How carbon fees promote “free-market innovation”

By Jonathan Marshall, CCL Economics Policy Network

When USA Today recently editorialized in favor of a national carbon fee and dividend to “prevent further catastrophic changes in the world’s climate,” a dissenting op-ed column by the chair of the Senate Committee on Environment and Public Works declared, “Free-market innovation—not government regulation or taxation—is the best way to reduce carbon dioxide emissions.”

Innovation is indeed one of humanity’s greatest weapons against climate disruption, but critics of carbon fees miss a fundamental point: Without proper price signals to reflect the true cost of greenhouse gas emissions, the discovery and adoption of cleaner energy sources will never progress fast enough to mitigate the climate crisis at a reasonable cost. Targeted tax breaks or government incentives to advance particular technologies, such as carbon capture and sequestration, can help, but only a price on carbon will drive innovation across all methods of reducing our emissions and accelerate humanity’s transition to a more stable and sustainable climate.

There is nothing “free market” about the huge market failure that allows polluters to continue dumping greenhouse gases into the atmosphere without charge. Carbon emissions impose a rapidly rising cost on all of us who must struggle to cope with rising sea levels, extreme storms, intense droughts, gigantic wildfires, habitat destruction, and other ills associated with climate disruption. Carbon fees push some of that cost back onto all who contribute to that harm by emitting greenhouse gases. In doing so, they give polluters a powerful market incentive to develop and adopt cleaner alternatives.

The truth is, “business people don’t innovate because it feels good; they innovate because there’s a return to that innovation,” remarked Glenn Hubbard, former chairman of the Council of Economic Advisors in the George W. Bush administration. “If you want a return to that innovation […] you will need to put a price on carbon.”

Many entrepreneurs agree. Two major clean energy investors, one a Republican and one a Democrat, wrote in Politico, “Putting a market price on carbon would provide clear price signals to investors like us. Then, the U.S. innovation engine—our most valuable asset—would be turned loose, and capital and U.S. jobs would follow.” Their judgment was confirmed by a survey of 35 large U.S. companies, which found that “among the nine policy tools listed in the survey, putting a price on carbon was by far the most important action that respondents think the U.S. government could take to advance low-carbon innovation.” Former Microsoft CEO Bill Gates, founder of the Breakthrough Energy Coalition, said, “Without a carbon tax, there’s no incentive for innovators or plant buyers to switch” to clean energy.

Numerous studies by economists confirm that rising energy prices and taxes induce faster innovation in energy efficiency and alternative forms of energy. Other studies confirm that such innovations will help accelerate and lower the cost of moving to a low-carbon economy.

Nobel laureate economist Paul Romer, an expert on technological change and economic growth, argues that the best way to structure a carbon tax is to start low and raise it over time. As he put it, “We want innovators to know that the tax is coming and to take steps now to make sure that when it bites, it will be little more than a nuisance.”

The good news is that the leading carbon fee bill now pending in Congress, the Energy Innovation and Carbon Dividend Act (H.R. 763), adopts just such an approach. It starts with a carbon fee of $15 per ton, rising at a rate of $10 annually. It would do little to disrupt consumers in the near term, while prompting a surge of new business investment and research and development (R&D) spending based on future cost projections.

Powerful as they are, carbon fees won’t promote enough innovation on their own. Most economists believe that government support for basic research has a big social payoff. Carefully targeted regulations, such as building efficiency standards, can also promote fruitful innovation. Such measures are excellent complements, but not substitutes, for market-based price signals that stimulate private R&D.

Economist Paul Krugman noted recently, “Even modest incentives for expanded use of renewable energy led to a spectacular fall in prices over the past decade.” Just think how much faster the clean energy revolution could unfold with the powerful incentive of rising carbon fees signaling the way.

Jonathan Marshall is former Economics Editor of the San Francisco Chronicle and is a member of Citizens’ Climate Lobby’s Economics Policy Network Action Team.

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