Monday, October 24, 2011

The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy

The Drill-Baby Carbon Tax is my proposed grand compromise for energy policy in the United States. As the name suggests, it has two parts. On one side, there would be a national commitment to move ahead with all deliberate speed in developing the vast U.S. fossil fuel energy resources that are now technologically available. On the other side, the United States would enact a appropriate carbon tax to offset concerns over the risks of climate change. The Drill Baby Carbon Tax basically takes the view that while the United States is working on phasing down fossil fuels and moving to alternative energy resource, let's produce a greater share of the fossil fuels that we consume here at home.

Personally, I like both sides of the Drill Baby Carbon Tax. But for many, it's a proposal with something to like and something to loathe. Is there any chance for at least some environmentalists and some of those who favor aggressively developing our domestic energy resources to support such a compromise?

A number of environmentalists have been warning about the dangers of climate change in near-apocalyptic terms. If it is, as often claimed, the preeminent environmental issue our time with a risk of extraordinarily large and even catastrophic costs, then surely a carbon tax should be worth accepting some other tradeoffs.

At a more subtle level of argument, many environmentalists would be horrified by a proposal that would involve taking pollution from U.S. and dumping it elsewhere; but after all, a policy in which the U.S. burns imported fossil fuel is only saving environmental costs in the U.S. while imposing them elsewhere. From a global environmental perspective, if fossil fuel resources are to be developed, better that it happen here under the eye of U.S. regulatory agencies and courts and everyday U.S. citizens, rather than in Nigeria or Russia. Moreover, if energy development was happening in America, U.S. citizens would need to face the reality of what they are using.

By trying to block, for example, a pipeline from Canada that would bring oil from the "tar sands" to the U.S., environmentalists are missing the fact that these resources are going to be developed somewhere in the world--and carbon emissions are the bigger issue. For example, Nature magazine editorialized in its September 15 issue: "In fact, the pipeline protests say more about the sorry state of the environmental agenda than anything else. It is true that greenhouse-gas emissions from oil extracted from the sands are 15–20% higher than those from average crude oil if assessed on a life-cycle basis, but industry officials are correct in pointing out that this is on a par with other dirty oils produced in the United States and elsewhere using steam injection. And halting this pipeline is unlikely to halt development of the tar sands or other dirty sources of energy. What is missing, now as ever, is a policy to address the larger climate threat."

For those in favor of developing U.S. domestic energy resources, it's  important to be clear such a policy isn't going to have much affect on the average price over time, which is set in a global market of supply and demand. However, oil produced in North America is less susceptible to disruptions and cutoffs that can cause sharp fluctuations in world prices and stagger economies. If more oil was produced here, there would be less reason for a U.S. military presence in the Middle East, and fewer trigger points for conflict over oil around the world. Perhaps most important, if oil is going to be produced somewhere, having it produced and refined by U.S. workers creates jobs here, rather than having the U.S. run a large trade deficit in part because of importing oil produced somewhere else. 

Of course, many of those who favor expanding domestic oil drilling don't think the evidence for climate change is very strong, and don't think a carbon tax is justified. But essentially everyone acknowledges that burning fossil fuels creates standard pollutants: sulfur oxides, nitrogen oxides, particulate matter, and the like. Even if reducing carbon emissions is unimportant, reducing these other pollutants has some gains. The distaste for a carbon tax would also have to be weighed against the gains from additional U.S. jobs, a less volatile world energy supply, less pressure to seek political stability in the Middle East, and a lower U.S. trade deficit. And for advocates of developing domestic energy resources, imagine the political power of generously offering a grand compromise that might co-opt and defang the climate change issue!

What might the specific dimensions of the Drill Baby Carbon Tax look like? On the production side, the concrete and goal would be how much the U.S. ramped up its domestic fossil fuel production. Earlier this month, I blogged on "America as a Conventional Energy Powerhouse?", where an energy expert predicts that thanks to horizontal drilling and other technological developments, "[b]y the 2020s, the capital of energy will likely have shifted back to the Western Hemisphere ..." The process here would be make sure that environmental regulations are met, but not to let those regulations be used to shut off developing these fossil fuel resources.

On the carbon tax side, the question is how large a tax is justified by the existing scientific evidence. A useful starting point here is a paper by three economists: Michael Greenstone of MIT and Elizabeth Kopits and Ann Wolverton of the EPA. All three of them participated in a group that tried to calculate a social cost of carbon for the federal government. (Greenstone was Chief Economist on the staff of Obama's Council of Economic Advisers in 2009 and part of 2010.) In March 2011, they published a working paper on "Estimating the Social Cost of Carbon for Use in U.S. Federal Rulemakings: A Summary and Interpretation."

The social cost of carbon (SCC) depends to some extent on what discount rate one uses. A higher discount rate makes future costs less salient in the present, and vice versa. They write (footnotes omitted): "For 2010, the central value is $21 per ton of CO2 emissions and sensitivity analysis is to be conducted at $5, $35, and $65. The $21, $5, and $35 values are based on the average SCC across the models and scenarios examined for the 5, 3, and 2.5 percent discount rates, respectively. The $65 value—the 95th percentile of the SCC distribution at a 3 percent discount rate—was chosen to represent potential higher-than-expected impacts from temperature change.These SCC estimates also grow over time based on rates endogenously determined within each model. For instance, the central value increases to $24 per ton of CO2 in 2015 and $26 per ton of CO2 in 2020."

For economists, of course, a natural approach is to phase in a carbon tax at the level that matches the social cost of carbon, so that users of fossil fuels need to pay the social costs that they are imposing, and will have an incentive to adjust their behavior accordingly. How much of a boost would a carbon tax at these levels cause to, say, gasoline prices? A Congressional Budget Office Report from October 2008 looked at "Climate-Change Policy and CO2 Emissions from Passenger Vehicles." The CBO estimate is that a carbon tax at $28/ton of carbon would add about 25 cents/gallon to the price of gasoline--if gas is $4/gallon, this would be a price increase of about 6%. A carbon tax would also affect coal and natural gas, so those prices would rise as well. This price increase is certainly noticeable; after all, part of the point is to provide incentives to developing non-carbon sources of energy. But on the other side, after the gas and energy price fluctuations of the last few years, it is hardly an unprecedented change for Americans to handle. U.S. gasoline prices, for example, would still be far below the levels common in Europe. In early October, the U.S. Energy Information Administration reported that the average U.S. price for a gallon of regular gas was $3.70, compared with almost $8/gallon in Germany, France, Italy, and the United Kingdom. 

 Of course, I'm well aware that the Drill Baby Carbon Tax would be hard to legislate. At least some of the same environmentalists who complain that people are highly reluctant to believe the science of climate change will be themselves highly reluctant to accept the evidence that a realistic carbon tax should be set at this level--and instead will want something truly punitive. At least some of the those who favor additional development of U.S. fossil fuel resources will be dead set against a tax that would raise the price of this energy.  There would be dispute over how to use the $100 billion or more in likely revenues from a carbon tax of $20-25 per ton of carbon: for example, these revenues could be used as part of a package for long-run reduction of budget deficits, or could finance cuts in other taxes. It would probably be necessary to yoke the rising domestic fossil fuel production and the rising carbon tax together, so neither one could increase without the other increasing as well.

But while the practical details are daunting, perhaps this is one of the rare cases where for both extremes,  the prize is worth the compromise. And I suspect that plenty of folks in the middle might buy into the grand compromise of the Drill Baby Carbon Tax.