Political Economy Constraints on Carbon Pricing Policies

by Makari Krause

While the scientific community and much of the public accept the reality of climate change, little is being done to curb our emissions. There are a number of ways to get emissions in check. You can have command and control regulations, you can use economic means such as a cap and trade system for GHG emissions or a tax on GHG emissions, and you can also provide subsidies or set production quotas for low-carbon energy sources. A lot of research has been done on these different alternatives and unsurprisingly the studies usually find that carbon-pricing policies are the most efficient. In their paper Jenkins et al. (2014) refer to this method of pricing as the “first-best” response or the most cost effective way to accomplish emission mitigation. While economists argue that carbon pricing should be used alone in order to internalize the negative externality, this is rarely the case in the real world. Often pricing policies are combined with many other instruments such as energy efficiency incentives and regulations to meet goals. While this mix of policy instruments may not provide the theoretically most efficient solution, in the real world this theoretical solution may not be attainable and research has shown that a mix of policy instruments may actually provide a better result than using only carbon pricing instruments.

Much of the research showing this has looked at market failures and institutional limitations but there are other political economy constraints that are also a major factor when looking at the efficacy of a carbon pricing system.

One of the most significant constraints is that there are several sectors of the economy that would suffer heavily from the imposition of a carbon price and these sectors would mount significant opposition to the policy. Sectors such as steel, chemicals, fossil energy and mining have fixed assets that depend heavily on maintaining particular market and regulatory conditions. As a result, firms in these sectors face strong incentives to overcome collective action hurdles and work together to influence the regulatory process. With the costs focused largely on a small number of sectors and the benefits widely diffused throughout the population, these small groups are often very capable of shaping policy and blocking mitigation efforts.

Additionally carbon pricing will lead to loss in private welfare and a transfer of welfare to the government through tax revenues and away from consumers and producers. The shift in market equilibrium caused by the new carbon price would also impose costs even if welfare is eventually maximized.

Another major constraint on carbon pricing is that the costs of mitigation are felt directly by private consumers and citizens in the near term while the benefits are primarily felt by future generations and will be dispersed across the entire world. Costs of dealing with climate change will, in fact, be most heavily felt by citizens of the United States while citizens of poorer nations will feel the majority of the benefits. This results in a very low willingness to pay for mitigation. Polling has shown that consumer willingness to pay falls between $80 and $200 per household per year which translates to a carbon price of $2-$8 per ton. At this level, a viable carbon tax would far outstrip consumers’ willingness to pay for mitigation even if the revenues from the tax were used to offset other federal taxes such as income tax. Carbon prices in associated literature fall between $12 and $150. This unwillingness to pay leads to a situation under the carbon price policy scenario that isn’t environmentally efficacious or economically efficient.

In the face of the abovementioned constraints on climate policy, Jenkins et al. believe that second-best policies can achieve superior economic efficiency, environmental efficacy, and political feasibility than carbon pricing policies alone when applied in the real world. Jenkins et al. conclude their paper with a list of policy implications that should be taken into consideration when designing a carbon mitigation strategy:

  1. Policies should be compared to an economically optimal carbon pricing instrument to evaluate their performance
  2. The choice of the policy mechanism itself can affect consumer willingness to pay
  3. Careful attention should be taken to neutralize opposition from energy-intensive manufacturers
  4. Mitigation strategies should aim to link long-term avoided climate damages with near-term benefits
  5. It should be kept in mind that economic and political constraints on the optimal climate policy are not static
  6. Constraints on carbon pricing instruments makes the creative use of resulting revenues critical to maximizing the economic efficiency and environmental efficacy of these instruments

Jenkins, J. D., 2014. Political economy constraints on carbon pricing policies: What are the implications for economic efficiency, environmental efficacy, and climate policy design? Energy Policy 69, 467-477.


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