If you ask a random economist – that includes me – about the best way to curb the emissions of CO2 to slow down, and eventually stop climate change, there is a good chance that they answer that carbon should be priced. And if you ask for slightly more details, they probably will suggest that we should proceed by implementing a tax on carbon emissions. Let’s call this the standard view.
The economics of the standard view is globally impeccable. It follows from the textbook kind of economic reasoning to which every first-year student is exposed. The problem is with its political economy. As we are acutely aware in France since the infamous “gilets jaunes” episode, the carbon tax raises issues of fairness. Given the socioeconomic and demographic characteristics of contemporary societies (in particular the relatively high level of economic inequalities), such a tax will disproportionally burden low-income households. These are not unsolvable issues. We may imagine for instance in the meantime increasing the proportionality of the income tax and then redistribute the additional proceeds to those households that are unjustly burdened. But public policies are not decided based only on economic and fairness considerations, without mentioning the fact that increasing (the marginal rate of) a tax has other general equilibrium implications.
Is there an alternative to the standard view that is still consistent with economic reasoning? You’ll find such a proposal in Kim Stanley Robinson’s novel The Ministry for the Future. I have already spoken of this novel in a previous post. Without spoiling it, a major part of the plot turns around an idea pushed by the so-called ministry for the future for developing what they call “carbon coins”. Robinson has developed this idea in interviews and articles, for instance here. As it happens, the idea is not from Robinson but from a civil engineer, Dalton Chen. You can learn more about it by reading for instance an interview with Chen in the Wall Street Journal. I find the idea intriguing and worth being discussed.
In essence, the idea of carbon coins is to use monetary policy instead of fiscal policy to incentivize individuals and companies to reduce carbon emissions. It is deeply related to the policies of quantitative easing that have been adopted following the subprime financial crisis. The major central banks in the world would agree to a scheme consisting in emitting a new money, carbon coins, in exchange for verified and certified actions for sequestering carbon for an agreed-upon time (e.g., one century). In other words, people would be paid to sequester carbon and implement decarbonization projects. Beyond this simple principle, details can vary. The emission of carbon coins could be tied to the issuing of long-term bonds guaranteeing their owners a return for the length of the carbon sequestration. Carbon coins could be traded on currency-exchange markets. In this case, central banks should commit to defend the value of carbon coins so that there is no risk of speculative attacks on it.
The economic logic behind carbon coins appears to be solid. Instead of incentivizing agents by making them pay for carbon emissions, we remunerate people for reducing emissions. In terms of opportunity costs, this is equivalent. But compared with the carbon tax, agents are not burdened, even less disproportionally so. In terms of political economy, carbon coins may therefore be easier to implement. There are some drawbacks, however:
1/ The implementation of carbon coins would necessitate an important and costly bureaucratic machinery, in particular, to verify and certify the sequestration based on which coins are emitted. You can be sure moreover that there would be a significant number of fraudulent behaviors.
2/ For the proposal to work, all the major central banks have to agree to commit to the scheme, which is unlikely. But note that implementing a carbon tax at the international level faces a similar issue.
3/ The scheme has a huge inflationary potential. If it works “too well”, huge amounts of carbon coins will be emitted. Whether or not they are tradeable against other currencies, the result will anyway be an increase in the quantity of money. In terms of monetary policy, quantitative easing was making sense because most economies were in a liquidity trap. It’s unclear that it is sustainable in economies that are stabilized (i.e., near full employment, with non-zero interest rates and normal inflation levels), even less in economies with high levels of inflation. This could create a problem of trust and credibility. The value of money is based on expectations about the willingness of everyone else to accept it in the future. As I said above, the idea would be that central banks commit to guaranteeing the value of carbon coins. But central banks can change their mind too. If the scheme is too inflationary, it is unlikely that they would remain committed. To be clear, I think that the scheme maps into a Nash equilibrium. With the right expectations, it is probably sustainable over the long run. But this equilibrium is also relatively fragile, in the sense that it exists only for very specific and extreme behavioral and epistemic conditions. In other words, the equilibrium is stable but not very robust.
4/ In terms of fairness, while carbon coins do not have the same problem as the carbon tax, they nonetheless have a counterintuitive implication. Assuming that the marginal rates of return for decarbonization are decreasing, the scheme will be extremely advantageous for the agents and economies that are extremely polluting. Of course, this is the point. Solving the climate change issue requires first and foremost making extreme polluters reduce their emissions. The implication however is that those who currently pollute a lot will not have too much difficulty reducing their emissions, generating a new stream of income for them. Others – most of us – will not benefit at the same level. Sure, the computation of costs and benefits should account for the positive externalities entailed by the decrease in emissions. It remains however that the scheme could increase economic inequalities worldwide. Combined with its inflationary effects, it would not improve the situation of many over the short run.
These are only brief remarks based on one hour or two of thinking. The idea of carbon coins remains interesting, and economists should start to take it seriously.