Last week Grist reported that cap-and-trade legislation to address climate change is feasible during 2009 but that the legislation may be postponed until a recession is dealt with. As a potential alternative, the Obama-Biden plan proposes (1) fiscal stimulus funds to build a green infrastructure and (2) a renewable portfolio standard that requires 25% of energy sources be renewable.
Everyone seems to want to know, "what does John think about all that? So far he has been so quiet on the issue." Ha!
My feeling is that cap-and-trade legislation should be pursued in 2009, recession be darned. Benefit-cost analyses indicate that addressing climate change, at least in a small way and then "ramping up" to something more significant over time, is a good idea. The net benefits of climate change don't change much during a recession (the benefits fall as current income falls but not by all that much since most of the benefits accrue in the future).
The economic case for cap-and-trade (or a carbon tax) is clear. Climate change and the associated negative impacts of emissions are known in economics as negative externalities. Much theoretical and empirical research supports an environmental regulation that taxes the polluting activity (or, equivalently, capping the pollution with permits and allowing polluters to trade the permits). The additional production cost of taxes or permits causes profits to be lower in the polluting industries, the supply of the polluting product falls and price of the polluting good rises. As the price of polluting goods rise consumers use less of the polluting good. As the price of nonrenewable energy rises and the price of renewable energy falls (with technological improvement) we reach the Hotelling "switch point" and the demand for renewable energy rises. The price of nonrenewable energy is, more or less, capped at the price of the renewable subsitute and the world is a greener place.
One reason why it might be difficult to enact climate legislation during 2009 is that raising broad-based taxes during a recession is not a great idea (see Keynes). However, one of the features of carbon taxes and cap-and-trade with auctioned permits is that revenue is raised for the government in addition to achieving reductions in pollution. The typical next line in this story is that these new revenues could be used to offset cuts in income, capital gains, business and other distorting taxes while keeping the government budget situation at least as sound as it was when we started. I've argued in the past that revenue recycling is a separate policy and should not be paired with a carbon tax in the minds of decision makers (since this second policy might not take shape). But during a recession we're already talking about cutting taxes. Indeed, during the 2009 recession we're talking about cutting taxes and increasing government spending so that the budget deficit is bigger than ever (as a percentage of GDP) while the budget debt is as big as ever. A new revenue source would help offset deficit risks.
My other feeling is that (1) subsidies for green energy are not as efficient as taxes on dirty energy in terms of pollution reduction and cost effectiveness and (2) forcing electric utilities and other entities that buy energy to purchase a mix of energy without appropriate price signals is not a good idea.
The case for subsidies for geen energy is less clear. In addition to the worries over the general use of environmental subsidies (e.g., subsidies reduce prices of clean energy and dirty substitutes when the goal is to increase the price and decrease the use of a bad thing; i.e., use of the bad thing and the associated pollution might not fall as much as intended), subsidies will make budget deficits bigger when deficit risks are feasible. The Obama-Biden 25% renewable energy portfolio standard would significantly increase the demand for renewables and reduce the demand for nonrenewable energy. The forced demand will increase the price of renewable energy. The decreased demand for dirty nonrenewable energy will decrease its price. The prices are moving in the opposite direction of where they need to go to provide the appropriate signals to energy consumers about the full social costs of the energy sources. Consumers will want to buy less green energy and more dirty energy. I don't know how all that would play out since it is not exactly textbook theory but there are some definite inefficiencies in that scenario.
