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Economic Impacts of Carbon Pricing

Posted on 15 November 2010 by dana1981

Putting a price on carbon emissions is often discussed as one of the main solutions to anthropogenic global warming. Carbon dioxide is a pollutant and in economic theory, pollution is considered a negative externality – a negative effect on a party not directly involved in a transaction, which results in a market failure. The Stern Review on the Economics of Climate Change concluded that climate change represents "the greatest example of market failure we have ever seen."

Despite the economic benefits of addressing this market failure, many skeptics argue that putting a price on carbon emissions will cripple the economy. Such arguments generally focus solely on the costs associated with pricing carbon while wholly ignoring the benefits. For example, a Heritage Foundation analysis of the Waxman-Markey climate bill proposed in the US House of Representatives in 2009 concluded that the legislation would cost the average American family $1500 per year – a figure 10 times higher than any non-partisan economic analysis (see below).

The reason the Heritage estimate was so high is that it evaluated the costs of a carbon cap, and then ignored the distribution of those funds. When a price is put on carbon emissions, it creates a revenue stream. The funds which are generated from the carbon price can be distributed in any number of ways – usually through reductions in other taxes, investment in research and development of 'green' technologies, funding of energy efficiency programs, etc.

The Heritage Foundation report effectively assumed that the generated funds would disappear into a black hole. Their analysis was the equivalent of doing your household finances by adding up your expenditures while ignoring your income. It sure looks bad, but tells you nothing about your overall finances.

Here we will look at a few of the climate bills proposed by the US Congress which would have put a price on carbon emissions, and examine a number of economic analyses mainly by non-partisan economic groups which evaluated both the costs and benefits of each proposal.

Carbon Pricing Proposals

Lieberman-McCain (2007)

Senators Lieberman and McCain introduced the Climate Stewardship and Innovation Act of 2007. This bill would have capped greenhouse gas (GHG) emissions at 22% below their 1990 levels in the year 2030, and 60% below 1990 levels in 2050. The Energy Information Administration (EIA) analyzed this bill using the National Energy Modeling System (NEMS), and the US Environmental Protection Agency (EPA) analyzed the bill as well.

Lieberman-Warner (2008)

Senators Lieberman and Warner introduced the Climate Security Act of 2008. The bill called for a steadily-declining GHG cap, reaching 15% below 2005 levels by the year 2020 and 70% below 2005 levels by 2050. It was analyzed by the EPA using results from two economic forecasting models: the ADAGE model developed at Research Triangle Institute (RTI) in North Carolina; and the IGEM model run by a consulting firm founded by Dale Jorgenson, a professor at Harvard. The Massachusetts Institute of Technology (MIT) analyzed this bill using their Emissions Prediction and Policy Analysis (EPPA) model, and the EIA and Congressional Budget Office (CBO) also analyzed the bill.

Waxman-Markey (2009)

Congressmen Waxman and Markey introduced the American Clean Energy and Security Act of 2009. This bill would have reduced greenhouse gas emissions 17% below 2005 levels by 2020 and 83% by 2050. It was analyzed by the CBO, EPA, EIA, and Science Applications International Corporation (SAIC).

Kerry-Lieberman (2010)

Senators Kerry and Lieberman introduced the American Power Act. This bill would have reduced greenhouse gas emissions 17% below 2005 levels by 2020 and 83% by 2050. It was analyzed by the Peterson Institute, EPA, EIA.

Generic Policy

Research groups (MIT, RTI, and the Department of Energy's Pacific Northwest National Laboratories [PNNL]) have also analyzed the economic impacts of a generic comprehensive, economy-wide climate policy to reduce GHG emissions 50-80% by the year 2050.

Study Assumptions

These studies compare a particular climate policy scenario with a reference scenario corresponding to the model projection of business as usual (BAU) – that is, a world in which the economy continues on its current course with carbon emissions unchecked. All assume that a climate policy would be implemented in the year 2012, and most project economic impacts through the year 2050. The analyses evaluate the costs of reducing greenhouse gas emissions, but do not measure the resulting payoff – the benefits of averting dangerous climate change. Nor do they consider the ancillary benefits, such as the improved local air quality and reduced ocean acidification.

They merely model the economic impact of the climate policy to a BAU scenario where climate change does not impact the economy. Therefore, it is important to bear in mind that these analyses overestimate the policy impact on the economy as compared to a realistic BAU scenario in which climate change impacts the economy. These analyses should be viewed as a comparison between policy impacts and a scenario in which our understanding of the climate is wrong and the climate does not change significantly as GHG emissions continue to rise.

Since it is difficult to predict how much climate change will impact the economy, or how much climate change will be averted as a result of these policies (particularly since they may trigger similar GHG emission reduction policies by other countries), the comparison to an unrealistic BAU scenario is the best we can do.

Impact on Gross Domestic Product (GDP)

The majority of these analyses find that the evaluated climate policies impact the US GDP by less than 1% as compared to BAU. The main exception is the IGEM analysis, which finds a 2.15% reduction in GDP for the Lieberman-Warner by bill by 2030, and a 3.59% reduction by 2050. The IGEM model is an outlier because it assumes when the price of energy (and other goods and services) rises, people will respond by choosing to work less than they otherwise would (EDF 2008). This is a counter-intuitive and illogical assumption, since increasing costs generally result in people working more to increase income correspondingly.

Another outlier was the SAIC analysis of Waxman-Markey, which was funded by the National Association of Manufacturers, which has strongly opposed climate legislation. The study incorporated some unrealistically conservative and pessimistic assumptions, for example that American companies will be unable to deploy clean energy and energy efficiency technologies in a timely manner. Nevertheless, the report concluded that by 2030, GDP would grow 95% as much under Waxman-Markey as compared to BAU.

The MIT analysis in the generic 80% GHG emissions reductions below 1990 levels below 2050 (the scenario with the largest GHG emissions decrease) found that by 2030, GDP would increase by just 0.44% as compared to BAU.

Figure 1 and Table 1: Modeled Impacts of Climate Legislation on US GDP

Legislation
GHG Reduction by 2050
GDP loss vs. BAU by 2030
Lieberman-McCain
60% below 1990 levels
0.23%
Lieberman-Warner 70% below 2005 levels
0.44-2.15%
Waxman-Markey 83% below 2005 levels
0.2-0.9%
Kerry-Lieberman 83% below 2005 levels 0.1-1.0%
Generic 50% below 1990 levels 0.47-0.81%
Generic 80% below 1990 levels 0.44%

Impact on the Federal Deficit

The CBO analysis of Waxman-Markey found that the bill would reduce the federal deficit by $9 billion by the year 2019. The CBO analysis of a similar bill proposed by Senators Kerry and Boxer found the bill would reduce the federal deficit by $21 billion by 2019 and "would not increase the deficit in any of the four 10-year periods following 2019." And the CBO also found that Kerry-Lieberman would decrease the deficit by $19 billion by 2020.

Impact on Energy Independence

In the MIT analysis of Lieberman-Warner, the United States would spend $20 billion less on foreign oil in the year 2020, and $81 billion less in 2030.

Impact on Gasoline Prices

The EIA study of Lieberman-Warner found that the bill would add 42 cents per gallon to gas prices in 2030 as compared to BAU (a 12% increase). Analyses of Waxman-Markey found that it would increase gas prices 22 to 35 cents per gallon by 2030 (6 to 9%). The Peterson Institute analysis of Kerry-Lieberman found it would increase gas prices by approximately 10 cents per gallon (3%) by 2030.

Impact on Utility Bills

Analyses of Waxman-Markey found that its impacts on monthly utility bills by 2030 ranged from a $5.60 decrease to a $2.80 increase. The Peterson Institute analysis of Kerry-Lieberman found that by 2030, monthly utility bills would range between a $0.67 decrease and a $2.62 increase.

The potential decrease in monthly electric bills is due to the energy efficiency programs established through the bill's provisions. Though energy prices are expected to increase modestly, energy consumption is expected to counteract these increases as households take advantage of these energy efficiency programs.

Impact on Household Costs

The analyses of Waxman-Markey concluded that the bill would cost the average American household between $84 and $160 per year by 2020, which corresponds to $0.67 to $1.28 per person per week. The majority of the increase comes through increased gasoline costs. The studies also concluded that the costs would be lower for lower income families. For example, the CBO analysis of Waxman-Markey concluded that families in the lowest income quintile would see a net decrease in average annual costs of about $125 in 2020 due to low-income assistance provisions (CBPP 2009).

Over the entire span of the Waxman-Markey bill (to 2050), EPA found the average annual cost would be $80 to $110 per household in current dollars (64 to 88 cents per person per week).

Bottom Line - Carbon Pricing is Relatively Cheap

To summarize, most of these economic analyses agree that a carbon pricing policy will reduce US GDP by less than 1% over the next 10–40 years as compared to an unrealistically optimistic BAU scenario in which climate change does not impact the economy. The analyses also concluded that the evaluated policies would reduce the federal deficit. Gas prices would rise somewhere between 3% and 12% over the next 20 years compared to BAU. Although energy prices would rise modestly, energy costs would be offset through increased efficiency. Total household costs would rise somewhere in the ballpark of 75 cents per person per week. Studies which conclude costs will be significantly higher either make unrealistic assumptions or only consider half of the picture.

In addition, energy independence and air quality would be improved. The reduction in GHG emissions would be a major step toward addressing both climate change and ocean acidification, although these beneficial impacts were not included in these economic analyses.

In short, even when compared to the perfect world where climate change has no impact on the economy, carbon pricing would have a very minimal economic impact, and would have several ancillary benefits. Compared to the real world in which unchecked increasing GHG emissions will certainly lead to numerous adverse economic impacts, putting a price on carbon emissions to reduce those impacts will almost certainly prove to be a net economic benefit.

This post is the Intermediate version (written by Dana Nuccitelli [dana1981]) of the skeptic argument "CO2 limits will harm the economy".

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Comments 1 to 50 out of 54:

  1. The major flaw in all of the mentioned studies is that non could have forseen nor implimented the current economic distress of the world. The precarious nature of most major countries economies for the forseeable future because of the explosion of government(local/state/federal) debt will be a continuous drag on the growth level of GDP of the world.
    A world wide growth level of 2% per annum, impacted by carbon pricing costs of .5 to 1.0% of GDP is not acceptable and will only cause even more widespread unrest.
    We are in perilous times, the cause of which is not carbon based but financially based from over extension.
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  2. Camburn - the analyses of Waxman-Markey and Kerry-Lieberman were done during the current economic distress.

    You're also ignoring the fact that unabated climate change will also have an adverse impact on the global economy.
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  3. And the costs aren't .5 to 1% per annum either.
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  4. Camburn:

    An ounce of prevention is worth a pound of cure. The costs of future AGW consequences will reach 20% of GDP in the BAU scenario. I read this over and over from climate progress. This was also not covered in this article. Possibly for a little more advanced version of this could be included in a future article of "co2 limits will hurt the economy".

    Plus if this is designed correctly, it helps the poor, reduces the trade deficit, efficiency of automobiles is increased which can actually lower the cost of transportation. Semi trucks will be forced to give up freight to the railroad because it is more efficient. The person that plays their cards right reduces costs and gains more financial and energy security in an uncertain future.
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  5. Dana1981:
    The analyses of Waxman-Markey totally ignored the current economic distress. It thought it would be temporary. The rise of debt to GDP just in the US is not temporary.
    renewable guy:
    Semi trucks have become predominant because the rail road is so inefficient at moving perishable cargo. That is why you see most semi trucks pulling a reefer type trailer.
    We differ on the cost of future GAWG consequences. I see any mitigation required as adding to GDP rather than subtracting from it. The reason being that climate moves so slowly that mitigation will be like building the interstate highway system. We aren't going to wake up tomorrow to an earth temp 2.0C warmer than yesterday.
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  6. Alec Cowan,
    What are the costs then?
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  7. http://climateprogress.org/2010/11/14/debt-commission-carbon-budget/#more-36867

    Climate Progress is probably one of the best I know for talking about costs of AGW. Cap and trade will reduce our dependence on oil over time by 200 billion a year. Reducing our trade deficit by half. Cap and trade is a wise investment in the future of any country that practices it. Becoming energy independent is the best investment any country could make in themselves.

    The failure of a business is to not recognize the importance of long term planning taking carbon into their business models. Increasing carbon into the atmosphere will cost much more than reducing carbon for our energy consumption. Short term thinking will only get us problems down the road. The benefits have been laid out for us to look at. We need businesses to see the importance of long term goals of the world society. This has to go wider than just profits to investors.
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  8. renweable guy:
    This isn't about profits to investors. IF that was the case, the Carbon Exchange in Chicago would not have shut down.
    This is about the economic impact to people.
    Fossil fuels are finite, no question about that unless you are Russian. The cost of fossil fuels will go up as they become more scarce. They are doing so now in case you haven't noticed.
    That, in and off itself, will drive people to conservation all on their own. IT is called economic self interest.
    Business is wayyyyyy ahead of cap and trade on carbon issues. One looks at energy consumption as a cost and does everything possible to reduce that cost. It is much much cheaper to insulate a building, install new windows etc than it is to pay the price of increased energy. That is one of the reasons that the US is a low, per unit of production, energy consumer.
    Short term thinking will get us cap and trade with no decernable effect on temperatures. The Copenhagen accords would have resulted in how much of a decrease in temps if the models are to be believed?
    Provide the figure if you would. And for that measely decrease, what would be the cost?
    Think in terms of economic stress, not only dollars, pounds, rubles etc.
    Cap and trade is an idea that was started by Enron, endorsed by Goldman Sachs. Why do you think they invested so much money in the concept?
    Prof Hansen sees through the smoke and mirrors of this idea. I have to agree with him in that it is about the most stupid idea that has every come about with regards to co2 restraints.
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  9. The first problem with the above analyses is the assumption that GDP is a valid measure of a society's well being. GDP has been criticised by a number of economists including Nordhaus, Tobin and Daly who developed an alternative measure (ISEW: Index of Sustainable Economic Welfare).
    The second problem is the assumption that ongoing economic growth ( particularly in the US) is desirable. There is now a solid body of economic literature including work by Herman Daly and others which demonstrates that endless economic growth is not possible in our finite world.
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  10. @Camburn at #5: Mitigation is a drain on GDP - if you have to spend 20% of GDP due to effects of climate change, that is not an increase in GDP - it's a very large pile of money & resources that have to be spent to fix a problem, that might otherwise be spend elsewhere.

    Your analogy of the interstate system is incorrect. The interstate road system is enabling infrastructure. The increases in commerce, trade, and other economic activity that it enabled more than paid for it's construction. Mitigation of climate change, on the other hand - how does it help the GDP if you have to evacuate every city below 5m above sea level, and reconstruct them on higher ground? How does it boost GDP to repair damage after more severe weather events? How is GDP increased by crop failures or increased mortality from heatwaves?

    These are all the sorts of effects that may occur from global warming induced climate change. I don't for a second doubt that there is the potential for some people to make a lot of money out of it (construction firms, for instance, will be busy for centuries rebuilding coastal cities on higher ground), but I'm afraid I don't see how that's a good thing for the economy, overall.

    It's like saying a plague is good for the economy, because all those extra coffins & burials cause a boom for the undertaking business...
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  11. Bern:
    At the rate of climate change, mitigation is NOT a drain on GDP.
    5m sea rise? How many centuries is that going to take?
    More people die every year from cold than die from heat.
    And when you talk heat waves....there have always been heat waves.
    Even the Russian heat wave this summer is not out of the ordinary climate wise. Look at Russian history please.
    (Besides, the cause was not from co2).
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    Moderator Response: You make claims regarding many topics (covered elsewhere on this site), yet furnish no links for others to read and learn from. If you wish to make contributions to the individual threads whose topics you touch upon, please use the search engine at the upper left of each page for the most appropriate thread. Thanks for your compliance on this. Comments deemed off-topic will be deleted from the inappropriate threads.
  12. Russian heat wave:
    Black Swan Event not related to GAWG.
    So says Dr. Martin P. Hoerling of NOAA. But I have drifted off topic.
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    Moderator Response: When making claims, please furnish a link for others' edification.
  13. Camburn, please make up your mind. First you say these analyses could not forsee the economic problems which were already underway when they were done. Then you say the analyses ignored the current economic distress because they assumed it would be temporary - which is obviously true! I certainly hope you don't think the recession is permanent.

    Bern @ #10 is referencing the Stern Report (5-20% of GDP spent on mitigation). Your suggestion that mitigation will be cheap because sea level won't rise 5 meters is just a wee bit ridiculously oversimplified and wrong.

    Phil263 #9 - you may have noticed that GDP was only one of many economic factors analyzed here.
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  14. dana1981:
    I really wish that the current economic distress will be temporary. However, economic history shows that this is far from a temporary condition. The void of leadership in the USA fortells of more floundering, rather than solutions to the debt crisis presented and acted upon.
    A rise in sea levels of 5 meters will not happen overnight, if it happens at all.
    According to climate models, a reduction in co2 growth would result in a decline in the projected temp trend of .1C by 2050.
    Do you really think that a .1C reduction in the rise of temp is going to change the sea levels by any degree?
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  15. Response to moderator:
    http://therese-phil.livejournal.com/171196.html

    Google translator will tranlate the link of historical Russian heat waves.

    This is off topic for this discussion and I will not comment on Russia again.
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  16. I'm suspicious about any economist who predicts the GDP in 40 years time to a precision of 0.01%! ("The main exception is the IGEM analysis, which finds a 2.15% reduction in GDP for the Lieberman-Warner by bill by 2030, and a 3.59% reduction by 2050").
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  17. Mike, that coal is almost certainly going to run out one day-the faster we use it, the faster it will disappear. When it runs out, so too will the jobs & the money. So we have a choice: accept the need to switch to *sustainable* jobs before the source of your regions prosperity runs dry, or wait until after the coal is gone, & watch the whole area go the way of a host of Rust Belt Towns.
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  18. I find it odd though, Mike, that some people accept the word of economists as Gospel Truth in matters relating to Privatization & De-regulation; yet they're suddenly not to be trusted the moment they start modeling the potential impacts of CO2 mitigation. For the record, a number of Economists *did* see the recent GFC coming, but their calls for action were largely ignored by a Republican Dominated Congress.
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  19. Camburn:

    Cap and trade is about investing our way out of a serious problem. It seems that this 200 billion for the United States for instance in oil imports would be a really good target for the US to work on as well as other countries. Strategic investment while pulling ourselves out of a slump. The government being the stimulus to move in a more self sufficient direction. The market will kick in its stimulus a little too late when we are already at the point of panic. To prepare for the problems down the road eases the magnitude of crisis. For instance cap and trade will accelerate us towards the solution for Peak Oil.
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  20. Dana

    Even though you mentioned other variables, GDP IS your headline indicator. I also note that "utility bills" "Gasoline prices" and "household costs" are all sub-variables that will come somewhere under the GDP calculation.
    What about costs such as: loss of clean air and clean water due to economic activity, loss of species,loss of pristine landscapes such as the Great Barrier Reef.... I know hard to quantify, but real nonetheless!

    And...you haven't addressed my second objection: IS ongoing economic growth (measured by GDP) sustainable and desirable? Can we keep using non-renewable resources as infinitum? Can we exploit renewable resources below replacement capacity?
    Reducing our carbon emissions is urgent, but the debate about human economic activities should be far broader.
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  21. Camburn:
    *******************************************************************
    According to climate models, a reduction in co2 growth would result in a decline in the projected temp trend of .1C by 2050.
    Do you really think that a .1C reduction in the rise of temp is going to change the sea levels by any degree?
    ******************************************************************

    Moving the average earth temperature downward is a win and cap and trade can acheive that. And do so at a profit. When businesses get the economic signal from cap and trade, they will look at their bottom line and look for the way to acheive the carbon goals in the most efficient way. Cap and trade frees up the businesses to acheive the goals in the cheapest, most timely fashion.

    http://www.edf.org/page.cfm?tagID=1085

    The site above does a nice job of tieing the financial incentives with reducing carbon emissions.
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  22. Mike - I provided links to the studies and models where possible.

    Phil263 - your second question is beyond the scope of this discussion.

    Camburn - by itself, a single country's cap and trade system would not have a significant impact on global temperatures. But we don't act in a vacuum. If the USA enacts serious climate legislation, other countries will follow suit. If we don't, they'll use our inaction as an excuse for their own (i.e. see Australia and Canada).
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  23. One little flaw in all this. What if the people don't want it? I mean, just hypothetically, what if they vote out the politicians who favor this kind of legislation?

    @renewable guy
    To move the average temperature down you have to remove carbon, and you have to do it now. Cap and Trade won't do that. Planting trees will.
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  24. The problem, TOP, is that the people are making these decisions based largely on falsehoods. Simple actions like improvements in fuel & energy efficiency will not only reduce CO2 emissions (by as much as 20% or more) but also reduce people's energy & fuel bills. Yet if you even suggest that to most people (especially those who listen to the mainstream press too much) they look at you like you're some kind of *Communist*!
    As to planting trees, TOP, well that's all well & good but-where do you suggest? Our global population grows in leaps & bounds-& forests are usually the first to go in our desire for living space. When you can convince the Economic Fundamentalists that forests are more important than more population growth, then you'll really have achieved something!
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  25. Dana

    "Economic impacts of carbon pricing" Hmmm!

    I thought that discussing the paradign used to assess these impacts would be relevant...Any way It doesn't matter. If you've got a chance, I suggest the following:
    Daly, H 1997: Beyond growth, the economics of sustainable development
    Jackson T 2009, Prosperity without Growth: economics for a finite planet
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  26. #6 @Robert Way

    Whatever you had in mind when you asked, costs in terms of relinquished GDP growth are in table 1.

    As the initial "and" let you deduct, my answer was intended for Camburn (#1) who seems to be arguing "something must be done but not in this very moment" by comparing something recurrent -annual- with some one time cost depicted as abruptly incurred. This new argument is the way to get a new ten-year delay and it is the expected response to this site's 'moving into solutions' new approach.

    So, I expect more of this kind: A comparing a function and it's derivative in an argument, B pointing that fact and C asking B 'so, what's the function then?'.
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  27. I hope I may be allowed to make an observation on Camburn's posts above. If he/she wants to take it further, I suggest moving the discussion to Extreme weather isn't caused by global warming.


    Camburn wrote : "Russian heat wave:
    Black Swan Event not related to GAWG.
    So says Dr. Martin P. Hoerling of NOAA."


    As usual, things are not quite as simple as some would have us believe :

    As we learn from our 2010 experience what a sustained heat wave of +5ºC to+10ºC implies for human health, water resources, and agricultural productivity, a more meaningful appreciation for the potential consequences of the projected climate changes will emerge. It is clear that the random occurrence of a summertime block in the presence of the projected changes in future surface temperature would produce heat waves materially more severe than the 2010 event.
    The Russian Heat Wave of 2010 - Dr. Martin Hoerling



    As for Camburn's second link (HERE in translation), it is a collection of stories and reports, without any comparative data whatsover. Would anyone rely on this rather than something like the previous NOAA report ?
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  28. @Dana

    Thanks for your efforts.

    You might be interested in reading the report from the Danish Climate Commission (it is also in English).
    www.klimakommissionen.dk
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  29. Ok, now a derogatory comment on my own country, Brazil.

    Back-of-the-envelope bill: stop deforestation now, effectively cutting down 1994 emissions by some 20-30% immediately, with very marginal impacts to national GDP (logging in the Amazon is about 0.07% of the national GDP).

    Here's our emission inventory. Unfortunately in Portuguese, but the wrap-up graph on the last page is understandable with minimal google translating work.
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  30. Very good topic, btw. About time.
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  31. Here's a different way of visualizing the costs of cap-and-trade that shows just how small they really are:

    http://akwag.blogspot.com/2009/09/visualizing-costs-of-cap-and-trade.html
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  32. "When a price is put on carbon emissions [government sells allowances], it creates a revenue stream." True. "The funds which are generated from the carbon price can be distributed in any number of ways – usually through reductions in other taxes, investment in research and development of 'green' technologies, funding of energy efficiency programs, etc." Not necessarily. The money can also be wasted, here is a libertarian response http://townhall.com/columnists/RobertMurphy/2009/05/02/the_cost_of_cap_and_trade/page/full/
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  33. Eric (34), if you are a "skeptic" about government spending, then you should equally advocate a cap-and-trade bill or a carbon tax while demanding tax cuts, not just scrapping economic action against climate change altogether. "Government wastes money" is a poor excuse and just amounts to a simplist libertarian pirouette against taking action against global warming just because the Gov't is involved. Reasonable libertarian-leaning economists support cap-and-trade (for example, Tyler Cowen). There are even some cap-and-dividend proposals which involve directly handing over the money to the citizens, therefore deflecting your critique.

    One small remark:

    "> The IGEM model is an outlier because it assumes when the price of energy (and other goods and services) rises, people will respond by choosing to work less than they otherwise would (EDF 2008). This is a counter-intuitive and illogical assumption, since increasing costs generally result in people working more to increase income correspondingly"

    Actually, this is a bit more complex. Economic theory says that price changes have _both_ a "substitution effect" (if working is less useful, people work less) and an "income effect" (if work "pays less", people will try to work more in order to "offset" its effects). Both effects do exist in the real world, and which effect is stronger depends on a lot of things and it is an empirical question rather than a theoretical one. AFAIK some economists find a significant substitution effect in the economy as a whole (Prescott) while others report a smaller one. I don't know in depth what does the literature say, but I wouldn't go so far as to declare substitution effects "illogical" or "counter-intuitive". They're just as real as income effects, the real question is whether they are big or small. This is relevant for a number of reasons beyond climate change (tax policy, for example).
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  34. Some believe any government intervention puts us on slippery slope to world socialism. If they admit climate change or warming is occurring and has human causes, then they also admit the need for government intervention. They won’t do that.

    The irony is that the more they delay political and economic action to correct this problem, the greater the crisis will become and eventually much more radical government interference will be needed than if we had started addressing the problem earlier. Imagine, perhaps, CO2 rationing. We only need to look at airport security today to understand how much governments will spend when they perceive a matter to be urgent, and the freedom we will lose in the process.
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  35. Might I add that government/international regulation of pollutants (either a cap and trade on sulphur emissions or the phase-out of CFCs has been succesful in the past.

    As such, there is no a priori reason why some effort to regulate carbon emissions in a similar manner is destined to fail.

    Further to SoundOff's comment #36, airport security is as bad as it is because governments perceive the need to be seen doing something immediately. This leads to such wonderful ideas as full-body scans. Personally, I'd prefer that they take steps now, carefully and rationally, to do something about greenhouse gas emissions instead of trying to be seen doing something about them in a panic in 10-15 years.
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  36. SoundOff@36 & Composer99 @ 37

    The main advantage of market solutions such as C&T and carbon tax is that it internalise external costs into the cost of the polluting process. For that reason, this approach for dealing with externalities is preferred by most (neo-classical) economists over the regulatory approach. Businesses on the other hand tend to prefer regulations as they generally have the lobbying power to influence the design and implementation of regulation and make it as "toothless" as possible.
    Pricing carbon on the other hand (either through a carbon tax or using C & T) means that the cost of polluting has to be met and passed on.

    This is one of the reason why conservative political parties (eg the opposition in Australia) favour regulation and resist the adoption of a C & T scheme. They prefer calling it a "carbon tax" as this sounds very "evil" when it is actually a market based solution.
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  37. I’m agnostic about which method should be used but I lean towards Cap & Trade if it’s done right. Part of right is a meaningful cap and no (or few) free allocations handed out at start-up. I worry somewhat about the trading mechanism (will we have CO2 derivatives?) but I think the biggest issue is measuring the emissions of all the players to see that they actually stay within the allocations they purchase. It’s workable when the number of players is relatively small, as was the case for sulphur emissions by power plants to combat acid rain.

    I don’t have the expertise to assess whether society can monitor GHG emissions with the necessary resolution – player by player – though I think so for the larger players. And I don’t know that the idea of returning C&T revenues to the public coffers to reduce taxes is really productive, as some have suggested be done. That just removes the capital from the innovation process that will find new low emission means of energy production, manufacturing, etc. and the subsequent updating to use that new technology. It just prolongs the problem. Can others fill in some of the blanks?
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  38. * The Cantwell/Collins Cap and Dividend bill should be addressed (this is simply a tax, that is then refunded to the American people) www.capanddividend.org

    It is the most efficient because it is a tax (you tax what you don't want).

    I don't believe these studies adequately consider innovation. When you put a tax on Americans - they respond with innovation to avoid the tax. Some will work against the policy - buying gas in Mexico, black market fuel, etc. Some will be neutral - under-the-table biodiesel, for example. Some will be good - increased insulation, car pooling, buying more fuel/energy efficient products (this is what IS in the analysis).

    Some will be very bad - burning everything. The initial response will be a run on wood stoves, and a huge increase in burning wood/tires/trash for heat (this is "renewable" in the same vague way that mashed potatoes are renewable. Yes you can regrow the wood, yes it is current cycle carbon but NO it is not good for our air quality, and it will release a few hundred years of current cycle carbon in about a decade plus all sorts of products of combustion nasties).

    And there WILL be paradigm shifting solutions that are to the good. The rate of increase in PV efficiency will increase, solar thermal with above 100% energy conversions (imagine reflectors and other concentrators), wind/wave stuff that is economically viable. This is baked in the models. But the paradigm shift is not (a technology that we are either not thinking about, or currently believe it is on the 50-year horizon). The breakthrough that a tax on energy WILL produce because

    AMERICANS HATE TAXES!

    So I will go on record to say that a tax on carbon (especially an efficient one like cap and dividend) will actually INCREASE the GDP over BAU by at least 1%.

    Another thing that I doubt is in the models is what Americans will do with the money from the energy savings. I have customers who are increasing their retirement savings, using their savings to double down on renewables (ie add renewable electric in a round 2 of energy investments). I have customers who are using the savings to invest in education. I myself am doing two things - affording a house I otherwise could not (somewhat of a waste...) and saving up for my own double down with PV/wind.

    In other words, there will be tons of unintended consequences from any tax effort - but you can predict that the upside will easily outweigh the downside.

    (note to the wise - when the tax policy comes into existence and energy prices approach a true cost - incentives will evaporate (no longer necessary). Put in your renewable systems now, with the incentives and laugh all the way to the bank when cap and trade or cap and dividend or a straight tax finally comes to be). Even if the tax never comes, you will make (save) money just based on the inflation of energy costs.)
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  39. Cap and trade is an idea that is dead in the US. Thankfully.
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  40. @42: What is it exactly that you oppose about "Cap and Trade"? I would think that you'd be in favor of market-based solutions...

    Personally, I'm for legislated limits, but then again I'm not a Laissez-faire proponent and I believe markets should in general be regulated.
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  41. #42: "Cap and trade is an idea that is dead in the US."

    Sounds like the old MP dead parrot routine: 'This parrot Cap and trade is deceased. It is a late parrot.'

    No, it's not dead yet:

    Barclays Capital announced today the first forward trade of Carbon Allowances created under California's Cap-and-Trade program, the California Climate Solutions Act

    But for California, real Americans will no doubt be proud to watch Europe leave us in our own carbon dust.

    America’s only nationwide carbon trading market will shut its doors next month, a tacit acknowledegment that Republican gains in Congress spell doom for any sort of federal greenhouse gas regulations. But other countries — even mega-polluter China — are ready to fill the void.
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  42. @43:
    Let China fill that void. It seems that they are building more coal fired power plants every day.
    http://www.nytimes.com/2009/05/11/world/asia/11coal.html?_r=1
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  43. Camburn - China is leading in both coal plants and renewables. China is big.

    This says nothing about the validity of cap and trade as a market based solution to the climate disruption problem.
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  44. I found this blog post very interesting, well presented and valuable. It doubtless took a ton of work as well. Thank you, Dana!

    I guess I’m having a hard time believing that these large reductions in CO2 emissions by 2050 from Lieberman-Warner and Waxman-Markey (70% and 83% below 2005 levels) are capable of being achieved with such small increases in gasoline prices. The gasoline price increase by 2030 (not the 2050 end-point of the emissions reductions estimates) given is just 42¢/gallon from Lieberman-Warner (MIT model estimate); and only 22¢ - 35¢/gallon from Waxman-Markey (EIA model estimate), again by 2030.

    Of course, these should be considered more or less equilibrium gasoline price level increases (i.e. one can assume many long-term adjustments have been made by consumers). And another part of the problem is that we don’t have estimated CO2 emission reductions for either bill by 2030, but rather for 2020 and 2050. Assuming a simple linear trend between 2020 and 2050 would give a 33% reduction in CO2 emissions by 2030 from Lieberman-Warner; and a 39% reduction in CO2 emissions by 2030 from Lieberman-Markey. Clearly these aren’t up there at those high 2050 endpoint reductions, but neither are they trivial in size.

    A couple of meta-analyses of the price elasticity of demand for gasoline in the US give estimates around -.58 to -.64, meaning that a 10% increase in the price of gasoline would lead in the long run to a decline in the demand for gasoline of around 6%. As we are given that these 2030 estimated increases in the price of gas are in the neighborhood of 9% -12% (relative to BAU), with our elasticity of demand (long run) estimates we would expect a 6% to 8% reduction in demand for gas (Markey and Warner respectively).

    The only way I can reconcile the difference between 22-42¢/gallon price increases in gas and reductions in CO2 emissions by 2030 of 33% to 39% is if there were some very large short-term price increases in gasoline between 2012 and 2030 that induce some very significant changes in efficiency of cars (especially, since they would persist) and/or driving habits. And then these changes in efficiency (especially) and driving habits reduce demand and dampen down the rise in gas prices by 2030. [Of course, the percentage reductions in CO2 emissions across different sectors like automobile transportation, housing and manufacturing may vary substantially from proportional as I’ve assumed here.] Finally, I guess it’s possible that some psychological factors like heightened concern for the impacts of ACC could come into play to induce people to reduce their demand for gasoline from a given price increase by more than standard estimates suggest. But those are the kinds of things I would not want to bet too much of my lunch money on. More to the point, I would think that modelers would find these too hard to quantify to take these into account, but I may be wrong here.

    Anyone have any other thoughts on this? BTW, I’m about as far away from being a skeptic as concerns ACC as one can get in this world. I’m just puzzled by the relative size of the estimates of the impacts of these proposed CT bills on CO2 emissions compared to intermediate outcomes like gas prices.
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  45. Gestur - re-analysis is always useful. I don't think Waxman would be front loaded, as they were trying to pass it, which inevitably means put the pain off.

    However, when we had $4 gas in Bush's last year - it sure seemed like there was a tipping point achieved and the gas guzzlers were seen as a HUGE liability. I doubt this can be modeled, but somewhere between $4 and $5 gas this country will start to pay attention to fuel economy, and switch from marketing for excess (SUV) to marketing for usefulness (this vehicle converts a set amount of fuel to a further distance traveled/weight hauled). One could look at Europe - they have figured out how to tax energy (and grow their economies.

    Also, are those figures restricted to transportation? Anytime you reduce coal your numbers look pretty good because coal is so CO2 rich. So the big documented savings may be in the electricity side.
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  46. actually thoughtful, $4 per gallon?

    Yesterday morning, petrol was 1.33 a litre at my nearest servo, which is just over $5 a US gallon. I managed to buy some in the afternoon for the wonderful bargain price of 1.15. $4.35 a gallon.

    I do not understand why petrol is so cheap in the USA. I do not understand why people think that the USA could not survive if prices were higher.
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  47. actually thoughtfull--Thanks very much for your thoughtful comments.

    Your response got me to do what I should have done in the first place and that’s to look at the CO2 emissions by economic sector and then think about how a carbon tax would actually work in the economy. The assumption that I used in my back-of-the-envelope exercise (I wouldn’t grace it by calling it a re-analysis)—that the CO2 reductions should be more or less proportional across all the economic sectors—was naïve at best, at very best. What I relatively quickly realized is that a tax of a specified amount on a ton of carbon would represent quite different amounts of the prices of various products due to the quite different amounts of carbon in the final products. Specifically, the initiation of a carbon-tax would entail a larger _percentage_ increase in the price of ten thousand tons of delivered coal than it would for the price of 100 gallons of gasoline at the station. Consequently, other things constant like elasticities of demand, the drop in CO2 emissions by product or sector will not be anywhere close to proportional.

    And by the first end-point of 2030, I think that this consideration likely explains by itself—given that the reductions in total CO2 emissions are modest enough—why the contribution of coal-generated electricity could be pretty out-sized, as you correctly note, and why the contribution of gasoline could be pretty small proportionately, as I puzzled over.

    That noted, when we move to the last end-point of 2050, things become more complicated. Looking at the CO2 emissions by economic sector, according to the EPA and in 2006, electricity accounted for 41% of CO2 emissions in the US, and eyeballing the bar graph, it looks like a good 80% of that is from coal. [Seems high to me based on where I live where it’s closer to 60%, but there are very large differences regionally across the US.] Given that the substitutes for coal in electric generation will be dominated by natural gas (although hopefully renewables will not be trivial), we will get some significant reductions in CO2 emissions from reduced use of coal but it won’t come close to being 41% x 80% , or ~ 21%. And currently (~2006), eyeballing again from the bar graphs, it looks like around 32% of CO2 emissions in the US are accounted for by transportation, and 2/3 of this, according to the EPA, is accounted for by cars and light trucks. So perhaps around 21% of CO2 emissions in the US are the result of cars and light trucks and hence the gasoline that drives them. So this tells me that by 2050 we would need to have a very substantially higher carbon tax in order to effect the reductions in CO2 emissions estimated, and that would imply some substantially higher prices of gasoline. Of course, we weren’t given those intermediate model outcomes for 2050 for the various bills. If I want to think about this some more, I need to dig into these models more deeply myself.

    I have to take exception to your comments about the impacts of $4/gallon gas on gasoline consumption, however. For much of the time that these gas prices were ramping up, I was downloading gasoline consumption data and miles driven from various federal websites and then calculating arc-elasticities of demand using these data over various lengths of time. Of course, these were relatively short-term measures of the sensitivity of gasoline consumption to price rises, but before the recession introduced a big income effect and clouded the picture substantially, I was really disheartened by how small these elasticities were. [This was a real pain for someone like me who won’t even drive a car anymore, I must say.] So I don’t really share your view that this period represented a tipping point, although I sure hope it comes soon.

    Finally, and thanking you again for getting me to think a lot more critically about this issue, it occurs to me that I just displayed what a true skeptic should do: someone who can’t quite accept some finding on initial assessment, and then through more critical analysis finds grounds for changing his initial views (or rock-solid support for them).
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  48. Elasticity of demand describes how demand responds to price changes with all else being equal – e.g. alternatives don’t change in price. The goal of additional carbon pricing is not just to discourage fossil fuel usage but to raise capital towards development and use of low-carbon emitting technologies, advances that would change the alternatives available and/or their prices. This greatly complicates our assumptions about elasticity rates over longer time periods.
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  49. Adelady - Are you OK? Can you breathe? As an American, our current political majority leaves me to believe you should be dead right now. We CANNOT survive if fuels are priced anywhere near their actual cost (ie over $4/US gallon).
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  50. Gestur,
    If you share some links about where you are looking I will waive my eyeballs over the graphs too. Coal accounting for 80% of electricity emissions makes sense - I think source 2 and 3 are zero carbon (ie nuclear and hydro-electric). Then you get to gas, which of course does have emissions.

    As to 2050 - let's get this puppy started. I doubt that whatever policy we have now will have any bearing on 2050. Course corrections will be required.

    Regarding behavior changes. We only had about 6 months in 2008 to pull your data. I am giving you anecdotal evidence, both from people I knew looking for/buying cars, and from my solar thermal business, which went through the roof at that moment, and has since almost collapsed. Incredibly fuel priced sensitive (in my little corner of the universe).

    And, as SoundOff points out - whatever we are doing now doesn't really matter. As soon as we price in carbon, significant breakthroughs will occur (not the least of which will be behavior changes).

    We really, really, really need to take the baby step of putting a tax on carbon.
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