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About the Commentary

Series Editor: Joshua Linn
Managing Editor: Felicia Day
Assistant Editors: John Anderson and Adrienne Foerster

Welcome to the RFF Policy Commentary, which is meant to provide an easy way to learn about important policy issues related to environmental, natural resource, energy, urban, and public health problems.

Views expressed are those of the author. RFF does not take institutional positions on legislative or policy questions.

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Climate is a global public good, and climate policy is very much a public-goods game, one fraught with difficulties when it comes to cooperation among countries. The default policy choice to date, commitment to an emissions cap, exacerbates the problem of getting all sides to agree. Commitment to a global carbon price best facilitates the cooperation needed for the strong actions required to stabilize the climate.

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Carbon Price: A Better Climate Commitment
Peter Cramton and Steven Stoft
April 16, 2010
 

Carbon Price: A Better Climate Commitment

When it comes to picking the right tool for the job of crafting international emissions commitments, it pays to be flexible. An international commitment to an emissions cap can be honored without cap and trade. Similarly, commitment to a global carbon price does not require carbon taxes, nor does it interfere with distant goals for global temperature or emissions. The question of which international commitment to prefer—a cap or a price—should not be confused with the domestic debate over whether to cap or tax carbon. Either will work for either commitment, as will a few other financial incentive policies.

This flexibility solves a crucial problem—historically, developing countries have refused to commit to binding emissions caps. But a global target price avoids their two common objections: stifling economic development and imposing a cap far below that of the United States. However, for developed countries, a national commitment to a price, rather than a tax, facilitates cap and trade by counting the cost of carbon allowances as a price on carbon. Besides avoiding major objections, a price commitment has other intrinsic advantages. Its predictability makes the remarkable affordability of any carbon pricing policy more apparent, as can be seen in Table 1 below. Also, requiring the same carbon price is like requiring the same effort per ton of emissions, while the same cap applied to each country would impose hugely different economic burdens. This allows negotiating only a single target instead of hundreds—an enormous simplification.

But cooperation also requires that incentives favor cooperation, and for this purpose, a global compensation fund that subsidizes climate policy in poor countries, often called a Green Fund, is required. Our proposal follows.

Flexible Global Carbon Pricing

Table 1. $30/ton carbon pricing with a $2/ton Green Fund

 

Starting Emissions per capita

Emission Abatement Cost

 Green Fund Cost

 

tons/year

cents per capita per day

India

1

0.8 ¢

−1.7 ¢

Avg. Country

5

4.1 ¢

0.0 ¢

United States

20

16.4 ¢

6.6 ¢

Carbon pricing is assumed to reduce emissions by 20 percent from the amount shown. China has nearly average per-capita emissions.

 
Our proposal rests on two internationally negotiated global parameters: P, the global carbon price target, and G, the Green-Fund rate. All countries are required to price carbon at P on average or to buy carbon-revenue credits supplied by countries that exceed their pricing commitment. This trade is analogous to trading emissions credits under international cap and trade, except that is takes place through a central exchange, similar, in principle, to a stock exchange.

For illustrative purposes, the price target, P, will be taken as $30 per ton. The Green-Fund rate is expected to be much lower, say, $2 per ton, and it applies only to deviations in emissions from the global per-capita average. For the United States, this would come to roughly $30 per person per year. This revenue could come from auctioned allowances, oil-leases, or any source at all. Countries with per-capita emissions below the world average would receive similar payments, with India, for example, receiving about $8 per person per year.

Unlike commitment to a cap, which can produce large surprises when emissions change unpredictably, as has happened in Canada and China, the cost of commitment to a price can be estimated quite reliably using a formula provided by EPA. This allows us to compute the values in the following table.

Notice that India is likely to agree to such a commitment because the Green Fund more than covers its cost of imposing a $30 per-ton price on carbon. A country with average per-capita emissions like China would see a small cost, but this would only mean they must wait until July 13, 2020 to be as rich as they would otherwise be on July 1, 2020. The most problematic cost is likely the 6.6¢ per person per day that the United States would need to spend.

Selling points for such a contribution include that it reduces foreign payments considerably compared with the offsets in the cap-and-trade bill passed last year by the House; that if poor countries do not comply with carbon pricing, the United States will not have to pay; and that there could be a requirement to spend the contribution on U.S. exports. But likely, even more creativity will be required.

Advantages

Besides being demonstrably affordable, carbon pricing—even without a Green Fund—is far less offensive to poor countries. How could an Indian politician ever explain to his or her constituency about accepting the U.S. request to cap India at half the per-capita emissions of the United States back in 1880?  (Yes, you have to go back some 130 years before the United States is found to be emitting only twice as much per person as India is today.) With a price commitment, which is identical for all countries, Indians can plainly see that nothing stops them from becoming as rich as Americans.

If China had accepted in 2000 the type of cap the United States now proposes, it would have been spending roughly $100 billion per year buying carbon reduction credits from foreign countries by 2010. Again, this is politically infeasible.


Peter Cramton


Steven Stoft
Even without outright rejection by developing countries, emissions caps are intrinsically difficult to  negotiate. In each negotiation, the party with the strongest interest is the party being capped, whose self interest is in weakening the cap as much as possible. Unlike national caps, the global price target countries must consider the global impact. If they weaken the cap for themselves, they also reduce the abatement efforts of all other countries, action that would benefit them. This gives all countries an incentive to favor a reasonable global target instead of a weak one.  

Also making for easier negotiations, it is far simpler to update one carbon price than many caps in response to new information or recognition of past mistakes. The Green Fund’s rate parameter, illustrated at $2 per ton, would be chosen to elicit the widest possible agreement. Emissions per capita correspond quite closely with income, providing intrinsic fairness. At the same time, linking Green-Fund payments only to actual emissions and not to income or historical emissions maximizes the incentive value of the Green-Fund charges and payments.

The Green Fund serves two other purposes as well. First, in stark contrast to the Clean Development Mechanism, which inadvertently rewards countries for not adopting any commitment to caps or other forms of carbon pricing, the Green Fund rewards commitment. A country with below average per-capita emissions must fully comply with carbon pricing to receive its full Green-Fund payment. Second, the Green Fund rewards government informational and research programs that reduce emissions but are not susceptible to pricing.

Finally global carbon pricing calls for the use of trade sanctions against countries that shirk their commitments and thereby threaten the stability of the treaty. Sanctions are powerful, and if the threat is credible they should almost never be needed. Instead, the inexpensive but proportionate penalties inherent in the carbon-revenue market and the inducement of the Green Fund should keep the system on track with few exceptions.

Conclusion

Strong targets and unpredictable caps, especially when they are obviously unenforceable, discourage commitment in a game that is already notorious for its uncooperative outcome. Instead we need a systematic approach to treaty design that focuses on solving the commitment problem. Only then can we expect strong action.

Peter Cramton is a professor of economics at the University of Maryland, College Park and an expert on market design.

Steven Stoft is director of the Global Energy Policy Center and the author of Carbonomics, Diamond Press, December 2008.

Further Readings:

Cooper, Richard N. 2008. The Case for Charges on Greenhouse Gas Emissions. Discussion Paper 08-10. Cambridge, MA: The Harvard Project on International Climate Agreements.

Cramton, Peter and Steven Stoft. 2009. Global Carbon Pricing: A Better Climate Commitment. Research Paper 09-06. Global Energy Policy Center.

Cramton, Peter and Steven Stoft. 2010. Price Is a Better Climate Commitment. The Economists' Voice 7(1): Article 3.

McKibbin, Warwick, Adele Morris, and Peter Wilcoxen. 2009. Achieving Comparable Effort through Carbon Price Agreements. Policy Brief. Cambridge, MA: The Belfer Center, Harvard University. December 18.

Stiglitz, Joseph E. 2010. Overcoming the Copenhagen Failure. Project Syndicate, January 6. Available at

Stoft, Steven E. 2008. Carbonomics: How to Fix the Climate and Charge It to OPEC. Diamond Press, December.

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