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JesseJenkins @JesseJenkins
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A new OECD report finds carbon pricing policies are spreading worldwide, but are almost uniformly too low to fully capture damages caused by CO2 or drive needed emissions declines. Here's a thread on why carbon pricing falls short and what we might do about it…
Using a social cost of carbon -- the estimate of societal damage caused by one ton of CO2 -- of €30/ton, the OECD finds that almost 90% of total global CO2 emissions are priced at a level below the damages they cause. About 55% of global emissions are not priced at all.
The OECD calculates the "carbon pricing gap" -- or the cumulative sum of each ton of global emissions times the gap between the carbon price applied to that ton and the €30/ton social cost of carbon estimates -- is 76.5%.
Even in economies with tough carbon prices, exemptions for some sectors reduce the impact. Sweden has highest carbon tax in the world, but it exempts trade-exposed industries, other industries pay 1/2; electricity falls under much lower prices in the EU emissions trading scheme.
The OECD report finds that the carbon pricing gap thus differs across sectors. It is worst in industry at 91%. Electricity and residential/commercial sectors are worse than average too (84% & 87% gap respectively).
On-road transportation has the smallest gap, at just 21%. However, this is because the OECD counts not only carbon pricing policies, but also any specific taxes on fossil fuels -- e.g. gas or petrol taxes -- which account for the majority of that pricing in transportation.
Estimating the social cost of carbon is also tricky, and there's a wide range of credible possibilities. For more, see @drvox's timeless primer on discount rates… and this great primer on the use of SCC in US policy making by @noahqk…
An inter-agency Obama Admin task force proposed using several numbers, ranging from $12-62/ton in 2020 (the report used 2007 $, which would make that more like $15-77/ton in 2018 $)…. Some estimates put it as high as $150-250/ton…
When the OECD uses a 60/ton estimate for the social cost of carbon, the cumulative carbon price gap jumps up across all sectors, from a low of 58% in on-road transportation to over 90% in industry, electricity, and residential/commercial sectors.
Carbon pricing is widely regarded as both the most efficient (aka cost-effective) and most important tool to confront climate change (see…)

So it's a big deal that we dont fully price the damages from CO2. Why do we keep falling short with carbon pricing?
As I have written extensively, the “carbon pricing gap” can be best explained by paying close attention to the political economy of carbon pricing. See my 2014 paper… 2017 paper… and great discussion by @drvox…
Carbon pricing might lower the cost of climate policy across the entire economy. But pricing carbon also creates winners and losers in the economy. Getting a carbon price in place requires organizing winners and overcoming fierce opposition from losers.
In case of carbon pricing, the losers – fossil fuel cos, firms w/significant capital invested in coal or gas power plants, energy-intensive industries – are concentrated & well organized. Benefits are more diffuse, spread across everyone in the world and for generations to come.
As a result, policymakers tend to support policies that minimize direct, salient impacts on businesses & households, minimize burdens on regulated & strategically important sectors, and/or redistribute the benefits in a manner that secures a politically-durable coalition.
When it comes to climate, policy makers preferred regs that are narrowly targeted allowing for regulatory capture &reducing scope for opposition) or subsidies (allowing transfers of rents & spreading costs broadly and indirectly across tax base), rather than uniformly pricing CO2
This is endlessly puzzling to some economists, who tend to blame "complementary policies" like subsidizing renewables or EVs as costly distortions that prevent the CO2 price from working as intended. See MIT's John Reilly explaining this to @bstorrow here…
But to political economists (like @leahstokes or @mmildenberger), there's nothing puzzling. Policy is made within the real constraints of political economy. The political economy of carbon pricing keeps leading us to the same place: CO2 prices too low to do the job intended.
In my work on carbon pricing, I've thus tried to start from the view that political economy forces arising from the winners & losers created by carbon pricing (so-called "distributional impacts") will fundamentally shape what can and can't be done…
While most economists focus on efficiency first & view distributional impacts as a secondary effect, this lens views distributional impacts as fundamentally shaping policy design and thus efficiency in a so-called "second-best" world where we fall short of fulling pricing carbon.
For ex, if we assume we can fully price carbon at the social cost of carbon, then any additional subsidy for renewable energy or clean vehicles is an unnecessary distortion that raises costs without delivering added benefit. That's what Dr. Reilly is explaining in the quote above
But in a world where we fall short of fully pricing CO2 -- e.g. the world the OECD describes & we all live in! -- subsidies for additional decarbonization can deliver welfare benefits, so long as the marginal climate damages reduced exceed the marginal distortion from the subsidy
That’s what @vjkarplus and I demonstrate in this paper, “Carbon pricing under political constraints”… (also part of a book, The Political Economy of Clean Energy Transitions from Oxford Univ. Press in 2017, which is free as PDF…)
We argue it is important to consider how both the CO2 price itself and the use of carbon revenues to fund transfers (eg dividends, tax cuts, rebates, transition payments) or supplemental climate policies (eg clean energy subsidies) intersects with political constraints...
...constraints like limited willingness of households to pay more for energy, organized opposition of energy-intensive industry or fossil fuel producers (not same dynamic btw), etc. We model this in a stylized way but richer analysis & creative policy design is essential today.
The revenues from carbon pricing may in the end be just as important as the price itself, as how you use that $ substantially alters who wins and who loses from the policy and thus the chance the policy passes in the first place and how efficient/effective it is if it does pass.
For example, some argue that using the $ for rebates or dividends or lowering taxes will offset costs of carbon pricing policies on households and that will boost support for the policy. Possibly, but we need real evidence of that dynamic, and so far it is scant.
One Yale study found that using money for dividends actually *lowered* overall support for the policy. Why? That's a really important question for further research.
(My hypothesis: loss aversion means people see $ in dividend as less valuable than $ in higher energy prices, people dont trust we'll see our money back, and populations have little familiarity w/using a tax to change behavior rather than raise $ for govt to solve key problems)
In contrast, using revenues to fund clean energy research and subsidies tends to be popular in this kind of research. It aligns with the idea that the purpose of taxes is to raise money to solve problems (rather than change our behavior) and it makes the benefits tangible.
Spending money this way to drive additional deployment of low-carbon solutions AND to drive down their price over time. Under political economy constraints, both of those factors can improve welfare, rather than simply cause costly distortions as it would in a "first best" world.
This is for 3 reasons:

1. Subsidies for additional mitigation above what a constrained carbon price would deliver reduce further climate externalities. If marginal reduction in externalities exceeds marginal distortions from the subsidy, welfare and efficiency improve.
2. Funding public research, development and demonstration and subsidies for deployment of climate mitigation technologies will drive down the cost of these opportunities over time, allowing greater mitigation within a given political constraint.
3. These subsidies grow and strengthen clean energy industries, which create more direct winners of these policies (versus the diffuse benefits of climate mitigation itself) that can change political dynamics over time in favor of sustained policy or greater policy ambition.
All three of those dynamics deserve much greater scrutiny and attention from academics and policy designers as well.
So to sum up this already monster thread: Why do we keep falling short on carbon pricing policies across the world? Primarily because political economy constraints bind carbon pricing policies (just as they do every other realm of policy making).
How do we improve climate policy outcomes? By paying MUCH closer attention to the intersection of political economy, climate policy design, and efficiency of policy outcomes. That means interdisciplinary insights from economists, political scientists, and policy design experts.
The stakes are simply too high to keep repeating "carbon pricing is the best!" and hope policy makers eventually get the picture and do the right thing. It is time for much more creative effort to design efficient & effective carbon policy within real-world political constraints.

Feedback welcome.

Seen good research on this topic? Please share and I'll append to this thread.

Are you a PhD student in economics, political science, or public policy looking for a good dissertation topic? Hit me up and let's chat...
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