Although the distribution of carbon reduction pledges in the Paris Agreement roughly corresponds to the local social cost of carbon (LSCC), the scale of these pledges is largely insufficient to achieve the goals of the Agreement.
Not all regions of the world experience – and will experience – the effects of CO2 emissions in the same way. Some will suffer greatly from the resulting climate change, while others may even benefit. These heterogeneous effects mean that different countries will have different incentives to comply with the 2015 Paris Agreement, a climate change treaty intended to limit global warming to below 2°C above pre-industrial levels.
These different incentives also complicate a classic economic tool for influencing behavior: taxes or prices. Do you want to reduce smoking? Increase taxes on cigarettes. Do you want to encourage the purchase of a house? Offer tax relief. People respond to incentives, and price is a key incentive. In this case, if you want to reduce carbon emissions to a desired level, tax their production accordingly. However, given the heterogeneous effects of CO2 emissions, what are the incentives to impose carbon taxes in different places around the world? How do these incentives relate to the actual promises of the Paris Agreement? What are the implications of these promises for global temperatures and the economies of different regions of the world?
This new research examines these questions using a spatial integrated assessment model that the authors developed in recent work1 determine a local social cost of carbon (LSCC). This allows the authors to address the challenge of linking heterogeneous climate effects to appropriate local action. Very briefly, the authors note the following:
- Most people would object to a policy that simply imposes carbon taxes such that the price of carbon everywhere equals the social cost of carbon. In other words, just as there is no single carbon cost that applies to all regions of the world, neither is there a single tax that will please everyone.
- Setting carbon taxes to meet Paris Agreement targets would mean rates that most, if not all, countries would consider sky-high and unsustainable, exceeding $200 per tonne of CO2 in some scenarios. The authors consider such a policy so unrealistic that they question the feasibility of the 2°C target itself.
- The carbon taxes needed to achieve the Agreement’s objectives would involve very large intertemporal transfers or different effects from one generation to the next. Asking people to pay a high price today so that someone can reap the benefits cheaply in 100 years, in other words, is not an easy political sell. When future generations are valued almost as much as the current generation (including the effect on growth), the resulting welfare gains are small, but negative for most developed countries. They become positive when the elasticity of substitution between clean energy sources and fossil fuels is greater, or when this substitution is easier.
Conclusion: Increasing the elasticity of substitution between energy sources is essential to make the carbon policy required in heterogeneous regions more acceptable.
Originally published by the Energy Policy Institute at the University of Chicago
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Working document: Local carbon policy
We study the local carbon policy to deal with the consequences of climate change. The standard analysis suggests that the social cost of carbon determines the optimal carbon policy. We start by using the integrated spatial assessment model of Cruz and Rossi-Hansberg (2021) to measure the local social monetary cost of CO2 emissions: the local social cost of carbon (LSCC). Although the greatest welfare costs of global warming are concentrated in the hottest regions of the developing world, adjusting for the local marginal utility of income implies that LSCC peaks in hot, low-income regions. high as the southern parts of the United States and Europe, as well as Australia. We then proceed to study the effect of actual carbon reduction commitments in the Paris Agreement and the progress they can make in implementing the expressed goal of keeping the temperature rising. world below 2°C. We find that although the distribution of commitments is roughly in line with the LSCC, their magnitude is largely insufficient to achieve its objectives. The carbon taxes needed to keep temperatures below 2°C in the current century are orders of magnitude higher and involve large implicit intertemporal transfers. Increasing the elasticity of substitution between energy sources is important for reducing the carbon taxes needed to meet warming goals.
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Originally published by the Energy Policy Institute at the University of Chicago.
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