Monday, June 18, 2007

Should carbon taxes be linked to global temperatures?

I’ve mentioned before the possibility of creating markets in long-term weather – that is, betting on future climate change – as a method of predicting and insuring against climate change. Betting markets are good at predicting future outcomes – you can look at the odds on horses in a race if you want to get an idea of who’s likely to win. The idea is that allowing climate scientists, businesses, etc to bet on future climate change would be a way of aggregating all the knowledge that people have about likely future climate change in a way that’s more decentralised and independent than say the consensus method of international scientists at the Intergovernmental Panel on Climate Change (IPCC). There are advantages and disadvantages of either way of distilling the information from thousands of climate scientists into consensus estimates of likely climate change.

In an article last week in Canada’s Financial Post, Canadian economist Ross McKitrick proposes a different method of removing scientific uncertainty about climate change from the policy response to climate change. He proposes a carbon tax where the tax rate is linked to average global temperatures over the prior 3 years:

Climate models predict that, if greenhouse gases are driving climate change, there will be a unique fingerprint in the form of a strong warming trend in the tropical troposphere... The Intergovernmental Panel on Climate Change (IPCC) states that this will be an early and strong signal of anthropogenic warming. Climate changes due to solar variability or other natural factors will not yield this pattern: only sustained greenhouse warming will do it. Temperatures in the tropical troposphere are measured every day using weather satellites…

Suppose each country implements something called the T3 tax, whose U.S. dollar rate is set equal to 20 times the three-year moving average of… estimates of the mean tropical tropospheric temperature anomaly [warming], assessed per tonne of carbon dioxide, updated annually. Based on current data, the tax would be US$4.70 per ton...

This tax rate is low, and would yield very little emissions abatement. Global-warming skeptics and opponents of greenhouse-abatement policy will like that. But would global-warming activists? They should -- because according to them, the tax will climb rapidly in the years ahead.

The IPCC predicts a warming rate in the tropical troposphere of about double that at the surface, implying about 0.2C to 1.2C per decade in the tropical troposphere under greenhouse-forcing scenarios. That implies the tax will climb by $4 to $24 per tonne per decade, a much more aggressive schedule of emission fee increases than most current proposals. At the upper end of warming forecasts, the tax could reach $200 per tonne of CO2 by 2100, forcing major carbon-emission reductions and a global shift to non-carbon energy sources.

Global-warming activists would like this. But so would skeptics, because they believe the models are exaggerating the warming forecasts. After all, [the average tropical troposphere temperature] went up only about 0.08C over the past decade, and has been going down since 2002. Some solar scientists even expect pronounced cooling to begin in a decade. If they are right, the T3 tax will fall below zero within two decades, turning into a subsidy for carbon emissions…

Under the T3 tax, the regulator gets to call everyone's bluff at once, without gambling in advance on who is right. If the tax goes up, it ought to have. If it doesn't go up, it shouldn't have. Either way we get a sensible outcome.
It’s an intriguing idea. I suspect its biggest detractors would be energy-intensive industries, who would have no certainty about the level of carbon taxes in the future. McKitrick’s response is that those industries will just have to forecast that as best they can and actually sees this as an advantage:

best of all, the T3 tax will encourage private-sector climate forecasting. Firms will need good estimates of future tax rates, which will force them to look deeply, and objectively, into the question of whether existing climate forecasts have an alarmist bias. The financial incentives will lead to independent reassessments of global climate modelling, without regard to what politicians, the IPCC or climatology professors want to hear.

(This is the advantage too of a long-term weather market. Presumably McKitrick’s proposal would lead to the development of such a market so that energy-intensive industries could assess - and hedge - their exposure).

There are a few potential problems with the proposal that immediately spring to mind.

The first is that it relies on the fact that “climate models predict that, if greenhouse gases are driving climate change, there will be a unique fingerprint in the form of a strong warming trend in the tropical troposphere”. But what if that isn’t the case? McKitrick’s claim is that his proposal takes the scientific debate out of the policy response, but it relies on climate model predictions that troposphere warming reflects man-made emissions and leads other warming. If he’s prepared to accept this finding, why not go the step further and accept the estimates of warming presented by those models and then base the level of tax on those?

It also doesn’t really deal with the problem of lag periods: the tax paid now depends on the level of warming now. But the purpose of the tax is to prevent increased warming in the future: surely its level should be based on an assessment of what’s required to constrain future temperature increases.

McKitrick’s answer is that “investors planning major industrial projects will need to forecast the tax rate many years ahead, thereby taking into account the most likely path of global warming a decade or more in advance”. And that’s no doubt true for major industrial projects. But household consumers of electricity and petrol will make their decisions based on today’s prices.

A related problem is that it doesn’t deal with dangerous thresholds. The tax is linear: it increases by US $20 for every 1 degree rise in temperatures. But damage isn’t linear. What happens if our best science suggests that damage will be moderate up to, say, two or three degrees but that, above that, there will be feedback loops and greatly increased risks of catastrophic damage? If that was the case, we’d want an aggressive tax before those dangerous levels are reached. McKitrick’s tax would only start becoming aggressive once those levels were passed, by which time even much higher tax rates may have become much less effective.

It’s an interesting idea though that deserves some attention and debate. I think it’s interesting that market approaches may help not only with developing effective and low-cost policy responses, but may also help improve our understanding of the science on which policies must be based.

[HT: Lars Smith at Conservation Finance]

1 comment:

Unknown said...

It's a ridiculous idea. It is a attempt to pick holes in climate science disguised as a real carbon tax proposal.

First, why base the tax on the tropical tropospheric temperatures, which are difficult to predict in global models? Wouldn't global average temperatures make sense? McKitrick's is purposely choosing a metric because it could be used to cast false doubt on climate change projections.

Second, basing government revenues on the climate, which despite a long-term warming trend still has large interannual flucations, would wreak havoc with the economy.

Third, even if the scheme were approved, the tax rate would be extremely low at the beginning, and do little to encourage action. I'd be surprised if "global-warming activists" would not like the idea that the tax could reach $200/tonne of CO2 per 2100, as the article claims. By then, so much warming would be realized that the tax rate would be irrelevant. As it is, the tax he proposes is rising at about the same rate as inflation, so a $200 tax in 2100 is the equivalent of about $11.50 in 2007.