It’s 2009: Why Are We Still Dealing with Voodoo Climate Economics?

You would think the basic facts would be clear by now, but you would be wrong. A New York Times article this morning on Missouri’s fear of higher electricity prices under carbon regulation had lines like:

[Politicians from Missouri] are concerned that the new costs would get passed on to consumers...., to farmers from rural Missouri and to employers like the energy-hungry Noranda aluminum plant in New Madrid in the southeast of the state, which has 1,000 workers. And they worry that in an already wounded economy, increased costs could turn one of the relatively few economic blessings into a blight.

Where to begin? The whole point of issuing permits for carbon is to dramatically raise the cost of burning these fuels; people are supposed to cut back on goods and services that use them, thereby preserving a liveable planet. There is no “would” or “could” about it: if we want to limit climate change we have to get hundreds of millions of people to change their consumption habits (and firms to change their production methods). Since we don’t want to do that with regulations, police and prisons, we will do it with prices.

Given that, the core economic problem is how to carry out this program with the minimum cost to the well-being of our fellow humans. Part of this is about efficiency, getting the most carbon reduction for the lowest cost. Another part is about investment and innovation, building a low-carbon economy that produces a high quality of life for all of us. But front and center are those higher prices that we will have to pay for goods that continue to require carbon fuels.

In the voodoo view of the world, money just disappears down a black hole. Consumers pay higher prices, the economy suffers, and that’s the end of the story. It doesn’t take much economic sophistication, however, to notice that the money has to go somewhere—specifically, it finds its way to the companies that acquire carbon permits in the first place, and that’s why the permits are valuable. Now, either those companies get the permits for free and make out like bandits, or the permits are auctioned. If they’re auctioned, the money from those hard-pressed Missourians is now in the hands of the government agency that ran the auction. At this point we have a new sales tax. But we don’t want a new sales tax. So the government agency can simply rebate all the money back to the public, ideally on a simple, equal per capita basis. This means that the folks from Missouri highlighted in the Times article would be earning carbon revenues and not just paying them. They can stimulate their economy by spending this loot on other items that don’t pump carbon into the atmosphere and whose prices haven’t gone up.

True, on average people in some regions will come out somewhat ahead or behind on the deal, based on the sort of energy infrastructure that’s currently in place, current commuting patterns, climate and such. No doubt a carefully constructed policy package would offer sweeteners to the more impacted areas, like extra investment funds. But these considerations are second-order compared to the voodoo vision of higher prices that just vanish into thin air.