Monday, November 25, 2013

Can Negotiating a Uniform Carbon Price Help to Internalize the Global Warming Externality?

Martin Weitzman has a new NBER working paper on whether negotiating a common global carbon price will be more likely to succeed than negotiating for emissions quantity reductions has been. His answer is, yes, on the grounds that it is easier to negotiate a common carbon price than separate emissions reduction targets for each country, and that each country has an incentive for a high price on everyone else and to collect taxes itself. For the developed countries it also has the political advantage that they won't be forced to buy permits from developing countries and transfer money overseas.

But, as we showed in our paper in AJARE last year, a common carbon price will impose much higher total direct costs on developing countries than developed countries. Developing countries already argue that global warming is mainly the historical responsibility of the developed countries and, therefore, they should take stronger action. So, a common carbon price doesn't look very politically attractive to developing countries unless there are large side payments. Weitzman misses this dimension of the problem. This will negate the supposed political advantage that developed countries would see in retaining all their carbon tax revenue. Weitzman does admit that: "The model of this paper is so abstract and so removed from reality that it is open to enormous amounts of criticism on many different levels" (p. 17). He does write that: "Nothing in the model excludes side payments to help obtain an international agreement on harmonized national carbon prices" (p18). But won't those change the political acceptability of such an approach?

Fossil fuel exporting countries are a group that will suffer high GDP losses under any emissions reduction plan. Not only do they have fossil fuel intensive economies, but the reduction in demand for fossil fuels under a carbon tax reduces their income, which maybe a cap and trade approach does not do to the same extent. I'm skeptical that they would find it optimal to agree to a high carbon tax. These countries differ from the players in Weitzman's model who only suffer costs from their own abatement.

I do think that carbon taxes have important advantages over cap and trade schemes but I'm skeptical that a global uniform tax rate would see more success than a global Kyoto style quantitative emissions reduction.

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