Can we get more carbon out of a politically acceptable climate policy?
The outlook for Build Back Better (BBB) is not very good. And the problem with swinging for fences is, if you swing big and miss, you can end up with nothing. So the time has come for a pragmatic pivot.
Last week, Senator Elizabeth Warren spoke about smash BBB to get passable pieces across the finish line. Senator Edward Markey warned that the time had come to focus on a smaller package that has the votes. Biden admitted it’s it’s time to break it.
If Democrats are looking for passable coins, the clean energy tax credits in the current BBB proposal seem like a relatively safe bet. But can these tax subsidies put us on the right track to meet our GHG targets? Recent research suggests they won’t be close enough. If we want to fight climate change with tax incentives, can we build them better?
The do nothing option (not a good option)
It’s been hard to watch BBB falter. It sounds somewhat familiar. In 2009, we had a new administration with unprecedented climate ambition. After pushing a massive economic stimulus bill through Congress, Obama aimed to push through a comprehensive climate bill with ambitious (for the time) GHG targets for 2020. We all remember how that was. is over – in disappointment.
Despite this failure of federal climate policy, the United States ended up overachieving Obama’s GHG emissions targets for 2020. So it’s tempting to think/hope that the forces that have reduced GHG emissions over the past decade will keep rolling (twice as fast for achieve Biden’s more ambitious goal of 80-100% clean energy by 2035).
Some recent work by Harvard economists Jim Stock and Daniel Stuart highlights this hopeful idea. Jim and Daniel focus on emissions modeling in the electricity sector which is expected to provide a disproportionate share of total emissions reductions over the next decade. Their work is summarized in two recent articles (here and here).
One thing I really like about their approach is that they illustrate emissions trajectories in a range of plausible energy market worlds we might find ourselves in. These scenarios differ in terms of clean technology cost assumptions, natural gas price trajectories and electricity demand projections. . Details can be found in the log.
The chart below summarizes the GHG projections under a federal climate policy removal scenario. This assumes that no new federal policies come out of Congress and that tax credits are phased out in accordance with applicable law.
Different lines on the graph follow different GHG emissions trajectories under different assumptions about future technology costs, electricity demand, and so on. The scenarios in the legend are as follows: low/high electricity demand (D); low/benchmark/high natural gas prices (G); low/benchmark/high renewable energy costs (R).
You can see that these GHG projections are particularly sensitive to assumptions about future renewable energy costs. But even in the best-case scenario (where wind, solar, and battery storage costs drop faster than expected and efficiency improves dramatically), a removal of federal climate policy leaves us quite far from our goals of decarbonization.
Can we green the network with tax credits?
The figure above highlights the need for political intervention. But what form should this political intervention take? What shape can it take given gale force headwinds?
In addition to modeling some home-run policy scenarios, Jim and Daniel analyzed a range of possible second-best policies. This includes a scenario where the only part of BBB that makes the policy cut is the hardware expansion and extension of the $24/MWh production tax credit (indexed to inflation), the 30% investment tax and CCS tax credit.
Their modeling results are summarized below. By comparing these GHG trajectories to the removal case above, you can see that tax incentives reduce GHGs under a range of energy market scenarios:
In “HiR” scenarios, where the costs of renewable energy and storage technologies only drop by 20 to 30% by 2035, tax credits have a fairly small impact. What is going on?
The problem is that tax credits do not directly target GHG emissions. These tax incentives subsidize clean technologies at the same rate whether these resources displace hydroelectricity or coal. And fossil generators can pollute without penalty, regardless of their carbon intensity. Carrot and no stick is like fighting climate change with one hand tied behind your back.
A modest proposal
I am not a carbon tax or bust economist. But I’m climate-conscious and I’m looking for the most effective policy response possible. So let’s just assume that savvy politicians could win enough votes to support not only expanded tax credits, but also a modest carbon price of $20/tonne.
A carbon price of $20/tonne is well below the social cost of carbon. It is much lower than the carbon price in force in Europe (90 USD) or in Canada (40 USD). But it is higher than the current price of carbon in much of the United States ($0/tonne).
The figure below projects GHG emissions under the BBB tax credit extension + $20 carbon price (increasing by 3% per year in real terms):
This figure illustrates two key points. First, even a modest carbon price can make a big difference. A carbon price of $20/ton increases the operating costs of an average coal plant by about $20/MWh (assuming 2.23 pounds/kWh for charcoal production). This cost increase is enough to drive coal out of the market given the range of natural gas prices considered. And that helps explain the sharp drop in GHGs when the carbon price kicks in.
Another lesson: tax incentives and carbon pricing are real complements. The emission reductions achieved through the combination of the tax credit subsidy and the modest carbon price exceed the reductions we would achieve under either policy acting alone.
Create better tax incentives
Tax credits will help accelerate the necessary investments in clean technologies. This will reduce GHG emissions at home and help reduce costs for the rest of the world. Funding clean technology investments with federal taxpayer dollars, rather than utility bills, will also mitigate the impact on retail electricity prices. This is important, because a clean energy transition financed by higher electricity tariffs will undermine efforts to electrify other sectors.
In other words, clean energy tax credits have a lot to offer. And the BBB proposal adds more. The plan passed by the House includes design changes that reduce investment uncertainty and add a direct payment option. These refinements will help grease the wheels of needed clean energy investments. But they won’t solve a fundamental problem: GHG polluters can continue to pollute for free.
If Democrats could tie a modest carbon tax around this package of tax credits, we would see much greater GHG reductions. But ISince the price of carbon is not on the cards at the moment, slow progress on good climate policy is better than no progress. Let’s work to adopt the best practicable tax incentives for clean energy. And then look for every opportunity to increase focus on carbon of our political tools.