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Heep Papers: 2017-2

Heep Papers: 2017-2

The Political Economy of Carbon Pricing Policy Design

Enel Foundation offers additional support to the Enel Endowment for Environmental Economics to the Harvard Environmental Economics Program (HEEP). HEEP develops innovative answers to today’s complex environmental issues, by providing a venue to bring together faculty and graduate students from across Harvard University engaged in research, teaching, and outreach in environmental and natural resource economics and related public policy.

The program sponsors research projects, convenes workshops, and supports graduate education to further understanding of critical issues in environmental, natural resource, and energy economics and policy around the world. In the context of this relations, since 2012, Enel Foundation has promoted the development of discussion papers adressign important topics in international climate policy, especially those pertaining to market- based approaches to climate change. The papers are discussed during side events that take place in the framework of the Conference Of the Parties.

The Political Economy of Carbon Pricing Policy Design

In 2015, the international community established the goal to limit “the increase in global average temperature to well below 2⁰C above pre-industrial levels.”2 In light of historic greenhouse- gas emissions and the ambition of mitigation actions pledged under the framework of the Paris Agreement, this is an ambitious goal that will require global emissions to decline eventually to zero or, in some scenarios, even be on net negative through carbon sequestration technologies (Clarke et al. 2014; UNEP 2016). With more than 80% of the world’s energy coming from the combustion of fossil fuels (IEA 2016), achieving this goal will necessitate a dramatic transformation of the energy foundation of the global economy.

To drive reductions in greenhouse-gas emissions, policymakers have employed a vast array of policy instruments: voluntary agreements with industry, subsidies for low- and zero-carbon technologies, product labeling, emission-performance standards, energy-efficiency standards, mandates for low-carbon technology procurement and use, emission cap-and-trade programs, and carbon taxes. Economists have long endorsed the last two of this set — cap-and-trade and carbon taxes — because they can directly price carbon emissions. In doing so, the policymaker can leverage the incentives of businesses and individuals alike to seek out and exploit the lowest cost ways of reducing emissions. Pricing carbon delivers clear signals to innovators and entrepreneurs to develop and market new, low- and zero-carbon technologies and products. Policymakers can apply carbon-pricing policies to a very broad set of sources in an economy, potentially covering all fossil-fuel-carbon emissions under a single policy. In contrast to alternative instruments, carbon pricing can enable emission abatement at lower costs, across all activities associated with the production and consumption of energy; spur more innovation to lower technology costs over time; and maximize the social benefits of climate policy by explicitly aligning the carbon-pricing policy with the benefits of reducing greenhouse-gas emissions (Aldy et al. 2010).

This paper reviews a variety of design issues that play an important role in the political acceptability and the long-term durability of carbon-pricing policies. Different countries have pursued different avenues in the choice of pricing instrument and its design. These choices will influence the cost-effectiveness, environmental performance, and distributional outcomes of carbon pricing in practice. Given the long-term risks posed by climate change and the long lifetimes of carbon-polluting capital, a successful climate change policy will need to be politically durable (Carlson and Fri 2013). The design of carbon pricing policy in practice reveals political preferences over key elements of these programs, subject to important institutional constraints idiosyncratic to each governing jurisdiction (Burtraw 2013).

The Political Economy of Carbon Pricing Policy Design

Joseph Aldy

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