Kotlikoff et al., ‘Making Carbon Taxation a Generational Win Win’

This is a linkpost for https://​​kotlikoff.net/​​wp-con­tent/​​up­loads/​​2019/​​04/​​Op­ti­mal_Car­bon_Tax­a­tion_in_a_Large_Scale_OLG_Model_3_30_19-11.pdf, also available at NBER

Sum­mary: Kotlikoff et al. hold that stan­dard in­te­grated as­sess­ment mod­els (IAM), in­clud­ing Nord­haus’s most re­cent 2017 ver­sion, rely im­plic­itly on in­ter­gen­er­a­tional al­tru­ism and pay no at­ten­tion to the in­ter­gen­er­a­tional dis­tri­bu­tion of welfare. The au­thors pro­pose a model that op­ti­mizes for a Pareto im­prove­ment for all fu­ture gen­er­a­tions and com­pen­sates cur­rent gen­er­a­tions for the cost of pro­vid­ing this fu­ture im­prove­ment. The model pro­poses an ini­tial car­bon tax of $70 per cu­bic ton of CO2, ris­ing at 1.5% per year (in con­trast to Nord­haus’s lat­est, which pro­poses a $30 ini­tial tax, grow­ing at the same 1.5% rate), im­prov­ing all gen­er­a­tions’ welfare by an es­ti­mated 5%.


Car­bon tax­a­tion has been stud­ied pri­mar­ily in so­cial plan­ner or in­finitely lived agent mod­els, which trade off the welfare of fu­ture and cur­rent gen­er­a­tions. Such frame­works ob­scure the po­ten­tial for car­bon tax­a­tion to pro­duce a gen­er­a­tional win-win. This pa­per de­vel­ops a large-scale, dy­namic 55-pe­riod, OLG model to calcu­late the car­bon tax policy de­liv­er­ing the high­est uniform welfare gain to all gen­er­a­tions. The OLG frame­work, with its self­ish gen­er­a­tions, seems far more nat­u­ral for study­ing cli­mate dam­age. Our model fea­tures coal, oil, and gas, each ex­tracted sub­ject to in­creas­ing costs, a clean en­ergy sec­tor, tech­ni­cal and de­mo­graphic change, and Nord­haus (2017)’s tem­per­a­ture/​dam­age func­tions. Our model’s op­ti­mal uniform welfare in­creas­ing (UWI) car­bon tax starts at $30 tax, rises an­nu­ally at 1.5 per­cent and raises the welfare of all cur­rent and fu­ture gen­er­a­tions by 0.73 per­cent on a con­sump­tion-equiv­a­lent ba­sis. Shar­ing effi­ciency gains evenly re­quires, how­ever, tax­ing fu­ture gen­er­a­tions by as much as 8.1 per­cent and sub­si­diz­ing early gen­er­a­tions by as much as 1.2 per­cent of life­time con­sump­tion. Without such re­dis­tri­bu­tion (the Nord­haus “op­ti­mum”), the car­bon tax con­sti­tutes a win-lose policy with cur­rent gen­er­a­tions ex­pe­rienc­ing an up to 0.84 per­cent welfare loss and fu­ture gen­er­a­tions ex­pe­rienc­ing an up to 7.54 per­cent welfare gain. With a six-times larger dam­age func­tion, the op­ti­mal UWI ini­tial car­bon tax is $70, again ris­ing an­nu­ally at 1.5 per­cent. This policy raises all gen­er­a­tions’ welfare by al­most 5 per­cent. How­ever, do­ing so re­quires levy­ing taxes on and giv­ing trans­fers to fu­ture and cur­rent gen­er­a­tions rang­ing up to 50.1 per­cent and 10.3 per­cent of their life­time con­sump­tion.
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