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Costs of reducing greenhouse gas emissions in the USA and Canada
EnergyPolicy. Vol. 24, Nos 10/1 I, pp. 889-898. 1996 Copyright © 1996 Elsevier Science Ltd Printed in Great Britain. All rights reserved 0301-4215/96 $15.00 + 0.00
ELSEVIER
PII:S0301-4215(96)00084-5
Costs of reducing greenhouse gas emissions in the USA and Canada M a r k Jaccard Simon Fraser University
W David M o n t g o m e r y Charles River Associates, Suite 750 North, 1001 Pennsylvania Avenue, NW, Washington, DC 20004-2505, USA A number of possible policy responses can be adopted in order to address the prospect of increasing greenhouse gases in the earth's atmosphere. These include mitigation measures, that reduce greenhouse gas emissions or enhance the processes that remove greenhouse gases from the atmosphere, adaptation measures that reduce the consequences or damages from climate change, and information measures, including scientific research on climate processes and research and development on new energy technologies. Climate research can reduce current uncertainties about the consequences of greenhouse gas emissions and new energy technologies can reduce the costs of mitigation measures. All of these measures have a role in a balanced approach to climate policy. Copyright © 1996 Elsevier Science Ltd. Keywords: G r e e n h o u s e gas reduction; Climate research; Mitigation measures
This paper reviews existing studies on the economic costs o f mitigating greenhouse gas emissions in the USA and Canada. Since costs are strongly influenced by the availability of new energy technologies and the timing of emission reduction, information measures play an important role in at least some of those studies. This paper begins with an overview of the results from recent mitigation cost studies and of the issues that arise in interpreting those results. The next two sections review the results of two very different approaches to analyzing costs in more detail. The paper concludes with an evaluation of the results from different approaches and their implications for policy and research. According to the convention adopted by the Intergovernmental Panel on Climate Change, the term 'costs' should be interpreted as a cost net of any beneficial effects of measures other than the benefits of reducing or delaying climate change. The benefits of addressing climate change are discussed separately from costs under these definitions.
striking aspect of the table is that some studies have concluded that substantial emission reductions can be achieved at nearly zero or negative cost, while others reach the conclusion, that efforts to reduce CO 2 emissions will be costly, and that the costs will rise as greater reductions are undertaken. Key issues The first and second articles in this issue (Hourcade and Robinson, and Richels and Sturm) summarize the key methodological and empirical issues in estimating mitigation costs. These include, among other things, different assumptions about: (1) underlying social-economic trends; (2) underlying economic growth rates; (3) the GHG intensity of future autonomous technological evolution; (4) the ability for firms and households to substitute away from GHG-intensive goods and services; and (5) how GHG taxes will be recycled and the resulting effects.
Cost estimation: the methodological issues
Bottom-up and top-down models
In recent years there have been numerous studies of the costs of reducing CO 2 emissions in the USA and Canada. Table 1 depicts typical results from a number of these studies. The
As noted in the preceding articles in this special issue, a critical distinction is made between top-down and bottom889
890
Costs o f reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Table 1 US CO 2 abatement cost modeling studies Author (year)
Key a
CO 2 reduction from baseline (%)
GNP impact/cost (reduction) from baseline (%)
Barnes et al (1992) Barnes et al (1992) Barnes et al (1992) DRI (1992) CBO-PCAEO,DRI (1990) CBO-DGEM (1990) CBO-IEA-ORAU (1990) Edmonds and Barnes (1991) Goulder (1991) Jackson (1991) Jorgenson and Wilcoxen (1990a) Jorgenson and Wilcoxen (1990a) Jorgenson and Wilcoxen (1990b) Manne and Richels (1990a) Manne and Richels (1990a) Manne (1992) Manne (1992) Manne (1992) Mills et al (1991) NAS (1991) Oliveira-Martins, Nicoletti et al (1992) Oliveira-Martins, Nicoletti et al (1992) OTA (1991) Rutherford (1992) Rutherford (1992) Rutherford (1992) Shackleton et al (1993)
BG (2020) 26, 45, 60 0.6, 2.0, 3.2 BG (2050) 45, 70, 84 1.9, 4.9, 7.5 BG (2095) 67, 88, 96 4.3, 8, 10.9 B (2020) 37 1.8 CBI, CB2, (2000) 8, 16 1.9, 2 CB3 (2000) 36 0.6 CBG (2100) 11, 36, 50, 75 1.1,2.2, 0.9, 3.0b EB (2020), EB (2100) 35, 59 1.3, 2.3 G (2050) 13, 18, 27 1.0, 2.2, 4.5 J (2005) 34, 40, 46 -0.2, -0. I, 0.1 JW (2060) 20, 36 0.5, 1.1 JW (2100) 10, 20, 30 0.2, 0.5, 1.1 JW (2020) 8, 14, 32 0.3, 0.5, 1.6 MR (2020) 45 2.2 MR (2100) 50, 77, 88 0.8, 2.5, 4.0c MRG (2020) 26, 45, 60 0.8, 2.2, 4.2 MRG (2050) 45, 70, 84 1.4, 2.7, 3.3 MRG (2100) 67, 88, 96 2.3, 3.1,3.4 M (2010) 21 -1.2 d N 24, 40 0, 0.8 OMG (2020) 26, 45, 60 0.2, 1.1,2.4 OMG (2050) 45, 75, 84 0.4, 1.3, 2.4 O (2015) 23, 53, 53 -0.2%-0.2% 1.8 RG (2050) 26, 45, 60 0.5, 1.3, 2.5 RG (2050) 84, 45, 70 2.4, 1.2, 2.5 RG (2100) 67, 88, 96 1.8, 2.6, 2.8 SJW (2010), 22, 2 -0.6, 0.1 SLINK (2010) Shackleton et al (1993) SDRI (2010), 5, 28 -0.4, 0.2 SG (2O10) US Energy Choices (199 l) USEC (2030) 67.5 -0.6 alf the model used is a global model, the key includes the letter 'G' before the date. bThe first two results use multilateral taxes, others use unilateral taxes; taxes are flat only in the first and third estimates, cValues represent different assumptions in technological developments; an optimistic, an intermediate, and a pessimistic view. dArising from eleven specified regulatory changes, estimated from claimed savings of US$85 billion per year. eThe benefit shown in the OTA cost estimates is only an indicative value, no explicit modeling value has been calculated.
up models. This distinction is important for explaining the divergences in US and Canadian estimates o f the costs o f G H G emission reduction. Top-down studies have g e n e r a l l y been based on more aggregate e c o n o m i c analysis which places energy supply and d e m a n d in the context o f a m o d e l o f the entire economy. These studies have generally concluded that emission reductions are costly. Bottom-up studies have been based on engineering studies o f specific energy efficiency or renewable energy technologies and have concluded that emission r e d u c t i o n s a c h i e v a b l e with those t e c h n o l o g i e s are either nearly free or have negative costs. The two sides o f this debate are far from agreement. Topdown modelers argue that the conclusions o f the bottom-up modelers can only be correct i f there are imperfections in energy markets that can be corrected through sufficiently non-burdensome policy interventions. They also point out conceptual and methodological disagreements with the way in which bottom-up studies estimate economic costs. Modelers in the technology based school accuse economic models o f assuming away market imperfections and ignoring the results o f engineering studies o f specific technologies. Other issues
Two other fundamental issues account for some o f the differences in conclusions about costs.
Some studies have found low or negative cost is their inclusion o f so-called 'double dividends' o f CO 2 emission reductions. These double dividends could come in two main forms: the use o f revenues from taxes designed to discourage CO 2 emissions to reduce other, more burdensome taxes, and the value o f other environmental benefits from reduced energy use. Figure 1 mixes results for many different years, which accounts for some o f the diversity o f results. Costs o f reducing CO 2 emissions can also be expected to be lower if more time is allowed for the stated emission reduction to be achieved. A l l o w i n g time for capital stock t u r n o v e r and other adjustment processes to take place and for lower cost future technologies to b e c o m e available are the principal reasons for lower costs.
Results of top-down studies The differences in cost estimates that come from top-down models have been examined carefully in a study conducted b y S t a n f o r d ' s E n e r g y M o d e l i n g F o r u m (EMF, 1993). A group o f fourteen US economic models, e m p l o y i n g common assumptions for selected numerical inputs, were used to analyze a c o m m o n set o f emission reduction scenarios. The E M F study makes it possible to reconcile many o f the different results shown in Figure 1 for top-down studies.
Costs o f reducing greenhouse gas emissions in the USA and Canada. M daccard and W D Montgomery
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Figure 1
U S studies: cost o f C O 2 a b a t e m e n t relative to baseline projection a
aLabels are not attached to all points given danger of crowding. For key see Table 1.
The assumptions on which EMF standardized included GDP, population, the fossil fuel resource base, and the cost and timing of long-term supply options. For its reference case, EMF adopted the average of the IPCC high and low economic growth rate cases, and the population growth projections of Zacariah and Vu. Within the limitations imposed by differences among the models in their representation of technologies, the study attempted to adopt uniform assumptions regarding world oil prices, the oil and gas resource base, and the cost of new energy technologies. These included world oil prices beginning at US$24 per barrel in 1990 and rising at US$6.50 per decade until 2030, oil and gas resources at the optimistic 95th percentile estimates of Masters and Root, and coal based synthetic fuels at US$50 per barrel, carbon free liquid fuels at US$100 per barrel, and a carbon free electricity technology at 75 mills per kWh. The technologies are assumed available in 2010, but the models put limits on their rate of adoption. The following identity due to Kaya helps to explain why emissions differ.
Growth rate in emissions
growth rate in GDP; decline rate in energy use per unit of output; decline rate in emissions per unit of energy use.
EMF standardized assumptions about GDP growth, but the participating models differed with respect to the last two terms in the identity. The more emissions rise in the absence of mitigation measures (because of smaller declines in energy use per unit of output or emissions per unit of energy use), the higher baseline emissions and the cost of meeting any specific target will be. The size o f the tax
The policy measure assumed to be used to reduce emissions was a carbon tax. Each participating model estimated the carbon tax required to meet two objectives: a stabilization scenario in which emissions were held to 1990 levels after 2000 and a 20% reduction scenario in which emissions
892
Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
were held that much below 1990 levels after 2010. Estimates of carbon taxes required in 2010 were from US$20 to US$150 per ton for the stabilization case and from US$50 to US$330 per ton in the 20% reduction case. The price elasticity of energy demand and the speed with which the capital stock adjusts to higher energy prices are parameters, not standardized by EMF assumptions, that affect how large a tax is required. Those models that used higher price elasticities or assumed greater malleability of capital required lower taxes to reach the emission targets. All the models included improved technologies for fossil and non-fossil energy supplies, and improvements in energy efficiencies, in their reference. Even with these assumptions, they projected that intervention would be required to hold emissions at or below current levels. The size of the required tax increases with the stringency of the emission limit. The size of the tax doubles when the limit is tightened from stabilization to a 20% reduction below 1990 levels, and nearly doubles again for a 50% reduction. This suggests that the marginal cost of reducing emissions increases as the level of controls is tightened. GDP losses There is also a wide variation in GDP losses predicted by the models. Stabilizing emissions at their 1990 levels is estimated to reduce GDP by 0.2% to 0.7% in 2010, while costs of reducing emissions by 20% below 1990 levels in 2010 range from 0.9% to 1.7% of GDP. A more recent study by one of the authors (Montgomery et al, 1994) concludes that costs could range from 2.4% of GDP for the 'stabilization' scenario to over 4% of GDP for the 20% reduction scenario. This study incorporates near-term cyclical impacts, limits on how rapidly energy using capital stocks can turn over and investment effects that are not included in other models. GDP losses also increase with time, because increasing amounts of carbon must be removed from the energy system in order to hold emissions to a particular target. The average of all model results for the stabilization scenario rises from a 0.3% loss in 2000 to a 1.5% loss by 2050. In making these calculations, the modelers assumed a lump sum redistribution of tax revenues. That is, tax revenues are used to replace other tax payments by households and businesses, without affecting marginal tax rates or total tax revenues. The GDP losses calculated in this manner measure the cost of the distortions to the economy caused by the imposition of the carbon tax. The assumption of lump sum recycling avoids confusing the economic impacts of carbon taxes with costs or benefits attributable to potential uses of the revenues. GDP losses occur when carbon taxes lead to investments in price-induced conservation and fuel switching that are more expensive than those that would take place in the absence of the tax. It is the shift to more expensive sources of energy, and adoption of conservation measures that cost more than the value of energy saved, that result in the deadweight losses from carbon taxes.
Alternative emissions path
o
E
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Target emissions path
Time
Figure 2 Alternative time profiles of emissions
How timing of goals affects costs The EMF study and several more recent studies have addressed the issue of the timing of emission reductions. There are three reasons why deferring emission reduction may reduce costs. Large emission reductions in the near term will require accelerated replacement of the existing capital stock, the availability and cost of technologies for fuel switching and energy efficiency will improve over time, and a positive discount rate will favor deferred reductions. Manne and Richels (1991) first raised the question, by comparing two time profiles of emissions like those in Figure 2. They noted that the costs of adhering to the profile with higher emissions in the early years and lower emissions in the later years were about 25% lower than the costs of adhering to the profile of constant emissions at 1990 levels, even though cumulative emissions were identical. In their recent paper Manne and Richels find that the least cost time path of emissions that achieves the same concentrations of greenhouse gases in the atmosphere as a scenario of holding emissions to 20% below 1990 levels from 2005 on can reduce costs by over 50%. Since the same concentrations and therefore temperatures are reached with either path, the choice between them boils down to a matter of cost as long as eventual GHG concentrations and global temperatures are the predominant determinants of the impacts of climate change. There are three major reasons why delay in reducing emissions reduces cost. The first is that the alternative to investing in emission reductions is, in many cases, investment in productive capital. Therefore future costs should be discounted at a rate based on the investment that would be forgone because of current actions to reduce emissions, l
1As noted, the assumption is that the benefit side of the ledger is not effected by discounting because the benefit is identical and occurs at the same time under both cases - t h a t being the carbon concentration in say 50 years.
Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery The second reason that future costs will be lower than current costs is the turnover of the capital stock. It is considerably more costly to improve energy efficiency or change fuels with existing equipment than to make the same changes when equipment is being replaced at the end of its normal life. The third reason is that it takes time to develop technologies that make possible use of carbon free energy sources at reasonable cost. When these technologies - be they solar, biomass or nuclear - are available and can be incorporated in the infrastructure on a significant scale, considerably larger reductions in emissions than are feasible today can be achieved at considerably lower cost. The 'window of opportunity' for reducing costs implies a need for immediate and continuing action to develop new low carbon technologies and to begin shifting long lived investment decisions toward alternatives that produce lower carbon emissions. Absent these actions, the rapid future emission reductions included in the delayed emission reduction scenario may be more costly than more evenly paced, and earlier, reductions. Therefore policies to stimulate appropriate R&D and long lead time investments are supported by studies of the optimal timing of emission reduction. The issues o f how much should be invested in technology development, how large a cost should be incurred to alter long lead time investments, and what level of immediate emission reductions are justified all turn on how large the (discounted) costs of greenhouse gas emissions are judged to be. However, there are important additional considerations in choosing the optimal timing of emission reductions. First, in the absence of government policies to internalize greenhouse gas emission costs today, it can be difficult to stimulate the R&D that will lead to lower long-run costs of emission reduction, especially during a period when developed countries look increasingly to the private sector to fund R&D. Some analysts argue that implementation in the present of regulations or financial instruments can help to improve the profitability of private sector R&D, and that the possibility that such regulations or financial instruments might be implemented at some point in the distant future may not have the same effect. Second, it is argued that the delay approach overlooks the fact that there are decisions being made in the present that will imply much higher costs of adjustment in the future, regardless of advances in R&D. For example, it may be that a more concentrated urban form would be economic in the future once the costs of greenhouse gas emissions have been internalized. Opportunities to gradually adjust toward such an urban form can be lost during the period in which no internalization policies are implemented. Cost implications o f different poliey approaches Most mitigation cost studies have examined policies like carbon taxes, which use economic incentives to reduce emissions. Yet many of the policies that have been discussed in the USA and Canada for reducing emissions are regulatory policies, such as fuel economy and efficiency
893
Table 2 GNP loss, 1990-2010 (percentage of discounted constant price GNP) Goulder DRI LINK J/W
Lumpsum tax cuts Revenue raising Personal incometax cuts Corporate incometax cuts Payroll tax cuts (employeeonly) (employeronly) Investmenttax credit
-0.58 -0.40 -0.56 0.40
-0.46 -1.02 -0.53 -0.11
-0.58 0.19 1.55
-0.53 -0.25 1.67
-0.62 ~).24 -0.16 0.60
-0.24 ~3.16 -0. l 7 -0.18
Source: Shackletonet al (1993).
standards. Research in environmental economics has generally demonstrated that command and control regulations have higher costs when compared to economic incentives. Therefore it is necessary to examine the specific policies that might be adopted by real governments to achieve climate goals, and to avoid the fallacy of applying the cost estimates from studies that assume ideal policy instruments to goals that might in fact lead governments to adopt much more costly measures. Double dividends Economic impact studies have also examined the question of whether reductions in energy use motivated by climate concerns may provide other types of environmental or economic benefits. Environmental benefits could include reduced emissions of pollutants implicated in acid rain or urban air quality, or reduction of other environmental risks proportional to energy production or use. The most commonly cited form of other economic benefit is the use of revenues from carbon taxes to reduce other distorting taxes. The claim that climate policy could provide other economic benefits has been based on the idea of using carbon tax revenues to reduce other, burdensome taxes. This topic has been studied in several models. Early results suggested that the benefits from reducing other taxes might actually exceed the costs of carbon taxes. For example, Shackleton describes the results of experiments with four models to examine how different uses o f the funds raised by carbon taxes would affect GDP losses. In some models, the costs are more than offset with tax policies which encourage investment, while in others costs are reduced to some extent but not eliminated (see Table 2). When the claims that revenue recycling could produce net economic benefits from carbon taxes were subjected to careful theoretical analysis, the potential benefit largely vanished. Recent theoretical work shows that if carbon tax revenues are used to reduce general taxes, like personal or corporate income taxes, the best that can be achieved is a partial offset of some of the costs of carbon taxes. The reason that reductions in other taxes cannot offset the costs of carbon taxes is that carbon taxes are taxes on what are called 'intermediate goods' - goods that are produced in the economy and used to produce other goods. These taxes are shifted back to factors of production, like labor and capital. Therefore, carbon taxes cause distortions
894
Costs o f reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Table 3 Results, US emissions mitigation studies Study
Forecast year
Alliance to Save Energy et al (1991) National Academy of Sciences ( 1991)
2000 2010 2030 n/s
Office of Technology Assessment (1991)
2015
US EPA (1990) SEI/Greenpeace (1993) Carlsmith et al (1990)
2005 2010 2030 2010
Chandler and Kolar (1990)
2005
Chandler and Nicholls (1990)
2000
Chandler (1990)
2010
Lovins and Lovins (1991) Mills et al (1991) Nordhaus (1990) Rubin et al (1992) RIGES FFEF
n/s 2000 n/s n/s 2025 2030
both in energy markets, and in the markets for capital and labor. This means that the costs o f carbon taxes are necessarily larger than the cost o f taxes on capital and labor and cannot be fully offset by reducing capital and labor taxes. It is only if other highly distorting taxes besides those on capital and labor exist, or if taxes are not shifted to the factor of production subject to distorting taxes, that there is a theoretical possibility o f wiping out the costs o f carbon taxes through recycling (see Bovenberg and Goulder, 1993). Another difficulty with the recycling argument is the fact that virtually all tax economists already agree on the inefficiencies o f the current tax system, and that there are much less costly ways o f reforming the system than introducing carbon taxes. B y departing from this approach, the recycling argument confuses tax reform with use o f the tax system to achieve other goals. It is only possible to argue that carbon taxes are less distorting than other taxes if the monetary value o f climate benefits is brought into the comparison. In theory, there could also be an environmental benefit in areas other than climate change that might offset some of the costs o f emission reduction. In practice, these benefits have not been estimated in any o f the economic impact studies. In order to do so, it is necessary to examine the interaction o f climate policies with existing environmental regulations in the U S A and Canada. 2 Some o f these programs, such as caps on sulfur emissions, tailpipe emission standards for automobiles, and emission trading programs operate in ways that leave emissions o f conventional poilu2For example, with a cap on sulfur emissions implemented with a sulfur trading scheme, reductions in coal use at electric utilities will produce no reduction in total sulfur emissions. With emission standards for motor vehicles stated in grams per mile, reductions in carbon emissions that come about through increases in fuel economy will not have reduced other types of emissions.
CO 2 reduction (from base year) (%)
26 53 82 24 40 23 53 3 0 74 0 20 0 20 7 20 0 20 58 21 6 35 61 75
Cost Of reduction % of GNP
-0.4 -0.5 -0.6 0 0.8 -0.2 -0.2/1.8 0 0 0 0.5 0 0.5
Average cost (US$/tC)
0 9 0 0 0 0 82
0 -1.2 0 <0 <0
0 92 0 -231 13 0 -- <0 <0 <0
tants unchanged even if the underlying energy consumption is reduced significantly.
Bottom-up results in the USA and Canada Bottom-up research in the U S A and Canada has tended to suggest, as elsewhere in the world, that significant decreases in G H G emissions are possible without great cost to the economy. Most bottom-up research suggests that some range o f emission reductions can be achieved at negative cost. That is, that efforts to reduce emissions will provide economic efficiency and other environmental and social benefits even if climate benefits are excluded from the accounting. The bottom-up approach therefore argues that, at least for now, it is not necessary to address the thorny question of how to estimate the benefits o f reducing GHG emissions, because immediate commitments to emission reductions will provide economic benefits regardless o f the answer to this question. Most bottom-up studies have not attempted to explicitly model economic decisions or the feedbacks between energy consumption and the structure and performance o f the economy. The models are generally accounting frameworks that divide energy consumption into individual end uses, specifying equipment stocks and efficiencies, and then estimating the effects of changing stocks, efficiencies and fuel mix on total energy consumption. G H G emissions can be calculated from the fuel mix and equipment efficiencies. Table 3 summarizes results from some US bottom-up studies and Table 4 from some Canadian bottom-up studies. In both tables, CO 2 emissions have been the dominant focus and only this GHG is presented in these results. M a n y bottom-up studies do not specify a reference (business as usual) case for comparison with their CO 2 emission reduction scenarios. In the US sample o f studies in Table 3, the reference is therefore only to reduction relat-
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ive to the historical base year. In the Canadian sample of studies in Table 4, the CO 2 reduction is shown for some cases relative to both a reference case and a historical base year. While most top-down studies show the costs of GHG emission reduction in terms of US$/ton CO 2 or as a percentage of GDP, bottom-up studies frequently identify the amount of CO 2 reduction that appears to be 'cost effective'. This latter is stated usually as the economic potential for CO 2 reduction relative to the reference year (historical base year or business as usual forecast). Thus, the 'cost-effective' level of CO 2 reduction usually implies an average cost of US$0/ton CO 2 and a neutral effect on GDP. This explains both what is meant by economic potential in Table 4 and the large number of zeros in the columns signifying GDP cost and US$/ton cost of CO 2 reduction in Table 3. Among bottom-up analysis there has not as yet been an effort to establish common exogenous assumptions for a more controlled test of different models, as occurred with the work of the Energy Modeling Forum for top-down models. Thus, the analyses reported in Tables 3 and 4 may differ for a wide variety of reasons. In spite of these differing assumptions, the bottom-up studies reported in Tables 3 and 4 fall within a range that is significantly distant from the results of top-down studies. Several of the studies show that reductions from base year emissions of 20% or more can be achieved with GDP costs ranging f r o m - l . 2 % to +0.6% of GDE The remaining studies report either zero or unspecified negative costs. The percentage of CO 2 reductions estimated to be economically achievable are ranged as high as 75%, although the norm was much lower. Bottom-up studies for Canada reported similar results. Estimates of cost-effective CO 2 emission reduction potential by 2010, relative to a reference or baseline scenario, ranged from 20% to 40%. As noted, the cause of divergence between different bottom-up studies relates in part to the fact that each study is based on different assumptions about: (1) (2) (3) (4)
the overall rate of economic growth; structural change in the economy; energy prices; and business as usual (baseline) conditions
These are the standard exogenous assumptions required by all energy models and energy analysis. However, in addition to these uncertainties, bottom-up models also have their own specific sources of uncertainty that can also contribute to significant differences between model estimates. The first key area of concern relates to the assumptions about the fuel splits and efficiency levels of currently installed energy using technologies. This information is critical because if the efficiencies and fuel splits are incorrectly estimated, the CO 2 emission reduction potential for a future period will be over or understated. In this area, the USA and Canada are probably better placed than most countries because for the last ten years energy utilities have gained
considerable knowledge of current equipment stocks through end use surveys that were required for the evaluation of demand-side management potential. Nonetheless, there is still great uncertainty, especially in the industrial sector with its heterogeneous equipment stocks. The second key area of uncertainty is in characterizing the dynamics of equipment stock turnover. Most bottom-up analysis skirts this issue with a simplistic approach in which it is assumed that the most efficient (or least CO zintensive) technologies will achieve 100% market penetration by the end of the study period. Because some of these technologies appear cost-effective, when evaluated on an engineering/economic basis, the resulting calculation explains the tendency for bottom-up models to suggest that there are economic gains up to a certain level of CO 2 emission reduction. However, to the extent that more recent bottom-up analysis attempts to portray consumer behavior more realistically this can lead to substantially different results with respect to the estimation of CO 2 emission reduction costs. Several factors could be relevant, including: (1) the differences in consumer surplus associated with more and less efficient equipment (eg different types of lightb'ulbs); (2) the differences in risk associated with more and less equipment (eg efficient technologies, being newer in general, tend to be riskier); and (3) differences in the transaction costs associated with more and less efficient equipment (eg efficient technologies, being newer in general, tend to have higher costs of information, acquisition, installation and maintenance). In other words the issue of the costs and success level of CO 2 emission reduction policies has generally not been integrated into bottom-up studies, which would tend to suggest that this approach has understated the full costs of CO 2 emission reductions. By how much is very difficult to determine, Nonetheless, the issue of technological representation may be key in explaining the divergence of top-down and bottom-up cost estimates. Critical parameters in top-down models are the effect of autonomous technological evolution on energy efficiency and the elasticity of substitution between energy and other aggregate inputs to the economy, notably capital, labor and materials. Mainstream economic research since the 1970s has tried to estimate long-run values for these parameters. There is a concern that the aggregate historical data used in estimating these values may fail to portray what these values would be in some future period in which price expectations, government policy and overall R&D is much more focused on reducing GHG emissions. In such an environment, the values of such parameters could be very much different, with much lower costs of GHG emission reduction. Bottom-up analysis can at least anticipate this potential by examining the extent to which newly emerging technologies do change the values for autonomous technological change and for interfactor elasticity of substitution.
Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Conclusions and policy implications The top-down or market based approach uses standard economic models, extended to deal with energy supply and demand with sufficient detail to estimate CO 2 emissions. These models consistently conclude that measures to reduce carbon emissions below forecasted levels will have net economic costs. The bottom-up or technology based models have little or no representation of the general economy, but considerable detail on the stock of energy using equipment and on the technologies of energy use. They compare current or projected choices of equipment and technology with available alternatives and conclude that adoption of different technologies can reduce carbon emissions and reduce the lifecycle cost of energy use. The difference between the amount of energy actually consumed and the amount that would be consumed if all apparently cost-effective options for reducing energy use were adopted has been labeled the 'efficiency gap'. Consumers operating in free markets make choices that imply that they are neglecting opportunities to save money and save energy. The differences between these models arise in large part from differences in how market behavior is characterized. In the technology based models, future energy savings are assumed to be inadequately valued compared to initial capital costs for energy efficiency. In many cases this assumption is embodied in a high implicit discount rate or short payback period, and when costs are evaluated at a lower 'correct' discount rate, it appears that consumers are neglecting desirable opporttmities to invest in energy conservation. In market based models, consumers are assumed to make choices that are in their economic interest - that is, consumers use whatever the correct discount rate is for their individual circumstances. Thus, if a new technology for conserving energy becomes available, and can reduce correctly discounted lifecycle cost, it will be adopted in the baseline. Only those technologies whose higher initial costs are not justified by the present value of future savings at the correct discount rate will not be adopted. Basic economic principles suggest two explanations for the efficiency paradox. The first is that there are hidden costs of adopting the technologies that are claimed by the technology based studies to be cost-effective. These costs could be due to risks in new products and processes, changes in attributes that matter to users but are not represented in simple engineering calculations, or costs of fitting the new technology into existing practices. 3 If these hidden costs explain the efficiency paradox, the technology based studies are wrong about the possibility of reducing emissions at zero cost. The other explanation is that there are imperfections in energy markets, such as regulations that prevent the consumer from facing prices that reflect the true cost of energy,
897
so-called 'agency problems' in which decisions about energy use are divorced from responsibility for paying and costs of obtaining information. If these imperfections exist, if they consistently work in the direction of encouraging excessive energy use, and if policies to reduce the imperfections at a cost less than the net economic benefits of more efficient energy use can be designed, then some reductions in energy use could be achieved at no net cost. Indeed, achieving those reductions would be desirable even if there were no issue of climate change. The theoretical issues are reasonably well understood, but there has not been enough empirical work on either hidden costs or on market imperfections to decide which view of the conservation paradox is more correct. This means that, even if a general agreement that cost-effective policies to reduce market imperfections can be safely introduced into a climate strategy, it is impossible to determine accurately how far those policies would go toward satisfying any particular target for emission reductions and how much they would actually cost. Where top-down and bottom-up approaches do appear to agree is that it is sound policy to adopt truly low cost mitigation measures, and to do so by designing policies that address specific market imperfections. It may be difficult or impossible to provide definitive estimates of the reduction in GHG emissions attributable to these measures. Recent theoretical research, which has applied basic principles of public finance to the estimation of 'double dividend' benefits, suggests that it is not possible to fully offset the costs of significant emission reductions through reduction of ordinary taxes on capital and labor income. There is nearly universal agreement on the inefficiencies of the current US and Canadian tax systems, but the normal practice in public finance is to analyze the cost of each alternative tax separately. Thus a carbon tax would be compared with both the current burdensome system and with broad based consumption taxes like the value added tax. In this kind of comparison, broad based taxes always dominate carbon taxes as sources of revenue for tax reform. By departing from this approach, the recycling argument confuses tax reform with use of the tax system to achieve other goals. There have been no comprehensive studies to quantify the reduction in other emissions that would result from measures to reduce CO 2 emissions. Choice of appropriate timing for the reduction of emissions can reduce costs dramatically, and can make it possible to achieve much more ambitious goals for the levels which CO 2 concentrations, and ultimate global temperatures, would reach. Delaying emission reductions, while investing in the interim in climate science and in the development of new, carbon free energy technologies, can reduce costs of achieving goals specified in terms of concentrations by more than half.
Acknowledgments 3See the articles in the Energy Policy symposium, edited by Huntington and Schipper; and Montgomeryet al (1993).
The authors would like to thank their co-authors of Chapters 8 and 9 of the report of IPCC Working Group III, in
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particular Richard Richels who prepared the survey of topdown model results. This paper deals with just one of the topics covered in those chapters, by reviewing the results of studies of mitigation costs in the USA and Canada. It goes beyond what has been included in the IPCC chapters by developing the authors' own assessment and critique of that literature. The views and conclusions expressed in this paper are solely the responsibility of the authors, and do not necessarily reflect the views of their employers or of other contributors to this special issue. This paper is based on the authors' contributions to Chapters 8 and 9 of Bruce et al (1996).
References Alliance to Save Energy (ASE) American Council for an Energy-Efficient Economy, Natural Resources Defense Council, Union of Concerned Scientists (1991) America's Energy Choices: Investing in a Strong Economy and a Clean Environment Cambridge, MA Barnes, D W, Edmonds, J A and Reilly, J M (1992) The Use of the Edmonds-Reilly Models to Model Energy Related Greenhouse Gas Emissions Working Paper No 113, OECD, Paris Bovenberg, A L and Goulder, L H (1993) Integrating Environmental and Distortionary Taxes: General Equilibrium Analyses Working Paper, Stanford University Bruce, J P, Lee, H and Haites, E S (eds) (1996) Climate Change 1995, Economic and Social Dimensions of Climate Change Vol 3 of the IPCC Second Assessment Report, Cambridge University Press, Cambrige Burniaux, J M, Nicoletti, G and Martins, J O (1992) GREEN." A Global Model Jor Quantifying the Costs o f Policies to Curb CO 2 Emissions OECD, Paris Charles River Associates (CRA) (1991) Policy Alternatives Jbr Reducing Petroleum Use and Greenhouse Gas Emissions CRA, Boston Cline, W R (1992) The Economics of Global Warming Institute for International Economics, Washington, DC Edmonds, J A and Barnes, D W (1992) 'Factors affecting the long-term cost of global fossil fuel CO 2 emissions reductions' International Journal of Global Energy Issues 4 (3) 140-166 Edmonds, J A and Reilly, J (1983) 'A global energy economic model of carbon dioxide release' Energy Economics 5 (2) Edmonds, J A, Barnes, D W and Ton, M (1993) Carbon Coalitions: The Cost and Effectiveness o f Energy Agreements to Alter Trajectories of Atmospheric Carbon Dioxide Emissions Pacific Northwest Laboratories Edmonds, J A, Pitcher, H, Rosenberg, N and Wigley, T (1994) Design for the Global Change Assessment Model Proceedings of the International Workshop in Integrative Assessment of Mitigation, Impacts, and Adaptation to Climate Change, International Institute for Applied Systems Analysis, Laxenburg, Austria, 13-I 5 October Energy Modeling Forum (1993) EMF 12 Report, Stanford University, Stanford, CA Goulder, L H (1994) 'Energy taxes: traditional efficiency effects and environmental implications' in Poterba, J M (ed) (1994) Tax Policy and the Economy 8 MIT Press, Cambridge, MA Hazilla, M and Kopp, R (1986) The Social Cost of Environmental Quality Regulations: A General Equilibrium Analysis Resources for the Future, Washington, DC
IPCC (Intergovernmental Panel on Climate Change) (1992) Climate Change 1992: The Supplementary Report to the 1PCC Scientific Assessment, World Meteorological Organization, United Nations Environment Programme, Cambridge University Press Jorgenson, D W and Wilcoxen, P J (1993) Reducing US Carbon Dioxide Emissions: The Cost of DifJerent Goals Harvard University Kolstad, C D (1993) 'Looking vs leaping: the timing of CO 2 control in the face of uncertainty and learning' in Kaya, Y, Nakicenovic, N, Nordhaus, W D and Toth, R L (eds) Costs, Impacts, andBenefits of COe Mitigation IIASA, Laxenburg, Austria Koomey, J e t al (1991) The PotentialJor Electricity EJficiency Improvements in the US Residential Sector Lawrence Berkeley Laboratory Report, LBL-30477, Berkeley, CA Manne, A S (1995) Global Carbon Dioxide Reductions: Domestic and International Consequences American Council for Capital Formation, Center for Policy Research, Washington, DC Manne, A S and Martins, J O (1994) Comparisons of'Model Structure and Policy Scenarios: GREEN and 12RT OECD Model Comparison Project (II) on the Costs of Cutting Carbon Emissions, Economics Department Working Paper No 146, Paris Manne, A S and Richels, R G (1991) 'Reducing US CO 2 emissions: the value of flexibility in timing' IPIECA, Global Climate Change: A Petroleum Industry Perspective Manne, A S, and Richels, R G (1992) Buying Greenhouse Gas Insurance: The Economic Costs of CO2 Emission Limits MIT Press, Cambridge, MA Manne, A S, and Rutherford, T F (1994) 'International trade in oil, gas and carbon emission rights: an intertemporal general equilibrium model' The Energy Journal 15 (1) 57-74 Manne, A S, Mendelsohn, R and Richels, R G (1993) MERGE: A Model for Evaluating Regional and Global Effbcts of Greenhouse Gas Reduction Policies Mimeo, Electric Power Research Institute, Palo Alto, CA Montgomery, W D, Hughes, W and Yanchar, J (1994) Economic Impacts of Carbon Taxes Electric Power Research Institute, Palo Alto, CA Montgomery, W D, Johnson, K and Fauth, G (1993) No Free Lunch: A Review of Technology-Based Studies on Costs of Controlling Carbon Emissions CRA/DRI Moulton, R, and Richards, K (1990) Costs o f Sequestering Carbon Through Tree Planting and Forest Management in the United States US Department of Agriculture, Washington, DC Nordhaus, W D (1994) Managing the Global Commons: The Economics of Climate Change MIT Press, Cambridge, MA Office of Technology Assessment (OTA) (1991) Changing by Degrees: Steps to Reduce Greenhouse Gases: Summary US Government Printing Office, Washington, DC Oliviera-Martins, J, Burniaux, J M and Martin, J P (1992) Trade and the Effectiveness of Unilateral CO 2 Abatement Policies: Evidence fi'om GREEN Economic Studies, No 19, OECD, Paris Peek, S C and Teisberg, T J (1993) 'Global warming uncertainties and the value of information: an analysis using CETA' Resource and Energy Economics 15 (1) 71-97 Richels, R and Edmonds, J (1993) The Economics of Stabilizing Atmospheric COe Concentrations Proceedings of the Tsukuba Workshop of IPCC WG Ill Robinson, J, Fraser, M, Haites, E, Harvey, D, Jaccard, M, Reinsch, A and Torrie, R (1993) Canadian Options for Greenhouse Gas Emission Reduction Royal Society of Canada Schelling, T C (1992) 'Some economics of global warming' American Economic Review 82 1-14
ELSEVIER
PII:S0301-4215(96)00084-5
Costs of reducing greenhouse gas emissions in the USA and Canada M a r k Jaccard Simon Fraser University
W David M o n t g o m e r y Charles River Associates, Suite 750 North, 1001 Pennsylvania Avenue, NW, Washington, DC 20004-2505, USA A number of possible policy responses can be adopted in order to address the prospect of increasing greenhouse gases in the earth's atmosphere. These include mitigation measures, that reduce greenhouse gas emissions or enhance the processes that remove greenhouse gases from the atmosphere, adaptation measures that reduce the consequences or damages from climate change, and information measures, including scientific research on climate processes and research and development on new energy technologies. Climate research can reduce current uncertainties about the consequences of greenhouse gas emissions and new energy technologies can reduce the costs of mitigation measures. All of these measures have a role in a balanced approach to climate policy. Copyright © 1996 Elsevier Science Ltd. Keywords: G r e e n h o u s e gas reduction; Climate research; Mitigation measures
This paper reviews existing studies on the economic costs o f mitigating greenhouse gas emissions in the USA and Canada. Since costs are strongly influenced by the availability of new energy technologies and the timing of emission reduction, information measures play an important role in at least some of those studies. This paper begins with an overview of the results from recent mitigation cost studies and of the issues that arise in interpreting those results. The next two sections review the results of two very different approaches to analyzing costs in more detail. The paper concludes with an evaluation of the results from different approaches and their implications for policy and research. According to the convention adopted by the Intergovernmental Panel on Climate Change, the term 'costs' should be interpreted as a cost net of any beneficial effects of measures other than the benefits of reducing or delaying climate change. The benefits of addressing climate change are discussed separately from costs under these definitions.
striking aspect of the table is that some studies have concluded that substantial emission reductions can be achieved at nearly zero or negative cost, while others reach the conclusion, that efforts to reduce CO 2 emissions will be costly, and that the costs will rise as greater reductions are undertaken. Key issues The first and second articles in this issue (Hourcade and Robinson, and Richels and Sturm) summarize the key methodological and empirical issues in estimating mitigation costs. These include, among other things, different assumptions about: (1) underlying social-economic trends; (2) underlying economic growth rates; (3) the GHG intensity of future autonomous technological evolution; (4) the ability for firms and households to substitute away from GHG-intensive goods and services; and (5) how GHG taxes will be recycled and the resulting effects.
Cost estimation: the methodological issues
Bottom-up and top-down models
In recent years there have been numerous studies of the costs of reducing CO 2 emissions in the USA and Canada. Table 1 depicts typical results from a number of these studies. The
As noted in the preceding articles in this special issue, a critical distinction is made between top-down and bottom889
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Costs o f reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Table 1 US CO 2 abatement cost modeling studies Author (year)
Key a
CO 2 reduction from baseline (%)
GNP impact/cost (reduction) from baseline (%)
Barnes et al (1992) Barnes et al (1992) Barnes et al (1992) DRI (1992) CBO-PCAEO,DRI (1990) CBO-DGEM (1990) CBO-IEA-ORAU (1990) Edmonds and Barnes (1991) Goulder (1991) Jackson (1991) Jorgenson and Wilcoxen (1990a) Jorgenson and Wilcoxen (1990a) Jorgenson and Wilcoxen (1990b) Manne and Richels (1990a) Manne and Richels (1990a) Manne (1992) Manne (1992) Manne (1992) Mills et al (1991) NAS (1991) Oliveira-Martins, Nicoletti et al (1992) Oliveira-Martins, Nicoletti et al (1992) OTA (1991) Rutherford (1992) Rutherford (1992) Rutherford (1992) Shackleton et al (1993)
BG (2020) 26, 45, 60 0.6, 2.0, 3.2 BG (2050) 45, 70, 84 1.9, 4.9, 7.5 BG (2095) 67, 88, 96 4.3, 8, 10.9 B (2020) 37 1.8 CBI, CB2, (2000) 8, 16 1.9, 2 CB3 (2000) 36 0.6 CBG (2100) 11, 36, 50, 75 1.1,2.2, 0.9, 3.0b EB (2020), EB (2100) 35, 59 1.3, 2.3 G (2050) 13, 18, 27 1.0, 2.2, 4.5 J (2005) 34, 40, 46 -0.2, -0. I, 0.1 JW (2060) 20, 36 0.5, 1.1 JW (2100) 10, 20, 30 0.2, 0.5, 1.1 JW (2020) 8, 14, 32 0.3, 0.5, 1.6 MR (2020) 45 2.2 MR (2100) 50, 77, 88 0.8, 2.5, 4.0c MRG (2020) 26, 45, 60 0.8, 2.2, 4.2 MRG (2050) 45, 70, 84 1.4, 2.7, 3.3 MRG (2100) 67, 88, 96 2.3, 3.1,3.4 M (2010) 21 -1.2 d N 24, 40 0, 0.8 OMG (2020) 26, 45, 60 0.2, 1.1,2.4 OMG (2050) 45, 75, 84 0.4, 1.3, 2.4 O (2015) 23, 53, 53 -0.2%-0.2% 1.8 RG (2050) 26, 45, 60 0.5, 1.3, 2.5 RG (2050) 84, 45, 70 2.4, 1.2, 2.5 RG (2100) 67, 88, 96 1.8, 2.6, 2.8 SJW (2010), 22, 2 -0.6, 0.1 SLINK (2010) Shackleton et al (1993) SDRI (2010), 5, 28 -0.4, 0.2 SG (2O10) US Energy Choices (199 l) USEC (2030) 67.5 -0.6 alf the model used is a global model, the key includes the letter 'G' before the date. bThe first two results use multilateral taxes, others use unilateral taxes; taxes are flat only in the first and third estimates, cValues represent different assumptions in technological developments; an optimistic, an intermediate, and a pessimistic view. dArising from eleven specified regulatory changes, estimated from claimed savings of US$85 billion per year. eThe benefit shown in the OTA cost estimates is only an indicative value, no explicit modeling value has been calculated.
up models. This distinction is important for explaining the divergences in US and Canadian estimates o f the costs o f G H G emission reduction. Top-down studies have g e n e r a l l y been based on more aggregate e c o n o m i c analysis which places energy supply and d e m a n d in the context o f a m o d e l o f the entire economy. These studies have generally concluded that emission reductions are costly. Bottom-up studies have been based on engineering studies o f specific energy efficiency or renewable energy technologies and have concluded that emission r e d u c t i o n s a c h i e v a b l e with those t e c h n o l o g i e s are either nearly free or have negative costs. The two sides o f this debate are far from agreement. Topdown modelers argue that the conclusions o f the bottom-up modelers can only be correct i f there are imperfections in energy markets that can be corrected through sufficiently non-burdensome policy interventions. They also point out conceptual and methodological disagreements with the way in which bottom-up studies estimate economic costs. Modelers in the technology based school accuse economic models o f assuming away market imperfections and ignoring the results o f engineering studies o f specific technologies. Other issues
Two other fundamental issues account for some o f the differences in conclusions about costs.
Some studies have found low or negative cost is their inclusion o f so-called 'double dividends' o f CO 2 emission reductions. These double dividends could come in two main forms: the use o f revenues from taxes designed to discourage CO 2 emissions to reduce other, more burdensome taxes, and the value o f other environmental benefits from reduced energy use. Figure 1 mixes results for many different years, which accounts for some o f the diversity o f results. Costs o f reducing CO 2 emissions can also be expected to be lower if more time is allowed for the stated emission reduction to be achieved. A l l o w i n g time for capital stock t u r n o v e r and other adjustment processes to take place and for lower cost future technologies to b e c o m e available are the principal reasons for lower costs.
Results of top-down studies The differences in cost estimates that come from top-down models have been examined carefully in a study conducted b y S t a n f o r d ' s E n e r g y M o d e l i n g F o r u m (EMF, 1993). A group o f fourteen US economic models, e m p l o y i n g common assumptions for selected numerical inputs, were used to analyze a c o m m o n set o f emission reduction scenarios. The E M F study makes it possible to reconcile many o f the different results shown in Figure 1 for top-down studies.
Costs o f reducing greenhouse gas emissions in the USA and Canada. M daccard and W D Montgomery
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Figure 1
U S studies: cost o f C O 2 a b a t e m e n t relative to baseline projection a
aLabels are not attached to all points given danger of crowding. For key see Table 1.
The assumptions on which EMF standardized included GDP, population, the fossil fuel resource base, and the cost and timing of long-term supply options. For its reference case, EMF adopted the average of the IPCC high and low economic growth rate cases, and the population growth projections of Zacariah and Vu. Within the limitations imposed by differences among the models in their representation of technologies, the study attempted to adopt uniform assumptions regarding world oil prices, the oil and gas resource base, and the cost of new energy technologies. These included world oil prices beginning at US$24 per barrel in 1990 and rising at US$6.50 per decade until 2030, oil and gas resources at the optimistic 95th percentile estimates of Masters and Root, and coal based synthetic fuels at US$50 per barrel, carbon free liquid fuels at US$100 per barrel, and a carbon free electricity technology at 75 mills per kWh. The technologies are assumed available in 2010, but the models put limits on their rate of adoption. The following identity due to Kaya helps to explain why emissions differ.
Growth rate in emissions
growth rate in GDP; decline rate in energy use per unit of output; decline rate in emissions per unit of energy use.
EMF standardized assumptions about GDP growth, but the participating models differed with respect to the last two terms in the identity. The more emissions rise in the absence of mitigation measures (because of smaller declines in energy use per unit of output or emissions per unit of energy use), the higher baseline emissions and the cost of meeting any specific target will be. The size o f the tax
The policy measure assumed to be used to reduce emissions was a carbon tax. Each participating model estimated the carbon tax required to meet two objectives: a stabilization scenario in which emissions were held to 1990 levels after 2000 and a 20% reduction scenario in which emissions
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Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
were held that much below 1990 levels after 2010. Estimates of carbon taxes required in 2010 were from US$20 to US$150 per ton for the stabilization case and from US$50 to US$330 per ton in the 20% reduction case. The price elasticity of energy demand and the speed with which the capital stock adjusts to higher energy prices are parameters, not standardized by EMF assumptions, that affect how large a tax is required. Those models that used higher price elasticities or assumed greater malleability of capital required lower taxes to reach the emission targets. All the models included improved technologies for fossil and non-fossil energy supplies, and improvements in energy efficiencies, in their reference. Even with these assumptions, they projected that intervention would be required to hold emissions at or below current levels. The size of the required tax increases with the stringency of the emission limit. The size of the tax doubles when the limit is tightened from stabilization to a 20% reduction below 1990 levels, and nearly doubles again for a 50% reduction. This suggests that the marginal cost of reducing emissions increases as the level of controls is tightened. GDP losses There is also a wide variation in GDP losses predicted by the models. Stabilizing emissions at their 1990 levels is estimated to reduce GDP by 0.2% to 0.7% in 2010, while costs of reducing emissions by 20% below 1990 levels in 2010 range from 0.9% to 1.7% of GDP. A more recent study by one of the authors (Montgomery et al, 1994) concludes that costs could range from 2.4% of GDP for the 'stabilization' scenario to over 4% of GDP for the 20% reduction scenario. This study incorporates near-term cyclical impacts, limits on how rapidly energy using capital stocks can turn over and investment effects that are not included in other models. GDP losses also increase with time, because increasing amounts of carbon must be removed from the energy system in order to hold emissions to a particular target. The average of all model results for the stabilization scenario rises from a 0.3% loss in 2000 to a 1.5% loss by 2050. In making these calculations, the modelers assumed a lump sum redistribution of tax revenues. That is, tax revenues are used to replace other tax payments by households and businesses, without affecting marginal tax rates or total tax revenues. The GDP losses calculated in this manner measure the cost of the distortions to the economy caused by the imposition of the carbon tax. The assumption of lump sum recycling avoids confusing the economic impacts of carbon taxes with costs or benefits attributable to potential uses of the revenues. GDP losses occur when carbon taxes lead to investments in price-induced conservation and fuel switching that are more expensive than those that would take place in the absence of the tax. It is the shift to more expensive sources of energy, and adoption of conservation measures that cost more than the value of energy saved, that result in the deadweight losses from carbon taxes.
Alternative emissions path
o
E
LU
Target emissions path
Time
Figure 2 Alternative time profiles of emissions
How timing of goals affects costs The EMF study and several more recent studies have addressed the issue of the timing of emission reductions. There are three reasons why deferring emission reduction may reduce costs. Large emission reductions in the near term will require accelerated replacement of the existing capital stock, the availability and cost of technologies for fuel switching and energy efficiency will improve over time, and a positive discount rate will favor deferred reductions. Manne and Richels (1991) first raised the question, by comparing two time profiles of emissions like those in Figure 2. They noted that the costs of adhering to the profile with higher emissions in the early years and lower emissions in the later years were about 25% lower than the costs of adhering to the profile of constant emissions at 1990 levels, even though cumulative emissions were identical. In their recent paper Manne and Richels find that the least cost time path of emissions that achieves the same concentrations of greenhouse gases in the atmosphere as a scenario of holding emissions to 20% below 1990 levels from 2005 on can reduce costs by over 50%. Since the same concentrations and therefore temperatures are reached with either path, the choice between them boils down to a matter of cost as long as eventual GHG concentrations and global temperatures are the predominant determinants of the impacts of climate change. There are three major reasons why delay in reducing emissions reduces cost. The first is that the alternative to investing in emission reductions is, in many cases, investment in productive capital. Therefore future costs should be discounted at a rate based on the investment that would be forgone because of current actions to reduce emissions, l
1As noted, the assumption is that the benefit side of the ledger is not effected by discounting because the benefit is identical and occurs at the same time under both cases - t h a t being the carbon concentration in say 50 years.
Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery The second reason that future costs will be lower than current costs is the turnover of the capital stock. It is considerably more costly to improve energy efficiency or change fuels with existing equipment than to make the same changes when equipment is being replaced at the end of its normal life. The third reason is that it takes time to develop technologies that make possible use of carbon free energy sources at reasonable cost. When these technologies - be they solar, biomass or nuclear - are available and can be incorporated in the infrastructure on a significant scale, considerably larger reductions in emissions than are feasible today can be achieved at considerably lower cost. The 'window of opportunity' for reducing costs implies a need for immediate and continuing action to develop new low carbon technologies and to begin shifting long lived investment decisions toward alternatives that produce lower carbon emissions. Absent these actions, the rapid future emission reductions included in the delayed emission reduction scenario may be more costly than more evenly paced, and earlier, reductions. Therefore policies to stimulate appropriate R&D and long lead time investments are supported by studies of the optimal timing of emission reduction. The issues o f how much should be invested in technology development, how large a cost should be incurred to alter long lead time investments, and what level of immediate emission reductions are justified all turn on how large the (discounted) costs of greenhouse gas emissions are judged to be. However, there are important additional considerations in choosing the optimal timing of emission reductions. First, in the absence of government policies to internalize greenhouse gas emission costs today, it can be difficult to stimulate the R&D that will lead to lower long-run costs of emission reduction, especially during a period when developed countries look increasingly to the private sector to fund R&D. Some analysts argue that implementation in the present of regulations or financial instruments can help to improve the profitability of private sector R&D, and that the possibility that such regulations or financial instruments might be implemented at some point in the distant future may not have the same effect. Second, it is argued that the delay approach overlooks the fact that there are decisions being made in the present that will imply much higher costs of adjustment in the future, regardless of advances in R&D. For example, it may be that a more concentrated urban form would be economic in the future once the costs of greenhouse gas emissions have been internalized. Opportunities to gradually adjust toward such an urban form can be lost during the period in which no internalization policies are implemented. Cost implications o f different poliey approaches Most mitigation cost studies have examined policies like carbon taxes, which use economic incentives to reduce emissions. Yet many of the policies that have been discussed in the USA and Canada for reducing emissions are regulatory policies, such as fuel economy and efficiency
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Table 2 GNP loss, 1990-2010 (percentage of discounted constant price GNP) Goulder DRI LINK J/W
Lumpsum tax cuts Revenue raising Personal incometax cuts Corporate incometax cuts Payroll tax cuts (employeeonly) (employeronly) Investmenttax credit
-0.58 -0.40 -0.56 0.40
-0.46 -1.02 -0.53 -0.11
-0.58 0.19 1.55
-0.53 -0.25 1.67
-0.62 ~).24 -0.16 0.60
-0.24 ~3.16 -0. l 7 -0.18
Source: Shackletonet al (1993).
standards. Research in environmental economics has generally demonstrated that command and control regulations have higher costs when compared to economic incentives. Therefore it is necessary to examine the specific policies that might be adopted by real governments to achieve climate goals, and to avoid the fallacy of applying the cost estimates from studies that assume ideal policy instruments to goals that might in fact lead governments to adopt much more costly measures. Double dividends Economic impact studies have also examined the question of whether reductions in energy use motivated by climate concerns may provide other types of environmental or economic benefits. Environmental benefits could include reduced emissions of pollutants implicated in acid rain or urban air quality, or reduction of other environmental risks proportional to energy production or use. The most commonly cited form of other economic benefit is the use of revenues from carbon taxes to reduce other distorting taxes. The claim that climate policy could provide other economic benefits has been based on the idea of using carbon tax revenues to reduce other, burdensome taxes. This topic has been studied in several models. Early results suggested that the benefits from reducing other taxes might actually exceed the costs of carbon taxes. For example, Shackleton describes the results of experiments with four models to examine how different uses o f the funds raised by carbon taxes would affect GDP losses. In some models, the costs are more than offset with tax policies which encourage investment, while in others costs are reduced to some extent but not eliminated (see Table 2). When the claims that revenue recycling could produce net economic benefits from carbon taxes were subjected to careful theoretical analysis, the potential benefit largely vanished. Recent theoretical work shows that if carbon tax revenues are used to reduce general taxes, like personal or corporate income taxes, the best that can be achieved is a partial offset of some of the costs of carbon taxes. The reason that reductions in other taxes cannot offset the costs of carbon taxes is that carbon taxes are taxes on what are called 'intermediate goods' - goods that are produced in the economy and used to produce other goods. These taxes are shifted back to factors of production, like labor and capital. Therefore, carbon taxes cause distortions
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Costs o f reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Table 3 Results, US emissions mitigation studies Study
Forecast year
Alliance to Save Energy et al (1991) National Academy of Sciences ( 1991)
2000 2010 2030 n/s
Office of Technology Assessment (1991)
2015
US EPA (1990) SEI/Greenpeace (1993) Carlsmith et al (1990)
2005 2010 2030 2010
Chandler and Kolar (1990)
2005
Chandler and Nicholls (1990)
2000
Chandler (1990)
2010
Lovins and Lovins (1991) Mills et al (1991) Nordhaus (1990) Rubin et al (1992) RIGES FFEF
n/s 2000 n/s n/s 2025 2030
both in energy markets, and in the markets for capital and labor. This means that the costs o f carbon taxes are necessarily larger than the cost o f taxes on capital and labor and cannot be fully offset by reducing capital and labor taxes. It is only if other highly distorting taxes besides those on capital and labor exist, or if taxes are not shifted to the factor of production subject to distorting taxes, that there is a theoretical possibility o f wiping out the costs o f carbon taxes through recycling (see Bovenberg and Goulder, 1993). Another difficulty with the recycling argument is the fact that virtually all tax economists already agree on the inefficiencies o f the current tax system, and that there are much less costly ways o f reforming the system than introducing carbon taxes. B y departing from this approach, the recycling argument confuses tax reform with use o f the tax system to achieve other goals. It is only possible to argue that carbon taxes are less distorting than other taxes if the monetary value o f climate benefits is brought into the comparison. In theory, there could also be an environmental benefit in areas other than climate change that might offset some of the costs o f emission reduction. In practice, these benefits have not been estimated in any o f the economic impact studies. In order to do so, it is necessary to examine the interaction o f climate policies with existing environmental regulations in the U S A and Canada. 2 Some o f these programs, such as caps on sulfur emissions, tailpipe emission standards for automobiles, and emission trading programs operate in ways that leave emissions o f conventional poilu2For example, with a cap on sulfur emissions implemented with a sulfur trading scheme, reductions in coal use at electric utilities will produce no reduction in total sulfur emissions. With emission standards for motor vehicles stated in grams per mile, reductions in carbon emissions that come about through increases in fuel economy will not have reduced other types of emissions.
CO 2 reduction (from base year) (%)
26 53 82 24 40 23 53 3 0 74 0 20 0 20 7 20 0 20 58 21 6 35 61 75
Cost Of reduction % of GNP
-0.4 -0.5 -0.6 0 0.8 -0.2 -0.2/1.8 0 0 0 0.5 0 0.5
Average cost (US$/tC)
0 9 0 0 0 0 82
0 -1.2 0 <0 <0
0 92 0 -231 13 0 -- <0 <0 <0
tants unchanged even if the underlying energy consumption is reduced significantly.
Bottom-up results in the USA and Canada Bottom-up research in the U S A and Canada has tended to suggest, as elsewhere in the world, that significant decreases in G H G emissions are possible without great cost to the economy. Most bottom-up research suggests that some range o f emission reductions can be achieved at negative cost. That is, that efforts to reduce emissions will provide economic efficiency and other environmental and social benefits even if climate benefits are excluded from the accounting. The bottom-up approach therefore argues that, at least for now, it is not necessary to address the thorny question of how to estimate the benefits o f reducing GHG emissions, because immediate commitments to emission reductions will provide economic benefits regardless o f the answer to this question. Most bottom-up studies have not attempted to explicitly model economic decisions or the feedbacks between energy consumption and the structure and performance o f the economy. The models are generally accounting frameworks that divide energy consumption into individual end uses, specifying equipment stocks and efficiencies, and then estimating the effects of changing stocks, efficiencies and fuel mix on total energy consumption. G H G emissions can be calculated from the fuel mix and equipment efficiencies. Table 3 summarizes results from some US bottom-up studies and Table 4 from some Canadian bottom-up studies. In both tables, CO 2 emissions have been the dominant focus and only this GHG is presented in these results. M a n y bottom-up studies do not specify a reference (business as usual) case for comparison with their CO 2 emission reduction scenarios. In the US sample o f studies in Table 3, the reference is therefore only to reduction relat-
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ive to the historical base year. In the Canadian sample of studies in Table 4, the CO 2 reduction is shown for some cases relative to both a reference case and a historical base year. While most top-down studies show the costs of GHG emission reduction in terms of US$/ton CO 2 or as a percentage of GDP, bottom-up studies frequently identify the amount of CO 2 reduction that appears to be 'cost effective'. This latter is stated usually as the economic potential for CO 2 reduction relative to the reference year (historical base year or business as usual forecast). Thus, the 'cost-effective' level of CO 2 reduction usually implies an average cost of US$0/ton CO 2 and a neutral effect on GDP. This explains both what is meant by economic potential in Table 4 and the large number of zeros in the columns signifying GDP cost and US$/ton cost of CO 2 reduction in Table 3. Among bottom-up analysis there has not as yet been an effort to establish common exogenous assumptions for a more controlled test of different models, as occurred with the work of the Energy Modeling Forum for top-down models. Thus, the analyses reported in Tables 3 and 4 may differ for a wide variety of reasons. In spite of these differing assumptions, the bottom-up studies reported in Tables 3 and 4 fall within a range that is significantly distant from the results of top-down studies. Several of the studies show that reductions from base year emissions of 20% or more can be achieved with GDP costs ranging f r o m - l . 2 % to +0.6% of GDE The remaining studies report either zero or unspecified negative costs. The percentage of CO 2 reductions estimated to be economically achievable are ranged as high as 75%, although the norm was much lower. Bottom-up studies for Canada reported similar results. Estimates of cost-effective CO 2 emission reduction potential by 2010, relative to a reference or baseline scenario, ranged from 20% to 40%. As noted, the cause of divergence between different bottom-up studies relates in part to the fact that each study is based on different assumptions about: (1) (2) (3) (4)
the overall rate of economic growth; structural change in the economy; energy prices; and business as usual (baseline) conditions
These are the standard exogenous assumptions required by all energy models and energy analysis. However, in addition to these uncertainties, bottom-up models also have their own specific sources of uncertainty that can also contribute to significant differences between model estimates. The first key area of concern relates to the assumptions about the fuel splits and efficiency levels of currently installed energy using technologies. This information is critical because if the efficiencies and fuel splits are incorrectly estimated, the CO 2 emission reduction potential for a future period will be over or understated. In this area, the USA and Canada are probably better placed than most countries because for the last ten years energy utilities have gained
considerable knowledge of current equipment stocks through end use surveys that were required for the evaluation of demand-side management potential. Nonetheless, there is still great uncertainty, especially in the industrial sector with its heterogeneous equipment stocks. The second key area of uncertainty is in characterizing the dynamics of equipment stock turnover. Most bottom-up analysis skirts this issue with a simplistic approach in which it is assumed that the most efficient (or least CO zintensive) technologies will achieve 100% market penetration by the end of the study period. Because some of these technologies appear cost-effective, when evaluated on an engineering/economic basis, the resulting calculation explains the tendency for bottom-up models to suggest that there are economic gains up to a certain level of CO 2 emission reduction. However, to the extent that more recent bottom-up analysis attempts to portray consumer behavior more realistically this can lead to substantially different results with respect to the estimation of CO 2 emission reduction costs. Several factors could be relevant, including: (1) the differences in consumer surplus associated with more and less efficient equipment (eg different types of lightb'ulbs); (2) the differences in risk associated with more and less equipment (eg efficient technologies, being newer in general, tend to be riskier); and (3) differences in the transaction costs associated with more and less efficient equipment (eg efficient technologies, being newer in general, tend to have higher costs of information, acquisition, installation and maintenance). In other words the issue of the costs and success level of CO 2 emission reduction policies has generally not been integrated into bottom-up studies, which would tend to suggest that this approach has understated the full costs of CO 2 emission reductions. By how much is very difficult to determine, Nonetheless, the issue of technological representation may be key in explaining the divergence of top-down and bottom-up cost estimates. Critical parameters in top-down models are the effect of autonomous technological evolution on energy efficiency and the elasticity of substitution between energy and other aggregate inputs to the economy, notably capital, labor and materials. Mainstream economic research since the 1970s has tried to estimate long-run values for these parameters. There is a concern that the aggregate historical data used in estimating these values may fail to portray what these values would be in some future period in which price expectations, government policy and overall R&D is much more focused on reducing GHG emissions. In such an environment, the values of such parameters could be very much different, with much lower costs of GHG emission reduction. Bottom-up analysis can at least anticipate this potential by examining the extent to which newly emerging technologies do change the values for autonomous technological change and for interfactor elasticity of substitution.
Costs of reducing greenhouse gas emissions in the USA and Canada: M Jaccard and W D Montgomery
Conclusions and policy implications The top-down or market based approach uses standard economic models, extended to deal with energy supply and demand with sufficient detail to estimate CO 2 emissions. These models consistently conclude that measures to reduce carbon emissions below forecasted levels will have net economic costs. The bottom-up or technology based models have little or no representation of the general economy, but considerable detail on the stock of energy using equipment and on the technologies of energy use. They compare current or projected choices of equipment and technology with available alternatives and conclude that adoption of different technologies can reduce carbon emissions and reduce the lifecycle cost of energy use. The difference between the amount of energy actually consumed and the amount that would be consumed if all apparently cost-effective options for reducing energy use were adopted has been labeled the 'efficiency gap'. Consumers operating in free markets make choices that imply that they are neglecting opportunities to save money and save energy. The differences between these models arise in large part from differences in how market behavior is characterized. In the technology based models, future energy savings are assumed to be inadequately valued compared to initial capital costs for energy efficiency. In many cases this assumption is embodied in a high implicit discount rate or short payback period, and when costs are evaluated at a lower 'correct' discount rate, it appears that consumers are neglecting desirable opporttmities to invest in energy conservation. In market based models, consumers are assumed to make choices that are in their economic interest - that is, consumers use whatever the correct discount rate is for their individual circumstances. Thus, if a new technology for conserving energy becomes available, and can reduce correctly discounted lifecycle cost, it will be adopted in the baseline. Only those technologies whose higher initial costs are not justified by the present value of future savings at the correct discount rate will not be adopted. Basic economic principles suggest two explanations for the efficiency paradox. The first is that there are hidden costs of adopting the technologies that are claimed by the technology based studies to be cost-effective. These costs could be due to risks in new products and processes, changes in attributes that matter to users but are not represented in simple engineering calculations, or costs of fitting the new technology into existing practices. 3 If these hidden costs explain the efficiency paradox, the technology based studies are wrong about the possibility of reducing emissions at zero cost. The other explanation is that there are imperfections in energy markets, such as regulations that prevent the consumer from facing prices that reflect the true cost of energy,
897
so-called 'agency problems' in which decisions about energy use are divorced from responsibility for paying and costs of obtaining information. If these imperfections exist, if they consistently work in the direction of encouraging excessive energy use, and if policies to reduce the imperfections at a cost less than the net economic benefits of more efficient energy use can be designed, then some reductions in energy use could be achieved at no net cost. Indeed, achieving those reductions would be desirable even if there were no issue of climate change. The theoretical issues are reasonably well understood, but there has not been enough empirical work on either hidden costs or on market imperfections to decide which view of the conservation paradox is more correct. This means that, even if a general agreement that cost-effective policies to reduce market imperfections can be safely introduced into a climate strategy, it is impossible to determine accurately how far those policies would go toward satisfying any particular target for emission reductions and how much they would actually cost. Where top-down and bottom-up approaches do appear to agree is that it is sound policy to adopt truly low cost mitigation measures, and to do so by designing policies that address specific market imperfections. It may be difficult or impossible to provide definitive estimates of the reduction in GHG emissions attributable to these measures. Recent theoretical research, which has applied basic principles of public finance to the estimation of 'double dividend' benefits, suggests that it is not possible to fully offset the costs of significant emission reductions through reduction of ordinary taxes on capital and labor income. There is nearly universal agreement on the inefficiencies of the current US and Canadian tax systems, but the normal practice in public finance is to analyze the cost of each alternative tax separately. Thus a carbon tax would be compared with both the current burdensome system and with broad based consumption taxes like the value added tax. In this kind of comparison, broad based taxes always dominate carbon taxes as sources of revenue for tax reform. By departing from this approach, the recycling argument confuses tax reform with use of the tax system to achieve other goals. There have been no comprehensive studies to quantify the reduction in other emissions that would result from measures to reduce CO 2 emissions. Choice of appropriate timing for the reduction of emissions can reduce costs dramatically, and can make it possible to achieve much more ambitious goals for the levels which CO 2 concentrations, and ultimate global temperatures, would reach. Delaying emission reductions, while investing in the interim in climate science and in the development of new, carbon free energy technologies, can reduce costs of achieving goals specified in terms of concentrations by more than half.
Acknowledgments 3See the articles in the Energy Policy symposium, edited by Huntington and Schipper; and Montgomeryet al (1993).
The authors would like to thank their co-authors of Chapters 8 and 9 of the report of IPCC Working Group III, in
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Costs o f reducing greenhouse gas emissions in the USA and Canada: M Jaceard and W D Montgomery
particular Richard Richels who prepared the survey of topdown model results. This paper deals with just one of the topics covered in those chapters, by reviewing the results of studies of mitigation costs in the USA and Canada. It goes beyond what has been included in the IPCC chapters by developing the authors' own assessment and critique of that literature. The views and conclusions expressed in this paper are solely the responsibility of the authors, and do not necessarily reflect the views of their employers or of other contributors to this special issue. This paper is based on the authors' contributions to Chapters 8 and 9 of Bruce et al (1996).
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