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Biden's Climate Plan

Crony Capitalism Ousts the Carbon Tax

October 25, 2022.


In this post, "climate plan" refers to the items in HR 5376, the budget reconciliation bill, as of August 2022.


This post is motivated by a common sense implication:


In a world of resource scarcity, a political leader that chooses the most economically expensive ways to reach a target will probably fall short.


And so it is with Biden's scheme to cap global warming at 1.5° F. This goal requires the most cost-effective policies, because curbing Greenhouse Gas Emissions (GHG) is plagued by the law of increasing marginal cost: once the low-hanging fruit is picked, it gets progressively harder to reach the remainder.

Unfortunately, the most economically efficient climate policy is politically inconvenient, to say the least. So, Biden has consigned it to the dust-bin of academic idealism, and replaced it with nostrums that are politically lucrative for Democrats, but economically expensive.


And because of the extravagant expense, public investment in climate stability is bound to be chipped away by more immediate demands on the Federal treasury. Eventually, the expense of adapting to the damage from climate change (e.g., seawalls) will crowd out investment in its prevention (e.g., offshore windmills); and the 1.5° cap will become unreachable. Then we will end up buying time with desperate technological Band-Aids, such as solar reflectors mounted on satellites.


This bleak scenario may be a little extreme, but it is consistent with politicians' short-term horizon. Their stalling on the impending financial crisis in Social Security is not a good omen for climate change.


Biden's plan dismisses the most efficient policy - a carbon tax


Putting a price on carbon is the most cost-effective tool for reducing GHG emissions. If people were charged a price for every ton of CO2 they spew into the atmosphere, they would have a powerful incentive to spew less.


That is the purpose of a comprehensive carbon tax. Ideally, the government would collect a tax on each ton of CO2 emitted by all users of fossil fuels, but especially in the transportation and electric power sectors. A carbon tax makes it profitable for polluters to switch to clean energy alternatives.


Most of Biden's economic advisors are staunch proponents of a carbon tax. His incoming Treasury Secretary Janet Yellen testified that "We cannot solve the climate crisis without effective carbon pricing." She was echoing a declaration signed by 3,600 economists of all persuasions, including 28 Nobel laureates as well as members of Biden's own Council of Economic Advisors. The declaration unequivocally endorses a carbon tax:


"A carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary. By correcting a well-known market failure, a carbon tax will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors towards a low-carbon future."


A few House Democrats have sponsored bills that put a carbon tax at the center of climate policy, for instance...


Tax CO2 emissions at an initial rate of $50/tonCO2, increase the rate 2%/yr, and return all the proceeds to households as a climate dividend.


Despite the chorus of endorsements, a carbon tax is conspicuously absent from Biden's climate plan.


Politics triumphs. The Democrats dread the label of "tax and spend liberals" so much that Biden has promised never to tax households earning less than $400K. Yet a carbon tax would betray that promise; it would increase the prices of virtually everything that households buy: electricity, gasoline, airline tickets, and anything that utilizes energy in its production. In effect, it is a tax on consumers, which makes it politically unpalatable.


Biden's Free Lunch Approach: Expensive Subsidies and Crony Capitalism.


Subsidies trade away cost effectiveness for political gain, in this case, tax credits for the production of electric cars and solar energy. Such subsidies function as fertilizer for a new crop of corporate contributors to the Party. Suppliers of electric cars, rooftop solar, turbine blades, and charging stations are drooling at the public trough, dispatching lobbyists, and opening checkbooks. Subsidies are the currency of crony capitalism. In the Democrats' greenwashed version of crony capitalism, subsidies make inefficient abatement policies profitable, to the benefit of party coffers.


Moreover, the Biden plan incorporates the economic nationalism of the Trump administration. The weapons against global warming are to be produced by union workers in American factories protected from import competition. (Note that Trump's 25% tariff on steel is still in effect). This "America first" policy will poison international cooperation on climate change and sacrifice the economic gains from comparative advantage.


Maybe The Atlantic is right. Biden's plan is the last nail in the coffin of a carbon tax.


Solar Subsidies: tax credits wasted on costly rooftop photovoltaic (PV).


The numbers in the following discussion are based on data from California where natural gas is the predominant fossil fuel. The output of electrical energy is measured in Megawatt Hours (Mwh).


Burning fossil fuels to generate electricity accounts for 25% of GHG emission in the US. For each 2.5 Mwh generated with natural gas, one ton of CO2 is emitted. Generating 2.5 Mwh with rooftop solar panels would cost $140 more than using natural gas, but it would be emission free. In other words, replacing natural gas with solar panels on residential and commercial rooftops would reduce CO2 emissions at a cost of $140 per ton ($140/tCO2).


To induce property owners to to actually install rooftop solar, Biden promises a tax credit that refunds 30% of the investment. Because of this subsidy, the cost of curbing emissions balloons from $140/tCO2 to $200/tCO2. The following calculations explain why:


Over its 25 year lifespan, a 10Kw rooftop installation would prevent the release of 150 tons of CO2. Under the Biden plan, the 30% tax credit which amounts to a $9,000 refund for the average 10 Kw system.

The National Renewable Energy Laboratory (NREL) estimates that this subsidy would increase sales of rooftop systems by almost 50%. This means that for every two purchases of rooftop-solar only one is induced by the tax credit; the other one would have been bought anyway, even without a subsidy.


Yet both receive a $9000 tax credit. So, to reap the climate benefit of one additional rooftop installation, a double subsidy ($18,000) is paid. This adds $60 ($9,000/150) to the cost of reducing emissions. The subsidized cost of eliminating one ton of CO2 with rooftop solar rises to $200/tCO2 ($140 + $60).


A carbon tax would do the job a lot cheaper.


Realistically, there are not enough qualified rooftops in the US to put a serious dent in in the emissions problem. Today, less than 1% of homes are covered with solar panels. According to one computer simulation, if coverage were increased to 50% of homes, annual CO2 emission would drop about 390 million tons at a total cost of $78 billion (390 M x$200/tCO2).


A carbon tax could accomplish this reduction at one-tenth the cost. Resources For the Future estimates that a carbon tax as little as $20/t would eliminate 390 million tons at a cost of 7.8 billion ($20 x 390 M).


What explains the huge advantage of a $20 carbon tax over Joe's subsidies?


A carbon tax incentivizes power companies to seek out the cheapest, most efficient ways to abate CO2 emissions. In the case of a $20 tax, the "cheapest ways" are those that costs less than $20, such as utility scale solar farms located in the sun-soaked south; and on-shore turbines in the howling Colorado Rockies.

In South Florida, for example, utility-scale solar farms might do the job for $18/tCO2. This makes it profitable for power companies to replace natural gas with utility scale solar: for each ton of CO2 they quash at a cost of $18, they save $20 in taxes, for a net profit of $2.00.

To reduce CO2 more than 390 million tons, the carbon tax rate will have to rise above $20/t so that more CO2 abatement projects become profitable to undertake.


With a carbon tax of $20/t there are just enough profitable opportunities to reduce CO2 by 390 million tons, and rooftop solar is definitely not one of them. There's no incentive to invest in rooftop solar because it's a loser: the $20 tax credit for eliminating a ton of CO2 is not enough to cover the $140 cost. But that's the virtue of a carbon tax over a subsidy: the tax deters spending on expensive solutions before cheaper opportunities are exhausted.


But eventually the cheapest opportunities will be exhausted. To reduce emissions by more than 390M will require situating solar farms in less sunny places, which would increase the cost of abatement to, say, $39/tCO2. To make these investments profitable, the carbon tax would have to rise $40/tCO2.


This is why all carbon tax proposals provide for a gradually increasing rate, say, 2% per year. It ensures that the most efficient ways to reduce CO2 are employed before more costly options are required to make further progress. In other words, the carbon tax is increased to keep pace with rising marginal cost of additional CO2 abatement. This is the first efficiency advantage of a Carbon tax over subsidies.


The second efficiency advantage of a carbon tax: energy conservation.


Biden's 30% production subsidy is politically attractive because it enables power companies to switch to renewables without raising energy prices. But, by keeping energy prices low, subsidies discourage energy conservation which would have dampened CO2 emissions.


On the other hand, a tax on CO2 emissions inevitably translates into higher electricity bills and fuel prices, which motivates households and businesses to find ways to use less energy. The conservation-effect shows up as as a decline in the economy's 'energy intensity' (the energy used to produce a dollar's worth of GDP).


A small portion of this decline stems from improved energy efficiency, e.g., LED lamps and foam insulation. But most of it comes from technological advances and better management of the input-mix: for example, peak-demand pricing of electricity, precision application of fertilizer in agriculture, and substitution of aluminum parts with carbon fiber.


In sum, by keeping energy prices artificially low, subsidies fail to restrain energy consumption. The advantage of a carbon tax is the extra reduction in CO2 it gets from inducing a decline in energy consumption.


The third efficiency advantage of a carbon tax: optimizing R&D.


By postponing investment in emission controls that cost more than the tax savings, a gradually rising carbon tax buys time for R&D to improve the efficiency of those expensive controls.


For example, the potential to reduce CO2 emissions is huge for both onshore and offshore wind technologies, but the cost of installing offshore capacity is three times that of on-shore wind farms. For now, onshore is more cost effective than offshore.


So, a gradually increasing carbon tax that starts at $20 would prioritize onshore wind projects until rising marginal costs justifies investments in offshore capacity. This buys time for R&D to improve offshore wind technology.


But Biden's climate legislation sacrifices this efficiency advantage by subsidizing operational offshore wind projects now. This fosters investment in relatively inefficient projects before they become cost-effective. The same criticism applies to Big Oil's ostensible savior - Carbon Capture and Storage.


Electric Vehicles (EV): $7500 tax credit for the purchase of a new EV.


The cost of reducing CO2 in this manner is insanely high - about $600 per ton of avoided emissions. Here's the arithmetic behind this claim.


Of all the EVs sold on a given day, the majority would have been purchased anyway, without the subsidy. Only one out of four sales can be ascribed to the Federal tax credit, but all the buyers qualify to receive it. So to put one extra EV on the road, taxpayers have to pay $30,000 (4 x $7500). According to Energy Department data, driving a Tesla instead of a Ford Escape prevents 60 tons of CO2 emissions over the car's lifetime (200,000 mi). So the cost of eliminating one ton of carbon is $500 ($30,000/60). However, the petrol-cars replaced by EV sales turn out to be 19% more fuel efficient than the Energy Department's average. This reduces the amount of CO2 avoided to 49 tons, which increases the cost to $612/tonCO2.


The Carbon Tax Alternative.


With a $50 carbon tax, the same reduction in CO2 emissions could have been achieved at one-tenth the cost: $50 or less to be exact. Part of the reason is energy conservation. A $50/ton tax on petroleum's potential CO2 would raise the price of gasoline by 50 cents/gal. The sticker price of a new vehicle would also increase (about $900 for an F-150) because the CO2 emitted in the process of production is also taxed.


These higher prices discourage the purchase of truck-like vehicles in favor of more fuel efficient cars. History shows that sales of pickups fall as gas prices rise. By contrast, EV subsidies discourage energy conservation. Why buy a cute 3600 lb. Chevy Bolt when, with a $7500 handout, you can move up to a macho 6500 lb. F-150 Lightning?


More important, a carbon tax would accelerate the replacement of petrol cars with clean energy EVs. By boosting gasoline prices, it would make petrol cars more expensive to drive. Although an EV's operating cost - fuel and maintenance - is much lower than a comparable petrol car, the EV's higher sticker price is slowing its rate of adoption.


Would subsidies for EVs and rooftop PV make a difference in emission levels?


Not much. The "budget score" for the Electric Vehicle provision in the bill indicates that the government would spend $9.3 billion on EV subsides over the 10-year authorization. However, Biden's goal of 50% EVs by 2030 implies a figure at least 10 times as big, i.e., $93 billion. Since it takes $612 in subsidies to curtail one ton of CO2 emissions, $93 billion would reduce emissions by 150 million tons. This represents a reduction in total energy-related emissions of only 0.03%. Clearly, EV subsidies is not the way to achieve net-zero emissions by 2050.


Similarly for rooftop solar subsides. The National Renewable Energy Laboratory estimates that extending the 30% investment tax credit would increase rooftop solar capacity by 12 GW at a cost of about $43 billion. Over the 25 year lifespan of rooftop systems, 12 GW of solar energy would reduce total energy-related emissions by a measly 0.015%.


The Fairness of Subsidies Versus a Carbon Tax.


Given that Tesla accounts for the bulk of EV sales, it seems obvious that EV tax credits are a gift to the rich. But this observation applies to clean energy subsidies in general, including solar. A 2016 study found that "the bottom 60% of the income distribution received about 10% of all tax credits, while 60% of the credits went to the richest 20%. The most extreme is the program aimed at electric vehicles, where we find that the top 20% received about 90% of all tax credits."


On the other hand, a carbon tax results in higher energy prices which impose a disproportionate burden on poorer households. So, the ultimate fairness of a carbon tax depends on how the tax receipts are recycled. If all the proceeds are divided equally among households, a.k.a., the climate dividend, the bottom 60% would enjoy a net gain of about $500/yr, while the top 20% would be worse-off by $2,000/yr.


Abandonment of a National Clean Energy Standard (NCES)


The most cost-effective policy endorsed by Biden is a National Clean Energy Standard. It would require electric power companies to abide by a schedule for meeting clean energy targets. Although it cannot match the power and scope of a carbon tax, it could reduce some emissions at a relatively low cost.


Unfortunately, under Senate rules, NCES does not qualify for inclusion in the $3.5 trillion budget reconciliation bill. So the Democrats are proposing a perverse revision that does qualify: the Clean Electricity Performance Program (CEPP). This program pays power companies to adopt clean energy. In other words, NCES has been warped into yet another inefficient subsidy scheme.


Biden's reliance on taxpayer subsidies for decarbonization is an affront to international cooperation in the battle against climate change.


The reason is that most US trading partners (TP) have implemented a carbon tax. Consequently, their energy costs are higher, and so are the goods produced with that energy. Meanwhile, American goods produced with subsidized energy are cheaper, which puts TPs at a competitive disadvantage in trade with the US. So, to level the playing field, some TPs are now planning to levy a carbon adjustment tax on countries (like the US) that fail to price carbon emissions.


Instead of leading the world toward a system of coordinated carbon pricing, the Party of Short-run Political Opportunism foments nationalism and protectionism. According to Adam Posen, America's retreat from free trade will be self defeating.


Conclusion: again, the can is kicked down the road.


The climate portion of the budget bill is not a genuine attempt to quell global warming. Mostly it is a vehicle for advancing left-wing populism: job creation, unionization, economic nationalism and protection from import competition. For example, it awards bonus subsidies to renewable energy projects that use American inputs (to the chagrin of our Canadian neighbors). By sacrificing the efficiency advantage of free trade, HR 5376 is guaranteed to make the transition to renewable energy a lot more expensive.


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