9. Policy mechanisms

What policy mechanisms are available to address the climate problem? Major options include:

Taxes and allowance trading — Either a tax or an allowance trading scheme puts a price on carbon emissions. How high should it be? How should it be designed? How should the tax revenues or the value of the allowances be allocated?
Public investment — What other government initiatives are needed? How can the public sector effectively intervene to reduce emissions and stimulate new research and development?

A Chinese sky trust?: Distributional impacts of carbon charges and revenue recycling in China
Mark Brenner, Matthew Riddle and James K. Boyce
Energy Policy (2007) 35(3): 1771-1784.

The introduction of carbon charges on the use of fossil fuels in China would have a progressive impact on income distribution. This outcome, which contrasts to the regressive distributional impact found in most studies of carbon charges in industrialized countries, is driven primarily by differences between urban and rural expenditure patterns. If carbon revenues were recycled on an equal per capita basis via a ‘sky trust,’ the progressive impact would be further enhanced: low-income (mainly rural) households would receive more in sky-trust dividends than they pay in carbon charges, and high-income (mainly urban) households would pay more than they receive in dividends. Thus a Chinese sky trust would contribute to both lower fossil fuel consumption and greater income equality.

Distribution of emissions allowances as an opportunity
Stephen J. DeCanio
Climate Policy (2007) 7(2): 91-103.

Much of the debate on climate policy in the USA focuses on the gain or loss to the macroeconomy of alternative policies to reduce greenhouse gas emissions. However, the economy is made up of multiple individuals, not a single representative agent. This article reports the results of alternative ways of distributing emissions allocations across citizens. Macroeconomic effects interact with the policy for distribution, but the distributional weights are more important for the welfare of individual agents than the economy-wide effects of the emissions reductions. Egalitarian distributions of the emissions allowances have the potential to increase the welfare of most people, even if significant emissions reductions are mandated. Focusing on the distribution of emissions allowances (or the revenues generated from an emissions tax) rather than on aggregate GDP may provide guidance in identifying and implementing politically viable solutions to the climate change mitigation problem.

An integrated analysis of policies that increase investments in advanced energy-
efficient/low-carbon technologies
D.A. Hanson and J. A. Laitner
Energy Economics (2004) 26(4): 739-755.

A new analysis by the EPA Office of Atmospheric Programs and the Argonne National Laboratory (ANL), using the All Modular Industry Growth Assessment (AMIGA) system, indicates that a technology-led investment strategy, can secure substantial domestic reductions of carbon emissions at a net positive impact on the U.S. economy. However, a moderate energy policy, even supported by a carbon charge ranging from US$48 to US$93 per metric ton, is insufficient to reach the so-called Kyoto targets.

Calibration bias in the analysis of environmental taxes
Richard B. Howarth
American Journal of Agricultural Economics (2004) 86: 813-818.

This article explores the role of preexisting taxes in gauging the costs and benefits of taxing CO₂ emissions to slow the rate of climate change. In a numerically calibrated model of the world economy that involves a 33% personal income tax, stabilizing emissions at year 2000 levels would yield present-value net benefits of $10.7 trillion. When the model is recalibrated based on the counterfactual assumption of zero taxes and public expenditures, present-value net benefits fall by 87%. This gap arises because the no-tax calibration both overstates people’s true time preference and understates the disutility of increased CO₂ levels. Thus, calibration bias adversely affects efforts to gauge the costs and benefits of environmental taxation.

Optimal environmental taxes under relative consumption effects
Richard B. Howarth
Ecological Economics (2006) 58: 209-219.

This paper explores the interactions between carbon dioxide emissions taxes and a pre-existing income tax in a numerically calibrated model of climate change and the world economy. Based on evidence from the recent empirical literature, the model allows for the presence of relative consumption effects in the specification of preferences. In the absence of relative consumption effects, optimal emissions taxes would rise from $44 to $229 per tonne of carbon (in year 2000 US dollars) over the course of the next century. These tax rates, which arise when emissions tax revenues are used to reduce taxes on personal income, are slightly above the present value marginal benefits of emissions control. Given realistic assumptions concerning the empirical magnitude of relative consumption effects, the optimal emissions tax rises to $63 per tonne in 2005 and $384 per tonne in 2105. Accounting for relative consumption effects reduces the perceived social benefits of consumption, thus increasing social willingness to pay for environmental quality while reducing both the costs of tax interaction effects and the benefits of efficient revenue recycling. Taken together, these factors support the implementation of comparatively high environmental taxes in the face of relative consumption effects.