But let’s start by accenting the positive.  Krugman’s explanation of mainstream environmental economics is clear and powerful.  He recognizes that there really are a lot of free energy lunches lying around uneaten, in the form of potential efficiency improvements.  He knows that predictions of economic disaster due to carbon policy are without foundation and fail to take into account the potential for innovation.  Above all, he understands that investments in minimizing climate change offer valuable insurance against potentially catastrophic outcomes—the ice-sheet meltoffs and methane megabelches that we have little ability to predict and from which we would have little chance to recover.

Why ask for more?  Because three enormous concepts are completely missing.

1. Equity.  How the burdens of climate policy, bearable as they may be, are distributed is a very big deal.  First, vast sums of money—hundreds of billions of dollars—are at stake.  Note that these do not reflect costs as economists understand the term.  We are not talking about overall loss of income and output, but transfers, money that will find its way from some folks’ pockets to others.  If carbon is priced, for example, then we will be paying this price, and someone else will be on the receiving end of those payments.  Who that is matters, big time.  Economists are not experts in climate science, but they have useful tools for analyzing and anticipating who will win or lose from a policy.  They have a large contribution to make in helping us design fair and equitable systems for controlling carbon, and this deserved some real estate in Krugman’s article.

But that may not even be the most important reason to support equity.  The bigger problem is that actual climate policy is lagging ever farther behind what is needed.  We still don’t have a policy framework at all in the US.  The European Union’s trading system has Europe on track to fail to meet its targets (unless the economic situation continues to deteriorate).  There are paltry carbon taxes here and there, too modest in size and coverage to make a difference.  There are many reasons for weak policy, but perhaps the most important is the fear of politicians everywhere that really cranking up the price of carbon will make voters furious once they get hit by rising energy costs.  An essential part of the solution, then, is a commitment, built into any legislation that has a whisper of a chance to be enacted, to return all or nearly all the proceeds from higher energy prices back to the public.  Just rebate it to them, and make the process completely transparent.  For every painful moment of facing a higher energy bill there needs to be a pleasant moment of getting a fat rebate check.  Can we break the political logjam otherwise?

Equity and political feasibility go hand in hand.

2. The pollution model.  It doesn’t work here.  The greenhouse gas problem is not a pollution problem, and if you apply pollution thinking you will come up with bad policies.

This is a problem for economists, since they have all been trained to see environmental problems in terms of pollution.  You will see in Krugman’s article, for instance, a comparison between the climate crisis and the problem of acid rain.  Acid rain was due to, among other causes, sulfur emissions from industrial smokestacks.  A cap and trade system was set up to limit the amount of these emissions, and the acid rain problem has been ameliorated.  Drawing on this experience, Krugman advocates cap and trade for carbon.  If carbon were a pollution problem he would be right, but it’s not.

Without going into detail, recall that there is a massive, planetwide carbon cycle, with huge quantities of carbon continually flowing between the atmosphere, the oceans and terrestrial ecosystems.  The flow of carbon from land and sea back up to the atmosphere is not the problem; it is part of the cycle.  The problem is that humans are burrowing into the earth to dig up carbon sources like coal, oil and gas that have been sequestered for hundreds of millions of years.  We are adding them to the carbon cycle, so that there will be more carbon everywhere, up in the sky and down on the earth’s surface.

What this means is that it is an error to try to mitigate climate change by controlling the “emissions” of carbon from human actions.  If the carbon has been dug up and added to the carbon cycle, it will find its way into the atmosphere no matter what we do.  And the carbon we emit that came to us from the atmosphere and will simply return there is not the problem.  This is a highly simplified version of the science behind climate change, and a longer account would explore the eddies and unevenness of carbon cycling, but it’s the right starting point.

Once you see that the pollution paradigm is wrong, two conclusions follow immediately.  First, what needs to be priced is not the carbon we emit, but the carbon that enters the cycle by being extracted from the earth.  That doesn’t invalidate Krugman’s broad generalizations, but it does suggest important dos and don’ts about carbon policy.  Don’t try to regulate the burning or other use of carbon on an industry-by-industry basis.  Don’t try to micromanage industrial processes.  Do keep carbon fuels in the ground, either by slapping high prices on their extraction, or directly restricting the amount that can be taken out.

The second point is that the offset business, by which permits to extract fossil fuels can be set aside in return for promises to plant trees or improve industrial processes in other countries, is a ruse.  It promises to make a lot of money for those in the right places, but it is antithetical to sound policy.  Period.

3. Economic interactions.  The market is a two-by-two mechanism.  It essentially sums up agreements between two parties, a buyer and a seller, altering prices according to the total buying and selling pressure at any point in time.  A fundamental limitation to markets emerges in situations characterized by interactions between many individuals and institutions, so that two-by-two adding up is ineffective.  An example is the role of cars versus trains in local transportation systems.  Markets can do a reasonable job of adjusting the number and quality of cars to the preferences of buyers and the costs of producers, but they cannot coordinate a system-shift from mostly-cars to mostly-trains, since there are so many interactions that are at stake, like urban density, the locations of jobs and residential areas, etc.  Markets tell us what people want, two at a time, based on what everyone else is doing, but they don’t coordinate shifts that make sense only if many do them at once.

This is important, since the shift to a low-carbon economy will be one of the largest system-level shifts in human history.  Much of it can be efficiently managed through markets, but only if the broad parameters are determined in a coordinated—that is, political—manner.  So far we are still in Krugman-land, in that he is advocating a mix of political (carbon pricing) and market mechanisms.  But there is a further wrinkle.  If we rely on the price of carbon to guide us from one economic configuration to another, we will almost certainly overshoot radically.  We will have to raise the price of carbon to a very
high level so that, in this economy, with all its inherited biases toward energy profligacy, people will begin to cut back to the extent necessary.  Then, as the rest of the economy adjusts, this price will be seen to be much too high.  Of course, since the process will take place over many years, a too-high price translates into a too-drastic energy squeeze during the transitional phase.  By contrast, relying on quantities—limiting the amount of fossil fuels that can be extracted and letting the price rise as it will—does not overshoot in the same way.  There will still be a big price spike that can be alleviated over time as we build a low-carbon infrastructure, but the amount of energy made available will not be over-squeezed, since it will be directly controlled.  In simple language: economic theory tells us that, to achieve a system-shift in a densely interconnected economy, it is more efficient to control quantities than prices.  A carbon tax is inferior to a permit system in which the number of permits is fixed.

So this is my appendix to the Krugman primer.  He did a fine job with what he set out to do, but he left out important pieces that the public should be aware of, and that economics has the ability to provide.

It’s easy to understand. We’ve had eight years of across-the-board hostility to sustainability investments by Bush & Co., and before that eight years of promises with no follow-through by the Clinton crowd. Now green groups are dazzled by the prospect of hundreds of billions of new dollars for mass transit, energy efficiency, and other projects, courtesy of carbon auctions. Their websites overflow with starry visions of how all this money can be spent, reminding us of all the pent-up needs from decades of neglect.

This strategy is deeply mistaken, and it risks pushing serious action against climate change many more years into the future, a delay we earthlings can ill afford.

Granted, the mainstream organizations are fighting the good fight on several key points. They recognize the need for strong action to reduce carbon emissions as soon as possible. They know that a central piece of the policy package must be a system of carbon permits, without which no one would have the legal right to extract carbon fuels from the earth or import them into our economy. These permits would be capped, and the cap would be tightened over time. Finally, the green groups have lined up behind the necessity of auctioning off the permits, rather than giving them away. All of these are laudable positions.

It is at the next stage, what to do with the auction revenue, that they go seriously wrong. Consider, for instance, the Sierra Club. Their website describes the sort of programs auction revenues should fund:

Such programs include financial assistance to help low and moderate-income consumers and workers offset higher energy costs as well as programs that assist with adaptation efforts in communities vulnerable to the effects of climate change. Revenue generated from emissions allowances should also aid the expansion of renewable and efficient energy technologies that quickly, cleanly, cheaply, and safely reduce our dependence on fossil fuels and curb global warming.

Similarly, the Natural Resources Defense Council website says, “The sale of pollution allowances would bring in new government revenue, allowing funds to be redirected toward infrastructure improvements and incentives for innovation.”

To be clear, I fully understand why these folks want to funnel carbon revenues into green projects. We need these investments desperately, and a fully auctioned carbon permit system would mobilize hundreds of billions of dollars soon after takeoff. But the money won’t be there if the carbon cap isn’t established in the first place, or if the political will to auction the permits falls short, and the strategy of spending auction revenues on environmental projects makes it less likely that there will be money to spend.

Face it: the carbon cap is a tax. Those megabucks have to come from somewhere, and where they will come from is us, in the form of higher prices for goods and services that use carbon inputs. Gas will become much more expensive, and so will heating oil and cement and a thousand other things. In effect, we will be paying an enormous sales tax on top of the taxes we already pay. So far as it goes, there is nothing wrong with this: it’s a feature, not a bug. It’s the way we will commit ourselves to consuming less of the stuff that’s endangering the planet. But it’s still a tax.

The political and business interests fighting a carbon cap will make this their central argument. They will concede that climate change is real and needs to be addressed, but they will say a cap is the wrong way to go, because such a large tax would be financially crushing. Worse, as a sales tax, the cap would be regressive, with larger impacts on the budgets of the poor than the rich. The Sierra Club goes part of the way to recognizing this in their proposal to use some of the revenues to help those on the lower end of the income scale. Creating a special benefit program, however, would hardly undo the regressive effects of the tax as a whole: the Club doesn’t promise (nor could they) that the full financial effect for the hardest-hit families would be offset, nor that the impacts for the great majority (who are also voters) will be offset, nor, above all, that anyone could guarantee that this benefit program will be well-funded year after year. Realistically, their reassurances will not be enough to assuage the fear of most households that they are about to get soaked.

But it’s even worse than this. We are in a serious economic downturn. Opponents of the cap will say this is no time for a major tax hike, and they will be right. The worst kind of tax to impose right now is a regressive sales tax — like the one a carbon cap would produce — that eviscerates family budgets and makes it more difficult for them to cope. It’s all well and good to promise that the government will spend this money wisely and reinject it back into the economy, but this takes time and, in any case, households trying to scrape through this crisis are not going to be reassured by visions of green jobs that only some will get. If you think they will ignore the anti-cap arguments and happily vote to tax themselves during an economic emergency for the good of the planet, you’re wrong.

Moreover, there is every indication that this financial mess will be with us for years. We can’t afford to wait until the economy recovers to put a lid on our carbon emissions.

And there is still another problem: why do the green groups assume that the government will spend these new carbon dollars any better than they spend the ones they already have? For an early indication of how political reality may differ from fantasy, see the design recommendations of the Western Climate Initiative, which propose such guidelines as “promoting economic efficiency.”

There is an overwhelming message to all of this, which environmental groups need to confront: it is absolutely necessary, for political reasons alone, for carbon legislation to be written in such a way that the auction revenues are given back — all, or virtually all, of them. Take the money and, several times a year, distribute it equally among all citizens. Only in this way can people be convinced that the cap will not hit them like a monster tax increase, imposing an extra burden during a period of economic hardship. Over time, if we get a carbon cap, and if the price carbon-intensive goods goes up dramatically, there will be much more support for redirecting government spending toward energy efficiency and sustainable infrastructure.

This is a time for leadership by environmentalists. They need to transcend the role of lobbyists, angling for a bigger share of the spending pie, in the struggle to get meaningful carbon legislation. By trying to use a carbon cap as a revenue stream for their own agenda, they are making it much more likely there will be no cap at all, or that businesses will be given the permits for free. Even during a time of deep economic distress, we can do what needs to be done for the climate, but only if the financial burden on households is kept to the minimum possible level. There are plenty of other opportunities for funding green projects out of existing taxes and economic stimulus.