The economics of climate change can usefully be divided into three parts. The first is determination of the overall objective of climate policy. The economists' approach to this problem is to choose a policy that produces the greatest margin of benefits over costs. Using economic jargon, I will refer to this as the "optimal" policy. Such a policy would stipulate a time path for future emissions of greenhouse gases that could be embodied in an international agreement.
After an overall objective is chosen, the second step is to devise a means of implementing this goal. Emissions of greenhouse gases would have to be allocated among the signatories of an agreement. In addition, emissions by countries that are not signatories would have to be taken into account, since the global climate is affected by total emissions. Third, given an allocation of greenhouse gas emissions among countries, each country would have to implement its emissions goal by devising policies that would hold emissions within the prescribed quota. Furthermore, the international community would have to monitor emissions for all countries.
Let me begin with an evaluation of our existing climate policy, the Climate Change Action Plan (CCAP) of 1993. This Plan consisted of voluntary actions projected to reduce emissions to 1990 levels by the year 2000. The goal was stipulated in the United Nations Framework Convention on Climate Change ratified by the United States in October 1993.
The impact of CCAP is summarized in the final chart, which compares a projection of U.S. emissions of greenhouse gases under the original CCAP "baseline," projecting emissions without the Plan. The CCAP actions were projected to reduce emissions to 1990 levels by the year 2000. The third line on the chart gives actual U.S. emissions through 1996. These are above the CCAP baseline and far above emissions levels required for stabilization. Clearly, we need to consider alternatives to our existing climate policy.
The starting point for a discussion of climate policy is the damages associated with a change in the climate. This is based on combining a physical description of the climate with an economic description of the world economy. This type of analysis is called "integrated assessment" and an assessment of this type has been carried out by William Nordhaus of Yale University in his 1994 book. The loss associated with climate change is 1.34 percent of world product in 2050.
How large are the damages associated with climate change? They are equivalent to the loss of about one year of world economic growth. Obviously, this is sizable, but not overwhelming. In the view of the signatories of the Economists' Statement on Climate change, this is sufficient to justify preventive steps to reduce greenhouse gas emissions.
Next, suppose we choose reductions in emissions that will produce the maximum difference between costs and benefits. How large are the benefits of this policy? Nordhaus has calculated the benefits for the world as a whole to be equivalent to $271 billion dollars. This is only 0.04 percent of future consumption! While damages associated with climate change are substantial, steps to mitigate these damages will produce only very modest effects.
Let me emphasize at this point that the policy I have described conforms to the Economists' Statement on Climate Change. Preventive steps are justified. Policies like the one I have described would reduce greenhouse gas emissions and could employ market-based mechanisms to do so. A policy appropriate for international implementation would be the system of internationally tradeable permits described in the U.S. Climate Change Proposal of January 17.
For domestic implementation of the optimal climate change policy an appropriate market mechanism would be to impose taxes on greenhouse gas emissions. These taxes would be relatively modest, amounting to an initial tax of $5.29 per ton of carbon and rising to $10.03 per ton by the year 2025. My paper with Peter Wilcoxen, "The Economic Effects of a Carbon Tax," analyzes the effects of a tax on emissions of carbon dioxide, the most important greenhouse gas, in greater detail. Wilcoxen and I calculate the cost of achieving various goals, including the stabilization goal of the United Nations Convention. We also consider different methods for "recycling" the revenues from a carbon tax and find that the economic cost is highly dependent on the use of the revenue. Finally, we consider the use of alternative tax instruments, such as a "Btu" tax on energy and an ad valorem tax on energy.
Our overall conclusions are, first, that a carbon tax is superior to other tax instruments. Second, by using the revenues to reduce the most burdensome taxes, namely taxes on income from capital, economic growth can be stimulated rather than retarded. Of course, reducing the tax burden on capital by substituting other forms of taxation would produce similar effects with no effect on emissions of greenhouse gases.
To sum up: The economics of climate change is well understood. The optimal policy, described in more detail in my written testimony, involves a modest reduction in the growth of greenhouse gas emissions. This should provide the basis for any international agreement that would supersede the United Nations Framework Convention of 1994. However, this involves smaller reductions than our existing climate policy, the U.S. Climate Change Action Plan.
The U.S. Climate Change Proposal from last January contains a useful contribution to international implementation by proposing a system of internationally tradeable permits for emissions. Domestic implementation requires a process for setting country-specific quotas for emissions. This might impose lower or higher reductions in emissions for the U.S., relative to other countries. After the U.S. quota has been determined, the final step would be to impose a tax on emissions like the carbon tax discussed in my paper with Wilcoxen.
William J. Clinton and Albert Gore, Jr., THE CLIMATE CHANGE ACTION PLAN, Washington, Executive Office of the President, October 1993.
Dale W. Jorgenson and Peter J. Wilcoxen, "The Economic Effects of a Carbon Tax," in Henry Lee (ed.), SHAPING NATIONAL RESPONSES TO CLIMATE CHANGE, Washington, The Island Press, 1995, pp. 237-260.
William D. Nordhaus, "Analysis of Policies to Slow Global Warming," Chapter 5 in MANAGING THE GLOBAL COMMONS, Cambridge, The MIT Press, 1994, pp. 77-100.
The World Bank, "International Environmental Concerns," Chapter 8 in DEVELOPMENT AND THE ENVIRONMENT, New York, Oxford University Press, 1992, pp. 153-169.
GLOBAL CLIMATE AS A COMMON PROPERTY RESOURCE
A MORE LIMITED ECONOMIST'S ROLE: MINIMIZING THE COST OF ACHIEVING THESE OBJECTIVES
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