A carbon price set to carbon damage
What damage are we causing with each new emission of carbon pollution?
Economists regularly assess the economic impact of each marginal greenhouse gas emission, which is labeled the "social cost of carbon." No surprise, this is hard to measure.
We still have an imprecise understanding of the specific regional damage greenhouse gas emissions will cause, in particular due to the uncertainty of how certain feedbacks in the climate system will accelerate or decelerate how the climate responds to emissions. Even with an estimate of future change and the resulting economic damage, economists then have to state its present value; how to discount that future damage is a normative question (not a scientific one).
Although this range is broad, attempts to price carbon through a tax or cap consistently fall short of establishing a carbon price that meets even the lowest estimates of the actual damage emissions will cause. Carbon prices from the major emitters — the Chinese pilots, our regional U.S. leaders in California and the Regional Greenhouse Gas Initiative, and the European Union’s Emissions trading system — are all below the best-case estimates.
In the world of cap-and-trade systems, this has consistently occurred because the cap has not been set stringently enough.
When setting the cap, Jenkins and Karplus wrote, "there is a strong incentive to base reduction on relative conservation growth and technology projections, increasing the relative certainty that the cap will not be hard to achieve."
Two real world examples of this: Both California and the European Union’s Emission Trading System have issued more permits to pollute than emitters actually need. Given the recession, rapid implementation of renewables and a broad swath of "complementary policies" to drive greenhouse gas reductions, California’s cap and trade system has at least 80 million more allowances (or more permits to pollute) than emitters require. These calculations are based on estimates from our work at the Climate Trust, a market actor accelerating the pace of carbon mitigation through conservation finance.
To the Climate Trust and other industry leaders, the message is clear: We are ready for more ambitious greenhouse gas reduction requirements. We cannot forget that, as carbon pricing systems "grow up," we must have the political courage to require the deep emission reductions we need to avoid the most catastrophic effects of climate change. Ignoring the political constraints that make it difficult to require these significant reductions is not prudent.
Most forms of carbon pricing raise new revenues. According to Jenkins and Karplus, given the political constraints on appropriately pricing carbon, those revenues should be used, in part, to further mitigate emissions. "We find that in all cases, without the ability to use revenues in ways that increase abatement or offset private surplus losses, the optimal CO2 price is beyond reach," they wrote.
As the leader in this space, California once again provides an excellent example of the opportunities we have in front of us. Through 2020, California is estimated to raise around $12 billion from its auction of permits to pollute in its cap-and-trade system, and must spend these revenues to mitigate climate change. Finding ways to leverage the private sector with that funding, while building the political will to require deep emission reductions, will be key to success in California and for the others that join them.