Transcript

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

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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.

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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:

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Why do governments intervene inmarkets? Market failure.

• Many examples of market failure:

– Information: the market for used cars (lemonlaws).

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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.

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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.

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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.

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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).

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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.

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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.

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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.

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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.

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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.

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Can government interventionfacilitate a more efficient outcome?

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S’ = social cost/unit consumed

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$

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

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D = benefit/unit consumed

Socially Optimal Equilibrium

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How can a government induce the optimal outcome?

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S’ = social cost/unit consumed

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$

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

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$

Q(energy)

S = cost/unit produced

Ptax

Qtax

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D = benefit/unit consumed

Tax set to cost borneby 3rd party/unit produced.

Tax revenue.

3636

$

Q(energy)

S = cost/unit produced

Pmarket

Qmarket

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D = benefit/unit consumed

Markets are efficient:Net Benefit Maximized

3737

$

Q(energy)

S = cost/unit produced

Qmarket

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D = benefit/unit consumed

Qsocial

S’ = social cost/unit consumed

Inefficiency fromtax

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$

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.

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Externality: an involuntary subsidy.

• Production and consumption produces waste.

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Externality: an involuntary subsidy.

• Production and consumption produces waste.

• Pollution (carbon) emissions are free wastedisposal.

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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?

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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.

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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.

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Carbon Tax 1.

• Corrects market failure.

– Embodies “missing” external cost.

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Carbon Tax 1.

• Corrects market failure.

– Embodies “missing” external cost.

• Changes behavior.

– Equilibrium quantity is lower than market.

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Carbon Tax 1.

• Corrects market failure.

– Embodies “missing” external cost.

• Changes behavior.

– Equilibrium quantity is lower than market.

• Raises revenue.

– Uses?

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Carbon Tax 1.

• Corrects market failure.

– Embodies “missing” external cost.

• Changes behavior.

– Equilibrium quantity is lower than market.

• Raises revenue.

– Uses?

• Offset other taxes.

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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.

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Carbon Tax 2.

• Carbon tax rate should equal external cost.

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Carbon Tax 2.

• Carbon tax rate should equal external cost.

– Corrects for the social costs associated withcarbon-intensive goods.

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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.

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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.

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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.

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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.

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Thank you.

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Nicholas Z. Muller, MPA, PhDAssociate Professor of Economics

Middlebury [email protected]


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