Tuesday, July 01, 2008

Post-Kyoto International Arrangments--Work through Prices rather than Quantities

This is a paper sent to the Belfer Center of the Kennedy School of Government at Harvard, responding to a call for thoughts on international climate protection after the expiration of the Kyoto Protocol in 2012. This is nominally a competition, but I sent the paper for somewhat different purposes. As usual, I was looking for a stimulus and a format to get my thinking down on paper, but more particularly, I wanted to get in some views that I understand are quite different from the prevailing ones at this Harvard unit.

The Belfer group, under economist Robert Stavins, would seem to be quite committed to a cap and trade approach to the creation of a "carbon price," which is an important step in the public policy of fighting global warming. I think that cap and trade is misguided, and that carbon taxation, despite the shudders that run through politicians at the word "tax," would be both more effective, and more flexible and manageable, so that it would not become a runaway, taking on a life of its own, as policy measures can do.

Carbon taxation versus cap and trade is a sub-set of the issue of whether it is better to regulate a public problem by pricing it, or through quantitative targets. That in turn comes under the general question of climate protection policy.

The broader subject is treated in an earlier, more general paper that I was working on last Fall. Its current draft will be found as the next paper on this blog. With the Belfer paper finished for the moment, I'm planning to get back to work on the longer, broader draft. Reading on climate change, and trying to follow the subject as it arises in Berkeley, continue.

Post-Kyoto: Coordinated Carbon Taxation and
Cross-border Investment Facilitation

I. Summary/Abstract II. Task definition III. Why is price regulation better than quantitative regulation? IV. A template for a national program, and supporting international linkages
V. Important, but not primary: International setting should offer carrots, shared information, and services, not sticks

I. Summary/Abstract

For the design of post-Kyoto international arrangements for climate protection, this paper tries to apply systematically the principle that CO2 will generally be more successfully regulated by price, than by quantity, following Martin Weitzman, William Neuhaus and others.

For the international context, it therefore supports “policies and measures” over “targets and timetables,” in contrast to the present quantity-based Kyoto Protocol. Pri-mary among policies and measures is the international coordination of national carbon taxation, following Richard Cooper, in place of cap and trade approaches to regulation.

It is proposed that a template country impose an initially modest carbon tax (perhaps $10 per ton of CO2), likely to rise thereafter. Part of the proceeds of the tax would be revenue neutral, to be redistributed in an economically stimulative, or otherwise useful fashion within the taxing country, per Goulder. The other part would go to a carbon reduction budget, of which a fraction would be spent domestically and the other fraction spent through an international agency investing worldwide via loans and grants in emissions reductions and in non-fossil energy, on the criterion of greatest efficiency (carbon reductions/dollar), independent of “where” constraints.

Participating countries would decide individually on what share of their carbon tax revenues would be revenue neutral and what share would go to carbon reduction. Similarly, each participating country would decide what fraction of its carbon reduction budget would be spent domestically, and what fraction could be spent internationally for the substantial efficiency gains of “where” freedom. (In the case of a post-2008 United States, half the carbon tax proceeds could be revenue neutral and half spent for climate protection, the latter portion being divided half and half between domestic and international investing.) Governmental spending of other, non-carbon tax revenues, for carbon protection, either domestically or internationally, is not excluded.

It could be expected that most international climate preservation funds would be invested in developing countries due to the lower costs of making energy facilities carbon free when they are first built, rather than through retrofitting or closing old plant. This would function as incentive to developing countries to take part in the international coordination. An example transaction is given.

The paper recognizes that national efforts to reduce greenhouse emissions, rather than the international setting, will be the primary arenas of action. Some discussion is provided of the relationship between the national and international contexts in this field, urging that the international regime recognize that it is secondary to intra-national actions, and that its style must be cooperative rather than authority-seeking, reflecting the realities of national control and sovereignty anxieties at this time and for this issue.

II. Task definition and structure:

The central work of climate protection (the avoidance of global warming, and internationally, the fulfillment of the Rio Treaty) is the worldwide replacement, as soon and as rapidly as possible, of the fossil-based energy systems which now predominate by non-fossil capacities to convert and deliver the energy required by modern and modernizing societies. The core systems are those that generate electricity, particularly since with the advent of improved batteries and the electric or plug-in hybrid vehicle, the large transportation/petroleum sector can be expected to shift very substantially to electric propulsion (Sanna, EPRI 2005: McElroy, 2008). A marked “tipping point” and thereafter a rapid transition are likely, since electricity for vehicles now costs about a quarter of the cost of gasoline/diesel, and perhaps less, and is abundantly available at off-peak hours. With the main exception of space heating, electricity will then be the strongly dominant medium of energy production, distribution and use.

Since worldwide energy demand, and the production to meet it, are growing, and capital-intensive new power generation facilities are being continuously constructed, a first policy goal is, from the earliest possible date, to build new energy systems as either renewable or nuclear.

Such new equipment will join the substantial portion of the existing system that is already renewable (notably hydropower) or nuclear. The capital cost of the new, non-fossil systems is likely to be higher than that of comparable fossil systems, but the operating costs will be substantially lower, meaning that the initial investment costs of these non-fossil systems will be larger, but over their service lifetimes the energy they will produce is very likely to be less expensive than fossil-based energy. This is particularly so since the cost of the non-fossil technologies (notably wind, concentrated solar, photovoltaic, and nuclear) is likely to decline as they are constructed in greater volume, and the spreading practices of energy economy and efficiency restrain the volume of energy that will need to be produced. Apart from ongoing growth in energy demand due to economic and population growth, demand reduction from efficiency may not mean a net decline in the amount of energy demanded, since petroleum-based transportation will heavily shift to electric propulsion. The large additional quantity of electric energy for electrified transportation, however, will mainly be taken from existing power plants off-peak. Using it therefore does not imply building proportionally more power generating capacity. On the other side of the ledger, the price of fossil fuels, in at least the medium term (say, ten years) is on a sharply rising trajectory, which should ease their replacement.

With new construction changed to non-fossil facilities, now-existing fossil systems will need to be replaced by non-fossil systems. Considering both the new construction and the retrofit/replacement parts of this changeover, leaving the immense existing and familiar fossil energy producing systems behind will be expensive, and will necessitate the infusion into the energy system of major amounts of capital. In each case, however, the expense of the changeover to non-fossil energy will not be the amount of funding spent on new or replacement energy facilities, but will be the difference between the cost of a fossil facility and the cost of a non-fossil facility, a much smaller, though still substantial amount.

However, although they are more demanding of capital at the outset, there is also a more favorable side to the nuclear/renewable coin. The new non-fossil systems for supplying energy are also capital and equipment (as opposed to resource) intensive in the second sense that they will demand far fewer, and in many cases nil, fuel resources over their productive lifetimes of many decades. It is very likely that over these service lifetimes, this characteristic of the new fossil-free energy production system will make energy less expensive than present fossil-based energy. Although there will necessarily be a major bump upwards in the cost of energy while the new non-fossil systems are being capitalized and built, even while this is going on, the expense can be substantially palliated by diffusion of the practices of energy efficiency and conservation, where the opportunities for cost savings are very large.

III. Why is price regulation (carbon taxation) better than quantitative regulation (cap with trading)?

Global warming, is for the most part an externality of the massive use of fossil-carbon based energy. The governments of the world have recognized greenhouse warming as a grave danger, and pledged to take national and international action against it in the Framework Convention on Climate Change of 1992-94. For governments, individually and collectively, restraining greenhouse carbon emissions is a problem in the regulation of a damaging externality. As such, it falls under the analysis by Martin Weitzman (Weitzman 1974) of whether such threats are better regulated by price or by quantity. For a case with the characteristics of greenhouse climate change (mainly an unknown or flat benefit schedule), the theoretical conclusion is that regulation by price is the more efficient approach, perhaps by a very wide margin (Pizer 1997, Neuhaus 2008).

At the administrative, implementing level, “targets and timetables” are a quantitative method, while the main approach to greenhouse gas regulation by price is found under the heading of “policies and measures,” and is carbon taxation. Despite the analytical result in favor of price regulation, the pre-Kyoto negotiations steered toward a “targets and timetables” approach (urged by the U.S., with the Europeans originally in opposition (Grubb, 1999)), disregarding the Weitzman advice. To implement, in turn, its targets and timetables, Kyoto employs “cap and trade” regulation, a quantitative method, rather than a price-based method, such as carbon taxation.

Very broadly, although the reasons are manifold and the greenhouse problem is formidable, Kyoto is not a successful international agreement. Nonetheless, in the present preparations for post-Kyoto arrangements, the predominant voices seem to advocate continuing with “targets and timetables,” and “cap and trade”. This paper, on the contrary, proposes that the new climate protection arrangements be based consistently on price rather than quantitative regulation.

It sees the challenge of climate protection as having three sections: the physical, (engineering, technological) domain, an economic (price-setting, investment) domain, and the political (mobilization of social capital, equilibration of interests) domain.

Outcomes in the physical domain will largely control the cost of climate protection. Whether costs are high or low is in turn a major contingency which will influence which economic/investment policies are best, as will be discussed.

This paper takes the view that the broad socio-political decision to recognize climate change as a great danger and to move against it on a large scale (that is to say, the mobilization of social capital) should be treated as if it had been completed, and that technical and economic considerations should now rule, to the greatest extent possible, in the present and coming phases of climate protection policy-making. We should be beyond the basic political decision of whether or not to take action against climate change, and have entered the strategic implementation phase of the problem. Extended and delaying debate, which takes protean forms, of whether we should be working to mitigate climate change should now be behind us, although in reality for climate protection, the politics of the mobilization of social capital to take action is not fully completed, and in any case, the politics of the balancing of interests among participants is always ready to flourish.

All international participants understandably both want to get ahead with ending the climate danger, and feel reluctance to take the necessary steps and make the necessary changes, often inhibited by the prospective economic costs of change. When reluctance or apprehension about economic costs dominates, there would seem to be a gravitation toward the quantitative approach, as at Kyoto under American urging. The impulse, which prevailed in Kyoto and prevails currently, to choose quantitative rather than price mechanisms can be seen as essentially coming into the world of economic rationality from the world of politics. It expresses not task commitment to preserve the climate, but rather expresses the “sidelong glance” impulse to measure one’s effort against the effort of others, and to work harder or less hard not in measure with progress against the greenhouse problem itself, but to work rather on a rhythm of constant adjustment of one’s effort with the efforts of others.

The climate change problem is a real and portentous one, as well as being genuinely difficult, and difficult for the public even to perceive. The effort among those who have worked on it and achieved some understanding of it must be to keep the focus on the problem of climate protection, and on effectiveness against it, not on the socio-political relationships surrounding the collective effort, although it is true that, instrumentally, they must be satisfied to at least some degree.

In more specific terms, why is price regulation of carbon emissions better than quantitative regulation?

1. In negotiations, promises of effort not achievement When a climate protection system is under negotiation among several potential contributors, as in the international case, under a quantitative system of regulation each participant promises an outcome, stating a target of an actual carbon reduction by a certain date. A participating country does not know what will be the cost of the result at the time it commits itself, and may not even know with certainty that it will be able to fulfill the commitment. At root, this is largely an anxiety about technology. David Victor (2001) points out that there is an additional major uncertainty for many countries, because governments commit themselves to reductions of the carbon emitted by their private sectors, which are not directly under the government’s control. These “performance uncertainties” encourage either low commitments, or ultimately hollow commitments, around the full circle of participants.

In contrast, in a setting of price regulation, a government’s central commitment is to impose a carbon tax at a given level. This is an action that is under its control, whose costs it knows, and that it can complete. It does not guarantee the quantitative carbon emission outcome, which in fact the government usually cannot guarantee in any case since it has limited control of the actual emission outcome from its society. In this sense, the participating government’s statement of effort, while more limited than a promise of results, is franker and more realistic, and should be able to be set forth in the negotiations with more confidence. In the actual exercise period of policy application, say five years, if the price elasticities in response to the tax prove to be low and the carbon emission reduction is not adequate, the tax and other measures can be adjusted at the next round of negotiations. In a price regime, there are not structural grounds to expect that a government will negotiate in bad faith with regard to the carbon tax and other measures it says it will apply. But in any case, imposition of the tax and other administrative and financial measures (including the elimination or management of underlying domestic fossil energy subsidies), will come under already-existing international economic monitoring by the IMF, WTO and other UN-linked financial bodies, as well as the FCCC secretariat. (It is proposed below that a new agency be created, or that the tasks and capabilities of the FCCC secretariat be substantially expanded.)

2. Intermittent vs. steady and predictable pressure against fossil energy In the nature of quantitative controls, especially when they take the form of cap and trade measures, a series of temporary quantitative targets (caps) will be set by each country for carbon reduction. Under each cap, permit fees will develop to bring emissions under the cap by raising the price of carbon. But this framing distorts the issue, since the authentic, strategic target is not partial, but complete, elimination of carbon emissions, not by a fixed date, but “as soon as possible.” Climate protection intrinsically is not a set of sprints, but a longer distance race.

Obviously, temporary partial targets will have to be set to create stages of work, and these partial targets will include dates, for example California’s 25% reduction by 2020. But these partial reduction tactical targets should be seen as operational matters, accounts kept “in pencil,” rather than the main strategic account, figuratively kept “in ink.” The partial reduction targets should be kept in secondary status because they are necessarily based on estimates of how much carbon reduction can be done in a certain amount of time. The true values behind these estimates, which depend on the costs of carbon reduction, technical possibilities, and other factors, cannot be known with certainty at the time the carbon reduction target or cap is set.

Some error in carbon reduction cost estimation is inevitable, and when the estimates are wrong, there is a penalty. The error can be either of the high cost kind (carbon reduction is slower and more expensive than scheduled, and “the bank is broken,” or a relief valve is used) or of the low-cost kind (progress is faster and cheaper than expected, as in the U.S. sulfur case, and gains are “left on the table”).

The latter low cost outcome is the more likely, since advancing technology, implementation learning gains, and economies of scale will reduce the cost of non-fossil energy alternatives. The penalty, or setback in progress against carbon emissions, occurs because the effort against carbon under the provisional target is completed sooner than expected. Effort then stops until a new target is devised, and/or a new target period opens. In this way, when there is better-than-expected performance or low costs, a quantitative program is self-limiting and self-stopping. What had been set as a goal becomes a ceiling. Pressure against fossil fuel use becomes not steady, but intermittent. The time in which the effort is stopped is wasted, and from the point of view of consumers and investors, an annoying and unhelpful unpredictability is introduced.

That is why the policy focus has to be kept not on the partial target, but on the long-term true goal of complete fossil carbon elimination, without dated deadlines or stopping points, but rather “as soon as possible.” Intermittency, caused by the need to re-set from one interim target to the next, each time delayed by political controversy and struggle, is a major source of loss of effectiveness in a quantity-based regime. A price regime does not suffer from it, as the carbon tax continues to operate on all market participants without interruption. The cap may well operate intermittently, and it operates on all participants only if permits are auctioned across the board.

Another way of putting this is that a cap, if set too tight, will either do macro-economic damage or require a release valve. If set too loose, it will waste opportunities to restrain carbon. This is according to whether the costs (of carbon energy efficiencies or non-fossil alternatives) come in high or low, as this matrix indicates.

If regulation is by:


And costs are
higher than expected:
I. Less carbon reduction than expected is achieved; the system can be adjusted to increase the tax, or to lower carbon reduction expectations in next cycle.

II. A government must pay high costs to meet target, damaging its economy, or it must renege on commitment or leave the pact or arrangement.

And costs are
lower than expected:
III. More carbon reduction achieved; in next cycle, tax can be adjusted in either direction, to slow down climate protection, or to press harder since costs have been seen to be low.

IV. Carbon reduction stops when stipulated quantity reduction is achieved; some available reduction gains go unharvested. (US sulfur case)

The major policy danger is that if the cap is too easy, or is made too easy by low costs, potential major gains against carbon will be lost—left on the table. Some analysts have thought that this could be a very large portion of potential gains (Pizer 1997). Rather than intermittency and uncertainty, there should be a steady economic incentive, making it always advantageous for all participants to reduce carbon use (for either current consumption choices or long-range investment decisions). That steadiness of incentive is achieved by a tax. It is also achieved to some degree by a cap which it is agreed from the outset will decline automatically over time. Still, if costs, for example are low, the rate of decline of the cap may fall behind its possibilities, and speeding up the downward adjustments of the cap to avoid leaving carbon reduction gains on the table again becomes an intractable political issue.

3. In relevant time ranges, quantitative outcomes are less strategic than the stability of price incentives A quantitative regulation offers certainty with regard to quantity, and uncertainty, particularly short term uncertainty, with regard to price, or cost to society. Which of these certainties is strategically needed and important against the carbon reduction problem itself? Pizer and Victor point out that the quantity of carbon emissions in a given year or interval is only a proxy for the real agent of damage, the stock level of long-accumulated carbon stored in the atmosphere. Small variations year by year in emissions are not critical, such that the primary effort need not be to control annual quantitative reductions directly, or even to obtain detailed information about them. For greenhouse emissions what matters is not short term, even annual, variations of quantity, but rather the long term direction and rate of stock change. Thus, the requirement from Weitzman, in order to prefer price regulation over quantity control, that the benefit schedule be relatively flat, is satisfied. Detailed, short term information on emissions serves less the problem of reducing atmospheric carbon, and serves more the social (i.e., political) needs of participating countries to equilibrate their efforts against emissions with the efforts of others.

The provision of this kind of short term quantitative information and assurance is held to be an advantage of a quantitative approach by academic cap and trade advocates and by many environmental NGOs. But, in fact this information does not serve the problem of getting the carbon emissions reduced, but rather serves the impatient problem of making sure that contributions are balanced among participants. It satisfies the “sidelong glance” hunger, the concern of a contributor to a public good (perhaps particularly a contributor whose own motivation is fragile) who fears that others are free-riding. That anxiety is in the end a socio/political phenomenon, as among participants, rather than an economic or physical one vis-à-vis the physical environment. Such concerns represent an impingement of politics into an economic-technical process.

Working through price on the other hand directly attacks the problem of disincentives for carbon use at the critical end-user level, although some, as Weitzman points out, have a hard time believing this is effective. It is true that the effectiveness of such price regulation depends on the availability of substitutes for the product or process which is sought to be regulated or suppressed. Non-greenhouse energy services must be available to replace fossil energy for costs that are about equal to the cost of fossil energy plus the tax-imposed “price of carbon.” It is an underlying belief of this paper, at least for the United States, that a package of investments in renewable and nuclear energy, highly modernized (digitally controlled) transmission and distribution capacities, and energy efficiency and conservation measures, taken together, constitute such an available substitute for greenhouse fossil energy.

Price regulation also provides the means to protect the economy, should the strains on it become excessive and counterproductive, by relenting on the taxes. Rather than following short-term effects on emission reductions, in a price-base regulatory regime effects on the economy are what is closely followed, and the economy, in reality, does need protection, while in the relevant time ranges the climate will be little changed by variations in emissions. If the elasticity of carbon emissions in response to the bite of taxes is inadequate, upward tax adjustment is made for that in next cycle, although it may be noted that important elasticities may be long-term, rather than rapid.

4. The expensive theater of carbon trading vs. simplicity of taxation A tax is administratively simpler and more transparent. This is because government takes responsibility for setting a carbon price, rather than creating a long-running spectacle of markets to convert emission reduction targets (that may have been set years before it is known what they mean) into caps and daily carbon prices. Government dodges behind a pose that it is letting the target set a price through hands-off “efficient market mechanisms” which, when transaction costs are considered, may not be efficient at all, though a form of daily theater is provided for the public.

The final carbon user (a firm, or a person driving a car), will meet the need to reduce carbon in the form of a rise in its price, no matter whether the high-level regulator operates by price or quantity. Whether following the cap is used to set the carbon permit price level week by week, or a government decision in the form of a tax is employed, the final impact will be felt by the true payer, the final consumer of the energy service in the form of a price increment, stable or varying, to what he or she buys. In no proposed system will the retail end-user face actual quantitative restrictions. Otherwise we are regulating fossil energy down to the final consumer by quantity, as in WWII rationing, clearly impossible today.

To the final user, and important intermediate ones as well, a tax offers needed and valuable fixity and reliability, which allows them to plan, rather than the fluctuating, never entirely predictable value of a carbon permit under a cap. The European Trading System, a quantitative operation, has experienced substantial fluctuations, of which the largest was due not to market realities, but to miscalculation (on the side of timidity) in setting the cap. The overall effectiveness of the ETS is very much in doubt, as reflected in recent press reporting (NYT, 6/20/08, James Kanter).

Fluctuations are damaging. Setting a cap or even a path of caps, and then trading emission rights under them, will generate a whole world of transaction costs that do not exist under a tax regime. A new industry in the financial sector will be created to establish the price of carbon daily and to trade. A small army of tassel-loafered traders is already arising, competing with each other and prospering, when their function is unnecessary, their costs a gratuitous burden on the process of climate protection, and on the larger society. A handful of faceless bureaucrats are a bargain by comparison.

Quantitative controls and cap and trade are often advocated on the grounds of the success of sulfur policies for coal-fired power plants, although in fact it is very likely that the sulfur gains were sub-optimal, and now suffer from the self-stopping characteristic of quantitative controls when further gains are available due to the low costs of sulfur mitigation that emerged. An alternative comparison is to the regulation of tobacco in the past thirty or so years. If this had been attempted by quantitative methods, would smoking caps have been set by brand labels, by individuals, by families, by cities, or by states? How would the allocation and trading of smoking rights among smokers, non-smokers, light smokers, and heavy smokers, have been arranged? The explosion of transaction costs and the absurdity of trying to apply quantitative restraints with trading arrangements against nicotine is clear. In fact, price regulation in the form of high cigarette taxes were effective, along with other steps, for the major gains that society has achieved against tobacco.

5. Caps conceals their shaky intellectual foundations; taxation is franker, and government takes its proper responsibilities for uncertainties. Since climate sensitivity is not known to a useful degree of precision, the calculations underlying the setting of a cap, as to what level of danger is safe or tolerable and what policies against it can be efficacious, are largely speculative, if not specious. The setting of caps, in fact, will necessarily be a political exercise, only masquerading as a scientifically generated one, and it is a real danger that the politically-possible caps will be too low. The genuine strategic purpose is not to set an always debatable cap, but to cut as much carbon as can be cut as fast as it can be done, a policy target which is much simpler -- in reality, so simple as to lose credibility.

The costs of the conversion to non-fossil energy should indeed be minimized, seriously and severely, but calculations in fine slices of the final climate benefits (global average temperatures) of individual, relatively small, climate preservation actions, have no basis in settled science, and should be eschewed. More broadly, and even apart from the intellectual and negotiating bottomless swamp of establishing baselines as part of evaluating reductions, the “benefit” side of climate protection (i.e., the avoided damage of uncontrolled climate change) is very large, indeed immense and overwhelming, but its value is unknown except in very general terms. It is not readily, if at all, convertible into economic, monetary terms, as Herman Daly makes clear, rightly stressing the deep fallaciousness of monetarizing major environmental change despite the apparent acceptance of such monetarization for working purposes by many economists (Daly, 2005). Moreover, the “benefit” side of climate protection work is difficult to perceive for the man in the street who is the final decider in a democracy. If climate protection is achieved, it will be largely invisible, the raging elephant which did not come. If very large carbon reduction is not achieved with some promptness, climate protection will not be achievable, and major devastation will then be beyond the reach of availing human action. We are not in the economics of normal running cost-benefit, but rather an economics of urgency, of “a stitch in time saves nine.”

In summary, a tax provides a steady, predictable incentive to final users to reduce carbon use and move to substitute non-fossil forms of energy, which is the function of the “price of carbon” in reducing greenhouse emissions. A tax stays on its target of disincentiving carbon energy, without being influenced by unrelated changes in the economic growth rate. It also provides a means to avoid economic damage, since it can be tempered in the case of excessive macro-economic pain. Cap and trade provides a shifting, unpredictable price signal, disruptively roiling the markets for many downstream fossil energy-based commodities, such as air travel. International arrangements to curb greenhouse emissions, like domestic policies country by country, will be on a stronger footing if they use carbon taxation rather than quantitative caps and trading. It must be said, however, and here again we are wrestling with the political realities, that if it can be shown that a given society will accept a substantially higher carbon price when it comes in the form of a cap and trade system than in the form of a tax, that would give serious pause in the choice between the two modalities.

IV. A template pattern for a national program and supporting international facilities

A prototype program’s main elements are an internationally coordinated fossil carbon tax of at least $10. per ton of CO2 ($36.67 per ton of carbon), after the coordinated elimination of present fossil energy subsidies. A part of the tax’s proceeds collected in each country are to be returned to national economies in the form of reductions in other taxes (i.e., part of the new tax is revenue neutral), while the second part of the tax’s revenue should be internationally administered by an agency of significant scale within the UN system to support energy decarbonization on a worldwide, cheapest-first basis. The international reach of the anti-carbon spending program is of the essence for finding the most economical solutions, since many, even most, low cost decarbonization opportunities, which should be the first to be implemented, are outside the present heavy per capita energy consuming countries, certainly outside the United States. This is because the many new energy facilities in the developing world can be built carbon-free less expensively than existing fossil-based plant in the developed countries can be retrofitted or replaced. This does not gainsay that international climate protection dealings will likely be more effective among a smaller, more “serious” group, including the major developing countries, than in a “universal” setting.

1. De-subsidization: a difficult but necessary preliminary The post-Kyoto protocol should work to lead countries, by example and through international consultation and exhortation, to agree on revising their legislation and budgeting to de-subsidize fossil energy over, say, a period of eight years. An amplified system of international reporting and advice, comparable to the work done by the secretariat of the FCCC, will guide countries in fulfilling this declared aspiration, and in making each country’s work as internationally transparent as possible. Technical assistance from centers of expertise such as the IMF, the World Bank Group, the IEA and WTO, and the technical branches of the UN will be available both to countries, and to a new international office (see below) to be set up in the UN system, to monitor de-subsidization. While in a sense de-subsidizing fossil energy is merely a housekeeping step necessary to make carbon taxation evenhanded and effective, removing longstanding subsidies will undeniably be a socially and politically controversial, complicated and very difficult process, in the United States as elsewhere. If it proves too difficult, another possibility is to adjust to levels of subsidization—to make them transparent, and work to reduce them, but layer the carbon tax on top of them and calculate a net effect of the old subsidy and the new tax.

2. Internationally coordinated carbon tax The post Kyoto treaty should encourage all countries, drawing out a stated commitment where that is feasible, to impose a coordinated national tax or fee on the use of greenhouse fuels of at least $10 per ton of carbon dioxide (t/CO2). The tax should reach all forms of carbon and should be paid upstream by large energy producers and importers. Government regulators would deal with a limited number of entities (say 2,000 in the U.S.) and their task would be administratively quite simple. The costs of the permit/tax, would, of course, be passed downward to be reflected in prices to end-users of energy products. $10 per ton of CO2 emitted is equivalent to nine cents per gallon of gasoline, or about a 3 % increase in the U.S. retail price—small when compared to current market fluctuations in world oil prices. A tax of $10 t/CO2. per ton would cost about $19. per ton of coal, equivalent at present to about 60% of the cost of coal to a power generator, and to about six tenths of a cent per kilowatt hour of coal-generated retail electricity to a householder.

The internationally coordinated tax could certainly be thought of as a minimum; countries would be free, and encouraged to make it higher—the IPCC’s Fourth Assessment Report in the third volume envisages CO2 taxes at $25, $50 and $100 per t/CO2. (IPCC, 2007) A main purpose when setting the carbon tax level, country by country, is to assure firmly that it is no longer economic to build new coal-based power generation plants. Many are planned, and ending construction of new coal power plants (such as the internationally financed Tata 4 GW Supercritical plant at Mundra, Gujarat in India (Wheeler, 2008)), is the most critical immediate policy goal of all. This may take specific, case-by-case funding interventions, as discussed below in an illustrative example, in addition to the carbon tax, especially when the tax is at its low initial levels.

Although $10 per tCO2 is proposed here, the proper level to set this tax initially would be subject both to technical evaluation, and to domestic and international negotiation. For example, $12.50 per tCO2 is recommended by Richard Cooper. Interestingly, ~$10 t/CO2 is about the initial tax level arrived at by a completely different route by William Nordhaus in 2008. It is thought of here as a low starting level to initiate and conduct the administrative “running in” of the whole system of internationally coordinated taxing of fossil fuel. At the same time, a great many emission reductions are available in the US and worldwide at a cost of $10 tCO2 or substantially less. These reductions would rapidly be carried out by emitters because doing so is less expensive than paying the carbon tax.

In the United States such a tax would initially raise about $60B per year (for scale, 10-15 percent of current U.S. defense spending). Worldwide it would realize about $240B per year, if universally applied, which it certainly would not be in early years. Those rightly concerned with equity should note that this tax, while it has an impeccable (and PRC-endorsed) “polluter pays” logic of taxing carbon equally no matter what its source, will automatically be most heavily borne by high fossil-using economies. Its bite will be smaller on economies which have lower per capita fossil energy consumption, either through past policy (France) or through emerging from recent underdevelopment (China, India, 3rd World in general). Because taxation will be applied worldwide, the “leakage” problem of international flight of carbon-intensive economic activity does not arise among participating countries. For non-participating countries, WTO rules can be revised as needed to permit anti-carbon or carbon-adjusting tariffs in countries receiving their carbon-intense exports.

A part of the proceeds of the $10. tCO2 fossil energy tax/fee would be considered revenue neutral in each country, and after collection by the government would be remitted back to the domestic population, probably through tax reductions in other areas of each national economy. Each government would determine which existing taxes have the greatest drag on their economy, and which form of tax relief would be the most stimulative and helpful, thus making possible a “double dividend” from this policy, as discussed by Goulder et al (1997). It is with these revenues, as well, that regressive effects of a carbon tax could be offset, country by country, at each country’s option.

The other part of the revenue earned by the fossil energy tax would be used to subsidize, incentivize and generally support project and program-level carbon emission reductions through investment in either energy efficiency or non-greenhouse alternative energy sources. The criterion for support is to be efficiency in long term carbon reduction. From the United States, at the initial level proposed here, this would generate roughly $30B per year. From the world as a whole, about $120B, if a 50-50 split were practiced universally as between climate protection funding and revenue neutrality or other uses.

Subject to each country’s decision, a portion of these climate protection funds could be retained for domestic spending. The balance would be remitted to a new international office, probably within the United Nations system (quite possibly an expansion of the FCCC secretariat and its CDM office), that would apply the funds to energy efficiency and non-greenhouse energy projects, on a grant or loan basis, prioritizing projects according to the cheapest decarbonization gains. The “cheapest decarbonization gains,” could be either in the country where the carbon tax was collected, or in another country, (and in practice, some preference could be given to the country where the funds were generated.) The international climate protection office could also use carbon tax revenues to support research and development work, education and training, or investment in such related projects as a section of intelligent grid or a power transmission grid upgrade in any country.

In all likelihood the majority of such projects would be physically in third world countries, since most new infrastructure construction is in developing countries, and the economics of introducing non-fossil systems at the time of new construction are favorable. This is an incentive to developing countries to particpate. Clearly, the existence of the fossil energy tax discussed above would already be giving carbon emitters a strong and steady incentive to seek non-fossil energy sources, and would make the subsidies drawn from a worldwide support fund go a great deal further.

In the negotiations to set up the international climate protection agency, the mandate and the autonomy given to the new organization for the selection of the most efficient anti-carbon investments should be as broad as possible. Rather than being narrowly rule-constrained in such a way as to politicize and diffuse geographically the funding of projects, the agency should have a mission to maximize long-term anti-carbon efficiency free of “where” constraints, and also to innovate. Projects should be competed and rank-listed against each other for their emissions reductions, and decarbonization contribution, rather than earning international grant funding through satisfying minimal requirements. Rather than being closely rule-bound to fund “entitled” projects, the officials of the agency should be able routinely to low-rank candidate projects, such as the trifluoromethane (HFC 23) operations which received large CDM funding, which have skewed economics, marginal greenhouse gains, or non-carbon environmental liabilities (Wara 2008). With funding coming through an international climate protection office enjoying reasonable latitude, a project like the Tata 4 GW Supercritical Coal Power Station in Mundra, Gujarat, just approved by the World Bank Group’s IFC, should have been converted to concentrated solar, wind, or nuclear generation, and certainly not have received international environmental financing for its marginal and obsolete difference between super-critical and simple pulverized coal generation (Wheeler, 2008).

3. A representative transaction within this system Let us say that a power-generating entity in China, is planning to build a new gigawatt of electrical generating capacity--a large thermal plant, or a large set of wind turbine arrays. The alternatives are a coal-fired plant costing $1200 per kilowatt of capacity, or a total of $1.2B or nuclear/renewable facilities costing $2,400 per kW, totaling $2.4 billion.

After the constructing country’s mobilization of $1.2B to pay the base costs of the plant in its inexpensive, coal-based form, the international agency would offer $1.2B of international climate protection funding to make the project nuclear or renewable rather than coal-fired. Of the $1.2 B, plausibly $800M could take the form of long term credits to permit the builder to acquire the capital-intensive nuclear/renewable plant. This credit would be repaid by the builder over the life of the plant from the $600M savings on a free (wind, solar) or less expensive (nuclear) fuel supply, and by $200M of regional and local environmental benefits (sulfur, NOx and particulate reduction) which the building country’s population would enjoy by not burning coal. From the point of view of the agency, these $800M are revolving loan funds.

$400M would be a straight non-reimbursable grant from the international climate protection fund against the additional cost of the nuclear/renewable facility, justified by the substantial reduction in global greenhouse gas emissions over the 50+ year life of a large non-emitting plant (nuclear, concentrated solar, wind arrays). The cost per avoided ton of carbon dioxide for this arrangement is about $ 4.20 per ton of CO2 for the first fifty years. (At 85% availability, a coal fired gigawatt plant produces 7.4 billion kWh/yr, which at 810 grams of CO2 per kWh emits about 6 million tonnes of carbon dioxide (MIT 2007). Estimating that $25.3 million per year is the annual cost at 6% of $400 million of capital with amortization in 50 years, we are avoiding annual emissions of 6 million tons of carbon dioxide per year for $25.3 million per year, or about $4.20 per ton avoided.) The carbon elimination is enjoyed globally at no cost for the succeeding life of the plant, which could well be significant further years.

Such calculations of cost-per-ton-avoided would be the basic, but not entirely rigid, yardstick for the international agency’s work of allocating international carbon reduction funds, mainly generated by countries’ application of the carbon tax.

If the country building the plant is a developing one, this supportive intervention in a national energy decision by the international agency fits well with an important characteristic of energy investments: in general the capital costs of renewable/nuclear power plants are higher than the capital costs of a fossil facility, but the nuclear/-renewable installation will have lower operating (fuel) costs. Because of this, over the service life of a plant, nuclear/renewable energy is likely not to be more expensive than fossil based energy, although it is more demanding at the up-front original investment stage. It is the third world country’s shortage of capital, not a poverty-based need for a permanently cheaper but dirty solution, that makes the international contribution of capital in the loan component of the package remarkably opportune and useful. The interest on the revolving loan component, of course, can be market rate, or can be concessionary to an appropriate degree, as desired and negotiated.

As the international climate protection authority lends $800M and spends outright $400M to make a power plant nuclear/renewable rather than coal fired, all sides of the transaction, must realize that the beneficial result of this spending is an improvement of the global atmosphere, a world-wide public good, participated in by all countries, and not a benefit as such to the recipient building country.

Let us assume for a moment that the international authority obtained the funding in this case from carbon taxation in the United States and that it was spent in China, which is now building coal-fired generating capacity at a very high rate, in contrast to the United States, where additions to our power system, including coal-based plants, are going on, but at a lower rate. It can be expected that the U.S. Congress will be willing to tax and spend to reduce GHG emissions, but is reluctant to “send money out of the country.”

It is justifiable to send the non-reimbursable greenhouse grant of $400M abroad, precisely because of the non-national, global nature of GHG emissions and atmospheric stocks of carbon. China, in this example, will be the locus but not the beneficiary of the $400M grant for a pure greenhouse reduction effect because such spending does not increase the quantity nor improve the quality of its electricity. The U.S. Congress has only incidentally sent the funding to China via an international agency. What Congress has really done is spent the money where it can be the most effective for the least-cost carbon reduction. Congress does have the alternative of spending the $400M within the United States on plants with lower emission reduction per dollar, but it would have to recognize that it had generated a smaller carbon reduction, and a therefore a smaller benefit for the U.S., than the same funds could generate if they were spent independently of national or geographic location, that is to say in China in this example.

That is the nature of reacting against a genuinely global danger, and seeking a global public good. Because of atmospheric carbon dioxide’s long residence time and ubiquity, climate protection funds spent on the most economical carbon reductions regardless of location are being spent in the most efficient way possible to obtain a global public good, a reduction in greenhouse warming, which is of benefit indiscriminately to Americans, Chinese, and other inhabitants of the globe. Despite appearances in our example above, there is no transfer of resources or of value from the U.S. to China. The lowered operating costs for fuel, and the local air quality benefits to China of the SOX, NOX and particulate-free plant are accounted for separately (by the $800M loan), and the electricity China obtains from a greenhouse-free plant is in no way an improvement for its consumers over coal-generated power.

There is the matter of the work which Chinese industry gets when a plant is built in China, with its positive employment and profit effects. Curiously, and somewhat delicately, this can be portrayed two ways: to the Chinese, getting this work and being paid from international funds is a benefit of participation in the international arrangement, and can serve as an incentive to participate. To the international (or in this example, the American) audience, it can be said, accurately that the costs of construction will be negotiated by the international agency and the host country contractors, and profit will be minimized in the bidding process. Locating the project in a particular country is not a matter of benefit to that country, or largesse, but simply paying costs which would have to be met anywhere.

Although we have used China and the United States in this example, the climate protection subsidy essentially is generated without respect to location, being paid for through the carbon tax by any user of fossil fuel anywhere. It is spent without regard to location, and the benefit of reduced warming has no location, but is global. The global environmental and economic benefit per dollar spent is maximized by the freedom from “where” and “who” constraints on climate protection spending. In the world of climate protection, governments become administrative agencies that collect the fossil energy tax and forward some portion of it to the international agency for spending. Political and non-economic considerations are minimized. Built into this system is the maximum form of internationally open emissions trading, which is extremely beneficial and may well cut the cost of worldwide carbon reduction in half or better, by comparison with intra-national trading programs. (Weyant, 1999)

V. Important but not primary role of the international setting; carrots, not sticks

The fundamental agency of the transition away from fossil energy in the countries of the world will be each of those countries. The post-Kyoto system of international coordination, in its design and functioning, is important, but even as diplomats and proto-diplomats work on it with intensity, the basic reality remains that the real drama of achieving climate protection policy or not achieving it, of how it is done, and how quickly it is done, will take place within each of the countries of the world. In 2001, President Bush said first that his new administration would not regulate carbon dioxide in the United States, and only thereafter that it would not support the Kyoto process.

Nonetheless, given the global diffusion of carbon in the atmosphere, and because the worldwide public good of controlling atmospheric carbon is sought, a well designed system of international coordination flowing from the Rio Treaty should be able to make a significant contribution by encouraging and facilitating the needed energy conversion across borders. Information disclosure and sharing, if agreed to, can be a significant help (Wheeler, 2007). However, an overly ambitious and self-referential international system that loses sight of the primacy of countries and goes too far in challenging and trying to coerce sensitive and even chauvinistic nation-states could produce more resistance than it does incentive, and be a net drag on the process it is trying to encourage.

The new international agreement should recognize that in all FCCC signatory countries, certainly including China and India, there are domestic motivations and constituencies to protect the climate, and it should work to leverage such domestic forces for maximum effect. It is not necessary for all incentive to come from abroad. Some countries, mainly developing ones, are less strongly motivated to reduce carbon, or believe that the global public good of climate protection, in which they will share, is overshadowed by the need for rapid economic development. Such nations should be encouraged by the consideration that when they impose a modest fossil carbon tax, they themselves will decide on what portion—perhaps the entirety-- of it will go back to any part of their domestic budget (revenue neutral portion) and what if any of their own carbon tax proceeds will be spent on climate protection measures, either domestic or international. Re equity, for any country, developing or otherwise, to impose a revenue neutral carbon tax is an internal re-allocation of domestic resources, and not a cost or sacrifice to the external world. Similarly, each country will decide on what part of its climate protection budget will be spent at home, and what part spent abroad through the international agency. Upon adherence, developing countries, for example China and India, would be eligible to have international anti-fossil funds spent within their borders, without an obligation to send their funds out. Given that they are massively building new energy facilities, which are less expensive to build carbon-free initially than to replace or retrofit, it is likely that such fund inflows, essentially from the industrialized countries, would be very substantial. They would bring real long-term benefit from the developed world to the developing world.

Under a policies and measures approach using taxation, participation in a cooperative effort is sought, but responding governments are committing themselves to actions, not to results, or as David Victor put it, to inputs, not outputs. This is a more specific, controllable and less anxiously risky matter. For at least the post-2012 five-year chapter, the somewhat untrusting pattern of approaching negotiations aiming to extract from reluctant countries reduction commitments with unknown costs, with attendant anxiety about whether and how the commitments are enforceable, is removed from international climate diplomacy. All countries will come under substantial exhortation to de-carbonize, but “legalization”, or “lawyerification” of the policy drive through binding commitments, and constraining, is avoided.

For the first post-Kyoto period, likely 2012-2017, such incentives should suffice to motivate adherence by all countries, which have since 1992 at least verbally accepted the goal of climate protection through agreement to the FCCC. The need strenuously to constrain resistant major nations to commit themselves internationally to stated quantitative carbon reductions should be left behind. By adjusting the international system to make it more cooperative and aspire less to be authoritative, we want to defuse claims, such as those coming from sections of Congress and the American public, that the United States cannot participate because of China and India’s unwillingness to make public and formal emission reduction commitments in the international forum. From the side of the developing countries, such emission reduction commitments are resisted on national sovereignty grounds even as countries perform on their own a good part of what they are unwilling to allow themselves to be internationally committed and constrained to do.

For all countries, the fact that a suggestion comes from abroad has both favorable and unfavorable aspects; some react against it for the fact of being international or foreign, perhaps more so as a country is large and powerful. In this case, it is large and powerful countries, notably China and India, that are the critical ones and they are assuredly not short of nationalistic feeling and sensitivities. Nor is the United States immune to such impulses.

The post-Kyoto international forum risks becoming a rather vivid and perhaps moralistic “theater,” where day to day developments are disseminated by an international media and followed by an international audience, as the December 2007 Bali meeting was. On the margins, this can be helpful for the persuasion and enlistment of countries, as indeed the U.S. at least verbally moderated its recalcitrant position in the last moments at Bali. However, much of the drama is media-driven and very distorted, and it should not be incautiously allowed to develop to the point that it intimidates and repels prospective participants in the international process.

If well done, the work of the international climate protection agency in analyzing and ranking energy projects according to their anti-emissions efficiency and bringing in funding for the most efficient, is an important facilitation, making economically feasible decarbonizing choices always available for a host country to implement in its energy development.

The post-Kyoto international nexus should support national efforts and drive them forward, individually and collectively, but it should not aim to supplant, or let itself become competitive, rather than cooperative, with national efforts, which are the critical ones. The international nexus in many ways is embryonic and should not be overambitious; it cannot solve this problem on its own and should recognize that. To be effective on a long-term problem, it should use positive reinforcements, not negative ones; carrots, not sticks; subsidies and rewards, not sanctions enforcing binding commitments which have been extracted. For the now-opening first post-Kyoto stage, it should encourage national programs, not gird its loins to confront governments for their inadequacies. A tougher approach may be needed and be possible in a third stage (post-post-Kyoto) but it is not indicated for the period beginning in 2012.

Rather, for the moment, it is a matter of a post-2008 United States joining with others (Europe) in soliciting and attracting further countries (India, China) into internally-motivated cooperation. Some vinegar, rather than honey, may be useful for smaller countries, and in future decades, but a predisposition to assume opposition and recalcitrance, and to think immediately in terms of an adversarial approach, is not what is needed now.


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