Testimony to State of Vermont House Committee on Natural Resources and Energy: Carbon Management March 30 th , 2016. Nicholas Z. Muller, MPA, PhD Associate Professor of Economics Middlebury College 1
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Testimony to State of VermontHouse Committee on Natural
Resources and Energy:Carbon Management
March 30th, 2016.Nicholas Z. Muller, MPA, PhD
Associate Professor of EconomicsMiddlebury College
1
My Background
• Associate Professor of Economics at Middleburysince 2007.
• MPA Indiana University – Bloomington.
• Ph.D. Yale University
• Research cited ~1,475 times.– Science (2x), American Economic Review (3x).
• Research used directly: USEPA, USDOJ, UNEP,USBOEM, US NAS.
• Current member USEPA SAB
2
My Background
• Associate Professor of Economics at Middleburysince 2007.
• MPA Indiana University – Bloomington.
• Ph.D. Yale University
• Research cited ~1,475 times.– Science (2x), American Economic Review (3x).
• Research used directly: USEPA, USDOJ, UNEP,USBOEM, US NAS.
• Current member USEPA SAB
3
Last 5 years, 8 peer-reviewed articleson climate change economics
and CO2 policy.
Outline of Testimony
• Markets.– Supply and Demand.
• Market Equilibrium.
• Motivation for Government Intervention.– Market Failure.
• Externality.
• Hidden subsidy.
• Policy Instrument Design.– Taxes versus command and control.
– Calibration of the tax.
4
Markets
• Markets are a means to allocate resources.
5
Markets
• Markets are a means to allocate resources.
– Quotas.
– Limits, bans.
6
Markets
• Markets are a means to allocate resources.
– Quotas.
– Limits, bans.
• Prices act as rationing mechanism.
– Importance of scarcity in price formation.
7
Markets
• Markets are a means to allocate resources.
– Quotas.
– Limits, bans.
• Prices act as rationing mechanism.
– Importance of scarcity in price formation.
• If there are many consumers and firms, pricesreveal a good estimate of society’s value ofgoods and services.
8
9
Markets
• Markets are a means to allocate resources.
– Quotas.
– Limits, bans.
• Prices act as rationing mechanism.
– Importance of scarcity in price formation.
• If there are many consumers and firms, pricesreveal a good estimate of society’s value ofgoods and services.
• Under certain circumstances markets efficient.9
$
Q(energy)
10
$
Q(energy)
S = cost/unit produced
11
$
Q(energy)
D = benefit/unit consumed
S = cost/unit produced
12
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
13
D = benefit/unit consumed
14
Total cost
14
$
Q(energy)
S = cost/unit produced
14
1515
$
Q(energy)Qmarket
15
D = benefit/unit consumed
Total benefit
16
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
16
D = benefit/unit consumed
Markets are efficient:Net Benefit (Total Benefit – Total Cost)
Maximized at (Pmarket, Qmarket)
Why do governments intervene inmarkets? Market failure.
• Many examples of market failure:
17
Why do governments intervene inmarkets? Market failure.
• Many examples of market failure:
– Information: the market for used cars (lemonlaws).
18
Why do governments intervene inmarkets? Market failure.
• Many examples of market failure:
– Information: the market for used cars (lemonlaws).
– Public goods: governments provide for parks andopen space, national defense.
19
Why do governments intervene inmarkets? Market failure.
• Many examples of market failure:
– Information: the market for used cars (lemonlaws).
– Public goods: governments provide for parks andopen space, national defense.
– Externality: two agents engage in markettransaction, a third party(ies) incur a cost forwhich they are not compensated.
20
Why do governments intervene inmarkets? Market failure.
• Many examples of market failure:
– Information: the market for used cars (lemonlaws).
– Public goods: governments provide for parks andopen space, national defense.
– Externality: two agents engage in markettransaction, a third party(ies) incur a cost forwhich they are not compensated.
21
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
22
D = benefit/unit consumed
S’ = social cost/unit consumed
23
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
23
D = benefit/unit consumed
24
S’ = social cost/unit consumed
24
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
24
D = benefit/unit consumed
Difference is cost borneby 3rd party/unit produced.
Implications of Externality
• Costs that firms “faces” are too low.
– Raw materials, labor, capital, land, insurance etc.
25
Implications of Externality
• Costs that firms “faces” are too low.
– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
26
Implications of Externality
• Costs that firms “faces” are too low.
– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
• Market prices are, likewise, too low.
27
Implications of Externality
• Costs that firms “faces” are too low.
– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
• Market prices are, likewise, too low.
• Equilibrium quantity is too high.
– Consumers face a price for goods that does notreflect the full cost of production.
28
Implications of Externality
• Costs that firms “faces” are too low.– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
• Market prices are, likewise, too low.
• Equilibrium quantity is too high.– Consumers face a price for goods that does not
reflect the full cost of production.
• Markets cannot yield socially optimaloutcome.
29
Implications of Externality
• Costs that firms “faces” are too low.– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
• Market prices are, likewise, too low.
• Equilibrium quantity is too high.– Consumers face a price for goods that does not
reflect the full cost of production.
• Markets cannot yield socially optimaloutcome.
30
31
Implications of Externality
• Costs that firms “faces” are too low.– Raw materials, labor, capital, land, insurance etc.
– Firms do not face impacts on 3rd party(ies).
• Market prices are, likewise, too low.
• Equilibrium quantity is too high.– Consumers face a price for goods that does not
reflect the full cost of production.
• Markets cannot yield socially optimaloutcome.
31
Can government interventionfacilitate a more efficient outcome?
32
S’ = social cost/unit consumed
32
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
32
D = benefit/unit consumed
Market Equilibrium
3333
S’ = social cost/unit consumed
33
$
Q(energy)
S = cost/unit produced
Psocial
Qsocial
33
D = benefit/unit consumed
Socially Optimal Equilibrium
34
How can a government induce the optimal outcome?
3434
S’ = social cost/unit consumed
34
$
Q(energy)
S = cost/unit produced
34
D = benefit/unit consumed
Tax set to cost borneby 3rd party/unit produced.
Psocial
Qsocial
3535
How can a government induce the optimal outcome?
3535
S’ = social cost/unit consumed
35
$
Q(energy)
S = cost/unit produced
Ptax
Qtax
35
D = benefit/unit consumed
Tax set to cost borneby 3rd party/unit produced.
Tax revenue.
3636
$
Q(energy)
S = cost/unit produced
Pmarket
Qmarket
36
D = benefit/unit consumed
Markets are efficient:Net Benefit Maximized
3737
$
Q(energy)
S = cost/unit produced
Qmarket
37
D = benefit/unit consumed
Qsocial
S’ = social cost/unit consumed
Inefficiency fromtax
38
$
Q(energy)
S = cost/unit produced
Qmarket
38
D = benefit/unit consumed
Qsocial
S’ = social cost/unit consumed
Avoided external costfrom tax
How to evaluate corrective tax?
• Compare loss ( ) to gain ( ).
• Since gain > loss, net benefits with thecorrective tax outweigh net benefits withoutthe tax.
• Avoided external costs exceed distortion fromthe tax.
39393939
Externality: an involuntary subsidy.
• Production and consumption produces waste.
40
Externality: an involuntary subsidy.
• Production and consumption produces waste.
• Pollution (carbon) emissions are free wastedisposal.
41
Externality: an involuntary subsidy.
• Production and consumption produces waste.
• Pollution (carbon) emissions are free wastedisposal.
• If this was solid waste, polluters would pay feefor disposal. Why?
42
Externality: an involuntary subsidy.
• Production and consumption produces waste.
• Pollution (carbon) emissions are free wastedisposal.
• If this was solid waste, polluters would pay feefor disposal. Why?
– Property rights over land well-defined.
43
Externality: an involuntary subsidy.
• Production and consumption produces waste.
• Pollution (carbon) emissions are free wastedisposal.
• If this was solid waste, polluters would pay feefor disposal. Why?
– Property rights over land well-defined.
– Property rights over the air, not well-defined.
44
Externality: an involuntary subsidy.
• Production and consumption produces waste.
• Pollution (carbon) emissions are free wastedisposal.
• If this was solid waste, polluters would pay feefor disposal. Why?
– Property rights over land well-defined.
– Property rights over the air, not well-defined.
• Assimilative capacity of environment acts asfree waste repository: hence, subsidy.
45
Carbon Tax 1.
• Corrects market failure.
– Embodies “missing” external cost.
46
Carbon Tax 1.
• Corrects market failure.
– Embodies “missing” external cost.
• Changes behavior.
– Equilibrium quantity is lower than market.
47
Carbon Tax 1.
• Corrects market failure.
– Embodies “missing” external cost.
• Changes behavior.
– Equilibrium quantity is lower than market.
• Raises revenue.
– Uses?
48
Carbon Tax 1.
• Corrects market failure.
– Embodies “missing” external cost.
• Changes behavior.
– Equilibrium quantity is lower than market.
• Raises revenue.
– Uses?
• Offset other taxes.
49
Carbon Tax 1.
• Corrects market failure.
– Embodies “missing” external cost.
• Changes behavior.
– Equilibrium quantity is lower than market.
• Raises revenue.
– Uses?
• Offset other taxes.
• Redistribute revenue to assist lower income folks.
50
Carbon Tax 2.
• Carbon tax rate should equal external cost.
51
Carbon Tax 2.
• Carbon tax rate should equal external cost.
– Corrects for the social costs associated withcarbon-intensive goods.
52
Carbon Tax 2.
• Carbon tax rate should equal external cost.
– Corrects for the social costs associated withcarbon-intensive goods.
• Taxes are more efficient than conventionalregulations.
53
Carbon Tax 2.
• Carbon tax rate should equal external cost.
– Corrects for the social costs associated withcarbon-intensive goods.
• Taxes are more efficient than conventionalregulations.
– Firms/consumers free to decide “Q” – conditionalon the tax.
54
Carbon Tax 2.
• Carbon tax rate should equal external cost.
– Corrects for the social costs associated withcarbon-intensive goods.
• Taxes are more efficient than conventionalregulations.
– Firms/consumers free to decide “Q” – conditionalon the tax.
– Governments typically do not know “S” and “D”.
• Can’t set efficient regulations.
55
Conclusions.
• Markets are efficient under mostcircumstances.
• Externality is justification for governmentintervention.
• Corrective taxation one solution to externality.
– Carbon tax rate should equal external cost.
• Taxes tend to be more efficient thanconventional regulations.
56
Thank you.
57
Nicholas Z. Muller, MPA, PhDAssociate Professor of Economics
Middlebury [email protected]
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