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A New Path to a Low-Carbon Economy

NEW YORK – The solution to man-made climate change depends on the transition to electricity production that, unlike burning oil, natural gas, and coal, emits little or no carbon dioxide – the main greenhouse gas responsible for global warming. Low-carbon electricity can be produced by solar, nuclear, and wind energy, or by coal-burning power plants that capture and store their CO2 emissions.

The policy problem is simple. Coal is a cheaper and more easily used energy source than the alternatives. It is cheap because it is plentiful. It is easier to use than wind or solar power because it can produce electricity around the clock, without reliance on weather conditions.

To save the planet, we need to induce power suppliers to adopt low-carbon energy sources despite coal’s lower price and greater ease of use. The obvious way is to tax coal, or to require power plants to have permits to use coal, and to set the tax or permit price high enough to induce a shift towards the low-carbon alternatives.

Suppose coal produces electricity at a cost of $0.06 per kilowatt-hour, while solar power costs $0.16/kilowatt-hour. The tax on coal-based electricity would have to be $0.10/kilowatt-hour. In that case, consumers would pay $0.16/kilowatt-hour for either coal or solar. The utilities would then shift to low-carbon solar power. The switchover, however, would more than double the electricity bill in this example.   

Politicians are loath to impose such a tax, fearing a political backlash. For years , this has stymied progress in the United States towards a low-carbon economy. Yet several European countries have successfully introduced the idea of a “feed-in tariff,” which provides the core of a politically acceptable long-term solution.

A feed-in tariff subsidizes the low-carbon energy source rather than taxing the high-carbon energy source. In our example, the government would pay a subsidy of $0.10/kilowatt-hour to the solar-power plant to make up the difference between the consumer price of $0.06 and the production cost of $0.16. The consumer price remains unchanged, but the government must somehow pay for the subsidy.

Here is another way. Suppose that we levy a small tax on existing coal power plants in order to pay for the solar subsidy, and then gradually raise consumers’ electricity bills as more and more solar plants are phased in. The price charged to consumers would rise gradually from $0.06/kilowatt-hour to the full cost of $0.16/kilowatt-hour, but over a phase-in period of, say, 40 years (the lifespan of the newest of today’s coal plants).

Assume that as of 2010, the entire electricity system is coal-based, and that the electricity price paid by the consumers is $0.06/kilowatt-hour. By 2014, suppose that 10% of the 40-year transition to solar power has been achieved. The consumer price is raised 10% of the way from $0.06 to $0.16, thus reaching $0.07/kilowatt-hour.

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The coal tax for 2014 is then set at $0.01/kilowatt-hour, which is just enough to pay the needed solar subsidy of $0.09/kilowatt-hour. Solar producers fully cover their costs of $0.16/kilowatt-hour, since they sell power to the consumers at $0.07/kilowatt-hour and receive a subsidy of $0.09/kilowatt-hour. A small coal tax can support a large solar subsidy.

Suppose, further, that by 2030 the transition to a low-carbon economy is halfway completed. The consumer price for electricity is now set at $0.11, exactly halfway between $0.06 and $0.16. The coal tax is now raised to $0.05/kilowatt-hour, just enough to cover the solar subsidy of $0.05/kilowatt-hour. Once again, the solar producers cover their costs exactly, since the subsidy of $0.05/kilowatt-hour closes the gap between the consumer price ($0.11/kilowatt-hour) and the producer cost ($0.16/kilowatt-hour).

Let us presume, finally, that by 2050, all electricity production has made the transition to low-carbon energy sources. The consumer price finally reaches $0.16/kilowatt-hour, enough to cover the full cost of solar power without a further subsidy. This approach allows higher consumer electricity prices to be phased in gradually, yet establishes strong, immediate incentives for adopting solar power. Moreover, the government budget is balanced every year, since the coal tax pays for the solar subsidy.

The actual transformation in the coming years will have one major advantage compared to this illustration. Today’s solar power plants might cost an extra $0.10/kilowatt-hour compared to coal, but such plants will be much less costly in the future because of improved technology. Thus, the magnitude of subsidies needed in a decade or two will be lower than they are today.

Energy debates in the US, Australia, and other countries have centered so far on introducing a cumbersome cap-and-trade permit system. Every major user of fossil fuel would need to buy permits to emit CO2, and those permits would trade in a special marketplace. The market price of the permits would be equivalent to paying a tax on CO2 emissions.

Unfortunately, cap-and-trade systems are difficult to manage and don’t give clear signals about the future price of permits. Europe has adopted such a system, but other parts of the world have repeatedly rejected it. In fact, Europe’s biggest successes in promoting low-carbon energy have come from its feed-in tariffs, and carbon taxes in some countries, rather than its cap-and-trade system. 

The time has come for the US, China, India, and other major economies to declare how they will foster their own transition to a low-carbon economy. A small and gradually rising carbon tax that funds a feed-in tariff system could win political support in the US. It could also help to foster consensus among the major coal-based economies, including China and India. 

There really are effective long-term solutions to manmade climate change that are politically acceptable and feasible to implement. It is time to embrace them.

Jeffrey D. Sachs is Professor of Economics and Director of the Earth Institute at Columbia University. He is also Special Adviser to United Nations Secretary-General on the Millennium Development Goals.

Copyright: Project Syndicate, 2010.

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