Fighting Global Warming with Economics

by Brian Dunning
October 1, 2019

Must we find ourselves stuck between two terrible choices: to either do nothing about global warming and suffer unaccountable planetary and economic damage; or to shoot ourselves in the foot by destroying our own economy in order to stave it off? These are the two options most often bandied about by those with minimal understanding of either climate science or economics, and fortunately nobody (that I've heard) is advocating for either one. Today we're going to look at a science based proposal that's already underway in many foreign countries.

Considering a solution to a problem that comes from outside the political sphere is a challenging concept for many people. As many draw their science positions from their political party, they tend to embrace whatever policies their favorite politicians endorse. Such solutions tend to be duly based on divisive politics and not on science — since science doesn't have a political affiliation. Today we're going to look at a solution to global warming based on economic theory — the science of human behavior and how people make decisions based on incentives and self interest. What that means to you, no matter who you are, is that this is a solution aimed directly at your own self interest: in short, it intends for you to make more money. If making more money is of interest to you, I invite you to listen further.

The main thing I want to obliterate today is the straw man argument frequently repeated by deniers of climate science, which is that addressing global warming would "destroy the economy". As it's true that some political figures — and some scientists too, in their roles as private citizens — do advocate for social and economic overhauls and wealth redistribution that include reductions of carbon emissions, we need to be very clear about differentiating between political initiatives and science initiatives. Climate science deniers will often take the most extreme of these political initiatives and mischaracterize them as the only alternative to doing nothing to address global warming. We hardly need to point out the false dichotomy.

There is a proposed solution to global warming well founded upon economic theory, and it would have little to no impact on economic growth. The plan is simple: a carbon tax. If you emit carbon dioxide, those emissions are taxed.

Self Interest vs. Public Interest

One of the fundamental principles of economics is that we should tax the behaviors we want to discourage, and incentivize the behaviors we want to encourage. The reason is both simple and obvious: economic theory shows — and history proves — that people act in their own self interest. Design a system in which it becomes profitable to avoid CO₂ emissions, and people will do it willingly.

This brings us to another fundamental of economics: the difference between self interest and public interest. Many people who accept climate science say that it's in everyone's self interest to avoid CO₂ emissions, since doing so will save countless trillions of dollars in the future. This is wrong. That's public interest, not self interest.

Here is an example of what we mean by that. Let's say the bank where everyone keeps their money blows up in Times Square, and thousands of $100 bills come raining down. It would be in the public interest for everyone to pick up no more than their own account balance, so maybe you and some of your like-minded friends would take only that. But if you think most people wouldn't run around grabbing all they could stuff into their shirt, you're delusional — we have centuries of studies of human behavior (and also just plain common sense) to know that's exactly what would happen. People respond to incentives that appeal to their self interest, like picking up more $100 bills.

How could we get people to take no more than their fair share? Economics gives us the answer. We change the incentives. If we applied a $200 penalty for every bill that people pick up above their fair share, nobody would grab more than that, and everybody would realize the best possible outcome. Only with such a system of incentives and penalties in place does it become true that picking up no more than one's own fair share becomes in everybody's self interest. Applying incentives and penalties is how economists get self interest to match the public interest.

Tragedy of the Commons

This brings us to the next fundamental of human behavior, the tragedy of the commons, defined in 1833 by economist William Lloyd. This is when a system which depends upon people acting in the public interest fails, due to the fact that people actually act in their self interest.

For the sake of illustration, let's assume the hypothetical that for everyone to buy an electric car is the best way to fight global warming, a public interest outcome. But every transaction has more than one side to it; and when you buy an electric car, an internal combustion car sits unsold at the dealership next door. Your purchase has reduced the supply of electric cars, thus increasing the demand for them and raising their price; while the unsold internal combustion car now has a higher relative supply. Higher supply and lower demand means its price comes down, and then they look more attractive to the next person who is car shopping. So your purchase of an electric car — seemingly counterintuitively — incentivizes someone else to buy an internal combustion car, thus negating any benefits to the environment you were hoping to catalyze, and triggering a tragedy of the commons.

No matter how much you personally might choose to act in the public interest, the fact will always remain that most other people will act in their self interest. Any plan and any action to address global warming that depends on people choosing to act in the public interest is doomed to failure in a tragedy of the commons. This is not a guess or an opinion; it is a fundamental tenet of economic theory.

In fact, carrying this concept further, it doesn't take all that much cynicism to see that any individual act to fight global warming — like cutting out steak dinners or putting solar panels on your house — incentivizes someone else to do the opposite. We are living, right now, in a tragedy of the commons; because as the planet warms and the oceans rise and die, we're doing little more than depending on public virtue — which we know must fail.

How a Carbon Tax Could Work

Before you counter that any new tax hurts the economy, hear how such a plan is laid out by economists not to do that. Taxing carbon emissions is not so much a new tax as it is a price correction. Carbon emission has a cost that is not already built into its price, and what that means is that it's underpriced considering its environmental impact. Imagine if a nuclear bomb cost 25 cents: they'd be used all the time, and the planet would be a wasteland. The effect of carbon is much slower than that, but the fact that hydrocarbon fuels are so cheaply and easily accessible has meant that they've been overused in that same way. So really, all we're talking about is correcting the price of carbon to more accurately reflect its effect.

The tax could be applied at the gas pump, on your utility bill, maybe even at the supermarket, anywhere there is consumption of a product with a proven carbon cost. In most proposed models, these taxes would add up to probably no more than a couple of hundred dollars annually per person. But — and it's a big "but" — this won't actually have any net cost to people. The reason is that the best way for the government to use that tax money is to give it right back to everyone as a tax rebate. The more you choose carbon neutral products, the less you pay at the register, and the higher your tax rebate will be compared to what you spent. This system automatically places the public interest outcome into everyone's individual self interest, and it comes at a negligible cost to the economy.

Again, I reiterate, this is not an opinion piece. Check the references at the bottom of the page for plenty of scholarly articles laying out the science behind how and why this works. And let's be clear that any claimed "harm to the economy" is negligible to begin with, and is more than offset by the savings alone to human health from closing coal fired power plants. In 2018, the Stanford Energy Modeling Forum EMF-32 report said of various carbon tax models:

...In every policy scenario, in every model, the U.S. economy continues to grow at or near its long-term average baseline rate, deviating from reference growth by no more than about 0.1% points. We find robust evidence that even the most ambitious carbon tax is consistent with long-term positive economic growth, near baseline rates, not even counting the growth benefits of a less-disrupted climate or lower ambient air pollution.

That the effectiveness of carbon taxes are widely accepted around the world is shown by the number of such programs. Currently over 40 governments, including the European Union member nations, impose some form of carbon tax, and China — the world's largest offender — has been testing them in some provinces in preparation to roll out the world's biggest such program beginning in 2020. The United States and Russia are nearly alone among the biggest economies in failing to implement any such program, although a number of American states have their own carbon tax systems given the lack of a federal one. Finland led the way with a carbon tax in place since 1990, with Sweden close on its heels in 1991. Generally these carbon taxes range from about $10 to $130 per metric ton of CO₂ released.

Most of these carbon taxes around the world are currently implemented as cap and trade programs, which place the incentive on companies rather than on consumers. A benefit of cap and trade programs is that they are easier to implement, as it's much more politically palatable to impose a burden on an industry than on the pocketbooks of the people. According to most economists, either could get us where we need to go if they are properly designed; however most economists — given their preferences — would still choose the carbon tax. For those of you interested in learning more about how a carbon tax would provide huge benefits for the United States without significant impact to the economy, I recommend a 2019 publication from the nonpartisan Brookings Institution, available for free, On the Economics of a Carbon Tax for the United States.

So in conclusion, I will leave you with two thoughts: one for those who embrace climate science, and one for those who reject it. To those who embrace it, you are wrong when you say it's in everyone's self interest to act on global warming. Nothing helpful will result from wishful thinking that everyone will suddenly abandon self interest. To those who reject climate science, you are wrong when you say action to curb emissions will hurt the economy, and even more wrong when you go hyperbolic and claim it will destroy the economy. The science of economics is a friend to all, no matter what side of the political aisle you prefer.

By Brian Dunning
Follow @BrianDunning