Episode 1: Intro to Carbon Pricing [Full Transcript]

Carbon taxes vs. cap and trade

Photo by Marcin Jozwiak on Unsplash

Casey: Welcome to Pricing Nature, a brand new podcast from The Center for Business and the Environment at Yale, and the Yale Carbon Charge. I’m Casey Pickett.

Naomi: I’m Naomi Shimberg

Jacob: And I’m Jacob Miller

Casey: In this introductory episode, we’ll walk through the basics of putting a price on the pollution that’s causing the climate emergency. Over the course of this series, we’ll talk to journalists, scientists, legislators, and economists about what it means to put a price on Carbon Dioxide Emissions, and the other Greenhouse Gases being poured into Earth’s atmosphere. But first, we try to get a gut sense of why anyone would want to put a price on something we can’t even see... 

I grew up in a house with a brook behind it.  We used to build dams and sail paper boats down it.  Across the brook was a tall bank, about fifty feet high that we would slide down.  But you had to be careful because you could get caught on an old car fender sticking out of the dirt.

Atop the bank was a farm and people used to use the bank as a dump, chucking trash and broken-down cars over the edge.  The slope swallowed them up over decades, and our sliding bottoms would reveal broken bottles and rusted car hulks.  Then we’d have to spend a few weekends digging them out, hauling them piece by piece across the brook to the road.

Think of all the hours playing with my brothers that I lost to digging that stuff out.  Think of all the time my Dad spent hauling wrecks from the bank--so his kids wouldn’t get gashes or tetanus--that he could have spent fixing up our house to make it warmer for the winter, or splitting and stacking wood for the stove. 

When I asked, “Dad, how come people threw cars over the bank?”  He said, “To give us a reason to work together, son, outside, in the dirt.”  And when I rolled my eyes, he said, “Well, back then there were no fines for dumping garbage on open land.” 

For those people, there was no price for dumping trash from the top of the bank.  But years later, at the bottom of the bank, it cost us.

Naomi: How old were the cars, Casey?

Casey: They were all rusted hunks of metal, and I was young.  But my impression at the time was like 1930s to 1950s? 

Naomi: So, at some point, people stopped throwing trash over the bank.

Casey: Right. For a while, there was no incentive to not throw the cars over that slope. The polluters were sort of shielded from the costs that their actions had on me and my family. But when the town threatened a fine, people stopped dumping their cars… 

Now, Carbon Dioxide pollution… it’s basically just invisible junk cars, or bottles, or other trash. And every year, we burn enough gas, oil, and coal across the planet to release about 38 metric gigatons of that trash into the atmosphere…. 

Jacob: Alright Casey, that sounds like a lot, 38 metric gigatons? Can you put that into perspective for me?

Casey:  Sure thing. A gigaton is a billion tons, Jacob.  38 gigatons is the weight of about six billion mature African bush elephants--those are the big ones…. 

Jacob: Got it. Okay. Six billion African bush elephants worth of carbon dioxide emissions globally each year.  That sounds pretty bad.

Casey: It’s real bad. Carbon dioxide and other Greenhouse gases in the atmosphere act like glass in a, well... greenhouse, trapping energy from the sun as it shines on the earth. This causes a rise in global temperatures and a changing climate, which sets off a long chain of dominoes….

Naomi: Yep.  A changing climate increases the likelihood and severity of a host of problems—hurricanes that flood homes, polar vortex breakups that freeze people’s hometowns, wildfires and mudslides across populated areas.

Jacob: Not to mention the spread of infectious diseases…

Naomi: You got it.  The list gets long pretty quickly.  There’s strong evidence that climate change is driving food shortages at the heart of global conflicts and refugee crises we’re seeing today.

Casey: Exactly. And all these horrible dominoes have costs.  If your house gets flooded, you have to pay for a new place to live.  If your city’s reservoir dries up, you have to pay for a new source of water.  If you get Lyme disease because the freeze cycle is no longer deep or long enough to keep the Deer Tick population at bay, then you could be out of work for weeks and be stuck with hefty hospital bills. We’re talking about real money that real people actually have to pay... And right now, there’s almost no charge for dumping Carbon Dioxide into the atmosphere in the U.S. just like those old cars and bottles and other junk, before towns put the fines in place.

Naomi, I feel like I’m being long-winded about this, and maybe getting a little hot under the collar. What’s a more concise way of talking about it?

Naomi: Well… I’ve got an example from an unexpected corner.

Casey: Sounds mysterious. Let it roll.

John Oliver: Carbon Pricing. The current situation with carbon is critical. Carbon emissions are by far the largest source of greenhouse gases yet right now it’s basically free to pollute the air with carbon dioxide, which is a little bit weird when you think about it because we've universally agreed that polluting is bad. And yet, it's free to do it. 

When you litter you pay a fine. When you drive above the speed limit you pay a fine. When you steal 400 hamsters from PetSmart, tie them to a sled and race through the streets on a hamster sleigh, you pay a fine. Is that fine worth it? Yes, of course it is. But you do pay it. 

Jacob: I love that guy.

Casey: There’s nobody like John Oliver...

Jacob: Okay, so, when he puts it like that... why don’t we already have a price on carbon?

Naomi: It’s complicated! It’s hard to implement! And it’s politically charged! There are tons of opposing interests to consider.

Jacob: Ok, well where can we start? How do you price an invisible gas that causes diffuse, disproportionate harm… especially one that plays such a pervasive role in our economy?

[Break]

Casey: Let’s talk about how carbon prices get set. Now I just gave an example of costs of pollution from my Vermont upbringing, which was pretty white, definitely privileged.  But the impacts of climate change land especially hard on people with fewer advantages.  It’s an issue of justice.  Putting a price on carbon dioxide up-front reduces the amount people emit, reducing the costs on those hit with climate impacts.

If you add up all the costs of all the harm CO2 in the atmosphere does to people, like flood damage, or health care bills, or paying for water transported to areas of drought… If you add up all those costs, you can estimate the cost to society of each new ton of carbon emissions. That’s what we call the Social Cost of Carbon.

Naomi: The idea of being able to calculate a Social Cost of Carbon (SCC) is basically what won Bill Nordhaus the Nobel Prize in Economics in 2018.  He was awarded the prize for incorporating climate change into long-run macroeconomic analysis. His model estimated that the social cost of carbon should be around $30… And we’ll learn more about that model in future episodes.

Casey: But it’s not the only way to develop a price on carbon emissions.

Naomi: Ya, I mean, we could just pick a number out of thin air! The old let’s-pick-a-nice-round-number approach. Like $10 per ton. Or $50. OR, you could look around and see what prices others are using.  

Casey: OR, you could estimate how much money it would take to get the world off of fossil fuels and divide that sum by the total number of tons we’re expected to emit before the transition is complete. That’s called an implicit price.  

Jacob: OR you could create a market and let the ~invisible hand~ decide.

Casey: Right now, there are a whole bunch of different methods being used around the globe to determine the price per ton of Carbon Dioxide, and a bunch of different systems being used to apply that price. The two most common pricing systems are called “Cap-and-Trade,” and “Carbon Tax.” This might be a good time to go into the differences between two.  Shall we do it?

Jacob: Seems as good a time as any!

Naomi: Let’s do it.  

Casey: Jacob, would you like to do the honors?  How fast can you explain the “Cap-and-Trade” system in sufficient detail? I’m timing you....go!

Jacob: Okay. A cap-and-trade system has two main parts. First, a government sets a limit on the amount of pollution allowed within a certain portion of the economy, like power production, for example. That limit is called the “Cap.” Then the government gives out permits to each company and institution, allowing them to pollute up to a certain amount based on the number of permits they have -- and each permit is usually worth something like 1 metric ton of pollution. Then the government also creates a marketplace where those pollution permits can be bought and sold. That’s where the trade part comes in. So if I have leftover permits because I was able to cut down on the emissions coming from my factory, and you need more permits because your factory is struggling to reduce its emissions, then you can buy some of my permits. And the price will fluctuate on the market based on the supply and demand of permits, and we end up reducing emissions at as low a cost as possible…  How’d I do?

Casey: 56 seconds.

Jacob: Alright!

Naomi: Okay, I can beat that.

Casey: Okay... go.

Naomi: In a cap-and-trade system, a government caps emissions, issues permits to pollute, and allows companies to trade those permits.  Boom.

Casey: Woah, uh… 7.5 seconds.

Jacob: Oh come on, that’s definitely cheating...  Casey said “sufficient detail,” I believe? You basically just said, “Well in a cap-and-trade system, you cap… and then you trade.”

Naomi: Well, Jacob, in a cap-and-trade system, you do cap and then trade.

Jacob: Alright, Naomi, I don’t know why you’re coming for me like this...

Casey: Okay you two… Well, we’ve got another system to look at -- Naomi, why don’t you go first on “Carbon Tax.”

Naomi: Okay.

Casey: Go.

Naomi: With a carbon tax, the government sets a price for each ton of emissions and charges companies that price for each ton of emissions they produce.

Casey: 9 seconds.

Jacob: Oh yeah? Watch this:  A carbon tax puts a tax on carbon emissions. You can’t see it but I just dropped my mic.

Casey: Dayum. With the mic drop, that’s 4 seconds.  Alright, well, clearly a carbon tax is simpler to explain. Why isn’t it the obvious choice?

Jacob: I think one of the main issues here is the pesky word, “tax.”  Nobody likes taxes, but we seem especially allergic to them here in the United States...

Naomi: And then there’s the concern that with a carbon tax, you’ve set a fixed price... but if the price isn’t high enough, it won’t stop companies from emitting carbon and just paying the price.  There’s no guarantee of a certain amount of carbon reductions.

Casey: And why isn’t the lack of a guaranteed amount of emissions reductions an issue with a cap-and-trade system?

Jacob: Well, because of the Cap! It’s not an absolute guarantee, but companies get heavily penalized if they emit more carbon than they’ve bought permits for, so there’s a really strong incentive to stay under. And since the Cap-and-Trade system allows for a fixed total number of permits in the market, the market can control exactly how much carbon is emitted in total.

Naomi: So there are pros and cons to each policy -- carbon taxes are more simple, and in theory harder for lobbyists to work around. But cap-and-trade policies allow the government to set emissions limits directly, in addition to the advantage of avoiding that pesky word, “tax”.

Casey: Well you’ve made all this seem pretty straightforward. So why have there been so many different carbon pricing bills in Congress over the past few years? What is there to debate?

Naomi: LOTS. Let’s call our first expert to discuss.

[Brief music]

Naomi: We talked with Susanne Brooks at The Environmental Defense Fund, a centrist environmental organization focused on market-based climate solutions.

Susanne: I'm Susanne Brooks and I am the senior director of US Climate Policy and Analysis at the Environmental Defense Fund.

Casey: Susanne, what are the key variables to consider when looking at a carbon pricing proposal? First, I would assume, does it use cap-and-trade or a carbon tax?

Susanne: I think the economists have debated cap-and-trade and taxes for decades. What are the pros and cons of each of those different policies, but I think there’s actually… the differences between them, and the distinctions between them are actually not as big as they may seem. They share really important elements and most of the existing programs in the world are actually hybrids that have qualities of both cap-and-trade and taxes.

Casey: OK, so whether it’s a cap-and-trade focused approach or a tax-focused approach, what do you look at first when you’re designing a policy to cut carbon emissions?

Susanne: I would describe this as the level of ambition of the program. So how aggressively, how quickly are you trying to cut pollution?

Naomi: Under the two different carbon pricing systems, there are different strategies for controlling how quickly you’ll cut pollution.. In a cap-and-trade system, you can set the Cap wherever you like, and lower the Cap as you try to cut more and more carbon from the economy. This means giving out fewer permits to pollute. Under a Carbon Tax, you would instead set a higher price, that is, higher fees on polluting. You could raise or lower the price to control how quickly you’re moving to a carbon-free economy.  Once you know how much and how fast you want to decarbonize, then you can figure out the next thing:

Susanne: The scope and what I mean by that is, what pollution sources are you actually covering with your policy?

Naomi: The question here is, who should be affected by the carbon price? Should it cover power utilities? Industry? Transportation? Farms? Homes?  

Susanne: It’s really important to cover as many sources of pollution as possible, in a carbon pricing program. That’s first because, one, you simply want to be reducing as much pollution as you can so you want to be covering as many sources as you can. But also, because broader coverage is going to help keep your costs low. Covering multiple sectors of the economy is going to allow you to find the cheapest reductions.

Casey: Naomi, why does covering more sectors allow us to keep costs down?

Naomi: Well, it allows us to cast a wider net. If we only focus on reducing the emissions of the electricity-generation sector, we might miss reductions in the transportation sector that would have been a lot cheaper, and just as effective.  

Casey: Got it. What else should we be thinking about?

Susanne: I would say that another important element that is really critical, particularly from a political perspective, is revenue use. 

Casey: Ah right.  A tax raises revenue directly.  And with a cap-and-trade program, the government isn’t just giving permits away for free. The program generates revenue by auctioning off the pollution permits.

Naomi: Right, and with revenue in hand, you’ve got to decide what to do with it. Now this has proved to be the most political aspect of these policies.  We could spend it on energy efficiency and clean energy, or on trains, ports, roads, parks. OR we could distribute it through tax cuts or even direct payments.

Casey: You mean, just send out checks?

Susanne: So some of the bills, they take all the revenue and split it up equally and then give that back to families and households in the form of this kind of lump sum check in the mail.

Naomi: Under carbon pricing policies, that’s called a “dividend.”  And some proposals call for distributing it to all taxpayers, making the policy what we call, “revenue neutral.”

Casey: Revenue neutral because the government doesn’t keep any of the money.

Naomi: Right. There’s no revenue left over at the end of the year. From a government’s perspective, there’s no impact to the revenue line, so it’s revenue neutral.

[Short break]

Casey: Okay so we’ve identified three main things to consider in designing a carbon-pricing policy. First, how much CO2 emissions do we want to remove from the economy? Second, which sectors of the economy will be paying for their emissions? And third, what should the government do with the revenue that’s generated?

Naomi: So, I’m just thinking… is there anything left to consider?

Casey: Well, here’s another issue: Where do we actually apply the tax? What I mean is, for income tax, that’s taken directly from your paycheck… Sales tax is applied at the register when you buy something. But carbon emissions are more complicated…  

Susanne: In Economist-speak people talk about that as “Point of Regulation”. So where exactly is the tax going to be implemented? Where exactly would a cap and-trade program be implemented? So which entities would have to hold allowances?

Naomi: Economists tend to agree that the most efficient place to put the price is as far upstream as possible—where fossil fuels enter the economy.  According to the U.S. Energy Information Administration,  there are about 135 oil refineries, 500 natural gas processing plants, and 660 coal mines in the United States. Fossil fuels typically enter the economy by being extracted from the ground, or processed, at one of these plants.

Susanne: Placing the program, or the point of regulation, as far upstream as possible is gonna be the most efficient and effective means of implementing the program. It allows you to make sure that you are covering all of the possible uses of those fuels and it allows that price to trickle down through the economy. So it covers the biggest swath of emissions and pollution sources and also makes sure that throughout the entire supply chain that investments are oriented towards low and zero carbon options. 

Casey: And what about companies with competitors in other countries?  How do you keep them from being hurt by a price on carbon in their home country?

Naomi: Good question. That’s definitely an industry concern. You create what’s called a “border carbon adjustment.”  

Susanne: The idea is to kind of level the playing field. It’s also designed to try to protect the competitiveness of companies that might be more energy-intensive or more vulnerable to competitiveness issues from companies in other countries. The idea is to try to level the playing field such that there isn’t such a disparity between the price that they’re feeling in this country and not being exposed to prices in other places.

Naomi: For any goods imported from countries with a price on carbon that’s lower than your country’s, you put a tariff to even things out.  And for companies exporting to countries with a lower price, or no price at all, you refund the carbon price they’ve paid.

Casey: How do you keep companies from moving to another country that doesn’t have a price on carbon?

Susanne: I think, the first thing I’ll say is that there hasn't been evidence really that the risk of companies moving to other countries for example is particularly high in the first place... 

Naomi: So, it’s important to put in place policies that guard against companies leaving, but it also may not be as big a risk as some people think.

[Short break]

Naomi: Now, there’s one more big issue we shouldn’t forget. At the end of the day, policy design is all about people whose lives are impacted by that policy. Climate change is an issue of justice -- both racial and economic justice. The negative chain of events set off by rising global temperatures disproportionately harms communities of color and low-income communities. So what we need to examine is, how will this hypothetical policy affect people, especially the people it’s intended to help? Let’s say we’ve got the price in place through a Cap or a Carbon Tax, we’ve applied it across different sectors, and now we’re generating revenue. Who benefits from the program? Is anyone left worse off?

Casey: One thing we’d expect is for companies affected by the price to pass on their increased costs to consumers… So products with especially high fossil fuel inputs--like gas, oil, cement, heavy goods that have to travel long distances, maybe plastics--we’d expect those prices to rise.

Naomi: And people who have to drive long distances for work, people who spend a high proportion of their income on home heating, and people who work in industries facing high prices--all those people will be hit harder than others. 

Susanne: You want to design policy to make sure that those kinds of families, those households are going to be protected from any changes in energy prices that might come about by putting in place a strong climate policy.

Naomi: It’s an issue of equity. And along similar lines, with revenue distribution, does it make sense to give everyone an equal sized check, or should some portion of the revenues be carved out to help communities that will be hit hardest by a changing climate?

Susanne: For example, coastal communities… communities that are going to be impacted by sea level rise, by storm surges, by the kinds of extreme weather impacts that climate change is going to be causing more of… Those communities that are going to be most affected by those impacts, whether they’re coastal communities, or agricultural communities, that are really gonna feel the impacts of climate change -- that there’s provisions in place to help support those communities. 

Casey: Ok, so not only does climate change affect different people differently, but so do climate policies.  It’s useful to hear these examples of the two ways carbon pricing policies can protect people: first, by providing aid to the people most likely to be hurt by climate change, and second, by supporting those most affected by changes in prices resulting from the policies themselves.  Now, we’re going to revisit equity, and we’re going to focus on how Environmental Justice relates to carbon pricing, in future episodes.  For now, it’s crucial to remember that fighting climate change isn’t just about science, and it isn’t just about economics -- it’s about the people who are being harmed, today, by inaction. 

[Short break] 

Casey: Naomi, we’ve learned a lot about the mechanisms behind carbon pricing proposals.  To sum up, what are the questions we should focus on when thinking about carbon pricing?

Naomi: Well there are a ton of questions… What’s more appropriate, carbon tax or cap-and-trade? How much should we charge? How should we distribute the revenue? How do we protect people most affected by climate change?

Casey: Alright, let’s close out this episode with some audience questions—

Jacob: Hang on, Casey, I gotta chime in here for a second… Audience questions? This is our first episode… We definitely don’t have an audience yet.

Casey: Jacob, I gotta say you have a strong point there. But riddle me this: As the listener listening right now listens, we DO have an audience. So...

Jacob: You’re tricky Casey…

[Casey pulling out a piece of paper and opening it]

Casey: This one’s from Ernst von Schladerhagen….

Jacob: Mm… not buying it.

Casey: It reads, “Dear Casey, Naomi and Jacob, Why do we keep talking about ‘carbon’? I thought the issue was greenhouse gases?  By the way, that Jacob Miller asks excellent questions.  Seems like a fine young man.”

Jacob: Oh well, Mr. Schladerhagen, I am so glad you asked. Carbon is actually shorthand for Carbon Dioxide, which is the most prevalent greenhouse gas. Since it’s the main culprit causing the climate emergency, we convert all the other greenhouse gases, like methane, into Carbon Dioxide equivalents. Different gases have different warming potential, or potencies, as we call them. So a ton of methane is equivalent to about 25 tons of carbon dioxide. The other greenhouse gases include things like nitrous oxide, fluorinated gases, things like that.

[opens another letter]

Casey: Okay here’s another one: I keep hearing this acronym on the news, the IPCC -- What is the IPCC?

Jacob: The IPCC, okay. You probably heard that acronym whenever there's a big international meeting or report about climate change. Like for example, the Paris Climate Accord. IPCC is short for Intergovernmental Panel on Climate Change. It’s the United Nations organization that consolidates and reports all the best climate science. And It’s really important to note that they are extremely careful not to overstate what we, as a scientific community, know. 

Casey: What have they said lately?

Jacob: In 2018, the IPCC reported there are significant risks to human health, security, and economic growth if global average temperature increases even 1.5°C (or 2.7°F, for our American audience). 

And it said to avoid going over 1.5°C we have about 10 years to cut global emissions in half compared to 2010, and 30 years to bring all carbon emissions in balance with carbon sequestration. That means by 2050 we can’t have more CO2 coming out of smokestacks and tailpipes than the amount of CO2 that gets sucked up by plants and oceans.  

[opens another letter]

Casey: How much should carbon cost?

Naomi: Okay, I can take that one! This is a pretty complicated question, which is why we’re devoting an entire episode to it... But according to some experts, carbon should cost between…. Zero and infinity dollars. And there’s really heated debate, so stay tuned.

Casey: Whoa, that was like a fake cliff hanger.  I thought we were going to get the juice on that one, and now I’m hanging here by my fingernails.

Naomi: Okay, I’ve got a question: Will a carbon price solve all our problems? 

Jacob: Probably not, but it's definitely a key tool to have in the toolbox.  

Casey: And that’s a good note to end on. In our next episode, we’ll talk to economists about the Social Cost of Carbon, and ask the big question: What's the right price?

Jacob: To get in touch--to send us yet more audience questions… I’m lookin’ at you Mr. von Shladerhagen --email us at carbon@yale.edu.

Casey: This is Pricing Nature from the Center for Business and the Environment at Yale and the Yale Carbon Charge. 

Jacob: This episode was written by Casey Pickett and me, Jacob Miller, with help from Naomi Shimberg, Maria Jiang, Whitney Mann, and Ben Linthicum.  Sound engineering by me, with help from Ryan McEvoy.  Music by Katie Sawicki. Special thanks to Stuart DeCew, Heather Fitzgerald, the folks at Last Week Tonight, and Tom Erb for their help making this episode possible.