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Would a Carbon Tax Spur Innovation?

by Michael Levi
August 10, 2010

Megan McArdle weighed in yesterday on a debate between Jim Manzi and Ryan Avent on whether carbon taxes (or their equivalent) can spur innovation. Their fight centers largely on whether high gasoline prices in Europe have spurred innovation in the transportation sector. The weight of evidence suggests that the impact has been marginal.

But focusing on transportation distorts the analysis. The cost gap between traditional internal combustion engines and alternative vehicles is huge, while the carbon content of gasoline is relatively small. Even a (politically implausible) $100 per ton carbon tax would increase gasoline prices by only a dollar. No one should be surprised that you don’t get much innovation from that.

Electricity generation, in contrast, is far more price sensitive. A host of near-competitive options already exists. A $100 carbon tax, meanwhile, would more than double the cost of coal-fired electricity, creating big incentives for those who can deliver alternatives. There is thus much more reason to expect a carbon price to drive innovation in electric generation than in transportation.

To be sure, there are countervailing factors. Electric generation assets tend to turn over very slowly – they can be in place for fifty years or more. That makes it harder for any private innovator to capture returns on its investment before others copy it. Many generation assets are also very expensive. That increases the risks for any innovator too. Cars and trucks, in contrast, are replaced more often (though still infrequently compared to typical high-tech products) and are cheaper to test out in the market.

The bottom line, though, is that resolving arguments about the efficacy of carbon pricing by focusing narrowly on transportation is a mistake.

Post a Comment 2 Comments

  • Posted by Ted & Marie Webb

    Focusing on transportation for carbon pricing to control global warming may be a mistake. However, focusing on energy producers with a cap and trade policy ignores the transportation contribution completely. Or is there a way to include oil in the net?

  • Posted by Allan Lindh

    All of the above might be true, but skips over one hopeful fact. Even though energy generating facilicities turn over slowly, it is still true that the yearly investment in their replacement is vast. So the only way forward is, for instance, to BAN new coal fired plants in developed countries, and tax every electricity user a small amount to raise money to build new wind and direct solar plants in their place. The problem with C taxes and cap&trade is that it puts the burden on the poorest portions of the developed world (rust belt in US, eastern Europe) which are already hurting. Everyone, especially the richer regions, must help pay for the transition away from coal for electricity. Only when that transition is underway can the next level of problems need to be tackled.

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