Skip Navigation | |
Limiting Carbon Dioxide Emissions:
|
Actual Outcomes |
||||
Expected Outcomes | If the Cost of Reducing Emissions Was 50 Percent Lower Than Expected | If the Cost of Reducing Emissions Was 50 Percent Higher Than Expected | ||
Set a Tax of $10 per Ton of Carbon | ||||
Marginal Cost (Dollars) | 10 | 10a | 10b | |
Emission Reduction (Millions of metric tons) | 29 | 56 | 19 | |
Net Benefit (Millions of dollars) | 143 | 280 | 96 | |
Set a Cap to Reduce Carbon Emissions by 29 Million Metric Tons | ||||
Marginal Cost (Dollars) | 10 | 5 | 15 | |
Emission Reduction (Millions of metric tons) | 29 | 29 | 29 | |
Net Benefit (Millions of dollars) | 143 | 215 | 72 | |
Memorandum:
Percentage Increase in Net Benefit from a Tax Rather Than a Cap |
n.a. | 30 | 34 | |
Source: Congressional Budget Office. Notes: This example arbitrarily assumes that the benefit of reducing carbon emissions is $10 per metric ton. It examines the net benefits that would result in the first year of each policy, assuming that the policy would apply only to the United States, that the initial year would be 2010, and that the policy would have been announced 10 years earlier. The cost of firms' emission reductions (and the response to various taxes) is derived from Mark Lasky, The Economic Costs of Reducing Emissions of Greenhouse Gases: A Survey of Economic Models, CBO Technical Paper No. 2003-03 (May 2003). n.a.=not applicable. a. The actual marginal cost of reducing 29 million metric tons of carbon (mtc) is $5, but the tax induces reductions up to 56 million mtc, at a marginal cost of $10. b. The actual marginal cost of reducing 29 million mtc is $15, but the tax induces fewer reductions (19 million mtc instead of 29 million mtc), up to a marginal cost of $10. |
If, however, the cost of controlling emissions by that amount was 50 percent lower than anticipated, firms would find it advantageous to undertake additional low-cost reductions--nearly twice as many as policymakers had anticipated--in lieu of paying the tax on those emissions. As a result, actual net benefits would be $280 million, which is $137 million greater than anticipated. Similarly, if costs were 50 percent higher than anticipated, firms would limit their emissions by a smaller amount--by 19 million mtc instead of 29 million mtc. The level of net benefits also would be lower than expected--but not as low as it would have been if firms had been forced to make the full 29 million mtc cut in emissions that policymakers had expected to result from the tax. Furthermore, given that firms would limit emissions up to the point at which the actual cost of the last ton of carbon emissions eliminated was equal to the expected benefit (because the tax had been set equal to that expected benefit), the value of total benefits minus total costs (that is, net benefits) would be maximized, regardless of whether the actual costs were higher or lower than anticipated.
Suppose, in contrast, that policymakers set an emission cap that they believed would limit emissions by the same amount as the $10 tax--a 29 million metric ton reduction from the baseline level. The cap would allow no flexibility if actual costs turned out to be different from the anticipated costs. If the marginal cost of meeting that cap turned out to be 50 percent lower than expected, for example, then actual net benefits, at $215 million, would be greater than expected--but still significantly lower than the $280 million in net benefits from the tax, because the cap would not induce firms to undertake any additional beneficial reductions.
Likewise, if the cost of meeting the cap was higher than anticipated, firms would still be required to limit emissions by 29 million mtc, even though each cut beyond a 19 million mtc reduction (the amount induced by a $10 tax) would cost more than the benefit that it created. As a consequence of that inflexibility, the net benefits from the cap would be 34 percent lower than the net benefits from the tax.
The safety-valve approach would provide some, but not all, of the advantages of a tax. Specifically, the safety valve would protect against excess costs (and thus would provide greater net benefits than a fixed cap) in the case in which the marginal cost of meeting the cap was greater than anticipated. The safety valve would not, however, lead to more reductions than those required under the cap if the cost of emission reductions turned out to be less than anticipated. Thus, unlike the tax, the safety valve would not maximize net benefits in that case.
The less information policymakers have about the cost of meeting a particular emission cap, the greater the advantage offered by an emission price. The cost of meeting a given cap on carbon emissions is likely to be difficult to estimate for at least three reasons. First, the cost of meeting a future cap would vary significantly with the amount of growth in carbon emissions in the interim. Those emissions are difficult to predict: they are a function of numerous factors, including population trends, economic growth, and energy prices. Second, policymakers have less information about the cost of controlling emissions than do the firms that create them. Third, the cost of meeting the future cap will depend on the technologies that are developed to reduce carbon dioxide emissions and the economic consequences of adopting those technologies--neither of which can be predicted with certainty.
Intuitively, the case for a cap on emissions would appear to be much stronger if there were evidence that temperature increases above a certain threshold would cause catastrophic damages--especially given the inertia of the climate system and the long adjustment to changes in concentrations. That possibility might seem to call for a cap on emissions to avoid crossing the threshold. But that intuition holds true only under a very restrictive set of circumstances:(3)
Under those circumstances, either an emission price or an emission cap (appropriately set) would probably yield very large net benefits, but the expected net benefits from using an emission cap would be greater.
If there is uncertainty about either the existence or the level of a trigger temperature--as is currently the case--the potential advantages of an emission cap decline. Under those circumstances, it is no longer clear whether, or at what level, to set a cap to avoid a catastrophic outcome. Thus, setting an upper limit on the incremental cost of reducing emissions via an emission price (even though that limit may be high) becomes relatively more important.
Similarly, a price instrument is generally superior if damages are expected to grow, but at a gradual rate of increase (rather than increasing very rapidly beyond a known temperature threshold). Under those circumstances, being able to control emissions precisely is less critical (because there is less concern about passing a trigger point).
Finally, a price instrument is preferred if modest emission reductions are called for. If policymakers wished to slow the increase of carbon dioxide in the atmosphere (or stabilize that level after a period of several decades), then there would be considerable leeway about when reductions occurred. Costs would be minimized by making cuts when it was least expensive to do so. A price instrument would allow for such flexibility in timing, whereas a short-term emission cap would not. Such a cap would become desirable only if extremely large cuts in current emissions were required to quickly stabilize the atmospheric stock to avoid crossing a threshold.
Related CBO Publications: In addition to the publications listed in footnote 1 and Table 1 of this brief, see The Economics of Climate Change: A Primer (April 2003); An Evaluation of Cap-and-Trade Programs for Reducing U.S. Carbon Emissions (June 2001); and Who Gains and Who Pays Under Carbon-Allowance Trading? The Distributional Effects of Alternative Policy Designs (June 2000).
This issue brief was prepared by Terry M. Dinan and Robert Shackleton, Jr. |
1. | Uncertainty about the benefits of limiting emissions can lead to the wrong level of control as well. However, the adverse consequences of having chosen the wrong level of control because of underestimating or overestimating benefits are expected to be the same under both price and quantity instruments. For a more detailed discussion, see Congressional Budget Office, Uncertainty in Analyzing Climate Change: Policy Implications (January 2005). |
2. | Furthermore, the example assumes that firms would minimize their compliance costs--by equating their marginal cost of reducing emissions either to the tax or to the allowance price. |
3. | See William A. Pizer, Climate Change Catastrophes, Discussion Paper 03-31 (Washington, D.C.: Resources for the Future, May 2003). |