an early mover in the sustainability and eco-friendly market, such as building brand loyalty among environmentally conscious consumers, as well as gaining market share in the sustainability space. For example, Toyota has reaped financial benefits from being among the first companies to develop a widespread hybrid vehicle, and certainly the first company to do it well [5]. It is also important to note that many corporations, and certainly the major ones whose actions would most affect our national carbon budget, stretch across multiple states. As such, they would be less likely to act as myopically as some individual states would. Of course, many corporations might not have a firm grasp on how to effectively construct a framework for valuing carbon, and there would be major growing pains associated with this process.

All three of the strategies examined in this piece have benefits and drawbacks, and I believe that the solution lies in between them. Instead of enforcing a “command and control” style regulation on its civilians, the federal government should instead work to help corporations develop a framework to price carbon internally, which they have vast experience in. Local state governments should have a seat at the table as far as determining the potential effects of climate change within their own state, but their tendency to think inwardly means that they don’t need to have any influence over far-ranging policies. As a part of this collaboration with the free market, the government as a whole would also have an obligation to even out disparities in subsidies and tax credits, which often times favor industries and processes with larger carbon footprints, and artificially shift energy markets. Adjusting subsidies and tax credits is a crucial step if we expect the private sector to be proactive in pricing carbon. These new policies must also be consistent over time, to encourage longer term thinking so that corporations may accurately plan for their future. With proper guidance and leadership, there is an opportunity for the American economy to become more sustainable, open up new areas of growth, and develop resistance to the myriad risks that companies face today from a changing climate. It is possible to accomplish this without placing an undue burden on the private sector, and without placing the responsibility squarely on the shoulders of government agencies, but it requires cooperation and constant communication. If we, as a country, are to adjust to this changing world, we must first adjust how we approach solving complex problems.

 

Citations

  [1] “Regional Greenhouse Gas Initiative,” (Memorandum of Understanding), 2005. [Online]. Available: http://www.rggi.org/docs/mou_12_20_05.pdf. Accessed: Jul. 12, 2016.

  [2] J. Wentz, “EPA’s Use of the Social Cost of Carbon Is Not Arbitrary or Capricious,” in Columbia Law School Climate Law Blog (Sabin Center for Climate Change Law), 2016. [Online]. Available: http://blogs.law.columbia.edu/climatechange/2016/03/07/epas-use-of-the-social-cost-of-carbon-is-not-arbitrary-or-capricious/. Accessed: Jul. 14, 2016.

  [3] Interagency Working Group on Social Cost of Carbon, “Technical Update of the Social Cost of Carbon for Regulatory Impact Analysis - Under Executive Order 12866,” Jul. 2015. [Online]. Available: https://www.whitehouse.gov/sites/default/files/omb/inforeg/scc-tsd-final-july-2015.pdf. Accessed: Jul. 10, 2016.

  [4] “The Obama Energy Agenda: Gas Prices,” in White House Shareables, The White House, 2013. [Online]. Available: https://www.whitehouse.gov/energy/gasprices. Accessed: Jul. 19, 2016.

  [5] Bibliography: [1] D. A. McIntyre, “Toyota Prius continues to lead hybrid car sales,” in 24/7 Wall St, 2015. [Online]. Available: http://247wallst.com/autos/2015/03/05/toyota-prius-continues-to-lead-hybrid-car-sales/. Accessed: Jul. 30, 2016.

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