The Unassuming Economist

From a new paper by Tarek Atalla, Simona Bigerna and Carlo Andrea Bollino:

“In the global carbon policy debate, pricing is considered to be a key instrument to achieving the desired levels of emissions reductions.

The Pigouvian tax is theoretically the best solution to tax carbon emissions, in order to achieve emissions reduction through financial investment, but it has not proved to be politically viable. A Pigouvian tax sets out to correct negative externalities, or consequences for society – such as the consequences of climate change – by levying additional taxes. However, from the viewpoint of the private sector, such taxation imposes a deadweight loss with respect to the original private equilibrium. This generates political resistance that may impede achieving the theoretical optimal solution.

Most international policy meetings since the Kyoto Protocol agreement have resulted in lukewarm commitments from developed economies and strong resistance from emerging economies over the fair economic allocation of the burden associated with the various calls for emissions reduction. This kind of situation suggests the need for alternative formulations, in the realm of what economists call ‘second-best options,’ to tackle the issue of realistically financing alternative policies.

This paper considers alternative policy formulation aimed at funding investment for climate policies, based on the principle of minimizing deadweight losses associated with taxation and on consumer preferences. (A deadweight loss is the added burden placed on consumers and suppliers when the market equilibrium is altered because of tax, for example. It results when supply and demand are out of equilibrium.)

The policy proposal we examine here is a Ramsey allocation, which aims at designing an economically optimal taxation scheme for financing climate mitigation investments. A Ramsey pricing policy, applied to energy prices, would mean that efficient taxation should be inversely proportional to the consumer (household) energy demand elasticity of the individual country. In other words, the more inelastic a country’s consumer energy demand, the higher the efficient taxation should be in that country. The overall taxation scheme is optimal because it minimizes the deadweight loss.

This strategy is not aimed at directly reducing emissions, and hence energy consumption. It can, in a more general way, help to assist with providing efficient funding for a wider range of policies, such as carbon sequestration, alternative fuels, energy efficiency, and the earth’s albedo enhancing. In this framework, notice that carbon sequestration and artificially enhancing the earth’s albedo represent technological solutions aimed at reducing carbon dioxide (CO2) concentration and adding sunlight reflecting aerosol in the soil
or stratosphere, thereby cooling the climate in a different way than reducing carbon emissions (NAS 1992). The strategy makes explicit use of household preferences, as expressed through their energy demand behavior, econometrically estimated at the world level.

A Ramsey allocation can be integrated into the general principle of mutual cooperation that motivates climate agreements, as it reflects a common but differentiated burden of all parties.”