Environmental and Energy Policy and the Economy: Volume 1

By James H. Stock

This volume presents six new papers on environmental/energy economics and policy. Robert Stavins evaluates carbon taxes versus a cap-and-trade mechanism for reducing greenhouse-gas emissions, arguing that specific design features of either instrument can be more consequential than the choice of instrument itself. Lucas Davis and James Sallee show that the exemption of electric vehicles from the gasoline tax is likely to be efficient as long as gasoline prices remain below social marginal costs, even though it results in lower tax revenue. Caroline Flammer analyzes the rapidly growing market for green bonds and highlights the importance of third-party certification to  the financial and environmental performance of publically traded companies. Antonio Bento, Mark Jacobsen, Christopher Knittel, and Arthur van Benthem develop a general framework for evaluating the costs and benefits of fuel economy standards and use it to account for the differences between several recent studies of changes in these standards.  Nicholas Muller estimates a measure of output in the U.S. economy over the last 60 years that accounts for air pollution damages, and shows  that pollution effects are sizable, affect growth rates, and have diminished appreciably over time. Finally, Marc Hafstead and Roberton Williams illustrate methods of accounting for  employment effects  when evaluating the costs and benefits of environmental regulations.   

• Language: English
• Publisher: University of Chicago Press Journals
• Release date: Feb 22, 2020
• ISBN: 9780226711201

Book preview

Contents

Series Introduction

James Poterba

Introduction

Matthew J. Kotchen, James H. Stock, and Catherine D. Wolfram

The Future of US Carbon-Pricing Policy

Robert N. Stavins

Should Electric Vehicle Drivers Pay a Mileage Tax?

Lucas W. Davis and James M. Sallee

Green Bonds: Effectiveness and Implications for Public Policy

Caroline Flammer

Estimating the Costs and Benefits of Fuel-Economy Standards

Antonio M. Bento, Mark R. Jacobsen, Christopher R. Knittel, and Arthur A. van Benthem

Long-Run Environmental Accounting in the US Economy

Nicholas Z. Muller

Jobs and Environmental Regulation

Marc A. C. Hafstead and Roberton C. Williams III

Series Introduction

James Poterba

President and CEO, NBER

Economic analysis has much to contribute in many spheres of public policy, but the fields of environmental and energy policy stand out for the centrality of economic issues. With regard to the environment, the relative attractiveness of many leading policy alternatives that emerge in the context of climate change and global warming depends on the social discount rate, an economic construct. Economic analysis is essential for judging the potential costs, and for some areas benefits, that may be associated with rising global temperatures, and for assessing the relative merits of abatement and amelioration strategies. A crucial economic insight is that when designing policies to reduce any type of environmental degradation, whether air, water, or noise pollution, it is essential to consider the relative costs of emission reduction at different point sources and to search for least-cost strategies to achieve a given emission target.

With regard to energy, current tax and regulatory policies play important roles in affecting the utilization of various fossil fuel and renewable energy sources. The rate of economic growth is one of the primary drivers of aggregate energy demand, both within countries and globally. Public spending on energy research and development and intellectual property rules surrounding new discoveries are likely to be key determinants of the future viability of alternatives to current energy sources.

In recognition of the importance of economics to the study of both environmental and energy policy, and with the generous support of the Alfred P. Sloan Foundation, the National Bureau of Economic Research (NBER) is pleased to launch a new annual initiative—the Environmental and Energy Policy and the Economy series—that will encourage leading economic researchers to prepare research papers on current issues in these two fields. The researchers must abide by the NBER’s prohibition on policy recommendations, but they are encouraged to draw on the latest cutting-edge research to distill findings that can affect the policy process. The initiative includes a capstone research meeting in Washington, DC, at which the researchers share their findings with members of the policy and research communities.

I am very grateful to Matthew Kotchen of Yale University for leading this new initiative and serving as the inaugural editor of the annual publication that will result from it. James Stock of Harvard University and Catherine Wolfram of the University of California, Berkeley, have generously agreed to serve as coeditors. All three are leading scholars in the fields of environmental and energy economics. Their good judgment in identifying important topics and their high standards in research quality are reflected in the research studies that were commissioned in the initiative’s first year. Those studies are collected in this volume. I also wish to thank Evan Michelson of the Alfred P. Sloan Foundation for his enthusiastic support for launching this initiative, Helena Fitz-Patrick at NBER for her outstanding management of the publication process, and the NBER Conference Department for handling the meeting planning for the inaugural conference with its usual efficiency and good cheer. I look forward to learning from the important research findings that will result from this initiative.

© 2020 by the National Bureau of Economic Research. All rights reserved.

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Introduction

Matthew J. Kotchen

Yale University and NBER

James H. Stock

Harvard University and NBER

Catherine D. Wolfram

University of California, Berkeley, and NBER

We are pleased to introduce the inaugural volume of Environmental and Energy Policy and the Economy (EEPE). All the papers published in this issue were first presented and discussed in May 2019 at the National Press Club in Washington, DC. The conference included participants from academia, government, and nongovernmental organizations, along with a luncheon discussion with Kevin Hassett, who at the time served as chairman of the White House Council of Economic Advisers. The broad aim of the EEPE initiative is to spur policy-relevant research and professional interactions in the areas of environmental and energy economics and policy. This is inspired by growing concerns about environmental and energy issues and by the significant economic consequences of policy making in this area. The EEPE conference and publication is modeled after the National Bureau of Economic Research’s (NBER) other and ongoing initiatives, Tax Policy and the Economy and Innovation Policy and the Economy.

In the first paper, Robert Stavins contributes to the long-standing debate about price versus quantity instruments for environmental policy. He focuses specifically on climate change and carbon pricing either through a direct carbon tax or indirectly through a cap-and-trade mechanism. Drawing on the theoretical literature, along with the use of carbon-pricing policies in practice, Stavins provides both positive and normative perspectives on the choice between policy instruments. He considers a broad set of issues ranging from efficiency, cost-effectiveness, distributional outcomes, and the likelihood of gaining the necessary political support for actual implementation. The paper combines an extensive review of the literature with real-world perspectives on the future prospects for climate policy in the United States. In addition, Stavins draws two broad conclusions of interest. One is that the particular design elements of either a carbon tax or a cap-and-trade mechanism can be more consequential than the choice between instruments themselves. The other is that, from a political economy perspective, the political feasibility of either instrument should be viewed as affecting its potential normative merits and vice versa. The paper is especially valuable and timely in light of the wide open, current state of affairs in federal climate policy.

Lucas Davis and James Sallee have written a novel paper based on the initial observation that electric vehicle drivers do not pay a gasoline tax, the revenue from which is used to pay for transportation infrastructure. They first consider whether this implicit subsidy for electric vehicles, compared with gasoline-powered vehicles, is warranted from the perspective of economic efficiency. The answer depends largely on whether gasoline is priced efficiently, taking account of the externalities associated with greenhouse gas emissions and local air pollution. Because gasoline prices do not reflect these social costs, they conclude that the subsidy is likely efficient because it encourages substitution away from gasoline-powered vehicles. Nevertheless, they argue that more research is needed to identify some key model parameters and that a two-part policy instrument, which combines a purchase subsidy with a usage tax, would be even more efficient. Davis and Sallee also provide estimates of the likely foregone tax revenue based on newly available data. They find that electric vehicles have reduced gasoline tax revenues by $250 million annually, that the foregone revenue is concentrated in a few states, and that the effect is highly regressive. Although the magnitude of the estimate is relatively modest because electric vehicles currently account for less than 1% of US registered vehicles, the authors show how the effect is likely to take on more importance given the ambitious goals to rapidly increase the future adoption of electric vehicles.

Caroline Flammer writes about the rapidly growing market for green bonds, which are debt instruments used to finance low-carbon, climate-friendly projects. She begins with an overview of the green-bond boom, with issuers that include corporations, municipalities, government entities, and supranational institutions. Although green bonds totaled $0.8 billion in 2007, the amount increased to $141.3 billion by 2018, and many commentators point to green bonds as an essential tool for financing the energy transitions to a low-carbon economy. But do green bonds meaningfully affect environmental performance? And what are the financial implications? Using firm-level data on corporate green bonds issued by public companies, Flammer finds evidence that the issuance of a green bond contributes to both the environmental and financial performance of companies, but the effect is only significant when the bond is certified as being green by a third party. These results provide important evidence on the operation of the green-bond market and raise questions about the potential need for a public governance regime related to green-bond certification. Flammer discusses a range of these financial and environmental concerns in an early contribution to the nascent field of green bonds.

Antonio Bento, Mark Jacobsen, Christopher Knittel, and Arthur van Benthem develop a general framework for evaluating the costs and benefits of fuel economy standards, and they use it to explain discrepancies between recent analyses by the US government. Their framework organizes many of the different effects studied in the literature, showing how they all come together to help understand the consequences of increasing vehicle fuel economy standards. The different elements include private costs (vehicle price and attributes), private benefits (fuel savings, mobility), and externalities (gasoline use, local air pollution and congestion, and safety). The authors then provide theoretical bounds on the different effects and use them to evaluate dueling cost-benefit analyses put out by the Obama and Trump administrations about the imposition and proposed rollback of changes to the Corporate Average Fuel Economy standards. They show how the latter’s analysis is inconsistent with standard tenants of microeconomic theory and provides a cautionary lesson in doing piecemeal equilibrium analysis, whereby prices in some parts of a model are not allowed to vary and cause feedbacks in other parts. Overall, the paper provides a foundation upon which future economic analyses of fuel economy standards can be built and evaluated.

Taking a macroeconomic perspective, Nicholas Muller estimates a measure of output in the US economy over the past 60 years that accounts for air pollution damages and shows how the pollution effects are sizable, affect growth rates, and have diminished appreciably over time. His work is not the first to augment a gross domestic product (GDP) measure to account for environmental damages, but his paper is novel because of the way he uses several data sources to construct a long-run perspective. His paper builds on one of the earliest works on the subject by William Nordhaus and James Tobin, which was published in an NBER volume in 1972 (see the reference in Muller’s chapter). One striking result that comes out of Muller’s analysis is based on a comparison of US economic growth in the decades before and after 1970. Although the standard measure of GDP shows a substantial decline in the average annual growth rate, the slowdown is completely reversed after taking account of lower environmental damages from air pollution. Muller estimates that since 1970, the US economy did not grow 127%, but 211% when accounting for environmental improvements. Muller discusses how these improvements started to occur at precisely the time of significant environmental regulations in the United States, including the founding of the US Environmental Protection Agency. The paper provides one of the best examples of how we are systematically ignoring the benefits of improving environmental quality because of the way that we do standard national accounting.

Finally, Marc Hafstead and Roberton Williams take on a question of utmost importance to policy makers, yet one that receives relatively little attention from academic economists: How should employment effects be counted when evaluating the costs and benefits of environmental regulations? They emphasize the need for general equilibrium analysis because of spillover effects that can be positive or negative, along with a recognition of the way that heterogeneous skills and frictions in the job market affect the rate and quality of job relocations. They also identify important distinctions between distributional effects of job losses/gains and aggregate social costs/benefits. Hafstead and Williams review the existing literature and point to areas where more research is needed. A large part of their contribution, however, comes from their own general equilibrium model, which they use to analyze the effects of three illustrative policies: a durable manufacturing regulation, a power sector performance standard, and an economy-wide carbon tax. One conclusion (among many) that they draw is that the employment effects of environmental policy are likely to be primarily job relocations, with fewer jobs in some industries and more in others. A further consequence is that the effects of environmental policy on overall employment are likely to be small, especially in the long run. Although different environmental policies will have their own specific effects, Hafstead and Williams provide an important contribution that will help organize the way that policy makers and researchers discuss employment effects, along with several useful benchmarks to get a handle on their potential magnitudes.

Overall, we are very pleased with the papers included in this inaugural volume of EEPE. We are grateful to the authors for their time and effort in helping to make the first year a success. We are also grateful to Jim Poterba, president and CEO of the NBER, for supporting the initiative. The NBER’s conference staff, including Carl Beck and especially Rob Shannon, helped make the organization a pleasure. Helena Fitz-Patrick’s help with the publication was greatly appreciated, and Denis Healy was tremendously valuable in helping to put together the initial proposal. Finally, we would like to thank Evan Michelson and the Alfred P. Sloan Foundation for financial support to get the EEPE initiative up and running. We are already looking forward to next year’s conference and volume 2.

Endnote

For acknowledgments, sources of research support, and disclosure of the authors’ material financial relationships, if any, please see https://www.nber.org/chapters/c14284.ack.

© 2020 by the National Bureau of Economic Research. All rights reserved.

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The Future of US Carbon-Pricing Policy

Robert N. Stavins

John F. Kennedy School of Government, Harvard University

Executive Summary

There is widespread agreement among economists—and a diverse set of other policy analysts—that at least in the long run, an economy-wide carbon-pricing system will be an essential element of any national policy that can achieve meaningful reductions of CO2 emissions cost-effectively in the United States. There is less agreement, however, among economists and others in the policy community regarding the choice of specific carbon-pricing policy instrument, with some supporting carbon taxes and others favoring cap-and-trade mechanisms. This prompts two important questions: How do the two major approaches to carbon pricing compare on relevant dimensions, including but not limited to efficiency, cost-effectiveness, and distributional equity? And which of the two approaches is more likely to be adopted in the future in the United States? This paper addresses these questions by drawing on both normative and positive theories of policy instrument choice as they apply to US climate change policy and draws extensively on relevant empirical evidence. The paper concludes with a look at the path ahead, including an assessment of how the two carbon-pricing instruments can be made more politically acceptable.

JEL Code:s: Q540, Q580, Q400, Q480

Keywords: climate change, market-based instruments, carbon pricing, carbon taxes, emissions trading, cap-and-trade, performance standards, technology standards

In this paper, I will compare the two major approaches to carbon pricing—carbon taxes and cap-and-trade—in the context of a possible future US climate policy, and to do so by treating both instruments in a balanced manner, examining their merits and challenges, without necessarily favoring one or the other.¹ I try to follow the principle that when making normative comparisons of policy instruments, it is most valuable to compare either idealized versions of two instruments or realistic (likely to be implemented) versions of both, thereby avoiding a comparison of an idealized version of one instrument with a less-than-ideal but realistic version of another (Hahn and Stavins 1992).²

In the next section, Section I, I describe the key premises I adopt, including the importance of global climate change, the current reality of US inaction at the federal level, and my view that in the long term, a truly meaningful, economy-wide US climate policy will likely need to have carbon pricing at its core, either in the form of a carbon tax or a cap-and-trade system. Then, in Section II, I examine the normative theory of policy instrument choice as it applies to US climate change policy, with brief reviews of the major options and particular attention to what normative theory suggests about the choice between price and quantity instruments for abating CO2 emissions. In Section III, I turn to the positive theory of instrument choice as it applies to US climate policy and assess what positive theory can tell us about this choice of climate policy instruments.

In Section IV, I examine empirical evidence, that is, what experience can tell us, first with regard to empirical evidence bearing on normative instrument choice, including lessons learned from experience with taxes and cap-and-trade, and then with regard to empirical evidence about positive instrument choices. In Section V, I offer some conclusions from the normative and positive analyses—both theoretical and empirical—and comment on the path ahead.

I. Setting the Stage: Major Premises

Gradually, over the 25 years since the US Senate ratified the United Nations Framework Convention on Climate Change, scientific assessments of the risk of global climate change have become increasingly compelling (Intergovernmental Panel on Climate Change 2013, 2018), and economic analyses supporting the wisdom of policy action have gained considerable prominence, if not influence (Nordhaus 2015).³ Although China’s annual emissions have surpassed those of the United States since 2006, the United States remains the largest contributor to the accumulated atmospheric stock of anthropogenic greenhouse gases (GHGs) (Boden, Marland, and Andres 2017).

Countries around the world—including nearly all the industrialized countries and large emerging economies—have launched or are in the process of launching national policies aimed at reducing their emissions of GHGs. Of the 169 Parties to the Paris Climate Agreement that have submitted specific pledges (known as Nationally Determined Contributions [NDCs]), more than half (88) refer to the use of carbon pricing in their NDCs. To date, some 51 carbon-pricing policies have been implemented or are scheduled for implementation worldwide, including 26 carbon taxes and 25 emissions trading systems (ETS) (table 1).⁴ Together, these carbon-pricing initiatives will cover about 20% of global GHG emissions (World Bank Group 2018), and many of these systems may eventually be linked with one another under the auspices of Article 6 of the Paris Agreement (Bodansky et al. 2015; United Nations 2015; Mehling, Metcalf, and Stavins 2018).

Source. World Bank Group (2018).

Note. GHG = greenhouse gas; MtCO2e = metric tons of carbon dioxide equivalent; BC = British Columbia; ETS = emissions trading system.

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In the midst of these global and national developments, the current US administration stands out for its rejection of the science of climate change, its decision to withdraw from the Paris Agreement, and its comprehensive moves to reverse climate policy initiatives of the previous administration. In this context, it is of value to assess the long-term future of US climate policy—both normatively and positively.

There is widespread agreement among economists—and a diverse set of other policy analysts—that at least in the long term, economy-wide carbon pricing will be an essential element of any policy that can achieve meaningful reductions of CO2 emissions cost-effectively in the United States, as well as in many other industrialized countries (Metcalf 2009; Kaplow 2010; Borenstein et al. 2018).⁵ The ubiquitous nature of energy generation and use and the diversity of CO2 sources in a modern economy mean that conventional technology and performance standards would be infeasible, and—in any event—excessively costly (Newell and Stavins 2003). The cost advantage of carbon pricing exists because of the flexibility it provides and the incentive it fosters for all sources to control at the same marginal abatement cost, thereby achieving cost-effectiveness in aggregate. In addition, in the long term, pricing approaches can reduce abatement costs further by inducing carbon-friendly technological change (Newell, Jaffe, and Stavins 1999).⁶

There is less agreement among economists regarding the choice of specific carbon-pricing policy instruments, with some supporting carbon taxes (Mankiw 2006; Nordhaus 2007) and others cap-and-trade mechanisms (Ellerman, Joskow, and Harrison 2003; Keohane 2009). That prompts two questions: How do the two major approaches to carbon pricing compare on relevant dimensions, including but not limited to efficiency, cost-effectiveness, and distributional equity? And which of the two approaches is more likely to be adopted in the future in the United States? Much has been written by academic economists about the first question, and the second question has been addressed from a number of disciplinary perspectives by social scientists, as well as by commentators in the broader policy community.

Among many findings from this survey and synthesis, two major conclusions stand out. One is that the specific designs of carbon taxes and cap-and-trade systems may be more consequential than the choice between the two instruments. The two approaches to carbon pricing are perfectly or nearly equivalent in regard to some issues and attributes while significantly different in regard to some others. But many of these differences fade with specific implementations, as elements of design foster greater symmetry. Indeed, what appears at first to be the dichotomous choice between two distinct policy instruments often turns out to be a choice of design elements along a policy continuum. A second major conclusion is that issues of positive political economy—such as the probability that a particular instrument will actually be adopted and implemented—frequently have normative dimensions, as well. Likewise, normative attributes—ranging from cost-effectiveness to distributional equity—have important implications for any political prognosis.

II. Normative Theory of Policy Instrument Choice

For much of the past 100 years, economists have considered environmental pollution to be a classic—indeed, textbook—example of a negative externality, an unintentional consequence of production or consumption that reduces another agent’s profits or utility (Pigou 1920). A separate but related strand of literature, stemming from Ronald Coase’s work (1960), has identified environmental pollution essentially as a public-good problem—that is, a problem of incomplete property rights. These two perspectives can lead to different policy prescriptions for climate change: carbon taxes versus tradable carbon rights.⁷

For some 40 years prior to Coase (1960), the literature focused on a single economic response to the problem of externalities: taxing the externality in question. In principle, a regulator could ensure that emitters would internalize the damages they caused by charging a tax on each unit of pollution equal to the marginal social damages at the efficient level of pollution control (Pigou 1920). Such a system makes it worthwhile for firms to reduce emissions to the point where their marginal abatement costs are equal to the common tax rate. Hence, marginal abatement costs will be equated across sources, satisfying the necessary condition for cost-effectiveness. In theory, this will hold both in the short term and in the long term by providing incentives for diffusion (Jaffe and Stavins 1995) and