Costs of Air Pollution in the U.S.

What costs does air pollution impose on the U.S. economy? Nicholas Z. Muller, Robert Mendelsohn, and William Nordhaus tackle that question in the August 2011 issue of the American Economic Review. AER articles are typically available only by subscription to the journal, but their article, \”Environmental Accounting for Pollution in the United States,\” is publicly available. I\’ll start here by summarizing some of their findings, and then backtrack to offer a quick overview of their methodology.

Total \”gross external damages\” the six \”criterion\” air pollutants in 2002–sulfur dioxide, nitrogen oxides, volatile organic compounds, ammonia, fine particulate matter,and coarse particulate matter–was $182 billion. Since GDP was about $10.5 trillion in 2002,  the cost of air pollution was a bit under 2% of the total.\”The effects included in the model calculations are adverse consequences for human health, decreased timber and agriculture yields, reduced visibility, accelerated depreciation of materials, and reductions in recreation services.\” This total does not include costs of carbon emissions, for which comprehensive sector-by-sector, place-by-place data are not available in 2002.

The sectors with the biggest air pollution costs measured in terms of \”gross external damages\” (GED) (counting the same six pollutants but again not counting carbon emissions) are utilities, agriculture/forestry, transportation, and manufacturing. If one looks at the ratio of gross economic damages to value-added in the sector, agriculture/forestry and utilities lead the way by far with ratios above one-third. Manufacturing has fairly high gross external damages, but the GED/VA ratio for the sector as a whole is only 0.01.

If one breaks down sectors into specific, here is a list of all industries that have either more than $4 billion in gross external damages from air pollution or a GED/VA ratio (gross external damages divided by value added) of more than 0.45. In particular, coal-fired power generation jumps off the list to me, with its very large GED and a GED/VA ratio of 2.2.

If pollution taxes or tradeable pollution permits were imposed, so that industry was required to take the social costs of pollution into account, the value of the gross external damages caused by air pollution would be reduced by about four-fifths.

Taking carbon emissions into account, which they do for the electric power industry, makes a relatively small difference to the harms of coal-fired plants, but a larger relative difference for natural gas power plants. Coal-fired power plants already have gross external damages of $53.4 billion, and adding the costs of carbon (priced at $27/ton of emissions) raises that total to $68.7 billion. However, natural gas power plants emit relatively small levels of the six \”criteria\” pollutants and have gross external damages of only $0.9 billion. For them, adding costs of carbon emissions nearly quadruples their gross external damages to $3.4 billion–and raises their GED/VA ratio from a worrisome 0.34 to an eyebrow-raising 1.30.

The methodology behind these estimates is quite reasonable, which means of necessity that it is also comprehensive and complex. The basic approach in this kind of work is to choose what you think are the most plausible estimates, but also to compare them with other data sources, other models, and other estimates, so that you can continually double-check the reasonableness of your choices.

They start with an inventory of all U.S. air pollution emissions published by the Environmental Protection Agency, covering emissions in 2002. It includes 10,000 emissions sources, including 656 point sources (individual facilities) and then area sources, like vehicles and other stationary sources, at the county level. The source of these emissions is distinguished by height–which affects their environmental costs–and also categorized by six-digit industry code. Thus, these authors use the Air Pollution Emission Experiments and Policy model to look at how these emissions spread. However, they cross-check this approach by looking at another model, the Community Multiscale Air Quality model. They look at particular studies for how each of these pollutants affects health and other costs–and compare their chosen studies to others that are available.
They use a value of a statistical life for an average worker of $6 million, but also do illustrative calculations using $2 million and $10 million.  The overall result is like building up a mosaic one tile at a time: even if you disagree with the placement or color of an individual tile here or there, the overall picture is persuasive.

To me, a lesson that emerges from these calculations is that the costs of air pollution and of burning fossil fuels are very high, both in absolute terms and compared to the value-added of certain industries, even without taking carbon emissions into account. Environmentalists who are discouraged by their inability to persuade more people of the risks of climate change might have more luck in reducing carbon emissions if they deemphasized that topic–and instead focused on the costs of these old-fashioned pollutants. 

The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy

The Drill-Baby Carbon Tax is my proposed grand compromise for energy policy in the United States. As the name suggests, it has two parts. On one side, there would be a national commitment to move ahead with all deliberate speed in developing the vast U.S. fossil fuel energy resources that are now technologically available. On the other side, the United States would enact a appropriate carbon tax to offset concerns over the risks of climate change. The Drill Baby Carbon Tax basically takes the view that while the United States is working on phasing down fossil fuels and moving to alternative energy resource, let\’s produce a greater share of the fossil fuels that we consume here at home.

Personally, I like both sides of the Drill Baby Carbon Tax. But for many, it\’s a proposal with something to like and something to loathe. Is there any chance for at least some environmentalists and some of those who favor aggressively developing our domestic energy resources to support such a compromise?

A number of environmentalists have been warning about the dangers of climate change in near-apocalyptic terms. If it is, as often claimed, the preeminent environmental issue our time with a risk of extraordinarily large and even catastrophic costs, then surely a carbon tax should be worth accepting some other tradeoffs.

At a more subtle level of argument, many environmentalists would be horrified by a proposal that would involve taking pollution from U.S. and dumping it elsewhere; but after all, a policy in which the U.S. burns imported fossil fuel is only saving environmental costs in the U.S. while imposing them elsewhere. From a global environmental perspective, if fossil fuel resources are to be developed, better that it happen here under the eye of U.S. regulatory agencies and courts and everyday U.S. citizens, rather than in Nigeria or Russia. Moreover, if energy development was happening in America, U.S. citizens would need to face the reality of what they are using.

By trying to block, for example, a pipeline from Canada that would bring oil from the \”tar sands\” to the U.S., environmentalists are missing the fact that these resources are going to be developed somewhere in the world–and carbon emissions are the bigger issue. For example, Nature magazine editorialized in its September 15 issue: \”In fact, the pipeline protests say more about the sorry state of the environmental agenda than anything else. It is true that greenhouse-gas emissions from oil extracted from the sands are 15–20% higher than those from average crude oil if assessed on a life-cycle basis, but industry officials are correct in pointing out that this is on a par with other dirty oils produced in the United States and elsewhere using steam injection. And halting this pipeline is unlikely to halt development of the tar sands or other dirty sources of energy. What is missing, now as ever, is a policy to address the larger climate threat.\”

For those in favor of developing U.S. domestic energy resources, it\’s  important to be clear such a policy isn\’t going to have much affect on the average price over time, which is set in a global market of supply and demand. However, oil produced in North America is less susceptible to disruptions and cutoffs that can cause sharp fluctuations in world prices and stagger economies. If more oil was produced here, there would be less reason for a U.S. military presence in the Middle East, and fewer trigger points for conflict over oil around the world. Perhaps most important, if oil is going to be produced somewhere, having it produced and refined by U.S. workers creates jobs here, rather than having the U.S. run a large trade deficit in part because of importing oil produced somewhere else. 

Of course, many of those who favor expanding domestic oil drilling don\’t think the evidence for climate change is very strong, and don\’t think a carbon tax is justified. But essentially everyone acknowledges that burning fossil fuels creates standard pollutants: sulfur oxides, nitrogen oxides, particulate matter, and the like. Even if reducing carbon emissions is unimportant, reducing these other pollutants has some gains. The distaste for a carbon tax would also have to be weighed against the gains from additional U.S. jobs, a less volatile world energy supply, less pressure to seek political stability in the Middle East, and a lower U.S. trade deficit. And for advocates of developing domestic energy resources, imagine the political power of generously offering a grand compromise that might co-opt and defang the climate change issue!

What might the specific dimensions of the Drill Baby Carbon Tax look like? On the production side, the concrete and goal would be how much the U.S. ramped up its domestic fossil fuel production. Earlier this month, I blogged on \”America as a Conventional Energy Powerhouse?\”, where an energy expert predicts that thanks to horizontal drilling and other technological developments, \”[b]y the 2020s, the capital of energy will likely have shifted back to the Western Hemisphere …\” The process here would be make sure that environmental regulations are met, but not to let those regulations be used to shut off developing these fossil fuel resources.

On the carbon tax side, the question is how large a tax is justified by the existing scientific evidence. A useful starting point here is a paper by three economists: Michael Greenstone of MIT and Elizabeth Kopits and Ann Wolverton of the EPA. All three of them participated in a group that tried to calculate a social cost of carbon for the federal government. (Greenstone was Chief Economist on the staff of Obama\’s Council of Economic Advisers in 2009 and part of 2010.) In March 2011, they published a working paper on \”Estimating the Social Cost of Carbon for Use in U.S. Federal Rulemakings: A Summary and Interpretation.\”

The social cost of carbon (SCC) depends to some extent on what discount rate one uses. A higher discount rate makes future costs less salient in the present, and vice versa. They write (footnotes omitted): \”For 2010, the central value is $21 per ton of CO2 emissions and sensitivity analysis is to be conducted at $5, $35, and $65. The $21, $5, and $35 values are based on the average SCC across the models and scenarios examined for the 5, 3, and 2.5 percent discount rates, respectively. The $65 value—the 95th percentile of the SCC distribution at a 3 percent discount rate—was chosen to represent potential higher-than-expected impacts from temperature change.These SCC estimates also grow over time based on rates endogenously determined within each model. For instance, the central value increases to $24 per ton of CO2 in 2015 and $26 per ton of CO2 in 2020.\”

For economists, of course, a natural approach is to phase in a carbon tax at the level that matches the social cost of carbon, so that users of fossil fuels need to pay the social costs that they are imposing, and will have an incentive to adjust their behavior accordingly. How much of a boost would a carbon tax at these levels cause to, say, gasoline prices? A Congressional Budget Office Report from October 2008 looked at \”Climate-Change Policy and CO2 Emissions from Passenger Vehicles.\” The CBO estimate is that a carbon tax at $28/ton of carbon would add about 25 cents/gallon to the price of gasoline–if gas is $4/gallon, this would be a price increase of about 6%. A carbon tax would also affect coal and natural gas, so those prices would rise as well. This price increase is certainly noticeable; after all, part of the point is to provide incentives to developing non-carbon sources of energy. But on the other side, after the gas and energy price fluctuations of the last few years, it is hardly an unprecedented change for Americans to handle. U.S. gasoline prices, for example, would still be far below the levels common in Europe. In early October, the U.S. Energy Information Administration reported that the average U.S. price for a gallon of regular gas was $3.70, compared with almost $8/gallon in Germany, France, Italy, and the United Kingdom. 

 Of course, I\’m well aware that the Drill Baby Carbon Tax would be hard to legislate. At least some of the same environmentalists who complain that people are highly reluctant to believe the science of climate change will be themselves highly reluctant to accept the evidence that a realistic carbon tax should be set at this level–and instead will want something truly punitive. At least some of the those who favor additional development of U.S. fossil fuel resources will be dead set against a tax that would raise the price of this energy.  There would be dispute over how to use the $100 billion or more in likely revenues from a carbon tax of $20-25 per ton of carbon: for example, these revenues could be used as part of a package for long-run reduction of budget deficits, or could finance cuts in other taxes. It would probably be necessary to yoke the rising domestic fossil fuel production and the rising carbon tax together, so neither one could increase without the other increasing as well.

But while the practical details are daunting, perhaps this is one of the rare cases where for both extremes,  the prize is worth the compromise. And I suspect that plenty of folks in the middle might buy into the grand compromise of the Drill Baby Carbon Tax.

Clean Energy Standard vs. Feebate vs. Carbon Tax vs. Cap and Trade

Alan J. Krupnick and Ian W.H. Parry of Resources for the Future have a nice short article on \”Decarbonizing the Power Sector: Are Feebates Better than a Clean Energy Standard?\” But if the policy goal is to reduce carbon emissions, there are at least four policies in play–all discussed in their article.

  • A clean energy standard. They write: \”Under this approach, electricity producers would be required to meet a rising fraction of their generation using zero-carbon sources or sources with lower carbon intensity (defined as CO2 emissions per kilowatt-hour [kWh]) than that of coal generation.\” In July, the Congressional Budget Office put out a report on \”The Effects of Renewable or Clean Electricity Standards:\” :
  • A \”feebate\” system, \”which involves fees for [electricity] generators with above-average emissions intensity and subsidies or rebates for those with below-average emissions intensity.\”
  • A cap-and-trade system, in which the government sets an overall cap on carbon emissions, and then allocates permits to emit this amount of carbon. These emission permits would have two important traits: 1) they would shrink over time, so a permit to emit amount of carbon in one year would gradually phase down to allow emitting only a certain percentage of that amount in future years; and 2) the permits could be bought and sold, so that those who could reduce emissions relatively cheaply would have an incentive to go ahead and do so, and to sell their excess permits to those who would find it more expensive to reduce emissions.
  • A carbon tax.  

I won\’t attempt to rank these options in any systematic way, but here are some of my thoughts about them.

1) A feebate system has some substantial advantages. Krupnick and Parry explain: \”The feebate approach has several potential advantages over a CES [clean energy standard]. For starters, the incremental costs of reducing CO2 are automatically equated across different generators, promoting a cost-effective allocation of emissions reductions within the power sector at a given point in time. Another attraction of the feebate is that it automatically handles changes in the future costs of different generation technologies or fuel prices. If, for example, the future expansion of nuclear power is temporarily held up, firms would be permitted a higher emissions intensity (at the expense of paying more fees or receiving fewer rebates); under a strict CES they would be required to meet a given emissions intensity standard, regardless of costs. Conversely, if the competitiveness of wind power improves, firms are rewarded for exploiting this opportunity and further cutting their emissions under a feebate system; with a CES, they have no incentive to do better than the emissions intensity standard. By establishing a fixed price on CO2 emissions, moreover, a feebate facilitates comparison of policy stringency across countries. This price could be set in line with estimates of the (global) environmental damages from CO2 (currently about $21 per ton, according to a recent review across U.S. agencies and subsequent use in U.S. regulatory impact analyses [U.S. Interagency Working Group on Social Cost of Carbon 2010]) or prices prevailing in the European Union’s Emissions Trading.\”

2) Anti-tax sentiment is a political constraint. I suspect that the clean energy standard is popular because, at least to politicians, it appears to have no costs. Similarly, cap-and-trade may appear to impose no costs either. In contrast, a carbon tax clearly looks like a charge. A feebate proposal does require collecting revenue and passing it to other actors–but there is no actual revenue retained by the government, so it may not look like a tax

3) The clean energy standard and feebate approaches both focus only on electricity generation, and for that reason would have less effect on carbon emissions than a broader-based cap and trade or carbon tax approach. This may also be a political selling point, because drivers using gasoline and firms that are heavy users of coal or oil or natural gas would be less affected by an approach that focused only on electricity generation. However, the feebate idea might have broader applicability. I have in the past seen feebate proposals in the past that focuses on automobile fuel efficiency: that is, those driving cars with below some level of miles-per-gallon pay a fee, and those driving cars above that level of miles-per-gallon get a rebate.

4) A clean energy standard is a pure regulatory approach, specifying what is \”clean\” and what is not, and thus is likely to be less effective than a cap-and-trade or a carbon tax approach. Here\’s how the CBO makes this point in its report: \”Even with a wide variety of compliance options, neither an RES [renewable electricity standard] nor a CES [clean electricity standard] would be as cost-effective in cutting CO2 emissions as a “cap-and-trade” program. Such a program would involve setting an overall cap on emissions and letting large sellers of emission-creating products (such as electricity generators, oil producers and importers, and natural gas processors) trade rights to those limited emissions. In that way, a cap-and-trade program would create a direct incentive to cut emissions; in contrast, an RES or CES would create a direct incentive to use more renewable or other types of clean electricity but would have only an indirect effect on emissions.\”

5) A carbon tax and auctioning of cap-and-trade permits would raise revenue that could be used to lower tax rates in other areas, in ways that could enhance efficiency–but it is difficult to guarantee that the revenues would be used in this way.

6) One great advantage of a carbon tax is that it reduces the incentives for political tinkering. A cap-and-trade proposal, for example, is likely to have extensive grandfathering of those who currently emit carbon, probably along with a parade of special rules and exemptions. Defining what is \”clean energy\” or even how the feebates would be structured are likely to be more highly political decisions.