public-policy, growth, carbon-tax, pigovian-taxHow can we have a triple dividend with respect to the adoption of carbon or green taxes?
I’m trying to figure out why a triple dividend could occur if green taxes, such as a carbon tax, are imposed. In short it’s a Pigouvian tax that aims to reduce a negative price externality: pollution associated to the use of goods and services with a carbon content.
The triple dividend that is normally referred to in the literature encompasses:
How real are triple dividends in the empirical/applied economics literatures?
My fundamental quibble (or stumbling block) is that these goods and services with a carbon content (basically heating and transportation) have a very low price elasticity of demand (there are very few substitutes and they are essential goods anyway) so it seems that there won’t be a reduction in emissions anyway. If not, what am I missing? I mean, with carbon taxes we’ll probably just have another source of revenue (the economic incidence of which is unclear to me at this point) that will allow other tax margins to be alleviated and thus enable a more efficient tax system. But then we won’t have a reduction in emissions …
But isn’t that the whole point of a carbon tax? I.e., to bring emissions down.
PS - I know that the price elasticities of demand will be larger in the long run, but then it seems that the issue is simply one of discounting, i.e. trading off the present against the future.
In short, what am I missing here from a conceptual viewpoint?
The triple dividend:
1) Environmental benefits
OK, hopefully this one is quite straightforward: a carbon tax prices pollutants: greenhouse gas emissions [GHGs]. By increasing the cost of goods and processes that emit GHGs, this reduces their equilibrium quantity - i.e. emissions go down. There are two types of substitution that might occur: there will be a combination of a switch to lower-carbon processes, and a reduction in the amount of carbon-intensive goods provided. For example, we might decarbonise paper production, or use less paper (or a combination of both those). OK, that's the basic microeconomics.
2) more efficient taxation
As discussed over in Which kind of taxes has lowest deadweight loss? , because a Carbon Tax is a Pigouvian tax, it actually has a negative deadweight loss (assuming revenue exceeds cost of collection). Insofar as the revenue from a carbon tax allows other taxes to be reduced, the taxation system will be more efficient, if those other taxes have a deadweight loss. And that's the basic macroeconomics.
3) greater social welfare
This is where things get complicated.
The first-order effect: long-term equilibrium - this will show a greater total welfare, as an externality has been internalised: effectively, the subsidy of GHGs is reduced or removed.
However, we currently have a very large industrial complex that has been built on highly-subsidised fossil fuels. This has led to large inefficiencies in how we lay out our patterns of land use, how we power our industries, light our offices, heat our homes. It's led to over-development of energy-intensive processes in industries, and under-investment in energy efficiency, and in lower-carbon technology. And it's led to market incumbents that have grown powerful enough to affect the policy of governments even in democracies. To move to a more energy-efficient lower-carbon equilibrium will require major shifts in industrial structure, urban structure, and changes in the allocation of political power. All of these shifts will have short-term transitional costs.
It might be that low-carbon energy can become as cheap or cheaper than subsidised fossil fuels, in which case there won't necessarily be a transition to higher energy efficiency. Nevertheless, there will still be major shifts in the allocation of global political power, away from fossil-fuel extractors.
Other notes
Is it true that:
"these goods and services with a carbon content (basically heating and transportation) have a very low price elasticity of demand (there are very few substitutes and they are essential goods anyway)"?
Funnily enough, it's not true that there are very few substitutes, although it's perfectly understandable to see why at first glance there might seem to be. Short-term marginal price elasticity of demand is fairly low, but long-term elasticity could be much higher. We're about to find out. It might be worth comparing energy consumed per unit GDP of, say, Denmark and Germany, to see the long-term impacts of some energy prices being higher (Denmark has, for about 30 years, had high energy taxes for domestic use, though not for industry).
Heating and transport are, in almost all cases, both derived demand.
Let's take transport first: I don't demand motorised travel directly: it's a demand that derives from the geographical separation of my home and my workplace. Because it's a derived demand, there are a lot of long-term substitutions: I could change my home and/or my trip destinations, to reduce my overall need for motorised travel. Or we could decarbonise the transport system, through some combination of biofuels, synfuels, zero-carbon electrification, and direct ambient CO2 capture and sinking (sinking = long-term storage in a form that is mechanically and chemically stable).
And now, let's look at heating. I'll separate out space-heating from water-heating, but first I'll note that both can be decarbonised through some combination of solar-heating, biofuels, synfuels and zero-carbon electrification. Now let's look at space-heating. I don't demand space-heating directly: it's a demand that derives from my demand for a thermally-comfortable building. Now, that needs a lot of energy for space-heating because our buildings are insufficiently insulated and/or make insufficient use of solar gains. A well-insulated, well-designed building such as a Passivhaus needs very little extra energy for space heating, even in Nordic climes.
So, both have plenty of zero-carbon substitutes, including reducing or eliminating the derived demand itself.
Will it be enough?
And finally, we can ask, will this be enough? The economic risks of failure to cut GHGs are potentially immense - the worst-case forecasts are of a loss of 90%+ of global GDP - but there are also high short-term political risks of setting a carbon tax high enough to be effective. The best-case forecasts are a loss of 2-5% of global GDP, relative to a contra-factual case of business as usual and GHGs being climate-neutral. With the cost of decarbonisation estimated at around 1% of GDP, the economics are overwhelmingly in favour of curbing GHG emissions. There have been very long discussions about the relative merits of quotas versus carbon pricing: as Marty Weitzman pointed out, to the first-order effect, they're equivalent. If quotas were sold by governments, rather than granted freely, then they too might show the triple dividend discussed above.
Chris Hope and Nicholas Stern have tried to estimate the marginal damage costs of GHGs, and the uncertainties are very large. So how high does a carbon tax have to be, to be high enough to be effective? Of the order of €120/tCO2e is enough to make onshore and offshore wind cheaper than gas or coal for electricity in windier parts of the world such as Britain (that would translate to about €0.11 extra on the cost of a kWh unit of electricity from coal, for example). It's enough to make PV cheaper than coal in sunnier parts of the world. Those who've been studying capture of ambient CO2 and long-term stable sinking, such as Klaus Lackner, have estimated an initial price of around €150/tCO2. So, somewhere in that range (€120-150/tCO2e) is probably, for now, a good estimate of the long-term equilibrium price for GHGs, given where we are at the moment. That's quite a lot higher than most carbon pricing being considered at the moment.
Sources
My fundamental quibble (or stumbling block) is that these goods and services with a carbon content (basically heating and transportation) have a very low price elasticity of demand (there are very few substitutes and they are essential goods anyway) so it seems that there won’t be a reduction in emissions anyway. If not, what am I missing?
In the longer term at least gasoline demand is affected by price. Countries where gasoline tax is high have vehicles with more efficient engines and more public transport.
You may have alluded to this in your question, but isn’t the real point of carbon taxes this: by increasing the current cost of carbon emissions to cover the long term cost of environmental damage, you encourage the development of clean technologies.
There must be an optimum rate and timing for this tax. If it is too high or too early then adoption of alternative technologies will proceed too early before the costs of damage have occurred. If it is too late or too high the opposite is true. It is conceivable that the cost of environmental damage is so high that a catastrophe occurs during which a switch to clean technologies would be prohibitively expensive.
If a carbon tax is imposed, it should be imposed on imported goods also, so that foreigners cannot “cheat”. I can think of ways that you could construct such a tax on imports, but it is a digression.
All content is licensed under CC BY-SA 3.0.