Memo to the Conservatives on climate policy: ‘Take the money, dammit!’

Why reducing greenhouse gases via regulations is the worst of both worlds

(Chris Wattie/Reuters)

Maclean’s Aaron Wherry has been documenting the Conservatives’ remarkable sophistry when it comes to carbon taxes and climate change policy (most recently here). As far as I can tell, the Conservatives’ position is the following:

  1. Market-based approaches such as carbon taxes and cap-and-trade are essentially equivalent.
  2. Since the Conservatives’ regulation-based plan doesn’t involve revenue generation, it is somehow better than market-based approaches.

The first line is largely correct. It’s the second one that makes no sense. The Conservatives’ rabid demonisation of the phrase “carbon tax” has obscured a point that should be better-known: as bad as you may think a carbon tax (or cap-and-trade) may be, the Conservatives’ regulation-based approach is worse. Regulations introduce large deadweight losses: costs that are not offset by benefits elsewhere. The advantage of market-based approaches is that they transform some of those losses into cash. The Conservatives’ reliance on regulation over markets means that they are leaving free money on the table, for no better reason than because they are afraid to be seen taking it.

This post is somewhat wonkish, but it’s important to set out in detail just why the Conservatives’ stance is so foolish.

First, some definitions based on the idea of economic surplus:

  • Consumer surplus: Demand curves are downward-sloping: the quantity demanded is relatively small when prices are high and increases as prices decrease. But consumers aren’t obliged to pay the maximum price they are willing to pay; they are only required to pay the prevailing market price. The difference between the market price and the amount that consumers were willing to pay is the consumer surplus.
  • Producer surplus: This is the counterpart of consumer surplus. Producers who would have been willing to sell at below-market prices benefit from the fact that they can sell at a price higher than their minimum reservation price.

In a standard graph of demand and supply, the market price occurs where the supply and demand curves intersect. Consumer surplus is the region above the market price and below the demand curve: this represents the difference between what some consumers would have been willing to pay and the (lower) market price they are actually required to pay. Similarly, producer surplus—the difference between the minimum price they would have been willing to accept and the (higher) price they actually receive—is the region below the market price and above the supply curve:

The graph above is incomplete if there are externalities, that is, if there are costs (or benefits) that are not attributed either to consumers or producers. If there are negative externalities—pollution is a common example—too much is being produced, and governments should intervene to reduce the quantities produced and sold.

Regulations essentially have the same effect of a technical setback: they oblige suppliers to undertake practices that increase the cost of production. This has the effect of shifting the supply curve up: Faced with higher costs, producers are going to raise the minimum price they’ll accept for any given quantity produced. This upward shift increases prices and reduces quantities produced, which is of course the policy goal. It also affects the producer and consumer surplus:

The increase in prices from P to P’ and the decrease in quantities from Q to Q’ clearly make consumers worse off: the size of the consumer surplus triangle in this graph is smaller than in the graph with no regulations. Part of the lost consumer surplus is transformed into producer surplus: producers benefit from the higher prices. But part of the producers surplus is dissipated by the higher costs of production. (In this graph, it looks as though overall producer surplus has decreased, but it’s possible to change the slopes of the lines and create an example where producer surplus actually increases.)

Regulations decrease total economic surplus—consumer surplus plus producer surplus. The difference between the economic surplus in the first graph and the graph with regulations is the green trapezoid. This reduction in total economic surplus is the deadweight loss: a loss that is not offset by benefits elsewhere. (Except, of course, the benefits that come with reducing quantities from Q to Q’ and thus the associated negative externality.)

Suppose now that instead of regulations, the government imposes a tax on the sale of the good. This also shifts up the supply curve, as producers will now require prices that offset the extra cost of the tax. The difference here is that government revenues are now introduced into the graph:

The reduction in consumer surplus is the same as in the regulations case; the effects on prices and quantities are the same. And the change in producer surplus is unambiguously negative: producers lose from the lower net-of-tax price and reduced quantities.

There is one important difference, though: some of the lost economic surplus is transformed into tax revenues, the black rectangle whose area is equal to the tax times the quantity sold. There is still some deadweight loss, but the green triangle is clearly smaller than the green trapezoid shown in the regulations case.

There is no way to eliminate all the costs associated from an effective policy for reducing greenhouse gas emissions. The reason why economists overwhelmingly prefer market-based mechanisms is that they reduce these costs to a minimum, and they also provide the government with revenues that can be used to compensate people for those losses and/or to advance other policy goals.

The regulatory approach preferred by the Conservatives is more—not less—costly because it doesn’t generate tax revenues. By refusing to adopt a market-based strategy to deal with climate change, we get the worst of both worlds: all the loss in economic surplus and none of the offsetting public revenue.

(P.S. There’s another important reason why market-based approaches are better than regulations—it will be the subject of my next post.)




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Memo to the Conservatives on climate policy: ‘Take the money, dammit!’

  1. What is left out of all this nonsense is that CO2 has no effect on either temperature or climate, so why do the MSM continue pushing the incredible scam?
    We know that temperature controls CO2 levels, not the other way around, and that it was warmer in the 1920-1940 period than the meager warming of the 1990s. It was warmer during the 400 year Medieval Warming period and the Roman Warm Period was warmer than both.

    Please, if this magazine is to retain credibility, it must expose the scam, not support it.

    • First, learn to read. Climate science wasn’t the point of Gordon’s article at all. He mentioned pollution (and it could be any sort of pollution — including smog) as a commonly known externality. Your hyper-defensiveness points you out as a loon.

      Second, learn some basic physics.
      Here’s something that you might be able to understand. A children’s experiment, run by Mythbusters.

      http://www.youtube.com/watch?v=pPRd5GT0v0I

      CO2 does have an effect on temperatures.
      Temperature increases on earth do release additional CO2, yes, but CO2 is also an additional driver of temperature. If the CO2 is there first, temperature will rise.. eventually causing glaciers to melt and releasing their CO2 (and methane) to the atmosphere to accelerate the process.

      As to the Medieval Warming Period and Roman Warm Period.. there’s a reason it’s called “Global” warming, and not “European Warming.”

      • The Medieval Warm Period in Northeast China

        Reference

        Wang, L., Rioual, P., Panizzo, V.N., Lu, H., Gu, Z., Chu, G., Yang, D.,
        Han, J., Liu, J. and Mackay, A.W. 2012. A 1000-yr record of
        environmental change in NE China indicated by diatom assemblages from
        maar lake Erlongwan. Quaternary Research 78: 24-34.
        http://www.co2science.org/articles/V15/N43/C2.php
        Multiple papers proving the MWP was GLOBAL!
        http://www.co2science.org/subject/g/globalmwp.php

        • Only on whacko sites. LOL

        • Was the Mythbusters thing too complex for you? I was afraid of that.

          Oh, and incidentally, last I checked, China and Europe are on the same land mass. But that you can’t figure that out is hardly surprising. Not that it matters. Even if warm periods happened in the past, that says nothing about today. It’s like saying every dog you saw this morning was black, so therefore all dogs are black. It’s the logic of the moron — and again.. not surprising.

    • What is left out of all this nonsense is that CO2 has no effect on either temperature or climate, so why do the MSM continue pushing the incredible scam?

      What???

      I’m sorry, but while pretending that climate change is a conspiracy might be cute, pretending that the greenhouse effect doesn’t exist is just a whole other level of ignorance.

  2. OK, I think I get, generally, the point you are making.

    But, so what?

    Is there any way of quantifying the difference in approaches? Because if regulation is inefficient, and not the preferred approach, how much does it cost the economy/individual relative to other approaches?

    1% GDP per year? Yikes.

    0.1% GDP per year? Ahhh, not so much yikes.

    0.01% GDP? zzzzzzz

    • To quote a saying favoured by an otherwise worthless Toronto politician, “mind the pennies and the pounds take care of themselves.” What ever happened to Conservatives wanting to take advantage of essentially “free” efficiency gains?

      • Not sure what exactly your point is.

        Mine was materiality described as a fact which is “significant to the issue or matter at hand”

        • Think about cost per tonne of CO2 emissions avoided. It’s hard to know how high this will be until we see the regs. With a carbon tax, every tonne of CO2 avoided costs less than the tax rate per tonne, as a profit maximizing firm will pay the tax rather than avoid the CO2 if it costs more. With regulations, many will end up costing very large amounts per tonne. For instance, look at the transit pass tax credit. Some calculations indicate that it cost thousands of dollars per tonne of CO2 emissions avoided.

          Depending on how bad the regulation is and how ambitious it is in terms of emissions reductions (not likely to be very ambitious), the impact can be very significant.

          • the impact can be very significant.

            How significant? :)

  3. In both cases (regulations and taxes), the demand curve shifts up because there is an increase in cost of doing business. Although taxes shrink the welfare loss trapezoid, as you said, isn’t it just a change of who pays for the “technical setback?”

    That is, wouldn’t the tax dollars be expected to go toward the externality (in this case, pollution)? It seems to me like it’s two sides of the same coin here.

  4. In both cases (regulations and taxes), the supply curve shifts up because there is an increase in cost of doing business. Although taxes shrink the welfare loss trapezoid, as you said, isn’t it just a change of who pays for the “technical setback?”
    That is, wouldn’t the tax dollars be expected to go toward the externality (in this case, pollution)? It seems to me like it’s two sides of the same coin here.

    • Who pays remains the same in both cases ie. the price to consumers is the same and the lower sales for producers is the same. Both have a shrinking “surplus”. So there is really no change in “who pays”.

      The difference is that the reduced pollution also generates tax revenues thereby allowing other taxes to be lowered or that money to be used for other things. Regulation reduces the pollution the same as the tax but that regulation doesn’t have those offsetting benefits of increasing revenue for the govt which people in general can benefit from.

      • Okay, thanks Kirk.

  5. I have no training as an economist, but I do find it maddening that there is an assumption that any dollar spent is equivalent.

    While the graphs & triangles above are nice (and make a point), the bigger difference between a market-based mechanism and regulation is the reaction of the company.

    Any market-based mechanism stimulates companies to strive to lower their costs, with the ultimate goal of lowering their supply curve. Customers reinforce this by moving to the producers who are successful. In many cases, the process is accelerated because companies can promote their brand based on their relative success in adopting to the new reality. In many cases, the industry actually becomes a lower cost producer over time because of the stimulated increases in efficiency.

    The first response to any regulation is to look for mechanisms to escape paying the fine or levy. That involves creative accounting & consultations with lawyers. Measurement and data stop being taken if not required; they can be used against the company. If required, care is taken to skew measurements in the company’s favour. For the company to actually change this behaviour requires that both the cost and probability of having to pay become substantive at which point it is often too late. At that point, you bail and give the company to a Brazilian outfit.

    • What did you think about the regulation that XL foods beef should contain no e-coli?

      • Different type of regulation, no?

        • I’m not sure, at a higher level. Just pointing out that in some cases (this one clearly an health issue) regulation and the high cost of corporate and gov’t is the safer approach than a market sol’n.

          If a good portion of the GHGs come from the tailpipe – what is the optimal approach to deal with it? Carbon tax, higher CAFE standards for manufacturers, or a combination of both?

          The CPC plan appears to be limited to higher CAFE standards (higher fuel economy by fleet of sales) which is regulation. This to me seems a necessary component. I have my doubts whether a carbon tax, by itself, would be as effective.

          • Ummm, yeah, I wasn’t as clear as I could have been.

            As it relates to reductions of pollutant emissions, I was more trying to clarify (in my mind, at least) that taxes tend to be used when government wants to dictate outcomes without specifying how those outcomes are to be achieved – the use of taxes allows the market to come up with the most efficient way of reaching the goal.

            Still with pollutants, regulations (I thought) tended to be more focused on specifying the solutions that the market will be obliged to implement.

            So a carbon tax might end up with cars that have the same fleet mileage as the CAFE standards specify, or maybe not. Maybe the market will come up with cheaper ways of achieving the goal.

            In the meat case, sure, it is a regulation that says meat should be free of e-coli, but that regulation, by itself doesn’t say how that will be done. OTOH, I’m confident that in the meat packing industry there are lots of true regulations in place that are aimed at supporting the e-coli-free goal/”regulation”.

  6. This Climate change nonsense needs to end. It’s not 2007 anymore!

    Anything the Tories can do to delay or deny or smear or stop any introduction of this nonsense is fine in my books. We’ll all be a lot better off for it.

    • Its too late to stop any action by the CPC – the government has indicated on many occasions that we are already 50% of the way to achieving the 2020 targets, and we are doing this through regulations, which seem to be the worst way, at least in terms of economic efficiency.

    • So you support the government lying to the people about what it is doing?

  7. Wow, what a bunch of deniers. CO2 continues upward and the temperatures flatline.
    Explain that one. There is no longer even a correlation between the miniscule amount of CO2 (392 ppm is less than 4/100 of 1%) and temperature. Warmist dogma dictates warming, not cooling! http://www.thegwpf.org/no-underlying-global-warming-in-recent-years/

    I loath Harper, but I refuse to vote for con artists who continue to push the AGW scam.

    • I always admire the tenacity of ignorance…

      Were there a correlation between miniscule changes and temperature, we effectively would be living on Mars in an entirely unregulated atmosphere.

      You do understand this, don’t you?

    • Are you 100% certain that CO2 is having no effect on global temperatures? Or, to put it another way, would you say that the science is settled?

  8. I’m pretty sure the CPC has acknowledged that climate change is real and that policy measures are required to deal with it. Please correct me if I’m mistaken.

    • Harper once called it a socialist wealth redistribution scheme. I think, since then, there has only been further evidence of this being true. Saying it’s true for them, at this point, would only serve to be of lipservice.

        • Yes, Skeptical Science is the one-stop-shop for debunking all climate-science denial nonsense…

      • Any other contributing factors (strong, mild or otherwise), or 100% related to incoming solar radiation?

    • “…I’m pretty sure the CPC has acknowledged that climate change is real and that policy measures are required to deal with it. Please correct me if I’m mistaken…”
      Technically correct I suppose. You seem to have missed the “wink wink nod nod” implied in all their other statments however.

    • I’ve seen Harper say at an international forum that climate change exists but we don’t yet have the technology to deal with it. This is simple climate-change denial rhetoric which can be summed up as: a) global warming doesn’t exist; b) global warming exists but it’s not caused by humans; c) global warming exists and is caused by humans, but there’s nothing that can be done about it… (The anti-global warming camp will vary from a) to b) to c) depending on what the latest news story is…)

      So I would say Harper’s position is political. He doesn’t want to be seen as a climate-science denier because he will alienate the moderate conservative vote. He doesn’t want to be seen supporting the “greatest hoax in history” because he will upset his hard-right conservative base. He also hammered Dion on his carbon tax “green shaft” and is trying to repeat that success by claiming the NDP’s platform is just another “job killing” green shaft. Last, Harper is ideologically opposed to government interference in the economy and would really prefer that nothing is done to address the issue.

    • It seems to be lip service to trick the electorate into thinking there is no policy space between them and their opposition. They made noise about their cap and trade policy prior to 2008 when the Liberals’ Green Shift platform presented a threat due to significant popular interest in climate change as an election issue. They never intended to do anything, hence the commitment to join a cap and trade scheme only if the US did first. It’s all about hoodwinking the electorate as being denialist or acknowledging climate change and refusing to act on it would be controversial and contrary to the beliefs of the majority of the electorate, especially the middle class suburbanites that the CPC were courting from the Liberals.

    • OK, to clarify…

      Regulations oblige producers to do something (eg add a gizmo to each widget)…but obtaining these gizmos has a cost….the supply curve moves up…..the values represented by the two surplus triangles changes…..and a green trapezoidal area appears. Does some (or all) of that area represent the cost of obtaining the gizmos? And more gizmo workers are working, or the same gizmo workers are earning higher wages, yes?

      But in the case of a tax, the producers have not been forced to add a gizmo to each widget, and in fact they do not add any gizmos to any widgets. Simply, the new higher cost dissuades some buyers, and demand falls. Presumably (in the extreme case) the tax money could be used to buy gizmos, which would never have to be installed in the first place. Or the tax revenue could be used to reduce income taxes or whatever.

      Am I on the right track, at all? Basically I’m trying to figure out what happens to the green cash – it isn’t just buried in a hole in the ground, is it?

  9. As long as the CPC answers primarily to the scientifically illiterate we will continue to see stupidity like this from our government. Their main thought here isn’t the logic or efficacy of their position, but how it will be perceived by morons, apparently.

    And as far as the anti-science idiocy being posted here: unless or until someone in the “denier” group is prepared to offer an explanation as to why the standard model of particle physics would somehow be wrong regarding the LONG ESTABLISHED Green House Gas effect of certain molecules, in addition to being able to dispute the only existing model that explains why the earth has maintained liquid water on its surface for billions of years, i.e. the CO2 Rock-weathering Thermostat Model, one is simply playing the fool trying to debate the point..

    The simple fact is that the CO2 Rock-weathering Thermostat Model is the only existing model for a reason. There is no other model left in contention because the evidence has become overwhelming in favour of this model. Talk to a paleo-geologist or paleo-climatologist if you want the details on that, or check out this lecture.

    http://www.agu.org/meetings/fm09/lectures/lecture_videos/A23A.shtml

    The only area in which there is any debate is the predictive modeling. Over the short term it is very difficult to predict the progression and timing, because we don’t understand fully all the micro-level interactions.

    Over the long term however, there is little doubt that we are heating the planet, and that we may trigger some very startling tipping point effects. The fact that we can’t predict the progression is therefore a further reason to be concerned, rather than the “evidence of conspiracy” the deniers desperately want to believe it to be.

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