The Institute for Policy Integrity (IPI) has released a new study [.pdf] touting the economic rationale of the Waxman-Markey climate bill. Titled “The Other Side of the Coin,” the study decries the tendency of recent analyses to focus just on the economic damages of Waxman-Markey, while ignoring all of the alleged benefits that would accrue from reduced emissions of greenhouse gases. The IPI study concludes that “the benefits of H.R. 2454 could likely exceed the costs by nine-to-one, or more” (p. 2).
There are so many problems with the IPI’s approach that it’s hard to know where to begin. But we can start by saying that their study actually says that for every $1 America spends it will get back 14 cents in direct benefits. By naively recycling higher energy prices back into the wealth of “households” through government spending or allowance handouts, IPI greatly understates the cost of Waxman-Markey on the typical American. On the other side of the ledger, IPI greatly overstates the benefits (measured in dollar terms) of Waxman-Markey, for two main reasons: First, it compares global benefits against the costs borne by Americans. (It might be nice or even a good idea to transfer American wealth to other countries, but this is an odd way to run a cost/benefit analysis for a U.S. program.)
Second and most crucial, when the IPI study counts the (worldwide) benefits of avoiding an additional ton of emissions, it relies on estimates that assume a worldwide cap is in place. But in reality, as Waxman-Markey constrains U.S. industries from emitting carbon dioxide, this will give incentives for other, less regulated industries—such as those in China and India—to increase their production and hence emissions. This means that global emissions will not be reduced ton-for-ton based on the U.S. restrictions contained in Waxman-Markey, causing the IPI study to greatly overestimate the benefits from avoided climate damage.
As a final nail in the coffin, the IPI results don’t match up with other analyses. The cost-benefit analyses in the environmental economics literature do not feature “optimal” emissions reductions anywhere near as aggressive as the 2050 target contained in Waxman-Markey. This suggests that something is fundamentally wrong with the IPI approach, because even models featured in the IPCC do not justify the Waxman-Markey targets on a cost-benefit approach. Finally, in the absence of concerted global participation in carbon caps—something that China, India, and Russia have publicly refused to agree to—Waxman-Markey will merely postpone global warming of a given amount by a few years.
Is IPI Sure It Wants to Look at the Full Coin?
The entire premise of the IPI study is that up till now, the critics of Waxman-Markey have been harping on its compliance costs, while the proponents have been silent on its (alleged) benefits, measured in dollar terms. That is the reason for the study’s title—The Other Side of the Coin—and leads the authors to write, “Congress is essentially conducting its deliberations after having reviewed barely half the data” (p. 4).
This is an ironic rhetorical move, precisely because Waxman-Markey cannot be justified on a cost-benefit basis. Indeed opponents of the bill have called for an examination of precisely this issue. Typically, the debate has focused on analyses of the costs, showing them to be feasible or tolerable, and then concluding, “Isn’t it worth spending this much to save the planet?” But once we move past emotional platitudes and see whether the leading models can justify the 2050 target in Waxman-Markey, the answer is a resounding no.
Waxman-Markey mandates that U.S. greenhouse gas emissions fall to 83% below 2005 levels by the year 2050. Yet if we look at the IPCC’s latest report (Table 3.10 on page 229 [.pdf]) we see that of 177 emission control scenarios from the leading models, only six considered reductions by 2050 in the range of 50%–85%. (Note that those percentages refer to a baseline of year 2000 emissions.) This is one clue that the 2050 target in Waxman-Markey is very aggressive.
If we want a precise estimate of just how inefficient Waxman-Markey is, we can turn to the latest calibration of Yale economics Professor William Nordhaus’ “DICE” model. Nordhaus is one of the pioneers in environmental economics, literally having written some of the field’s founding texts. He is also a strong advocate of a carbon tax; he is no “skeptic.” Yet in Nordhaus’ model, if the whole world adopted an emissions target as aggressive as Waxman-Markey’s the world would end up $15 trillion poorer than if no governments did anything to restrict climate change because the compliance costs would so swamp the environmental benefits.
These are not minor rounding errors. The IPI report is coming up with estimates that it calls “conservative” and which find that the benefits of Waxman-Markey may exceed the costs by nine-to-one. Yet as we’ve seen, actual full-blown models of the global economy and environment show that a cost-benefit analysis cannot justify the aggressive 2050 target in Waxman-Markey. Something must be wrong with IPI’s approach.
IPI Understates Actual Cost
One of the major flaws in the IPI study is that it takes the EPA’s cost estimate of Waxman-Markey at face value. Specifically, EPA found that “average annual household consumption [would] decline $80 to $111 (in 2005$) per year relative to the baseline scenario” (p. 10). To its credit, the IPI authors let the cat out of the bag:
Importantly, the [EPA] cost figures have been adjusted to reflect the value of emissions allowances that will be auctioned off under H.R. 2454’s cap-and-trade scheme, with some revenues being returned to consumers and to lower- and middle-income families.
We have discussed this clever move elsewhere in detail, but we’ll summarize it briefly: To achieve this breathtakingly low cost estimates for the “average household,” the EPA is counting all of the government revenue raised from the auction sales as flowing back into “households” when the politicians spend the money. Using the same logic, if the government imposed a tax on food and raised $100 billion, and then handed out a billion dollars each to the hundred biggest special interest groups, this would be a wash for the economy as a whole. “Households” would be unaffected, since after all $100 billion went out of households, and $100 billion went back in. Try that one at the next Town Hall Meeting.
American families will see their electricity and gas bills increase, perhaps sharply, because of Waxman-Markey. We don’t recommend banking on getting those rebate checks from Uncle Sam.
IPI Study Counts Foreign Benefits
Continuing the train of thought from above, suppose that the U.S. government raised $100 billion in new taxes from Americans, and then used the funds to donate $100 billion of food and medicine to Third World countries. If someone asked, “Did this program pay for itself?” most American taxpayers would say n
o. They might endorse the program because of altruism, but they wouldn’t say that it was free or that the benefits equaled the costs.
Yet this nonsensical approach is what the IPI study tells us it used when coming up with its stunning results for Waxman-Markey. Specifically, the “social cost of carbon” estimates were global figures—the IPI study counted up the benefits that a given ton of emission reduction would shower on the whole world. This is an odd thing to do, since the costs of the Waxman-Markey bill will fall entirely on U.S. industries and consumers.
We’ll quote the IPI study to see just how big this factor is:
Finally, the portion of benefits falling outside the United States could be viewed as a highly effective, highly leveraged form of foreign aid. If the global SCC [social cost of carbon] is assumed to be $19, then for every dollar the United States spends complying with H.R. 2454, about $2.29 in direct benefits is produced. According to the conservative domestic SCC approximation of 6%, at least fourteen cents comes back to the United States in direct benefits… (p. 34)
Got that folks? For every dollar that U.S. consumers spend (in the form of higher electricity prices, reduced economic output, etc.) to comply with Waxman-Markey, they will enjoy…fourteen cents of benefits in terms of avoided climate damage to the United States. (And here of course we are using the IPI study’s own numbers, which we think are wildly optimistic.)
The IPI authors glibly assume that the rest of the world will get on board and return the favor, but as we’ve shown in the links above, the rest of the world has told us they will not do so. At the very least, the reader should take the claims of “nine-to-one” ratios of benefits over costs with a huge shaker of salt.
The Problem of “Leakage”
The issue of foreign participation in carbon caps leads to the problem of “leakage,” whereby industries simply relocate from a regulated jurisdiction into a more liberal one. Although the IPI study notes the concern upfront (p. 8), it appears that their estimated ranges for the “social cost of carbon” do not take leakage into account. In other words, the estimates of SCC assume that one world dictator can cause total global emissions to go down by one ton, and then calculate how much global climate damage has thus been avoided. The IPI study then takes this number, multiplies by the expected avoidance of U.S. emissions due to Waxman-Markey, and comes up with the estimate of “benefits.”
But in reality, there is no global dictator who can enforce worldwide compliance with the Waxman-Markey targets. If the U.S. adopts the bill while other countries do not hamstring their own industries, then the “avoided U.S. emissions” will not translate one-for-one into “avoided global emissions.” This is because some of the reduction in U.S. economic output will be picked up by other countries, who will therefore see their own emissions grow faster than they otherwise would have. Thus, the SCC estimates in the IPI study grossly overstate the “benefits” of Waxman-Markey.
The Institute for Policy Integrity’s study, The Other Side of the Coin, suffers from too much abstraction from reality. Abstracting from reality is essential when creating models, but in the end the abstraction needs to have some relationship to the real world. Put bluntly, what matters most in global warming policy is the change in temperature. Policy makers also need to calculate the costs of their actions. A policy such as Waxman-Markey which, according to EPA’s own model only creates 0.05°C reduction in global temperature, will not have a measurable or meaningful impact on climate. If there is no meaningful impact on climate, there can be no benefits as IPI claims. If, indeed, there are no benefits and significant costs as in the case of Waxman-Markey, it is bad policy. Economists can get caught up in their models and in the end not notice that the output of the model has little to do with the real world. That appears to have happened in this case.
 The calculations and citations for the $15 trillion figure are explained in the middle of this post.