Carbon Price: A Better Climate Commitment

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.

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

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.