Friday, February 22, 2008

Climate Change: Technology vs. Taxation

Jim Manzi supports a prize-based model to spur investment in carbon-reducing technologies. A big chunk of his argument is based on the assertion that taxing carbon emissions isn't warranted given the best estimates of the economic damage done by climate change. Manzi argues that a hedge against unanticipated adverse impacts is warranted and that the best hedge is to invest a bunch of money in technology. He also points out that the best case for carbon taxation does not revolve around emissions abatement. Rather, it revolves around providing incentives to develop better technology.

From this reasoning, Manzi argues that straight investment in technology is more efficient than taxation-induced investment in technology. I see two flaws with this argument.

The first, more minor, flaw is that the money to invest in technology has to come from somewhere. You can raise general taxes to cover the investment, or your can impose a directed tax. A carbon tax would be such a directed tax and would seem to me to be a better solution. (NB: I continue to believe that cap-and-trade is a fool's errand. If we're serious, we'll tax the production or importation of carbon-based commodities and have done with it.)

The second flaw is much more serious. Government investments in basic research have a fairly decent return on investment if you know what you're researching. The problem with carbon-abating technologies is that we really don't know where the killer idea is going to come from. Even worse, there's a huge gap between developing technology that could work and developing deployable technology. The government sucks at the latter. The way to deploy technology massively is to convince the majority of consumers that the new technology has such an obvious return on investment that using it is a no-brainer.

Government can influence the deployment of technology using either carrots or sticks. The carrots are subsidies, usually in the form of tax credits. For such a subsidy to work, you first have to communicate its existence to the public. Then you have to provide an unambiguous method by which an individual can determine how much he has to pay up front, how much he'll get back in return, and how the overall investment will pay for itself over time. Then the individual has to be willing to apply for the tax credit.

In my business, we have a technical term for a process like this. It's called Bad Marketing, and it's killed more promising products than all the design flaws ever implemented.

Contrast this with the "stick" approach. Government taxes carbon commodities, making the consumer feel the pain of using them. At some point, specific market opportunities emerge where a business can provide a product or service that eases the consumer's pain. The consumer buys that product or service and the business gets rich. In short, we have a market-based solution to the deployment problem, rather than one based on subsidies.

Of course, you have to have the proper amount of basic research so that that products leveraging that research can be brought to market. So some government investment in technology is warranted. However, the vast majority of the innovations are going to come from the private sector. There's no way for the government to inject capital into that sector without incurring all sorts of hideous rent-seeking consequences.

The government can contribute most to solve the climate change problem by increasing demand for carbon-abating products. It can do that most efficiently through taxation. The necessary basic research can be funded through that taxation. But the solutions have to come from the private sector.

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