Dynamic Idiosyncratic Carbon Pricing

A proposal for carbon price application

Submission Name: Dynamic Idiosyncratic Carbon Pricing

Participants: Adam Wu

Node: Remote contributor

Discord channel: https://discord.gg/cT4cJqA

Contributing prompt:

Contribution

Contribution summary:

As the Yale Open Climate Platform is designed to be globally accessible for a variety of end-users (cities and countries down to the individual level), it could be beneficial if carbon prices are not aggregated but can be estimated based on one’s own marginal contribution to social costs. The idea in this proposal is to consider an economic agent that seeks to maximize current consumption while accounting for the potential impact of climate change on future consumption. Suppose this agent participates in economic activities that generate negative externalities for climate change, and is presented with the option of paying a carbon tax to offset these social costs. The pricing of the appropriate idiosyn- cratic carbon tax can then be broken down into their own consumption process and an estimation of their contributing social costs through the use of models such as IAMs.

Main output:

Conceptual explanation:

Here is a loose version of the idea in a story format —

So let's say little Timmy rides his bike around town, and is committed to preserving the environment so he uses as little carbon as possible. There is a power station next to him that burns massive amounts of fossil fuel, and is responsible for 99.9% of the social cost involved. Naturally since the usage of some degree of carbon is inevitable, Timmy bears a small 0.01% of it. The government decides to pass a carbon tax, so they take the sum of social costs and divide it by two. If social costs were say, $5 billion, Timmy is then responsible for $5 billion/2 x GHG emissions. Thus a significant portion of the costs of carbon pollution by the power station is put onto Timmy, despite his best effort to be environmentally-conscious (and should not be penalized). The power station's taxes are lower (because parts of the burden is transferred to Timmy) than the profit gained from the current level of emission, so does not decrease emissions as much as he should based on the tax. The next year, social costs are still there and not fully taxed away - an inefficient system. Now Timmy grows up and gets a car. He really likes strawberries but the nearest field is an hour away, so he is now faced with the economic dilemma of minimizing his carbon emissions (as it requires driving) and maximizing consumption (as he really likes strawberries). Should he do it? The benefit-cost analysis really depends on a ton of factors specific to the situation, i.e. how far it is, current gas prices, etc.

The government decides to pass an idiosyncratic carbon tax as in the model, and Timmy now has the option to invest parts of his income into a "Climate Fund". In this case, Timmy can now use the remaining income to consume as many strawberries as he'd like, without worrying about the carbon emissions from driving. This is because the investment (or tax) serves as a constraint on the maximum strawberries/driving he could do, and subsequently the returns on this investment (into environmental ventures, clean energy projects, etc) will at help offset the global impact from the driving that he does do. The power station from when Timmy was a kid also bears a tax rate (or investment into this fund as well) that is much more in line with the social costs that it is causing, thus significantly reducing emissions to what is socially optimal. Moral of the story: If Timmy was a power station, so there are two power stations in town with identical carbon outputs. Then the "aggregate divided by population" tax would work fine, the problem is when people have heterogeneous carbon outputs and subsequently social costs.