Dolan on the WPTC and energy policy

Lynne Kiesling

Economist Ed Dolan makes a thorough argument for using the upcoming expiration of the wind production tax credit as an opportunity to rethink energy policy seriously. In particular, his combined focus on energy policy and tax policy, and whether such tax credits are good examples of either (guess what? No), makes for an informative discussion. He also argues that such policy falls short because it fails to focus on the policy objective, which he defines as reducing negative externalities. For that reason, he makes the Pigouvian tax argument.

While he is more confident than I am that we can devise such a tax effectively, identify the magnitudes of such external effects as are Pareto-relevant, and implement them in a politics-and-lobbying-light way, I think it’s worth considering the extent to which such a proposal would be an improvement on the subsidies for commercialization that are the current renewables policy, which are an abomination of rent-seeking and inefficiency.

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26 thoughts on “Dolan on the WPTC and energy policy

  1. US EPA uses $9 million as the societal loss resulting from one “life unnecessarily shortened” when calculating the benefits of regulations which are “intended” to reduce emissions thought to contribute to increased illness and early death. That is one massive negative externality, which could be used to justify almost any emissions reduction effort.

    I will use an “off topic” example to demonstrate the impact of the $9 million number. Abortion on demand has unnecessarily shortened (read: ended) ~54 million lives in the US since Roe vs. Wade. Applying the EPA number for societal loss per life shortened, US societal loss resulting from abortion on demand totals ~$486 trillion; or, ~$11.5 trillion per year, which is more than 2/3 of annual US GDP. Losses of that magnitude could justify almost anything, except the obvious.

    Alternately, using one estimate of global annual carbon-related deaths (http://revmodo.com/2012/09/26/climate-change-carbon-energy-will-cause-100m-deaths-by-2030/), approximately 5 million deaths per year could be avoided by completely decarbonizing the global economy. These lost lives represent a global societal loss of ~$45,000,000,000,000. The estimate of the societal cost of lives unnecessarily shortened globally is awe inspiring. US EPA could likely justify mandating immediate cessation of fossil fuel use based on such estimates.

    US experience with assigning environmental externality costs is abysmal. It is hardly likely to be better next time.

  2. I agree with Lynne Kiesling (and with commenter Ed Reid) that it is not really possible to put an accurate number on the external costs of carbon emissions (or any of the other externalities of energy use). However, we should remember that the fact that some magnitude is hard to measure is not proof that its value is zero.

    For example, what is the value of having a fair and reliable court system to enforce private contracts? Absolutely impossible to quantify, but we all know the value is large. Although some anarcho-iibertarians have argued for compete privatization of the justice system, if practice, doing so is not high on the priority list of most of us. We are content to see the government spend a significant amount of money running a court system even though we really don’t know whether the amount spent is too much or too little, because we can’t measure the output of the system. We just guess. We keep trying to put pressure on to improve the functioning of the system, realizing that it is imperfect, that it is distorted by rent-seeking, etc., yet at the same time we are pleased that ours functions better than, say, Russia’s.

    Whenever I see people suggest that we should do nothing about pollution because we can’t accurately measure the value of externalities, I think of a long-ago conference where Murray Rothbard was holding forth with an ultra-Misesian rant to the effect that the concept of aggregate income or GDP was meaningless and unmeasurable. Someone asked him whether he agreed with a statement by Hayek to the effect that economic freedom was a major reason that America was more prosperous than China. Rothbard answered that yes, of course he agreed. The follow-up question was, “If you can’t measure aggregate income, how do you know America is more prosperous than China?” Rothbard’s answer was something to the effect of “You don’t have to measure it, you can just tell by looking!”

  3. Ed Dolan,

    It is not possible to begin reducing global annual CO2 emissions until we first stop increasing them. The increases in global annual CO2 emissions are currently occurring predominantly in Asia. I seriously doubt that the developed countries could reduce their CO2 emissions fast enough to offset the current rate of increase in Asia, no less produce an net reduction.

    Also, current non-fossil energy technologies, with the exception of hydro and nuclear, are “not ready for prime time”. We would be wise to avoid committing to eliminating fossil energy use until we have one or more viable alternatives.

    I agree that the magnitude of environmental externalities is likely not zero. However, I am not convinced that the net externalities resulting from the use of fossil fuels are negative.

  4. ER: Excellent points.

    Yes, no one country can stop climate change. There are three possible responses to that indubitable fact:

    1. Do nothing, it’s hopeless.
    2. Everyone is responsible for what he or she does, and every country for what it does. Doesn’t matter if everyone else behaves badly, that is no excuse for me or my country to behave badly, even if we’re the only ones in the world who do the right thing.
    3. Adjust policy to try to influence the rest of the world. For example, impose compensating tariffs on goods from countries that do nothing to control carbon. This one always ignites a firestorm with the free trade crowd, and I understand why, but . . .

    As to non-carbon energy not being “ready for prime time,” yeah, you’re right about that. That is why it is so very important to have a full-cost pricing policy that raises the price of all forms of energy to an externality-inclusive level, rather than leveling them all down to a “competitive” or “affordable” level, as the free-lunch crowd wants. If we are going to keep using mostly fossil energy, our best attack on the carbon problem is to price it in a way that makes the economy as a whole less energy intensive. Wonder of wonders, the US economy is already becoming less energy intensive. Let’s give this nice trend a boost.

    BTW, what offsetting positive externalities of fossil fuel do you have in mind?

  5. ER: Yes, heat, power, light, and transportation are valuable, but they are not externalities. Their value is fully captured (at the margin) by the people who buy energy for those purposes. The whole purpose of the market is to balance the value of, say, home heating fuel against the cost of producing it.

    True externalities are goods or bads that accrue to third parties who are neither producers nor users of the product in question. For example, if I live in an apartment building, when I turn on my heat, some of the heat I pay for warms the apartment above me. That is a true externality, but those effects of fuel use are seen only in relatively rare special cases.

    When you say ” I am not convinced that the net externalities resulting from the use of fossil fuels are negative.” What you really mean is that you think the total value of using fossil fuels for heating, etc., is greater than the total cost, including external costs. That may well be true for the totals (that is, the area under the demand curve up to the point of equilibrium compared with the area under the supply curve, even when the supply curve is adjusted for external costs like pollution.) However, policy should focus on the margin. At the margin, if a tax or tort law or something is not used to include external costs in the supply curve, marginal benefit from fuel consumption will exceed marginal cost (including marginal external costs.)

  6. Ed Dolan:

    Consider all of the externalities which are available to all of us as the result of the availability of heat, power, light and transportation. Our ability to live longer, healthier, more productive and more fulfilling lives is a positive externality of the use of fossil fuels. Even if we could maintain those advantages today with currently available non-fossil technologies, we would have come to those externalities far later in our history, both because of the later availability of the technologies and their higher cost, which would have greatly slowed their broad application. Imagine what would be involved in producing wind turbines or solar collectors without our ample supply of fossil energy.

    Many more of us would still be drinking dirty water, washing ourselves and our clothes in the river, cooking our food by burning dung and traveling on foot. Many of the advancements which have produced the pleasant life in the developed countries are now beginning to make life more tolerable, longer and healthier in the developing and undeveloped countries.

    We are far too ready to make the perfect the enemy of the very good. We need to “lighten up” a bit.

  7. ER: Well, you go ahead and call those things externalities if you want. You are free to use the language in a different way that economists normally use it. Yes, my life is longer and healthier because I can heat my home with natural gas, drive my car to the hospital when I am sick, cook my food with propane instead of eating it raw and all that. That’s why I buy the stuff. It’s not an “externality” as economists use the term, it’s just the value to me of the product. Externalities are a pathology of a market. Value of product to people who buy it is the healthy, normal functioning of the market. We are using the same word to talk about two completely different things. End of discussion.

  8. Ed,

    The problem with the externality argument as used by you and others is that it is an attempt at a cost benefit analysis that looks at costs only while studiously ignoring benefits.

    As such it is a fundamentally flawed analysis.

  9. Duracomm: Absolutely false. The externality argument fully recognizes all benefits produced by market transactions. The externality argument is based on classical liberal Lockean principles that market participants have an obligation to avoid uncompensated harm to the property and persons of bystanders. If you don’t like Locke, try Ayn Rand, who would say “polluters are looters.” If you don’t like Ayn Rand, try Heinlein, who would say TANSTAAFL.

  10. Ed Dolan,

    If it were a false those using the externality argument would estimate the positive benefits of the technology they are evaluating. Then they would determine the balance between costs and benefits.

    They don’t.

  11. OK, let me spell it out again. It’s really very simple.

    Normally, the market works fine and captures all costs and benefits, including

    (1) All “internal costs,” which mean costs of labor and materials purchased by the producer, and any harms to third parties that the producer must pay for, for example, if he is sued for damaging someone’s property or if he has to buy liability insurance for risk of an industrial accident or something like that.
    (2) All “internal benefits,” which mean benefits that accrue to the purchaser of the product, for example, the value of transportation gained from gasoline, the value of lighting your house with electricity, and so on.

    No policy intervention is needed to ensure that these costs and benefits are captured, and no bureaucrat needs to measure them. They are measured, subjectively or objectively, by the parties involved, the producer and customer. End of story (we hope)

    Sometimes, however, there are “spillover effects” from producing or consumer goods that are not captured in the market, so they are not reflected in market prices. The most common are property and persons damaged by pollution. In the classic example used by Ronald Coase, sparks from a train destroy a farmer’s crop. Destruction of the crop is an “external cost” of providing rail transportation. It is captured in the price of a rail ticket only if there is an appropriate policy in place to make sure that the railroad owner feels the economic impact of the lost crops. Possible policies that would do this:

    (a) Clearly defined property rights that specify the right of the farmer to grow his crop free of having someone else burn it.
    (b) A well-functioning civil court system that gives the farmer recourse in tort law in case someone violates his property rights

    Those are the two mechanisms favored by libertarian purists, and I agree they are best where they can be made to work. However, there are also other mechanisms that, perhaps less perfectly, act to “internalize” external costs, that is, cause them to be borne by the perp rather than by the victim

    (c) A criminal law system that imposes jail time or fines on people who harm others’ persons and property
    (d) An administrative, nonjudicial system of mandatory payments imposed by government on people who harm other persons persons and property. You can call these mandatory payments “fees,” “fines,” “taxes” or whatever, I really don’t care about the terminology.
    (e) A system of surrogate or administratively created pesudo-property rights such as tradeable pollution permits. I am not especially keen on that alternative, but some people like it and sometimes it works.

    There may also be external benefits that are not captured by the market. For example, a company that hires a private security guard to protect its own property may incidentally make its neighbors’ property safer by scaring criminals away from the neighborhood. These can be internalized by private negotiations (e.g., a group of businesses forming a security cooperative) or theoretically by a government subsidy, such as a tax break for company’s security costs (I am not recommending that, just mentioning it as a theoretical possibility).

    So where is your objection? I do not leave any benefits out. All “internal” benefits are counted, along with all “internal” costs, by supply-and-demand determined prices. I am completely willing to count any “external benefits” and weigh them against external costs; I absolutely do not want to be one sided about it. But where are the “external benefits” of producing electricity–benefits that are not captured by the people who buy it and use it? I just don’t see them.

  12. Ed, even if markets don’t fully price the cost of externalities, it’s an entirely different matter of figuring the best scheme to charge fully for the externalities and still a different matter to determine who receives the benefits of those charges. Furthermore, whatever scheme you come up with for capturing costs will produce its own externalities and the problem of the best way to charge for those externalities and distribute the benefits arises anew, and on and on, ad infinitum.

    Personally, if the climates a changing, I would prefer to just deal with it myself than be coerced into some scheme arrived at via a political process.

  13. Ed, I wrote the below comment on your blog piece, but I repost here since it is an example of a negative externality being created by a subsidy designed to address a negative externaltiy:

    “The bottom line: Wind power is good. It deserves a supportive policy environment. ” I used to believe this and I live in Texas, the largest wind power state in the nation. But I don’t believe it anymore because the subsidy has produced its own externalities which have had an adverse effect on baseload power producers and destroyed any incentive they have to invest in more generation in Texas. Now they are lobbying ERCOT for their own special subsidy to create more traditional baseload power plants. Imagine that!

    The problem arises because the wind producers, via the subsidy, are charging negative rates to electric retailers in the fall and spring when wind production is greatest and baseload demand is at a nadir. Without the subsidy it would be impossible to charge negative rates. The baseload producers are not able to recoup enough when demand is highest in the summer and winter and thus no longer find it worthwhile to invest in more production.

  14. Ed Dolan said,

    “So where is your objection? I do not leave any benefits out. All “internal” benefits are counted, along with all “internal” costs, by supply-and-demand determined prices.”

    The problem is you may have balanced the internal costs / benefits but you have not balance the external costs / benefits.

    You count the pollution costs but you do not balance the cost benefit equation by counting the benefits cheaper power costs provide throughout society.

    Energy costs are not a trivial issue, it is worth noting that high gasoline prices were probably the straw that broke the economies back and put us in the economic mess we are still trying to recover from.

  15. There are two flawed assumptions that are fatal to most externality arguments.

    1. Externalities can be accurately priced.
    2. There are policies that can account for the external costs.

    In other words the biggest issue is not “there ain’t no such thing as a free lunch” it is the “knowledge problem”.

    A third issues it the rent seekers ball energy policy devolves to when it is crossed with politics.

    The fourth issue is the (at best) utter incompetence of the political class.

    Examples of unintended consequences / knowledge problems related to energy policy.

    Some national security types supported biofuel mandates as a way of disentangling from the middle east.

    Result: biofuels have not substituted for Middle Eastern oil supplies. The higher food costs caused by biofuel mandates have caused untold human suffering and likely served to destabilize the Middle East.

    European biofuel policies were designed to reduce carbon emissions by mandating renewable sources of fuel.

    Result: The planting of palm oil plantations to provide feedstock for “renewable” biodiesel caused the destruction of vast amounts of tropical rain forests and increased carbon emissions.

    The sad fact is the environment can’t stand much more of these misguided attempts to help it out.

  16. Duracomm says “You count the pollution costs but you do not balance the cost benefit equation by counting the benefits cheaper power costs provide throughout society. . . . high gasoline prices were probably the straw that broke the economies back and put us in the economic mess we are still trying to recover from.”

    Sorry, you cannot strengthen the economy by fiddling the market to allow people to sell goods below cost. The “affordable energy” myth is third-world economics. Countries like India, Indonesia, Iran have kept fuel prices artificially low for decades at great cost to their economies. To hear you tell it, India should be a great economic power that beats the socks off the US in every area because they have cheap diesel fuel (although they are, belatedly, trying to reverse the policy.)

    Keeping gas prices artificially low (that is, below full marginal costs, including both production costs and external costs) only gives the illusion of creating wealth. Suppose, for example, we saw a poor inner city neighborhood where lots of kids were unemployed. We got a bright idea: Give the kids a license to steal stuff from 7-11s in middle-class suburbs and set up some cool government-sponsored shops in the inner city areas where they could sell Snickers bars and Cokes at low prices. The inner city neighborhood would quickly gain an illusion of prosperity: The kids would have jobs “harvesting” goods and reselling them, and the locals would have cheap smokes and Cokes.

    That is exactly the illusion of prosperity you give energy producers a free lunch by saying they don’t have to pay for the harm done by pollution

  17. Duracomm: Some line-by-line replies:

    “1. Externalities can be accurately priced.” I said this somewhere earlier, just because you can’t measure some quantity accurately does not mean its value is zero. Sometimes we have to guess, and a guess of a positive number for the harm done by pollution is likely to be a better guess than zero harm.

    “2. There are policies that can account for the external costs.” Yes, not always account accuratey, but better than doing nothing.

    “In other words the biggest issue is not “there ain’t no such thing as a free lunch” it is the “knowledge problem”.” I understand the knowledge problem, but I do not interpret it as counsel to do nothing just because we don’t know everything. For example, the knowledge problem does not say “don’t open a restaurant because we don’t know how many customers we will attract”

    “A third issues it the rent seekers ball energy policy devolves to when it is crossed with politics.” Amen. I am with you on this. Back in the 1970s, I spent a few years fighting against the rent seekers that had dominated transportation regulation through the ICC since the 1930s. It was a hard fight but free markets won that one. The ICC is no more.

    “Examples of unintended consequences / knowledge problems related to energy policy. . . .The sad fact is the environment can’t stand much more of these misguided attempts to help it out.” Good examples, you are right on all of them. However, I don’t think the solution is to give the free-lunchers free rein to trample on our property rights by polluting the hell out of the planet. That is the easy, feel-good reaction of a lazy cynic. What we need to do is keep pointing out the unintended consequences one by one, keep working to make policy better. If we took the lazy cynic’s way out, we’d still have the ICC.

  18. The current range of estimates of the carbon tax which would internalize all of the externalities resulting from the emissions of CO2 as fossil fuels are consumed is from ~$20 – $300 per ton. While that range is certainly non-zero, it does indicate some lack of specificity regarding the magnitude and significance of the externalities.

    It is possible that the actual number lies somewhere within that rather broad range, though that is hardly certain. 🙂

  19. I am not at all convinced that atmospheric CO2 emissions are a negative externality in the way that ground level ozone, lead, mercury,dioxin and fertilizer runoff are negative externalities. Rising CO2 levels could be a feature or a bug depending on other factors which effect climate. Climate change itself could be a feature or a bug depending on how the climate affects various locales of human habitation.

  20. Ed Dolan,

    Your conflation of the direct subsidies India provides to their consumers with the externalities this discussion started with does not help your argument. It also does not negate the point that energy costs have a very real impact on individual well being.

    Your confidence in the ability to design policy that does not cause more environmental damage than it prevents is not supported by history.


    Palm oil: the biofuel of the future driving an ecological disaster now

    Until now palm oil — of which 83% is produced in Indonesia and Malaysia — was produced for food.

    But the European Union’s aim of cutting greenhouse gas emissions by 20% by 2020, partly by demanding that 10% of vehicles be fuelled by biofuels, will see a fresh surge in palm oil demand that could doom the rainforests.

    That is likely to kill off the “flagship species” of wildlife such as the Asian elephant, the Sumatran tiger and the orang-utan of Borneo which are already under enormous pressure from habitat loss. Plantation owners regard the orang-utan as pests because it eats the young palm oil plants and hunt them down ruthlessly.

    It gets worse.

    Yet palm oil, mixed with diesel to produce biofuel, was hailed as a potential saviour for the environment. Put simply, the argument runs that the palm oil plants produce organic compounds that when burned in engines do not add to overall carbon dioxide levels. The CO2 absorbed by the plant in its life-cycle should balance the amount it gives out when burned.

    However, the more the ecological fairytale is scrutinised the more it begins to look like a bad dream.

    Researchers from the Dutch pressure group Wetlands International found that as much as half the space created for new palm oil plantations was cleared by draining and burning peat-land, sending huge amounts of carbon dioxide into the atmosphere.

    Awareness of the environmental destruction caused by bad policy is a big driver of why people like myself are rightfully concerned about the risk of implementing even more bad policy.

  21. Duracomm– Point taken that much policy is bad. My post was intended to describe what a better policy would look like. If I understand, you are not disputing that part of it, you just think it is a waste of time since regulators will always make a mess of things. I disagree–often but not always.

  22. Ed Dolan,

    We agree that the environment should be protected. I remain very concerned about the damage (in a number of areas) poorly thought out policy causes.

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