12.2: Current Policy- Market-Based and Regulatory Examples

New regulations aimed at climate change are rapidly appearing in both small and large communities around the world. They include an incredible number and variety of command-based rules. Some of these rules ask for actions that are likely to be near the top of a cost-effectiveness list, while other command-based rules ask for actions that are quite expensive per ton of carbon saved. Simultaneously, an increasing number of market-based policies are being enacted in cities, states, and countries around the world. We now turn to two specific examples, first a command-based policy and then a market-based policy (in the form of a carbon tax), to think about how cost-effectiveness works in practice.

Lightbulbs

The old-fashioned incandescent lightbulb is still a staple in many homes, hungrily chewing up electricity and providing what many find to be a reliable and pleasantly colored source of light. Swapping out incandescent bulbs for energy-saving alternatives, such as the fluorescent or LED light sources pictured in Figure 12.2.1, is often a very cost-effective way of saving carbon. Remember, though, that the complete cost-effectiveness list has to be very specific: swapping each bulb is a separate activity and needs to be separately ranked. If such a master list existed, we would find that some old incandescent bulbs are very near the top—swapping them out could be done with very little cost and would offer lots of carbon savings. We would also find, however, that other individual bulbs, such as those that are rarely turned on or are very costly to swap, appear in entries toward the bottom of the cost-effectiveness list.

Figure 12.2.1 Lightbulb technology. The old-fashioned incandescent bulb is on the left. The energy-saving LED is on the right. Image by Mark Jurrens from Wikimedia Commons.

Many command-based policies have been enacted that force lightbulb swaps to occur as old bulbs burn out.* US law (specifically, Section 321 of the Energy Independence and Security Act of 2007) now requires that all new lightbulbs have a minimum amount of light output per watt of energy consumed, subject to a long list of exceptions. Here are some of the exceptions that lawmakers added: bulbs not intended for “general service,” bulbs that have an odd-shaped base (in fact, anything other than a standard E26 screw base), bulbs that are very dim, bulbs that are very bright, bulbs that are not a standard size, and bulbs that don’t operate on 110 volts AC. Why all the exceptions? When writing this rule, legislators no doubt realized that while lots of bulb replacements are excellent and cost-effective ways to save energy, they could at the same time accidentally be forcing other lightbulb replacements that wouldn’t be saving much energy or that would be very high cost and so not worth the effort. For example, bulbs in medical equipment, movie projectors, and model train sets are all exempt from this particular command-based rule. These exemptions perhaps seem reasonable: the first two likely have very high-cost or no LED alternatives, and it is safe to assume the last one isn’t a very large source of carbon emissions.

Figure 12.2.2 Appliance LED lightbulb. Image by Geoffrey Landis at English Wikipedia.

Now let’s consider one of the other exemptions—lightbulbs inside refrigerators. These bulbs are not a standard size (usually smaller than a regular lightbulb), and so they are exempt from the rule. For some refrigerators, there are no fluorescent or LED options on the market, and so banning these bulbs would have meant very expensive retrofits, replacing entire refrigerators, or not being able to see which items are getting moldy. None of this is very appealing. However, what about refrigerators for which replacement LEDs are available (for example, the bulb in Figure 12.2.2)? Old-style incandescent refrigerator bulbs not only use a lot of electricity to make a little bit of light, they also add heat to the refrigerator. Many manufacturers of household refrigerators, and nearly all supermarkets (where the lights are on many hours a day), have already made the switch to LEDs for just this reason. Completely exempting replacement bulbs for old fridges, just to protect the few cases where no replacement is available, means missing out on many important, and very cost-effective, items on the master list.

We could perhaps write a more complicated command-based law to fix the refrigerator problem. It would need to have a precise list of exceptions to cover particular brands and models of refrigerator that have no available LED replacement, and the exception list should also get updated frequently as companies start to design different LED replacements and bring them to market. It is not just refrigerators, though. What about bulbs for other appliances, commercial lighting, and so on? You can see that it becomes almost impossible to write a command-based rule that correctly mandates cost-effective energy conservation for every size, shape, and application of lightbulb. Such complexity also dramatically increases the cost of enforcement.

Instead of trying to make the command-based regulation more complicated than it already is, economists would recommend a market-based policy. Most simply, imagine a carbon tax that raises the price of electricity. Not only would every individual and company get a reward (a lower electric bill) for making a lightbulb swap, there would also be incentives for engineers to come up with LED replacements for all different sizes and shapes of bulb. For specific bulb replacements that are too expensive per unit of carbon saved, people would keep buying the incandescent version. No lengthy list of exceptions would be needed.

The carbon tax

In January 2019, the Wall Street Journal published a letter calling for a carbon tax to be imposed in the United States. The letter was signed by more than 3,000 economists, including nearly every former chair of the Council of Economic Advisors (both Democrats and Republicans), every former chair of the Federal Reserve, and almost every living Nobel Laureate in economics. In contrast to their deep disagreements on topics like minimum wages, budget deficits, and health care, there is an incredibly strong consensus among economists that we must tax carbon.

The Wall Street Journal letter lays out some of the key advantages of placing a tax on carbon, mostly along the lines of the arguments in Section 12.1 Incentives and the Source of Cost-Effectiveness. A carbon tax puts an incentive everywhere and on every action possible. Unlike command-based regulation, the incentive is also uniform across all actions: saving a ton of carbon by turning down an air conditioner is rewarded exactly the same as saving a ton of carbon through buying more efficient cars, lighting, or any other activity that emits greenhouse gases. It would take a near-infinite number of command-based regulations (plus an implausibly large enforcement effort to monitor people’s everyday actions) in order to accomplish this without using a carbon tax.

At the same time a carbon tax incentivizes carbon savings, it also brings revenue in to the government. What the government should do with this money is a source of much debate. Some people advocate using the revenue to pay down the national debt, while others suggest it should be spent on education or health care, and still others think that the government should not spend the money at all, but should return it as a direct dividend check to each household. This last option is recommended in the economists’ letter and is perhaps the option most likely to be acceptable across different parts of the US political spectrum.

The British Columbia experience

It is something of a puzzle why most regulators remain reliant on command-based rules when economists agree that carbon taxes are simpler, are easier to enforce, and accomplish the environmental goal at much lower cost. Only a few jurisdictions around the world have implemented carbon taxation. The Canadian province of British Columbia is one prominent example and also represents the first significant carbon tax imposed anywhere in North America. British Columbia’s carbon tax came into effect in 2008, giving us more than a decade of data that can be used to examine the impacts.

As with many environmental policies, British Columbia’s carbon tax was phased in. The 2008 tax was set at $10 (Canadian dollars) per ton of carbon, with increases of $5 per ton per year until the tax reached $30 per ton in 2012. It has been held fixed since then, and the incentives are now felt in nearly every sector of the economy.** Even if a product or service does not produce any carbon emissions directly, there is almost always some fossil fuel being used somewhere along the way in production. Companies in British Columbia pass the carbon tax through each step of production, packaging, shipping, and so on until the final value shows up in the price tags seen by retail consumers.

The revenue from the carbon tax is returned to households, mostly in the form of tax cuts, rather than being used for increased government spending.*** This has likely been an important factor in the public’s growing acceptance of the tax. Low public opinion for the first several years of the tax, when people did not like seeing higher energy prices, gave way to popular support in more recent years as people realized their income and sales taxes were lower.

The goods that are most dramatically affected by a carbon tax are usually raw fossil fuels (for example, coal) and derivatives of fossil fuels (for example, gasoline). This makes sense: even though conserving a gallon of gasoline and buying a dog leash made in a solar-powered factory are both perfectly good ways to reduce your carbon footprint, and will both be incentivized by a carbon tax, saving the gallon of gasoline will be doing a lot more good for the climate. Table 12.2.1 shows how British Columbia’s $30 carbon tax changed the price of fuels faced by consumers. A gallon of gasoline, for example, became 20 cents more expensive. Filling a typical 20-pound propane tank for a patio grill went up by 64 cents. These are relatively small percentage changes (4% and 7%, respectively) but enough to push people toward somewhat less wasteful habits.

Table 12.2.1 Translating British Columbia’s $30 per ton carbon tax into fuel prices

Fuel Type	Units for Tax	Tax Rate	Carbon Tax as a Percentage of Final Fuel Price
Gasoline	$/gallon	$0.20	4.4%
Diesel	$/gallon	$0.23	5.1%
Propane	$/20-pound tank	$0.64	7.1%
Natural gas	$/MMBtu	$1.26	33.9%
Coal	$/ton	$48.60	54.7%

Notice that the prices of natural gas and coal rose much more dramatically, by more than 30%. Much less of the cost of those fuels is related to refining and distribution, and so the raw carbon content ends up being a much larger component. These price changes are more likely to be felt by industry. Switching an industrial process from natural gas to solar, for example, became quite a lot more attractive after the carbon tax was implemented.

*The command-based rules apply only to new bulbs manufactured after a certain date, so they don’t incentivize swaps before old bulbs burn out, which will also sometimes be cost-effective ways to save carbon.

**The most notable exemption in British Columbia is agriculture, which is allowed to use fossil fuel and to produce nonfossil greenhouse gas emissions such as methane without paying the tax. This type of exemption reduces cost-effectiveness: many farmers have actions they could take to reduce carbon emissions for less than $30 per ton, but they are not currently incentivized to do so.

***Many economists have studied the choice between (1) simple “dividend checks” and (2) reducing existing taxes (like sales taxes or income taxes) as a way to return carbon tax revenue to the people. Reducing existing taxes is more efficient, since most of the taxes we currently use to raise revenue cause unnecessary distortions in the economy.