What is Carbon Pricing, why we need it and why no one wants it.

As promised, here is the follow-up post to do with the final topic which we covered in Microeconomics on environmental economics and some discussion on the current events.

Anyone viewing the news these days will certainly have come across the plethora of articles from various media outlets covering the proposed carbon price, either the one being proposed in Alberta or the national price floor which will be implemented by 2018. (of course, these links are just a few of the many pieces written on the topic over the last few weeks and months!).

Without getting into the politics of this policy (may not be possible)  I want to discuss what a carbon price does and why we might want it as a society, but why no one likely wants it from an individual perspective.

Keep in mind, I will be addressing these from a general theoretical standpoint, I am not evaluating the details of either policy nor am I getting into the spin-off effects such policies may have on the macroeconomy or the distributional effects.

Let us start by looking at a simplistic case of heating our homes. In this area, homes are primarily heated through natural gas, electric or wood heat. All emit a level of emissions into the atmosphere in the process of heating our homes (Some worse than others of course!).

Presently when you pay for any of these sources of heat without a price on carbon (carbon, or emissions tax), you are paying simply for the good which you are using to heat your home (wood, natural gas, electricity). thus when you make the decision of how hot you are going to keep your house given the cost of heating, you are primarily making this decision with little to no regard for how your choices affect others due to the emissions released.

Truthfully, you individually add very little to the problem in your personal emissions. the problem is that the little bit that everyone adds, cumulates and is felt by all, becoming a massive amount of emissions hanging around either locally or in the atmosphere.

If we were to add a cost (emissions tax) to heating your home in line with the cost you impose on society (others) due to your emissions, then when you make the decision on how hot to keep your house, you are not simply factoring in the cost to heat your house, but also the respective cost of your emissions.

This has two main effects on your consumption habits.

(I) You will reduce your consumption due to the increased price. That is, you will choose to have a lower level of heat and wear a sweater instead. This, of course, will largely depend on how sensitive you are to the price change. (Income effect)

(II) As 'cleaner' options of heating your home will not be taxed or at least taxed less, these options become a viable alternative and relatively cheaper. Thus you may choose alternative sources to heat your home.  (substitution effect).

By pricing carbon appropriately we adjust our consumption habits of carbon-intensive goods, resulting in us consuming fewer goods which are carbon intensive while shifting our consumption towards goods which are produced in a relatively 'clean' fashion.

Well, this seems positive, pay more for goods which are 'dirty' resulting in us choosing 'clean' goods instead. so why all the backlash?

From a societal viewpoint, a price on carbon is ideal, it allows us to internalize a cost which we impose on others without bearing directly ourselves. but in that lies the problem.

Let's shift the narrative slightly. We all know (especially those who live in large cities) that driving our vehicles creates harmful emissions, which in turn can lead to the development of smog and other air-quality concerns.

Where a lot of the climate change debate seems rather ethereal to the average person, something that may affect them or their children off in the future, smog and the impacts of it are apparent and can be witnessed and felt by anyone who has been in a large urban center and felt or seen the deterioration of the air quality.

If the effects and the societal costs of smog are so apparent, why don't we willingly choose to reduce our driving?

the problem lies in the comparison of my personal benefit received from driving an additional Km vs my perceived cost of driving that additional Km. Specifically, driving has a huge benefit over taking transit or other alternatives, while at the same time the cost of driving that extra Km is minimal to me (Gas isn't that expensive, and from my individual viewpoint, I alone am not adding that much to the smog problem).

as a result, because my private costs are lower than the social costs, we all choose to drive more than we would socially want, resulting in high levels of smog and deterioration of air quality.

If we were to impose a tax on your driving and begin to charge people $X for every liter of gasoline, this would similarly have the effect of increasing your perceived cost of driving and thus you are left with two options, either drive less, or substitute towards a more fuel efficient vehicle.

Hence the reason why carbon pricing or tax is never going to be popular is because we see our individual contribution to the problem to be so small, that we personally see the tax as unjustified. Our personal consumption habits are hurt as we now have to arbitrarily pay more for a good that was cheaper just before the tax. that is we see this tax as having a great personal cost!

But what about the benefits, clearly the idea of this tax is that it reduces our consumption of 'dirty' goods, thereby reducing our levels of pollution, and cleaning up our air and environment. This is a good thing right!

It is a good thing, and society on whole benefits - the problem is the benefit any individual sees due to this tax is small, as this effect of reducing pollution seems rather ethereal or abstract and thus it appears in the end that this is actually just a money grab by the government over actually providing a cleaner environment. (The argument I often hear, is how is the government going to provide cleaner air by taking my money! This misses the point, the government doesn't provide cleaner air, we do by adjusting our consumption habits!)

By putting a price on carbon, we increase the cost of carbon-intensive goods, which decreases our output, but such policies are not going to be popular because although society on whole benefits, at the individual level we are left with higher costs and an unclear vision of how we personally benefit from paying these higher prices.

Personally. I think a carbon price is desperately needed to force us to individually realize the costs that we are imposing on society due to our choices. But of course this is just my opinion and there is much much more to this discussion.

There are of course distributional  (are the rich or the poor more greatly hurt or benefit from this policy?) as well as regional impacts to this policy (Some regions provide necessary goods to our way of life that are inherently 'dirty'), along with many other issues, which I do not mean to minimize, as they are serious effects which need to be addressed with any carbon pricing policy -- but due to scarce time, and attention on the part of the reader -- only so much can be discussed in one post.

There is still so much that can and could be said about other aspects of carbon pricing and its effects, what are your thoughts on the subject? feel free to add to the conversation in the comments below.