Economic Issues in Climate Change Kathleen Segerson Department of Economics University of Connecticut

Basic Premise Economics can help us to understand: Factors driving increases in GHG emissions Benefits and costs of reductions in GHG emissions Difficulties in developing consensus on reducing GHG emissions Effects of different policy approaches to reducing GHG emissions

Economic Factors Driving Increased GHG emissions Increasing wealth (economic growth) –Increased fossil fuel use –Increased demand for environmental protection Spatial patterns of development (transportation patterns) Population growth Development and adoption of new technologies

Benefits and Costs of Reducing GHG Emissions Numerous studies have been done for US and other countries Estimates of damages/benefits vary depending on assumptions about: –Climate change scenario –“Discount rate” and related assumptions –Economic and other trends (e.g., economic growth, population, technological improvements) –Amount of adaptation General conclusion: Some regions/sectors are harmed by climate change while others benefit, but aggregate effect is clearly negative

Difficulties in Developing Consensus Unequal distribution of benefits and costs across countries, across regions within countries, and across sectors Gainers vs. losers Perceived tradeoff between environmental and economic/development goals Role for developing countries

Alternative Policy Approaches Cap-and-trade (carbon trading) –Examples: European Union (Kyoto), 7-state RGGI –Cap limits emissions –Trading lowers cost (allows you to pay others to reduce emissions (abate) for you if they can do it more cheaply)

Cap and Trade Advantages: –Creates incentives to reduce emissions as cheaply as possible Disadvantages/challenges –Using historical baselines for targets –How to distribute allowances across polluters –How to treat newcomers to market –Setting baselines for defining credits –Volatility in price of allowances (EU: $44 - $143 in 2006) –Doesn’t raise any revenue

Carbon Tax Proposals –Nordhaus (economist, Yale): $17/ton of C, rising to $70 –John Dingell (US Congress): $50/ton of C, phased in –Stern Report (UK): $310/ton of C Note: $50/ton  about 15 cents/gallon of gas

Carbon Tax Advantages –Creates incentives to reduce emissions from all sources as cheaply as possible (same or greater than cap and trade) –Raises revenue that can be used to offset other taxes (e.g., income taxes) or for social programs –No issues with baselines, allocations or defining credits –Symmetric treatment of newcomers –No volatility in tax rate in response to market fluctuations Disadvantages –No explicit limit on emissions –Targets all emission sources, yet some demand (e.g., short run demand for gasoline) is not very responsive to price increases