Advice for the New Administration: Spend Green Today, Tax Green in the Future

Politicians are often tempted to think that a policy to help one goal, say air quality, must also help lots of other goals, say economic growth.  Economists are more likely to presume tradeoffs, and to use the principle of targets and instruments.  That principle says that you cannot expect to hit more than one bird with one stone, except by coincidence.

At the American Economic Association meetings in San Francisco January 3, I was on a panel titled “Energy and the Environment: Policy Advice for the New Administration” (along with some real energy experts; I am a relative latecomer to the area).  Within the framework of targets and instruments, I proposed a matrix such as the one that appears below.

There are examples that go either way.

• My favorite example of hitting several birds with a single stone is a gas tax.  This one instrument hits seven targets! (See page 4 of my slides. Too bad the gas tax has always been considered political suicide for whoever proposes it.)  More often, independent policy instruments have independent effects; a measure that helps one goal might hurt another.
• An example of an initiative that successfully addressed one important environmental goal with the side effect of making another worse was the Montreal Protocol.  It successfully addressed stratospheric ozone depletion, but banning CFCs led to substitution of HFCs and (worse) PFCs, which are Greenhouse Gases (GhGs) and thus worsen Global Climate Change.

• Another example, which arouses greater passion, is the question whether to start building nuclear power plans again.  Environmentalists should like that nuclear power is an energy source that does not create GhGs, but worry that nobody wants to store the nuclear waste in their own state.  National security buffs should like that it helps reduce dependence on imported oil, but nuclear plants in other countries increase risk of proliferation of nuclear weapons.

Government in practice makes decisions in largely independent policy processes (“stovepipes”).  We need an overarching conceptual framework.  Consider the matrix below.  Across the top are the labels of columns, each of which represents a different objective; down the side are the labels of rows each of which represents a different policy instrument.

To illustrate: the energy tax measures (gas tax, BTU tax, oil tax, carbon tax) all tend to work in the same positive directions: helping local reduce local air pollution and traffic congestion, improving national security, and providing revenue that the government can use to cut distortionary taxes or fund social security; thus energy taxes receive “pluses” in all these columns.  But CAFÉ standards, as other performance standards or “command and control” policies are an inefficient way to attain a given environmental goal, and so receive a “minus” in the Economic Efficiency column.  Indeed, the decision to grant more lenient standards to light trucks probably allowed the SUV craze to start, thereby perversely increasing traffic congestion and serious accidents (especially relative the alternative of a gas tax).

In two places in the table, I have distinguished between long run effects of a policy and shorter run effect.  One place concerns the Cheney-McCain policy of “drill, baby, drill” on federal lands and offshore.  The other concerns the Strategic Petroleum Reserve.  For details see the last two pages of my slides.

Computing the optimal combination of policy measures to hit the desired set of policy targets is straightforward in theory (so long as there at least as many instruments as targets).  Needless to say, it is more difficult in practice.

Moving to the situation that Barack Obama will step into on January 20, Priority no. 1 is, and should be, a fiscal stimulus package.  It can be a “green stimulus” package.  From a macroeconomic viewpoint, the goals should be stimulus in 2009, without abandoning all hope of fiscal discipline in future years.  From an environmental policy, the goals should be getting started quickly on those energy investments that meet a cost-benefit test, and also sending the signal that prices of energy, especially carbon, will be higher in the future.  All four goals can be met by the general principle:   Spend green today; tax green in the future.

.