We should put the environment on the balance sheet

Decoupling, carbon taxes, and unrealistic environmentalists

License plate in Santa Fe, NM

In a world where businesses focus on quarterly earnings and daily stock price trends, the market is largely blind to the fact that it’s driving us toward a climate cliff. The damages that are caused by CO2 emissions are not priced into our usage of fossil fuel products. Market failures like this are what economists call externalities, and we need to use tried and true fiscal policies to get the environment on the balance sheet.

When economists find externalities like this in the market, they tend to use “carrots” and “sticks” (incentives and penalties) to steer the market in a healthier direction. A good example of this sort of “steering” is how we tax tobacco products. We know that cigarettes cause cancer and increase healthcare costs for the public, so we tax tobacco to 1. reduce the number of people that use tobacco, and 2. raise money for healthcare costs. We should be treating the fossil fuel industry the same way.

The Inflation Reduction Act (IRA) is an example of fiscal carrots in action. The IRA is helping us finance more clean energy and transportation projects, especially at the state level. While many states have put a price on carbon, America is lacking a federal climate-friendly fiscal stick. We have a gas tax, but not a federal tax on industry-related CO2 pollution.

There are many policies we need to be using to reduce climate changing emissions, and pricing carbon is one of them. Pricing carbon at the federal level will help us decouple GDP growth and CO2 emissions, and grow the economy responsibly.

GDP and CO2 emissions

The carbon intensity of our GDP is high, but that doesn’t mean all economic growth is inherently bad. Calls for “degrowth” are growing in the EU, because they think that if they slow GDP to a halt they will reduce emissions. Degrowth advocates suggest that there is no possible way to decouple GDP and emissions. Maybe this is my MBA talking, but I don’t think we need to give up GDP growth and increased prosperity in our fight against climate change. We have shown that decoupling greenhouse gases from economic growth is possible and is already happening:

Source: Global Carbon Project; World Bank

Noah Smith has a recent post about this that I recommend reading: Degrowth: we can’t let it happen here!

Not only is degrowth a bad idea, we don’t even need to settle for slowed growth. Republicans and democrats both think carbon pricing would slow economic growth, but it’s not true. In fact, that’s not true with other types of taxation either. Carbon pricing is a tool that directs our economy to grow in a way that acknowledges the importance of preserving our environment.

How do you put a price on carbon?

The concept of putting the environment on the balance sheet brings to mind the old adage, “Measure what matters.” If we care about the environment so much, why don’t we have a uniform way to measure our ability to preserve it?

Well, it may not be uniform, but we do have the social cost of carbon (SCC). Professor William Nordhaus won the Nobel in economics for his work on SCC, which has helped states construct fiscal policies that put our climate on the balance sheet. Nordhaus developed the Dynamic Integrated Climate-Economy (DICE) model, a complex statistical model that estimates, in dollars, the economic damages that come from adding an additional ton of CO2 to the atmosphere.

The DICE model illustrated:

Credit: Penn State University

This cost-benefit analysis quantifies the negative and positive long-term effects of adding more CO2 into the atmosphere. Yes, there are some positive economic outcomes that come with warming temperatures, like some regions may experience higher crop yields, but it’s mostly bad. Really bad, actually.

Inputs to the DICE model are often tinkered with, and Republicans and Democrats tend to disagree over the inputs. One of the main assumptions in the DICE model is the discount rate. A higher discount rate means we expect higher economic growth in the future and it will be easier for us to pay for the damages caused by climate change. So, a high discount rate = a lower social cost of carbon.

On the other hand, assuming a low discount rate means we expect the economy to grow slowly and it will be more expensive for us to pay climate damages in the future. Therefore, a lower discount rate = a higher social cost of carbon.

Unsurprisingly, the Trump-era EPA adopted a high discount rate in an attempt to dismiss the negative effects of CO2 as part of his deregulation agenda (and it’s possible that Trump thought his economy would grow faster than any economy ever). The Trump-era EPA’s take on the SCC was $3-5 per ton of CO2. So far, the Biden-era EPA has adopted a moderate discount rate and the official SCC estimation is $51, although the EPA proposed a much higher $190 in November of 2022.

I’m no expert on SCC, but $3-5 per ton is laughable - especially when you think about the uncertainties of everlasting economic growth and all of the negative effects that the DICE model excludes:

Source: US Climate Alliance, NYU Institute for Policy Integrity

As the model is further developed by interdisciplinary scientists, I expect the known damages from greenhouse gases to increase, and the SCC to increase.

Now, just because the EPA recognizes that there is a social cost to emitting CO2, doesn’t mean Congress has to do anything about it. In fact, the feds have done nothing and there are only 14 US states that have enacted some sort of SCC use into law as seen in this chart of state climate policies from my most recent post:

Chart by Austin M. Anaya

Many states have enacted carbon trading schemes like in the liberal northeast and west coast states. Conservative states have not adopted a carbon tax, or any climate policies for that matter, but what is surprising is the pushback of carbon pricing from some environmentalists - largely environmental justice (EJ) advocates.

Environmental Justice Concerns

A paper by Boyce et al from February of this year summarizes EJ advocate’s concerns succinctly:

In brief, critics have argued that carbon pricing (i) fails to reduce carbon emissions significantly, (ii) fails to reduce the disproportionate impacts of hazardous co-pollutants on people of color and low-income communities, (iii) harms the purchasing power of low-income households, and (iv) commodifies nature.^{[3, 4]} Proponents of carbon pricing often, and in our view hastily, have dismissed these criticisms as baseless.

Boyce and the boys are right - these claims are baseless. Here are my quick rebuttals to the four claims (i, ii, iii, and iv):

(i) fails to reduce carbon emissions significantly

i. This is like saying seat belts are bad because they don’t save more lives. Nobody is saying carbon pricing is the only policy that needs to be enacted, but the fact that it will reduce emissions at all is a great start. An omnibus policy approach with many mechanisms - a carbon tax, mass transit investments, a low carbon fuel standard, and so on - would be the most beneficial policy approach to climate change, and carbon pricing is a key piece of that.

(ii) fails to reduce the disproportionate impacts of hazardous co-pollutants on people of color and low-income communities,

ii. Again, nobody is saying carbon pricing is the only policy that needs to be enacted. There are many other policies that can help us deal with particulate matter in EJ communities. Furthermore, revenue generated from a carbon tax or a low carbon fuel standard could and should go towards electrifying EJ communities - thus reducing the disproportionate impacts of hazardous co-pollutants on people of color and low-income communities.

(iii) harms the purchasing power of low-income households

iii. It is true that gasoline and airplane tickets would likely become more expensive, but that’s the point. We want people to start choosing greener alternatives to fossil fuels - many of which are cheaper, by the way. To ease the disproportionate burden for low-income households, we need to be subsidizing electric vehicles, building more public transit, and incentivizing clean fuels through a low-carbon fuel standard.

Also, some or all revenue generated from a carbon tax could and should be redistributed to low-income families via a dividend. I’m a little weary about a dividend tied to carbon emissions because, eventually, we hope to have a zero-emission economy and we don’t want emissions to be perceived as a payday. Ultimately, a dividend may be the best way to gain initial political support for a carbon tax.

(iv) commodifies nature

iv. Boyce and the boys squash this notion perfectly:

There is a fundamental difference, however, between valuing nature and turning it into a commodity. When we fail to put a price on carbon and allow emissions free-of-charge, we effectively value the resulting climate impacts on present and future generations at zero. This is not treating Nature as sacred; it is treating it as worthless.

Yes, in a perfect world, companies wouldn’t have the ability to emit CO2 at all, and maybe someday we can get there, but it is not economically viable unless you want to lose your job and live in a cave. We need to take the baby steps where we can get them.

Why the opponents are wrong, in a nutshell:

• Putting a price on carbon doesn’t have to be a fix-all for it to be worthwhile;

• A carbon tax or cap-and-trade system can be structured in a way that benefits EJ communities; and

• Suggesting that a carbon price “commodifies nature” is a distraction from the fact that it’s a step toward more ideal environmentalism.

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Nordhaus gave us the ability to put a price on, arguably, the most important externality in our economy, but there are still blind spots in the model. Even outside the DICE model, there are largely untouched areas of environmental fiscal policy development that need some attention.

For example: what is the economic value of preserving biodiversity? or culturally important landscapes? I’m looking to academia to help us with these problems that are part economic, part environmental science, and part philosophical in nature.

In the meantime, the climate is changing and we haven’t acted in enough meaningful ways. Luckily, we already have most of the technology and policy ideas we need to slow and reverse climate change. We need to stop climate change and embrace strategic growth by putting the environment on the balance sheet.