Carbon, Climate, and COVID-19

A three-part series on causes, effects, resolutions and connections

Part One

In today’s world, it seems that the only constant is change.  From the COVID pandemic to environmental and social injustices, the thing we can agree on is that more change is needed – positive change.  This three-part series delves into the impact of hydrocarbons on our economy; the risks and cost of Coronavirus; and the connection between energy and the food system.

Carbon Economy

Today’s economy depends on hydrocarbons—oil, coal, and natural gas—for most of its energy needs, as well as for thousands of industrial products including plastics, paints, asphalt, and chemicals. In the United States, shale oil and gas production surged after 2010; by 2018, the U.S. was the world’s largest producer of oil and gas. Oil and gas exploration and production alone accounted for 3.8 percent of world GDP in 2019, but that number scarcely suggests the importance of fossil fuels. Which of the goods and services that we enjoy came to us with no use of hydrocarbon inputs anywhere along the supply chain? We need only look back in history a century or two to see how dramatically oil and gas (leave aside coal), and the machines they power, have changed our world.

The age of carbon has been a remarkable moment in history, and it is fast drawing to a close. Worldometer estimates that at current consumption rates, proven oil reserves would last about 43 more years and natural gas about 49.

The cost to society of using a nonrenewable resource includes its “user cost,” the present value of the future loss incurred when the resource is used today rather than saved for later. Put another way, user cost is the portion of the gross receipts (before extraction cost) that must be invested in order to yield a constant, sustainable flow of net income, even after the resource is exhausted.

After the user cost of a nonrenewable resource is deducted from receipts, the remaining flow of net income is rent: the net gain from extracting now rather than later.

The prices of nonrenewable resource stocks reflect market estimates of marginal user costs, which depend on discount rates and on expectations about future demands, discoveries, and extraction costs. If, as is likely, long-term market interest rates tend to be higher than the socially-optimal discount rate, then user cost estimates will be lower than optimal and extraction rates higher. (Note that GDP does not deduct the future losses that result from depleting a resource today.)

CAC and WAC

Use of fossil fuels involves the complementary use of other resources as well, often with lasting damages. Ecosystems around mines and wells are disrupted; air and water are used as dumpsites for greenhouse gases and other pollutants. Firms do not generally pay for these damages as they pay labor and capital costs. They are “externalities” that cause direct harm to other people and interfere with economic activity. From a social point of view, these attendant external costs, not captured in market prices, may be considered as additional components of the user cost of hydrocarbons.

Thousands of economists have signed the “Economists’ Statement on Carbon Dividends,” which advocates a gradually rising carbon tax on hydrocarbon fuels as the best way to achieve climate stability. A carbon tax reduces greenhouse gas emissions by charging rent for the use of the carbon absorptive capacity (CAC) of the atmosphere and oceans. Applied at gradually rising rates, the carbon tax should eventually reach a level that halts anthropogenic climate change.

When the price of CAC is zero, energy firms ignore the external cost that their products impose on others, who then must either commensurately reduce their own use of CAC or suffer the adverse effects of climate change. A carbon tax “internalizes the externality” by inducing market participants to take into account the climate-related costs of fossil fuels.

Similarly, the environment has limited waste absorptive capacity (WAC) for the local, regional, and global pollutants generated at wellheads and coal mines, refineries, pipelines, engines, and furnaces. Many of these costs are external. Environmental charges can “internalize” such externalities by requiring firms to pay the rents, not only of CAC, but also of the other resources sacrificed by the use of fossil fuels.

To get incentives precisely right, emissions of each pollutant should, in principle, be assessed at a rate equal to the marginal external cost of emissions at each time and place. Assessment and enforcement considerations, however, easily justify folding many such charges into a single severance fee, just like the proposed carbon tax. Full efficiency would require system-wide price corrections.

Hydrocarbon taxes might be designed to approximate the rental values of CAC and other WAC associated with fossil fuel use, in addition to the rents and user costs of hydrocarbon resources themselves.

Governments employ a mind-numbing array of procedures for taxing hydrocarbons. At the same time, the fossil fuel industries receive generous direct and indirect subsidies. An IMF study calculated that global hydrocarbon subsidies in 2017 were $5.2 trillion, or 6.5 percent of global GDP. The U.S. was the second-largest subsidizer after China, with $649 billion in fossil fuel subsidies. The authors estimated that “efficient fossil fuel pricing in 2015 would have lowered global carbon emissions by 28% and fossil fuel air pollution deaths by 46 percent, and increased government revenue by 3.8 percent of GDP.”

Distribution of Dividends

“To maximize the fairness and political viability of a rising carbon tax,” declares the Economists’ Statement, “all the revenue should be returned directly to US citizens through equal lump-sum rebates.” The assertion that a 100% citizens’ dividend is a matter of “fairness” suggests an ethical understanding that the limited carbon absorptive capacity of the environment should be shared by all, neither hoarded by a few nor dissipated in a tragedy of the commons.  

It is hard to see why “fairness” would not similarly entail equal rights to the rental value of WAC more generally and, indeed, to all the gifts of nature, including subsoil minerals such as hydrocarbons themselves. Moreover, “political viability” aside, it seems fair to invest the user cost portion of the revenue on behalf of future generations, to compensate them for the depletion of Earth’s nonrenewable resources. Perhaps we should use a portion to finance public goods that benefit everyone while reducing unfair and inefficient taxes, such as payroll and sales taxes.

The second part of this three-part series addresses current and past pandemics and how travel, transportation and trade are essential pieces of policy creation to combat negative economic impacts.

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