Part III: Lecture 1Tax vs. Permits (vs. CAC)Carbon Taxes vs. Permits- To economists there are two main families of optimal (highest efficiency) carbon controls- Carbon taxes- Carbon permits or auctions (also called cap and trade)- Carbon tax: whenever you emit carbon you pay a tax of $x- Carbon permit: whenever you emit carbon you have to turn in a permit. You have to havea permit for each ton of carbon- Where do you get those permits?- The government decides the initial allocation- Maybe the government gives you some /9allotment)- Maybe you buy them at a government auction- Maybe you buy them from some other firm- Which is best?- Turns out they are (in a simple model) the same in terms of price, Q reduced, andgovernment revenuePrice of a Carbon Permit- Because people will buy and sell permits at an auction or from each other, this establishesa price for carbon- We can make the price of a prie of a permit equal to a carbon tax- How?- We can establish an auction and see what people bid- If the price is going too high, sell more permits- If it is too low, government can buy them backExamples- California has a permit scheme and auction off permits- Same with Alberta, China, the EU, and Switzerland- British Columbia, Sweden, the UK, Norway and many others do a tax- Both types of policies (can) make revenue for the government:- Tax we talked about earlier- Auction?- The firms pay the government the price of the permit- In one case you pay after you pollute, the other you pay before you polluteWe can get to the exact same equilibrium through either the price axis, or through the quantity ofpollution reduced axisLearning About Permit Prices- Getting to a well functioning permit market is not automatic- You know where to buy toothpaste, but where would you buy a carbon permit?- Who is selling and buying?- Often regulatory agency like the EPA or California’s ARB needs to get thingsstarted and establish a clearing house- These markets are often volatile for w whole because firms may not know howhard or easy it is to reduce carbon- What is the yellow box under a tax system?- What is the yellow box under a permit auction?- Who cares if these are the same?- Quantity of pollution/abatement and tax/auction revenue is the same for eitherprogram- This equivalence means we do not have to favor one or the other on efficiencygroundsSecondary Reasons: Uncertainty- Seminal work by Martin Weitzman- Only equivalent if demand and supply for pollution reductions goes as planned- What if you have a tax but it becomes more valuable to pollute?- Pollution will increase- What if you have cap and trade?- Same pollution, higher permit price- A tax ensures we won’t cross any compliance cost thresholds while Cap and Tradeprevents crossing damage thresholds:- A tax won’t ground all air travel accidentally- But a tax might push you over a key tipping point accidentallyCap and Trade with Business Cycles- What if we go into a recession?- Less demand for permits- Price falls- Or opposite in expansion: no extra pollution but very expensive- Unpredictable costs for firms- Under a tax, these unexpected shifts also cause problems- The future price of permits is unknown, which dampens investment- In an economic expansion people will just pollute more and pay the tax- Unexpectedly more pollution than planned- Economists tend to favor carbon taxesSecondary Reason: Moral- Tax:- Sin taxes are common - cigarettes, alcohol- Auction:- Some feel this is like a ‘license to pollute’ meaning that it makes pollutingmorally acceptableOther Reasons to Pick- Tax:- Easy to administer with existing structures (don’t have to organize an auction)- However the agencies that tax (IRS) often do not have the same goals as agenciesthat track the environment (EPA)- Auction:- Can give the permits away for free- This can help to convince industry (as was done in Australia)- Called “grandfathering permits”- Still limits the total pollution but firms only pay (other firms) if they needextra- Can issue permits to firms that consume carbon:- Carbon sequestration/offsets- Can be done entirely by EPA (as done with SO2 auctions)Part III: Lecture 2Value of Statistical LifeQuestionA new policy attempts to reduce pollution by moving a coal power plant outside of the cityDoes this pass a Cost-Benefit test?Yes because one 95-year old lives one extra day (infinite benefit)VSL: Value of Statistical Life- If the value is high, we will often enact more environmental policies since pollution isgenerally a health hazard- What is this value?- EPA uses $9.1 million but in the past has used values closer to $5 million- Other agencies use different numbers- In cost-benefits test for policy, particularly environment, deaths are often extremelyimportantVSL in Climate Change- It is the most important number in climate change (currently…)- So where does the VSL of $5-9 million come from?- Many ways to get at it- Labor market studies show how people trae risk against pay (often called hedonic wagemethod)Nonmarket Valuation- Revealed Preferences- Hedonic Pricing- Characteristics of a good each contribute to its value- Environmental amenities are “priced in” in housing market- Travel cost- Can we learn about the value of a site and it amenities by observingStates Preference- Sometimes these revealed methods don’t work- Surveys fill an important gap in valuation- Called contingent valuation methods because they areUse Value vs. Non-use Value- States preference is the only method of getting at non-use value- Non-use value is the value of something I never actually interact with- Arctic National Wildlife refuge- Biodiversity in the rainforest- I may never visit these places but I value them simply existing- There are also many psychological effects that come into play- Let’s look at one of these in particular- Willing to Pay (WTP)- The most you are willing to pay to get a good ro service- Willing to Accept (WTA)- The amount you need to be paid to lose a good or serviceWTP vs. WTA- Usually we ask people in a lab “how much would you pay for a mug?” (WTP) or givethem a mug and ask how muchHedonic Wage Method- Made up example:- Logging: 0.102% Annual Pay: $34,000- Taxi Driver: 0.020% Annual Pay: $32,000- $(34,000-32,000)/(0.00102-0.00020) = $2.4 million- People seem to be willing to pay to avoid risk…but it’s not infinite- Unsurprisingly these values can vary substantially by country, income group, age,etc.- We sometimes correct for age, but rarely