Why Rebating Carbon Emissions Revenue Works

Most economists and public policy analysts think that revenues from a carbon pricing scheme should be substantially rebated back to the public in one form or another. Most industry players and “moderate” legislators think there should be no revenue, and permits should be given away to polluters to profit from. And many environmentalists would prefer that the revenue be substantially invested in subsidies for green technologies. The Obama administration is proposing, basically, 80 percent of option one and 20 percent of option three. Dave Roberts, speaking up for option three, says he doesn’t understand how option one is supposed to work:

Say you put a price on carbon and rebate the revenue.

Business costs rise, but they get that money back by raising prices for consumers.

Consumer costs rise, but they get that money back via rebates.

Who, in this scenario, has any new incentive to shift to low-carbon electricity or efficiency?

It’s like if we put a $5 monthly tax on NetFlix use, and then sent every NetFlix customer a $5 check each month. Who would ever rent any fewer movies? It looks like you’re just moving money around to no end. Can someone explain what I’m missing?

What’s Dave’s got here is a poorly constructed analogy. It’s more like if we put a $1 per disc fee on Netflix rentals on top of the monthly fees, and then redistributed the revenue equally to Netflix users. The result would be that a Netflix user who rents the mean number of discs per month winds up in exactly the same situation he was in previously. But any Netflix user who rents a below-mean number of discs per month winds up paying less overall to Netflix than he currently does, whereas any Netflix user who rents an above-mean number of discs per month winds up paying more overall to Netflix than he currently does.

Realistically, this might just doom Netflix’s business model so it’s more useful to talk about carbon than DVDs.

If you rebate carbon revenue then above-average carbon consumers lose and below-average consumers win. What’s more, the further below average you are, the more you win. But the further above average you are, the more you lose. The system then goes on to exploit the ensuing collective action problem. For each individual, if you personally reduce your consumption of carbon-intensive goods and services, you wind up paying less in carbon fees without meaningfully impacting the total size of your rebate check. This gives each individual a reason to try to reduce his consumption through some combination of conservation, efficiency, and switching to clean sources. But since each individual has this incentive, overall carbon emissions should drop. Which means that next year, each person needs to redouble his efforts to reduce his carbon footprint in order to get on the “win” side of the line.

The big virtues of such a policy is that it reduces the macroeconomic impact of the carbon cap, and has progressive distributional implications, meaning that you can actually make it the case that most people are richer in the short-term under the carbon pricing scheme than they would be under the status quo. This is huge. The big problem, institutionally, of climate change is that it’s hard to get the political system to make a short-term sacrifice for long-term gain. A well-designed rebate system drastically reduces the need for short-term sacrifices—with the only problem being that industry shills misrepresent the distributive implications.

That said, I do think that we need to go beyond mere price-and-rebate. In a lot of respects the market can and will respond to price signals by offering us more energy efficient appliances, more renewable electricity sources, etc. But there’s a large public goods component to it. Michael O’Hare has observed that switching the incentives so that I want to take the tram to work rather than driving doesn’t work unless you build a tram. Similarly, we can’t power our cities with the wind power of the plains unless we build transmission lines that go from where the wind is to where the people are. The best thing, probably, is to rebate carbon pricing funds and then plow additional money on top of that into greener infrastructure or else to do something like the administration’s mixed approach.