Thursday, October 15, 2009

Financial Incentives & the Weather

In honor of Blog Action Day, whose topic this year is climate change, this post is dedicated to the impact of financial incentives on the weather. Yes, financial incentives can and do effect the weather. Granted this effect is subtle and is only noticeable over a period of decades, but it’s real and it’s happening.

Over the past 150 years or so the world has been rapidly industrializing. This industrialization has been an exceptionally good thing, vastly improving standards of living, dramatically lengthening average life spans and giving a huge number of us a comfortable way of life. Of course, while making this great progress we have been enjoying an unfair advantage. We have been using the atmosphere as our own personal dump. The reason for this is simple. It costs nothing to pollute and since industry is about maximizing profits, industry’s economic incentive was to ignore the cost to society that such pollution causes.

Because of its sheer size, our emissions have take over a century to make a noticeable impact on the atmosphere, but scientific consensus now tells us that our actions are changing the atmosphere in a way that could lead to catastrophic results. The good news is that the financial incentives that brought us to this point, can also take us in the opposite direction and help clean up the planet.

Congress is considering several ways to cut global warming causing emissions, cap and trade being one of those proposals. Under such a system, government would cap the amount of green-house gas emissions, give “pollution permits” to certain industries, and allow firms to buy and sell those permits according to their needs. The thinking is that the “cap” would be reduced over time. While this is a good fall-back plan, it is complex and somewhat circuitous. A simpler way: carbon tax.

A carbon tax would be very easy to administer. Set a price per pound of CO2, and tax every activity according to the amount of CO2 it generates. You buy gas? The cost of CO2 would be added to your bill. You buy a computer? Same deal. You buy transportation services? Pay for the CO2 you emit into the atmosphere. The cost would be very transparent and immediate to the buyer, and when strong financial incentives exist, behavior changes.

What would we do with the funds generated by a carbon tax? We could do several things. One possibility: return it to consumers in the form of lower income tax rates – this way the net impact on the economy will probably be close to zero. Another possibility: use the money to subsidize alternative energy and energy efficiency projects. Or, here’s a thought, how about we reduce the federal deficit so that each of us owes less money to the rest of the world?

Economics got us into this climate change mess, but the good thing is that it can also go a long way towards getting us out. Hooray for carbon tax!

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