by the Congressional Budget Office

“ Treatment of Expectations One of the most complicated aspects of economics is that people decide what to do today in part on the basis of their expectations about the future. Modeling people’s expectations is crucial to forecasting, but there is no simple formula to describe how people form them. Economists typically model expectations in one of two almost polar ways. One method represents behavior as adaptive: in that representation, people do not have an explicit understanding of how the economy will evolve and simply extrapolate from past experience into the future. ”

“ If resources are free for the taking, people will tend to overuse them; if nobody owns them, nobody will take care of them. That phenomenon is referred to as the tragedy of the commons: everyone wants to use free resources but will degrade them if they do, to the detriment of all.
In the case of climate, people want to use the atmosphere to absorb greenhouse gases so that they may benefit from cheap food and timber and from plentiful fossil energy. ”

“ Similarities and Differences Taxes and permits affect a regulated activity in similar ways as long as people can buy and sell the permits on open markets. A tax on the carbon content of fuels directly raises the price of those fuels for the end user; a strict permit system indirectly raises the price by reducing the quantity of fuel that suppliers can sell. (As noted earlier, a fixed-price permit system works like a tax.) Either way, higher prices lead people to reduce their fuel consumption and thus their emissions. ”

“ Economists who analyze public policy reason that if a public investment is going to improve public welfare, it should produce rates of return similar to those of the private investments that it displaces. So in analyzing the costs and benefits of policies intended to avert climate change, economists typically apply discount rates that are similar to market interest rates, after adjusting for taxes, risk, and inflation. Those discount rates reflect the distributional choices that people in the economy, taken together, actually make. ”

“ Developed countries have contributed the majority of historical emissions, but countries that are now in the early stages of development will account for the bulk of emissions over the next century. Even so, on a per capita basis, developing countries will continue to have much lower income and levels of emissions than developed countries will have, and they appear to be more vulnerable to damage from climate change. As a consequence, policymakers in many developing countries favor significant action to reduce global emissions—but only by developed nations. ”

“ Like their climate-related counterparts, modern models of the economy are composed of systems of mathematical equations that represent distinct but interacting processes in the real world and that are solved together to represent the simultaneous interaction of the parts within the whole. Even the most complex models of the physical climate or the economy inevitably lack detail. For example, many studies focus on the costs of mitigating climate change and ignore the potential benefits. Others focus only on costs in one sector or only on certain kinds of costs. ”

“ Some analysts have argued that the regulation of energy markets might not be costly because energy conservation pays for itself. According to that point of view, people fail to use energy efficiently, either because they do not make sensible decisions about energy use or because they are poorly informed, or because they face a variety of market failures or barriers that deter them from making more-sensible decisions or becoming better informed. ”

“ Some of the uncertainty is scientific. For a given amount of greenhouse gas emissions, what portion will accumulate in the atmosphere? How much will a given change in those concentrations affect the global climate? How will that global change be distributed throughout the world, and how rapidly will it occur? How much will regional climate change affect sea level, agriculture, forestry, fishing, water resources, disease risks, and natural ecosystems? ”

“ But developing nations, which are expected to be the chief source of emissions growth in the future, will also be reluctant to adopt policies that constrain emissions and thereby limit their potential for economic growth—particularly when they have contributed so little to the historical rise in atmospheric greenhouse gas concentrations and may suffer disproportionately more of the negative effects if nothing is done. ”

“ Certain types of rights, such as rights to emit greenhouse gases by burning fossil fuels, could be delineated without great difficulty. Other rights, such as credits for carbon stored in the soil and trees of a forest stand or in the ocean, would be more complicated to define. Still others—such as the right to enjoy a particular type of climate in a particular part of the world at a particular time—would be impossible. Without clearly delineated, enforceable rights, individuals cannot easily bargain with one another in markets to resolve their conflicting claims. ”

“ If the government restricts emissions by imposing a tax, it will receive the scarcity rent as tax revenues. By contrast, if it imposes a permit system and gives the permits away, the permits’ recipients will receive the scarcity rents as higher profits—because they can either charge higher prices for the fuel they sell or sell the permit. The income received as tax revenue or scarcity rents can be many times larger than the net efficiency loss. ”

“ Developed, industrialized countries—the members of the Organisation for Economic Cooperation and Development (OECD) and of the former Soviet bloc—are responsible for nearly 80 percent of historical carbon emissions, even though they have only about 20 percent of the world’s population. Historically speaking, people in developed countries have emitted roughly 10 times more carbon per person than people in developing countries. Indeed, it is the technological access to energy from fossil fuels that has helped make them roughly 10 times wealthier. ”

“ The effectiveness of those institutions depends in part on characteristics of the resources. Market institutions do not work well when resources have the characteristics of public goods—that is, when it is difficult to prevent people from using the resources without paying for them (consumption is “nonexcludable”) and when the incremental cost of allowing more users is near zero (consumption is “nonrival”) . Market failures also arise when the many people using a resource affect each others’ use—for instance, when rush-hour drivers create congestion and air pollution. ”

“ A variety of technological options are available to restrain the growth of emissions, including improvements in the efficiency of people’s use of fossil energy, alternative energy technologies such as nuclear or renewable power, methods for removing greenhouse gases from smokestacks, and approaches to sequestering gases in forests, soils, and oceans. But those alternatives are likely to be costly, and they are unlikely to be widely implemented unless measures are taken to lower their price or to raise the price of greenhouse gas emissions. ”

“ When models with adaptive expectations are used to estimate the costs of a tax on emissions or a permit system, they tend to produce somewhat higher cost estimates than models with forward-looking expectations, all else being equal. That happens because people in forward-looking models have time to adapt to any policy that is announced in advance. Modelers who use adaptive expectations adjust for that limitation by gradually phasing in the policy, to simulate the anticipation of forward-looking individuals. ”

“ Several characteristics of greenhouse gases make it possible to lower the costs of regulation by allowing for a great deal of flexibility in controlling emissions. Different greenhouse gases, measured in metric tons of carbon equivalent, have essentially the same effect on climate; they mix uniformly throughout the atmosphere and will only gradually affect the climate as they accumulate over time. Consequently, which gas is controlled and where—and, to some extent, whether a given reduction in emissions occurs this year or next—are immaterial. ”

“ Uncertainty about the scientific aspects of climate change and about its potential effects complicates the challenge of developing policy by making it difficult to estimate or balance the costs of restricting greenhouse gas emissions and the benefits of averting climate change. ”

“ In practice, though, reforestation on that scale is infeasible: people need much of the land to grow crops and to live on. Furthermore, people would continue to use fossil fuels, and all of the carbon sequestered in trees over several decades would be replaced in the atmosphere by the continued emissions. So carbon sequestration in forests and agricultural soils can only partially offset past and future carbon emissions from fossil fuels.
But forests can offer a partial alternative to fossil fuels as a source of energy. ”

“ That balancing of current costs and future benefits also includes weighing the cost of reducing emissions to avert climate-related problems in the future against the cost of adapting to the climate change that occurs—that is, balancing mitigation and adaptation. If the incremental costs of reducing emissions today are higher than those of adapting to the consequences of emissions in the future—say, by spending more on insect control to prevent the spread of tropical diseases—then it would be more cost-effective to reduce emissions less and to adapt more. ”

“ Private firms have relatively little incentive to undertake basic scientific research on the functioning of the climate or on the costs and benefits of averting climate change because they cannot easily reap profits from the wide-spread, long-term public benefits of learning about or averting such change. Nor does industry have sufficient incentive to develop low-emissions and emissions-free energy technologies as long as the prices of fossil fuels do not reflect the potential costs of the damages to the climate that fossil fuel use may cause. ”

“ Government policies that deal with use of the atmosphere inevitably affect the distribution of resources. Inaction benefits people who are alive today while potentially harming future generations. Reducing emissions now may benefit future generations while imposing costs on the current population and may benefit countries at relatively higher risk of adverse effects from warming while hurting those that stand to gain from it. ”

“ At a deeper level, how will future generations value the effects of averting climate change? Future generations are likely to be wealthier, on average, than people are today and thus better able to adjust to changes in climate. ”