Carbon Taxes Alone Aren’t Good Climate Policy: Gernot Wagner

(Bloomberg) -- I love taxes.

OK, let me qualify: I love how simple the intended effect of taxes is, if and when it is intended. For climate change that means taxing carbon and watching demand for it go down. Markets will take care of the rest. The goal ought to be to find the right price for each ton of CO₂ and get out of the way. Economics 101.

Econ 102, meanwhile, tells us that taxes alone aren’t enough. In much the same way that there are negative spillovers from too much carbon pollution that need to be taxed, there are also positive spillovers from technological change.

This goes for basic research and development—think scientists doing foundational work in a lab. It also goes for RD&D, with an extra “D” for deploying existing technologies. Add a third “D” for demonstration, if you want to demonstrate your insider knowledge: RDD&D. The fourth, RDDD&D for diffusion, appears to not have caught on.

Every one of these letters deserves to be subsidized.

The reasoning is simple. Inventors tinkering in their garage might stand on the shoulders of giants, but by and large they consider the benefit to themselves only when deciding how much to invest. They don’t consider that they are creating shoulders for others to stand on. That logic goes for the R, and it extends through every one of the Ds. Diffusion often comes in the form of network effects. When someone puts a solar panel on the roof, his neighbors are more likely to do so, too. The right answer: Subsidize.

Perhaps the most famous climate-related case is solar photovoltaic (PV), with prices declining by around 85% in a decade and about 99% since the 1970s. The reason? Subsidies every step along the way.

At first it was basic R&D, leading to enormous efficiency gains and other improvements in the panels themselves. That’s to be expected from an infant technology. Beginning in the 2000s, a team of researchers at the Massachusetts Institute of Technology, led by Jessika Trancik, concluded that economies of scale had started taking over. The larger the overall market, the cheaper any one panel. Those scale economies were still very much aided by policies aimed at stimulating market growth.

Germany’s Energiewende, a government-led program to jump-start an energy transition away from fossil and toward renewable technologies, played a significant role. Germany has subsidized solar PV via ambitious feed-in tariffs, offering a favorable long-term contract for anyone installing solar panels. Initially, in 2010, those subsidies were more than ‎€0.4 (45¢) per kilowatt-hour, quickly scaled back to less than €0.15 per kWh by 2015.

Those government policies are textbook Econ 102: Subsidize heavily at first, and quickly scale back. California has done something similar with its Solar Initiative, offering large initial subsidies for everyone installing solar panels on their roof.

The upshot?

It’s clear that sensible climate policy needs to consist of both carbon prices and subsidies for the alternatives. It’s equally clear that “tax” is a four-letter word. Precisely for that reason, some political proposals go to pains to avoid stating the obvious. The latest Republican congressional proposal avoids the term, focusing instead on “innovation.” That—plus planting a trillion trees—might sound good, and it appears to take Econ 102 seriously, but it ignores Econ 101. (It does have some surprising echoes of Green New Deal-style proposals, with their focus on green industrial policy, while often shying away from mentioning carbon pricing directly.)

There’s also the inconvenient bit that subsidies for clean electricity go counter to some of the desirable Econ 101 effects of taxes. Subsidies, all else equal, lower prices and encourage consumers to use more overall electricity. The only way to counter that effect is to raise rates. That may well be what happens in reality anyway. The money for subsidies needs to come from somewhere. Germany has among the highest electricity prices in Europe precisely because its households are paying for the large initial feed-in tariffs.

Another problem: German subsidies helped create a boom in solar PV manufacturing capacity in China. The resulting bubble led to the inevitable bust, making it harder for others to raise capital. A further unintended effect of solar PV's success was the infamous Solyndra bankruptcy. Solyndra simply couldn't compete with its thin-film solar technology that proved too costly.

Still, there are some excellent reasons to emphasize Econ 102 over 101, subsidies over taxes. Even if pricing the negative carbon externality is key, the path to getting there might be via driving down the price of alternatives. The past may be a good guide. In the vast majority of cases, from California to Sweden, green industrial policy has preceded carbon pricing.

Time, of course, is quickly running out. We can’t afford to sit around and wait for the ideal policy. Although the rapidly declining price of low-carbon technologies has made extremely bad outcomes less likely, the news from scientists isn’t exactly good.

It’s precisely these uncertainties that ought to be front and center when evaluating policy options. Earnest Econ 101 studies have long argued that Germans have overpaid for their solar PV feed-in tariffs, calculating equivalent carbon prices of at least €500 ($550) per ton of CO₂ abated. If the goal is “just” to abate as much CO₂ as possible today, solar PV is simply not the way to go. There are cheaper ways—not least keeping nuclear plants operating for longer. (No mention of Germany’s low-carbon ambitions is complete without acknowledging that its post-Fukushima nuclear phaseout competes with its decarbonization goals.)

The goal of Germany’s energy transition, meanwhile, is not to cut today’s CO₂ emissions. It’s to cut tomorrow’s. That’s where subsidies for innovation shine. They are all about how today’s policies drive down future costs.

The right reaction for the rest of us, then, is to practice writing danke and start sending grateful notes to the German households who made it easier for everywhere else to pass sensible climate policies. Subsidies made low-carbon alternatives viable against fossil fuels.

That’s no longer Econ 101 or 102. It’s Political Economy 101—politics.

Gernot Wagner writes the Risky Climate column for Bloomberg Green. He teaches at New York University and is a co-author of Climate Shock. Follow him on Twitter: @GernotWagner. This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the editor responsible for this story: Emily Biuso at ebiuso@bloomberg.net, Aaron Rutkoff

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