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MIT Technology Review

Why carbon taxes may need to be far higher than we’d planned

A new model suggests the price should start high and then fall over time, in a total reversal of conventional wisdom.

October 2, 2019
Wind turbines.Wind turbines.
Wind turbines.
Credit: Johanna Montoya on Unsplash

Economists largely agree that one of the most effective ways of tackling climate change is taxing carbon pollution. Few things beat higher prices in reliably pushing companies and consumers to shift to more environmentally friendly practices and products.

But a new economic analysis flips some of the traditional thinking about a carbon tax, concluding that the price should fall rather than rise in the decades ahead. It should also start far higher than many previous studies and policy proposals suggested.

Notably, a plan put forth by former US secretaries of state James Baker and George Shultz in 2017 proposed a carbon fee that would start at $40 a ton and increase every year at 5% above inflation, in line with conventional views rooted in some of the earliest and most influential climate-economy models.

But the new model, published September 1 in the Proceedings of the National Academy of Sciences, concludes it would be much more effective to start with a price well above $100. That tax would tick up a bit further in the first decade or so, before slowly sliding downward for the next few centuries.

Why?

In basic terms, the so-called EZ-Climate model attempts to merge the tools of financial economics into climate economics, which ends up placing a higher estimated cost on uncertainty—and higher value on averting risks.

So the model finds a few things likely happen over time.

The higher the price is at the start, the more rapidly nations and businesses will develop and deploy cleaner ways of doing things, says Gernot Wagner, an author of the paper and associate professor at New York University’s Department of Environmental Studies.

That also means the price on carbon can start to decline sooner, as more and more of the economy shifts to systems and sources that no longer pump out emissions. But in addition, the world will simply learn more about the exact impacts of climate change, and what it takes to address them.

“Uncertainty resolves itself over time,” Wagner said in an email, so we no longer have to pay a higher price for it.

He cowrote the paper and created the new model with Columbia University economist Kent Daniel and Robert Litterman, formerly head of the quantitative investment strategies group at banking giant Goldman Sachs.

Another notable finding from the model is that the cost of putting off a carbon price rises at a staggering rate the longer we delay. If we wait a year to implement an effective carbon tax, the estimated cost of additional climate-change impacts will reach approximately $1 trillion. If we wait five years, that swells to $24 trillion. A 10-year delay could cost the world $100 trillion.

Wagner stresses that the most effective starting price for a carbon tax is impossible to know. But some scenarios in the model show it could be higher than $200, depending on certain assumptions.

Of course, as with much of climate policy, there’s a clear mismatch between the ideal solution in theory and the one that can actually be signed into law. Carbon taxes have proved very difficult to pass, and the higher the starting price, the harder it likely becomes.