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Tuesday, March 25, 2008

Should We Mimic Denmark's Energy Policy?

Is it possible to reduce greenhouse gas emissions, but still have a "remarkably strong economic record and without relying on nuclear power"?:

On Carbon, Tax and Don’t Spend, by Monica Prasad, Commentary, NY Times: Everyone seems to be talking about a carbon tax. ... The idea is that polluters should pay for the environmental damage they cause. Slap a tax on carbon, the theory goes, and you will get fewer carbon emissions, more revenue for government and energy independence, all at the same time. No wonder people from both sides of the political divide have come out in support of it.

But a carbon tax isn’t a new idea. Denmark, Finland, Norway and Sweden have had carbon taxes in place since the 1990s, but the tax has not led to large declines in emissions in most of these countries — in the case of Norway, emissions have actually increased by 43 percent per capita. ...

The one country in which carbon taxes have led to a large decrease in emissions is Denmark, whose per capita carbon dioxide emissions were nearly 15 percent lower in 2005 than in 1990. And Denmark accomplished this while posting a remarkably strong economic record and without relying on nuclear power.

What did Denmark do right? There are many elements to its success, but taken together, the insight they provide is that if reducing emissions is the goal, then a carbon tax is a tax you want to impose but never collect.

This is a hard lesson to learn. The very thought of new tax revenue has a way of changing the priorities of the most hard-headed politicians... But if we want lower emissions, the goal of a carbon tax is to prompt producers to change their behavior, not to allow them to continue polluting while handing over cash to the government.

How do you get them to change? First, you prevent policy makers from turning the tax into a cash cow. Carbon tax discussions always seem to devolve into gleeful suggestions for ways to spend the revenue. ...

Denmark avoids the temptation to maximize the tax revenue by giving the proceeds back to industry, earmarking much of it to subsidize environmental innovation. Danish firms are pushed away from carbon and pulled into environmental innovation, and the country’s economy isn’t put at a competitive disadvantage. So this is lesson No. 1 from Denmark.

The second lesson is that the carbon tax worked ... because it was easy for Danish firms to switch to cleaner fuels. Danish policy makers made huge investments in renewable energy and subsidized environmental innovation. ...[T]he tax gave companies a reason to leave coal and the investments in renewable energy gave them an easy way to do so... The key was providing easy substitutes. ...

[A] carbon tax has been promoted almost as a panacea — just pop in the economic incentives and watch them work their magic. But unless steps are taken to lock the tax revenue away from policymakers and invest in substitutes, a carbon tax could lead to more revenue rather than to less pollution.

An increase in gasoline taxes ... would likewise be the wrong policy for the United States. Higher gas taxes would raise revenue but do little to curb pollution.

Instead, if we want to reduce carbon emissions, then we should follow Denmark’s example: tax the industrial emission of carbon and return the revenue to industry through subsidies for research and investment in alternative energy sources, cleaner-burning fuel, carbon-capture technologies and other environmental innovations.

I thought cap and trade - which is economically equivalent to a carbon tax if implemented correctly - was what "Everyone seems to be talking about," but I'll go with the premise. Also, I don't know much about how energy usage statistics have changed over time for these countries, or why, so I'll have to take the information given on faith (anybody disagree?).

Here's a graph I constructed awhile back to show the effects of a proposal to impose a carbon tax, then return every dime to the public. The economic consequences of these revenue neutral proposals are covered in most microeconomics principles classes, and people such as Robert Frank have made somewhat more formal proposals along these lines (and Marty Feldstein has a scheme he says "actually raises the income of a majority of households" and prevents policy makers from turning the tax into a cash cow, one of the concerns above). So the lesson that "a carbon tax is a tax you want to impose but never collect," is not such a "hard lesson to learn," it's a fairly common exercise (though economists would use different terminology to describe it).

There is no doubt that we should find out where and why under-investment in energy saving technology is occurring and fix the problem as soon as possible, and that can be accomplished in a variety of ways, a dedicated carbon tax is not the only possibility. But if we do impose a carbon tax, a priority for me would be to make sure that the households most vulnerable economically to an increase in energy prices are given the help they need, and it's fairly easy to construct proposals that they have this characteristic. If anything is left over after lower income households are compensated it can be earmarked for other purposes, one possibility is to support policies that help to get the proposal through the political process and do some good at the same time, but the main thing is to get the tax (or the equivalent cap and trade policy, or something that is effective) in place so we can begin to make headway on the global warming problem.

    Posted by on Tuesday, March 25, 2008 at 02:56 AM in Economics, Environment, Policy, Regulation | Permalink  TrackBack (0)  Comments (57)


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