The main purpose of this series has been to identify a number of misunderstandings that have grown up around the topic of policy to mitigate climate change. There are a lot of them, so it’s been a big job. It would be sneaky, however, to duck out at the end without saying a few words about what a better approach might look like. What follows is a quick sketch of the main items.
1. The most direct and flexible way to limit fossil fuel extraction is by requiring anyone doing this to obtain a permit, and then restricting the number of permits according to an appropriate carbon budget. In this series I’ve used the IPCC carbon limits as a matter of convenience; naturally, before committing to any specific number, there should be careful consideration of the risks in both directions—picking a target that’s too loose and doesn’t remove enough risk of catastrophe, or one that’s too tight and gives us too little extra security for the added cost.
Perhaps the hardest part of the target-picking problem is not distilling what we know today into a specific emissions cap, but setting up a dependable system for revising it as new knowledge comes in. One possibility is to set up a semi-autonomous body, weighted toward science, which periodically reviews carbon targets and modifies them as needed. Think of the carbon equivalent of a central bank. Ultimately any such body is subject to political control, but it should have at least some discretion to make adjustments on its own.
Ideally the scope of a permit system would be global, but that’s unlikely to happen, at least at the start. If several national partners are available, it could begin on a club basis, as described in the previous post, but it could also encompass just a single country.
The permits should not be time-dated. Since the goal is to limit the accumulation of greenhouse gases and not necessarily their emissions in any single year, it should be possible to move permits backward or forward through time, leaving the total unchanged. In theory this could be accomplished by markets alone: the entire stock of carbon permits over the period from the present to, say, 2050 could be auctioned off at once, and anyone thinking of using one would compare the value of extraction today to their expected future value if they are saved. It’s a standard economic result that, under various conditions, the time profile of carbon extraction resulting from such a market would be optimal, in the sense that it would not be possible to increase the value we get from allowable fossil fuels by shifting their exploitation to different time periods.
In practice that's a big risk to take, however. Markets go awry for a number of reasons: insufficient competition, herd effects, perverse incentives (especially associated with default risk), and so on. It would be advisable for the permit issuing body to withhold a large portion of the undated permits, so that markets are allocating only the remainder. There could be periodic releases of withheld permits as markets demonstrate their ability to allocate them reasonably.
Permits should be issued specifically for the introduction of carbon into the economy, at the mine, wellhead, port or pipeline. This maximally upstream location enables the economic response to be as flexible as possible, it’s easily enforced, and it’s comprehensive—unlike end user controls.
2. All permits should be auctioned, with no exceptions. All revenues should be rebated back to the public on a per capita basis, but with two provisos. First, a portion should be set aside for international transfer payments, to be discussed in a moment. Second, a small amount may be set aside for specific domestic populations that are exceptionally vulnerable to the price impacts of the permit system. These latter funds should have a remedial aspect to them, such as relocation subsidies for people who live in areas with unavoidably high fossil fuel demands or retraining subsidies for workers in the fossil fuel sector.
As for the international transfers: there are two ways of doing this. One is to have separate national systems that auction carbon permits, and then have the higher income country set aside some of its revenues for the lower income one. The other is to pool the permit system, so that there’s a single revenue stream, and per capita rebates automatically result in a richer-to-poorer transfer. From a pure theory perspective, the second approach is preferable, especially since it targets the transfers more precisely (on the basis of income rather than location) and is less subject to interference. But suppose that our club consists of the US and Brazil. It’s not hard to imagine that the amount that a pooled system would transfer would make the program unacceptable to a large part of the US public, because their rebates would be too small to make up for much of the cost of energy price increases. For practical reasons, then, it might be better to either set up a partial pool or have an explicit system of transfers.
For purposes of visualizing such a system, suppose that 20% of carbon revenues were set aside for global transfers and 5% for domestic subsidies. This would leave three-quarters, enough to indemnify, at least initially, something like the bottom half of the income distribution and moderate the impact on the rest. Indeed, the bottom deciles might well see net income gains, since their per capita share, even discounting 25%, exceeds their extra direct and indirect fuel expenses. In other words, done right, climate policy can also be a form of progressive income redistribution.
3. The club of countries participating in the carbon permit system can be expanded primarily through the use of revenue transfers, either explicit or by pooling. To qualify for a transfer, a low-income country would have to join the club. On the other hand, the exports of countries outside the club would be subject to tariffs designed to offset as accurately as possible the production cost differences attributable to cheaper fossil fuel prices. The idea is to prevent leakage, such as when production sites are relocated to take advantage of policy-driven energy cost differentials.
4. If someone develops a genuinely reliable system for long term carbon sequestration, new permits will be issued equal to the amount of sequestered carbon and given (not auctioned) to whoever does the sequestering. They can sell them, and this provides the right level of subsidy: the value of carbon restrictions avoided.
5. As fossil fuel costs begin to rise, it should be possible to create support for a substantial shift in public spending in the direction of energy-saving technologies, renewable energy subsidies, and research and development to improve non-carbon technologies. The money to pay for these things could come from redirecting existing spending, additional taxes, and increased public borrowing if depressed macroeconomic conditions persist.
6. Regulations may need to be introduced to minimize the perverse effects of otherwise desirable carbon incentives, such as the restrictions on conversion of food crops to fuel crops, as discussed in a previous post.
7. Adaptation is largely beyond the scope of this series, but that doesn’t mean it doesn’t matter. In addition to all of the above, considerable sums will have to be spent protecting people from current and near-future climate impacts. It is especially urgent the upper-income countries support this work in poorer regions: the better-off benefited from the use of fossil fuels in the past which are responsible for today’s climate forcing.
Climate change is about the planetwide relationship between “people” and “nature”, but it also exposes enormous and deeply unfair inequalities between those disproportionately on the causing and receiving ends of the problem.