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What if we’ve had carbon taxes backwards all along?

The best way to use a carbon tax to fight climate change would be to set the initial carbon price high, increase it modestly for about a decade, and then let it fall slowly over the next few centuries.
October 8, 2019

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The best way to use a carbon tax to fight climate change would be to set the initial carbon price high, increase it modestly for about a decade, and then let it fall slowly over the next few centuries, researchers reported last week in the Proceedings of the National Academy of Sciences.

That’s opposite to the conclusions of conventional climate-economy models, which generally suggest that carbon taxes should start fairly low and increase gradually over time.

The reason for the difference is that the new model, dubbed EZ-Climate, incorporates the costs of uncertainty and the value of avoiding climate risks.

Conventional climate-economy models used for the last quarter-century don’t represent risk and uncertainty very well. People have known these concepts are important, but have struggled to incorporate them into models because it is so complicated and often requires outsized computing power to do so.

The new model pulls off this feat while keeping things simple by making use of an approach common in financial economics. The researchers treated carbon pollution as an “asset” – but one expected to yield negative returns rather than increasing in value over time.

“Unlike most modeled CO2 price paths, ours typically rise briefly before declining over time,” the researchers write.

One reason for this is that a higher initial tax will result in faster decarbonization. As technology advances and it becomes cheaper and easier to reduce emissions, the carbon tax can also be reduced.

In addition, the high initial price of carbon reflects uncertainty: What will the effects of climate change be? Are there catastrophic tipping points? What are the best adaptation strategies?

Those high-stakes questions mean that early on, decarbonization is valuable “insurance,” a hedge against disaster. As time goes on – and, hopefully, those climate tipping points are avoided – uncertainty resolves and the price on carbon can also fall.

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The analysis doesn’t yield a firm answer as to what the initial price of carbon should be. That depends on the assumptions used to calibrate the model. But it could be up to $200 per ton of CO2 – much higher than most of the policies in place or under consideration around the world today.

“None of the uncertainty around the ‘right’ price per ton of CO2 means we should delay implementing much stronger climate policy — a much higher price than we currently have,” says study team member Gernot Wagner, associate professor of environmental studies at New York University. “The costs of delay are indeed enormous.”

Wagner and his colleagues calculated that putting off a carbon tax by just one year results in additional climate change impacts costing $1 trillion. The cost of delay accelerates over time, so dragging our feet for 5 years results in a cost of $24 trillion, and 10 years a whopping $100 trillion.

“Of course, I’m under no illusion here,” Wagner says. Carbon tax advocates have struggled to put – or keep – in place much lower carbon prices. In that context, the feasibility of imposing a carbon price of $100 per ton or even more looks pretty grim.

But, Wagner points out, the analysis suggests that policies that are often dismissed as “too expensive,” including Green New Deal policies in the U.S., could in fact be right on the money.

Source: Daniel K.D.. et al.Declining CO2 price paths.” Proceedings of the National Academy of Sciences 2019.

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