The Economic Effects of Policies to Reduce Greenhouse-Gas Emissions

October 14, 2009

Today I testified about the economic effects of legislation aimed at reducing emissions of greenhouse gases, drawing on a report that CBO released a few weeks ago.

Global climate change poses one of the nations most significant long-term policy challenges. A strong consensus has developed in the expert community that, if allowed to continue unabated, the accumulation of greenhouse gases in the atmosphere will have extensive, highly uncertain, but potentially serious and costly impacts on regional climates throughout the world. Moreover, the risk of abrupt and even catastrophic changes in climate cannot be ruled out.

Reducing the extent of climate change would entail substantial reductions in U.S. emissions and in emissions from other countries over the coming decades. Achieving such reductions in this country would probably involve some combination of three broad changes: transforming the U.S. economy from one that runs on carbon-dioxide-emitting fossil fuels to one that increasingly relies on nuclear and renewable fuels; accomplishing substantial improvements in energy efficiency; and implementing the large-scale capture and storage of carbon dioxide emissions.

My testimony emphasized several points:

  • The economic impact would depend importantly on the design of the policy. Decisions about whether to reduce greenhouse gases primarily through market-based systems (such as taxes or a cap-and-trade program) or primarily through traditional regulatory approaches that specify performance or technology standards would influence the total costs of reducing emissions and the distribution of those costs. The costs would also depend on the stringency of the policy; whether other countries imposed similar policies; the amount of flexibility about when, where, and how emissions would be reduced; and the allocation of allowances if a cap-and-trade system was used.
  • Reducing the risk of climate change would come at some cost to the economy. For example, CBO concludes that the cap-and-trade provisions of H.R. 2454, the American Clean Energy and Security Act of 2009, would reduce GDP below what it would otherwise have beenby roughly to percent in 2020 and by between 1 and 3 percent in 2050. By way of comparison, CBO projects that real (that is, inflation-adjusted) GDP will be roughly two and a half times as large in 2050 as it is today, so those changes would be comparatively modest. In the models that CBO reviewed, the long-run cost to households would be smaller than the changes in GDP because consumption falls by less than GDP and because households benefit from more time spent in nonmarket activities. Moreover, these measures of potential costs do not include any benefits of averting climate change.
  • Climate legislation would cause permanent shifts in production and employment away from industries that produce carbon-based energy and energy-intensive goods and services and toward industries that produce alternative energy sources and less-energy-intensive goods and services. While those shifts were occurring, total employment would probably be reduced a little compared with what it would have been without such a policy, because labor markets would most likely not adjust as quickly as would the composition of demand for different outputs.
  • CBO has estimated the loss in purchasing power that would result from the primary cap-and-trade program in H.R. 2454, incorporating both the higher prices that households would face and the compensation they would receive (primarily through the allocation of allowances or the proceeds from their sale). CBOs measure omits some channels of influence on households well-being that cannot be readily quantified, and it appears that the measure probably understates the true burden to a small degree. As estimated, the loss in purchasing power would be modest and would rise over time as the cap became more stringent, accounting for 0.2 percent of after-tax income in 2020 and 1.2 percent in 2050. Households in the lowest fifth of households when arrayed by income would see gains in purchasing power in both 2020 and 2050, because the compensation they would receive would exceed the costs they would bear. However, households in the middle fifth would see net losses in purchasing power amounting to 0.6 percent of after-tax income in 2020 and 1.1 percent in 2050.