Publications Archive • Page 24 of 29 • The Aspen Institute Economic Strategy Group

Climate Policy Enters Four Dimensions

SUMMARY:
In this chapter, authors David Keith, the Gordon McKay Professor of Applied Physics at Harvard’s School of Engineering and Applied Sciences, and John Deutch, emeritus Institute Professor in the Department of Chemistry at MIT, describe what needs to be done to craft a politically stable and economically sound climate policy that includes balanced reliance on the four mechanisms to manage climate risks, which they call the climate control mechanisms: emissions reduction, carbon dioxide removal (CDR), adaptation, and solar radiation modification (SRM).

Emission reduction is the process of lowering carbon emissions without reducing economic growth. The authors assert that deep emissions cuts will be achieved primarily by replacing the high-emissions capital stock with low-emission capital stock in the energy system through an increased investment in clean energy. However, as the energy system becomes more decarbonized, it will become increasingly costly to further reduce the carbon content and thus require massive amounts of capital over a very long time period. Unfortunately, the U.S. and Europe have largely failed to live up to previous commitments to new investments and there is little coordination between countries on developing an overarching strategy.

CDR refers to the technologies that have the potential to transfer carbon dioxide from the atmosphere at gigatonne scales into physical or chemical storage, or into biological sinks, such as biomass or soils. Keith and Deutch note that CDR technologies, particularly those that involve physical or chemical storage methods, are at an early stage of technology readiness. Some technologies, such as aforestation/reforestation, forest management, uptake and storage in agricultural soils, and biofuels with carbon dioxide capture and storage (CCS) are ready for development but will require large, multi-year budgets extending into the tens of billions to be realized. Other methods, such as direct air capture—the chemical scrubbing processes for capturing carbon dioxide directly from the atmosphere via absorption or adsorption separation—are still under development, making it difficult to assess their costs.

Adaptation mechanisms are human-designed programs that aim to protect communities, commerce, and the environment from anticipated damage and adverse impacts from climate change. Adaptation does not slow climate change; but rather acts as an insurance policy that reduces the costs of damage from the impacts of a global temperature increase should it occur. The diversity of adaptation actions presents a challenge to its analysis as a control mechanism and to setting a common scale for comparing the costs and benefits of different proposed adaptation efforts. The authors also highlight the inequality associated with implementing adaptation methods, as poor countries often lack the necessary access to capital and investments that are readily available to rich countries.

The final mechanism discussed is SRM: the deliberate use of technical methods to alter the Earth’s radiative balance and reduce global temperatures along with other adverse climate changes. These methods include adding aerosols to the stratosphere, adding cloud condensation nuclei to specific low-lying clouds, adding ice nuclei to specific high-altitude cirrus clouds, or using space-based reflectors. However, the authors emphasize caution when using a SRM approach given that, while it’s possible to restore the global average surface temperature, the resulting climate would be different from the climate without GHGs.

There is no silver bullet for addressing the climate crisis, and any course of action will require extensive coordination and mobilization. The authors recommend:

Adoption of a multi-year RD&D program plan with input from climate experts, private sector firms, government officials, and the public;
A single federal agency with the responsibility and authority to implement the approved program;
Multi-year climate budgets to finance this program overseen by a single joint congressional climate action committee;
Adoption of a stable GHG emission charge that will stimulate private sector investment;
Greater global climate data collection, modeling, and simulation.

Climate Convexity: The Inequality of a Warming World

DOWNLOAD

SUMMARY:
In this chapter, author Trevor Houser of the Rhodium Group summarizes current forecasts of climate damages in the years ahead and their implications for the global economy, inequality, and health. Houser asserts that if carbon emissions and associated damages are left unaddressed, the climate crisis will not only become more costly to global health and the global economy, but also will exacerbate inequality within the U.S. and around the world.

As Houser explains, statistics about changes in global average temperatures do a poor job of communicating the significance of the shift in the climate that has occurred in recent decades. A relatively modest increase in average temperatures is accompanied by a much larger increase in temperature extremes, which, combined with high humidity, can prove enormously damaging to human health. Additionally, projected changes in the frequency and severity of climate events vary starkly across local geographies and how these changes manifest is a major factor in shaping the economic impact of climate change around the world.

After reviewing recent advancements in models of the economic impact of climate change, Houser provides U.S. estimates of climate damages under the different emissions scenarios. In a high emissions scenario, Houser estimates climate change costs the U.S. 1.4 percent of GDP by 2030, growing to 2.4 percent of GDP by mid-century.

Houser highlights the unequal distribution of damages, both within the United States and around the world. This is due to two factors. First, the directional impact of warming on various social or economic outcomes depends on the starting climatology of a given place. Second, the ability to adapt to these changes, at an individual, community, or country level, is dependent on income. Both within the United States and globally, hotter places tend to be poorer and less developed, leaving them vulnerable to the most pronounced effects of climate change without the resources needed to adapt.

To combat these challenges, Houser presents four policy recommendations for the U.S.:

Aggressively reduce GHG emissions at home and re-engage other developed and emerging economies to do the same.
Address inequality through emission reduction policies by adopting climate econometric models that incorporate the Social Cost of Carbon measurement.
Prepare for the irreversible effects of climate change yet to come, including making coastal communities in the U.S. more resilient, expanding access to low-cost air conditioning, promoting climate-resistant crops in the plains states, and reducing wildfire risk.
Preparing for climate displacement, anticipating large-scale climate migration both domestically and internationally.

Securing Our Economic Future: Foreword

DOWNLOAD

The American economy is in the midst of a wrenching crisis, one caused by the COVID-19 pandemic, intensified by the worst social unrest in a generation, and aggravated further by a series of climate-driven natural disasters.

The effects of the economic contraction are enormous. Over a ten-week period this spring, some 40 million Americans lost their jobs. Millions remain unemployed and tens of thousands of businesses remain closed. And while the economy has made some steps to recovery, the pandemic has laid bare that too many Americans are unable to meet many of their urgent and basic needs.

At the same time, it has become painfully clear that American society is not equipped to deal with the risks emerging from our changing climate. Hundreds of thousands have evacuated their homes in recent months due to raging wildfires on the West Coast and flooding in the South. And while these climate-driven shocks are a short- term certainty, we have not built the infrastructure needed to withstand them, nor have we adapted our policies to meaningfully reduce their likelihood in the future.

American policymakers need to tackle these crises head on, but they cannot afford to lose sight of the larger vulnerabilities that today’s crises have exposed. The challenge facing the United States is not simply to recover. We must rebuild an economy that is more secure, equitable, and better insulated from the risks of the 21st century.

How can we restore a sense of economic security to American workers and families? What policies will expand opportunities across large geographic, social, economic, and racial disparities? How can we adjust our economic policies to guard against the worst effects of climate change? These are questions that many Americans are asking—to which policy makers will need answers.

This book is a contribution toward this end. It was largely written before the pandemic crises beset our country. But the analyses, diagnoses, and prescriptions contained within, all shed new light on the underlying fragilities that have since been exposed. The book is divided into three sections, covering the ‘Economics of the American Middle Class’; the ‘Geographic Disparities in Economic Opportunity and Place-Based Economic Development’; and the ‘Geopolitics of the Climate and Energy Challenge and the US Policy Response.’ Even after the pandemic recedes, the larger forces covered in this book will continue to shape our economy and lives.

As with previous publications, this volume is not intended to represent the consensus view of Economic Strategy Group members. It does, however, bring the best evidence to bear on some of the deep challenges facing the American economy, and does so in the same non-partisan spirit in which the Economic Strategy Group was conceived.

Securing Our Economic Future: Introduction

DOWNLOAD

The United States is currently gripped by deep uncertainty and economic anxiety. At the time of this writing, the United States is six months into the COVID-19 pandemic. More than 190,000 Americans have died from COVID (CDC 2020); more than 13 million Americans remain unemployed (Bureau of Labor Statistics 2020); and tens of thousands of businesses remain closed (Grossman 2020). Meanwhile, protests against racial injustice continue across the country, and in a number of tragic instances, they have been overtaken by violence. Wildfires rage through the northern Pacific states. In Oregon, 40,000 people have been evacuated and more than 1,500 square miles have burned. California has already experienced three of the top four largest wildfires in its history in this year alone. Perhaps more than any time in recent memory, the economic future of our country feels uncertain.

The overarching theme of this book “Securing our Economic Future” and the specific topics therein—the economics of the middle class, geographic divergence and place- based economic development, and the global climate challenge and U.S. policy response—were chosen in early 2020, before the COVID pandemic and associated recession had taken hold of the nation. But the acute challenges before us make the goal of securing our economic future even more imperative. Today’s alarming and immediate crises expose deep, structural weaknesses that have been building. The pandemic-induced recession has exposed the economic fragility of so many American households. The wildfires of historic proportion reveal the effects of environmental pressures. Bitter partisan and social divides that characterize the country during this Presidential campaign season reflects—among other things—increased economic divergence that often falls along geographic lines. These divides fall along racial lines as well, but those critical challenges are beyond the scope of this single volume.

By the time this volume appears in print, the election will have been decided. We fervently hope that the public health crisis will be abating, the labor market will be recovering, the wildfires will be under control, and that social change will progress peacefully. But without a doubt, the elected administration will face critical economic policy challenges. This volume focuses on three of the most important ones.

Keep reading.

Is the Decline of the Middle Class Greatly Exaggerated?

DOWNLOAD

SUMMARY:
In his chapter, Professor Bruce Sacerdote of Dartmouth College argues that increased inequality and declines in the number of manufacturing and middle-skill jobs is a distinct issue from declines in middle-class living standards and even the disappearance of the middle class. Sacerdote also asserts that claims about a vanishing middle class are not well-founded. Instead, the real challenges, he argues, are the rapidly changing nature of work and the skills demanded in the labor market; the unequal distribution of income growth in the United States in which median income and consumption are growing less quickly than the economy as a whole; and the deterioration of happiness and mental health indicators.

Because the income distribution has widened over time, the number of households falling within a given income range has also declined. However, these trends do not necessarily result in a “hollowed out” middle class, in which there are poor households, rich households, and no one in the middle. Sacerdote documents that middle-income households have become more likely to transition into the upper part of the income distribution over time than they are to move lower in the distribution.

As a result, Sacerdote finds that key measures of consumption, such as the likelihood of owning a home, having two cars, or sending a child to college, have increased among households at all income levels including the middle class, which he defines as those in the middle 60 percent of the distribution. Sacerdote also finds that although the cost of higher education has risen tremendously in the last two decades, tuition at selective private institutions and two year public institutions have remained quite affordable, especially after Federal Aid is taken into account. Costs of attendance at four year public institutions have risen dramatically. Sacerdote also notes that growth in inequality in the upper-middle of the distribution and lower-middle of the distribution is not as severe as the pre-tax income inequality of everyone relative to the very top.

Despite these positive indicators of middle-class economic well-being, rising inequality and slower economic growth have led to lower rates of intergenerational mobility, while advances in global trade and automation have disproportionately negatively affected many longstanding middle-class occupations.

Perhaps more concerning to Americans than statistics of inequality, Sacerdote writes, are visible losses of the jobs that have traditionally been stable, well-paying sources of employment for non-college-educated workers. As automation and technology become a larger part of routine cognitive and manual tasks, evidence of job polarization—particularly among non-college educated workers—becomes more noticeable.

Sacerdote also points to the cost of housing, which has risen unequally across the U.S. In addition mental health and wellbeing have declined among segments of working-class Americans, while the positive time trend in happiness has leveled off and has potentially started to decline. He also notes the finding that a combination of rising inequality and slower growth has significantly reduced the probability that children are better off than their parents.

Walking the Tightrope: Variable Income and Limited Liquidity Among the US Middle Class

DOWNLOAD

SUMMARY:
The Great Recession, and now the economic upheaval surrounding COVID-19, have intensified focus on this financial tightrope that many American families walk. In this chapter, author Dan Silverman, Professor and Rondthaler Chair at the W.P. Carey School of Business at Arizona State University, describes a body of evidence showing that large fluctuations in household income are commonplace both across and within years. However, these households’ reactions to shocks reveal substantial resilience despite their lack of a financial buffer. Silverman argues these facts imply that successful policies will focus on limiting the uninsured risks that families face.

Recent studies based on administrative data cast doubt on the idea that being middle class means receiving steady earnings year-to-year. In fact, tax records show that large changes in annual earnings are not rare, including for those around the middle of the earnings distribution.

How do households with little liquid savings respond to large income shocks? Silverman says that when families face financial turbulence, research finds that many briefly delay making bill payments in order to meet most of their usual consumption needs. Though potentially costly, recent studies suggest that a combination of payment grace periods, along with the tendency to pay bills when households are liquid rather than when the bills are due, allowed for little lasting damage to result from any delay in payments.

Silverman argues that these findings question long standing economic theories about the importance of precautionary saving to smooth consumption. Silverman suggests that the cost to total income or nearer-term spending in order to build up a savings buffer are not worth bearing, perhaps, because households can often use other mechanisms to get by when income is low.

In this view, Silverman argues that policy aimed at promoting greater financial security for the middle class would do better to focus on addressing the uninsured risk these households face, a feature held by traditional forms of social insurance such as public unemployment and disability. Silverman concludes by emphasizing that if reducing uninsured risks is indeed the better path, policy makers must then confront the costs of doing so, whether that cost be to the taxpayers or the workers themselves. The hope is that by providing such insurance at scale the costs will be less than those of self-insurance which, it appears, are too high for many households to accept.

Middle-Class Redistribution: Tax and Transfer Policy for Most Americans

DOWNLOAD

SUMMARY:
In this chapter, authors Adam Looney, Professor of Finance at the David Eccles School of Business at the University of Utah, Jeff Larrimore, Chief of Consumer and Community Development Research at the Federal Reserve Board of Governors, and David Splinter, an economist for the Joint Committee on Taxation, provide an in-depth analysis of after tax and transfer incomes of middle-class Americans over time.

The authors find that in recent decades, government tax and transfer policy has increasingly benefited the “middle class,” defined as the individuals in non-elderly households in the middle three income quintiles. The share of federal taxes paid by the middle class has declined over time, while their share of means-tested transfers has risen. They also document that middle-class income support is a relatively recent phenomenon. Market income—that is, amounts that individuals earn from work, running a business, or investments—and income after taxes and transfers grew together before 2000 but, since then, middle-class income after taxes and transfers has grown at three times the rate of market income.

Although middle-class market incomes have grown less quickly than aggregate income, public policies have offset some of this disparity by boosting after-tax, after-transfer income and enhancing economic security. Comparing the more comprehensive measure of after-tax, after-transfer income, Looney, Larrimore, and Splinter find that between 1979 and 2016 middle-class market income per person increased 39 percent while their after-tax, after-transfer income increased 57 percent over the same period.

Over the past few decades, transfer programs have reflected an increasingly sizable share of federal expenditures. From 1979 to 2016, the amount that the federal government devoted to human resources increased from 53 to 73 percent of the budget and from 10.4 to 15.2 percent of GDP. The middle-class benefited tremendously from these spending increases; specifically, the authors found that the share of means-tested transfers going to middle-class households increased from 27 percent to 49 percent between 1979 and 2016. At the same time, the middle class share of federal taxes paid fell from 45 percent to 31 percent.

This substantial growth in federal spending on social insurance programs was financed in part by reductions in defense spending and in part by deficit spending, while the tax reduction stemmed primarily from declines in federal income tax liabilities. With the cost of health care rising and non-transfer government spending on public goods at an historical low, the authors argue that it will be hard for fiscal policy to continue to boost middle-class income growth.

Looney, Larrimore, and Splinter also question whether it is possible to continue boosting income growth by raising new revenues from the top income quintile or top 1 percent and redistributing that revenue to the middle class. The authors present several scenarios in which taxes are increased on high-income households in order to reduce the tax burden on or finance new benefits for low- and middle-income households. While increases in progressivity and government revenues are feasible and would be effective at reducing poverty among low-income households, they find that this approach has significant limitations when the intent is to boost the income of the broad middle class. In one example, they show that the top one percent could not pay for a 10 percent increase in middle-class income, because the necessary marginal tax rate would exceed 100 percent.

Harnessing the Power of Markets to Solve the Climate Problem

DOWNLOAD

SUMMARY:
In this chapter, Gilbert E. Metcalf, the John DiBiaggio Professor of Citizenship and Public Service and Professor of Economics at Tufts University, argues that a carbon tax should be the centerpiece of any portfolio of policies that aim to achieve zero net emissions. However, a carbon tax alone is insufficient to achieve zero net emissions, and argues that regulation, federal support for innovation, and reforming current energy tax incentives and regulatory rulemaking should be part of a comprehensive climate policy agenda.

Metcalf describes key decisions that policymakers face when designing a federal carbon tax:

Tax base and point of taxation: Because the carbon content of fossil fuels is consistent at each stage of the process, they can be taxed at any point along the chain from extraction to consumption, allowing for flexibility when administering the tax.
Tax rate: Economic efficiency dictates that the tax rate would be set equal to the social marginal damages from emissions—so-called the Social Cost of Carbon (SCC). Pinning down the SCC is difficult given its reliance on key parameters that are subject to considerable uncertainty: climate sensitivity, the discount rate, and the magnitude of economic damages. Given these three areas of uncertainty, other approaches, such as revenue targeting and emissions reduction targeting, will also be relevant for setting the tax rate.
Trade and competitiveness: A carbon tax can be designed on a production or consumption basis. Although levying a consumption-based tax is more challenging than a production-based tax, consumption-based taxes mitigate the competitiveness concerns raised by production-based taxes. To simplify the consumption-based tax, Metcalf suggests imposing a tax on select carbon-intensive goods based on the carbon content of like-domestically produced goods.
Achieving desired emissions reductions: Metcalf proposes a tax mechanism called an Emissions Assurance Mechanism (EAM) designed to achieve any desired emission-reduction goal. Once a carbon tax legislation is enacted with an initial tax rate and default growth rate, the EAM tracks cumulative emissions and automatically adjusts the tax rate as needed. The EAM avoids the need for Congress to continually revisit the tax rate over time.
Use of revenue: A carbon tax could collect significant amounts of revenue which could be used in numerous ways. Metcalf argues that the tax should be implemented in a revenue-neutral way, including, potentially, progressive household rebates. It could also be used to finance Green New Deal initiatives though he argues that the currently low interest rates make borrowing for green infrastructure investments highly attractive.
State-level policies: Most state-level carbon pricing programs are cap-and-trade programs. Implementing a carbon tax will drive down allowance prices in state or regional programs and so affect revenues. Congress should consider how best to address potential revenue losses to these programs so as not to punish states that are early movers on climate policy.

Other policies will be necessary in addition to carbon taxes to achieve a significant reduction in the country’s GHG emissions. Metcalf highlights the need for policies that regulate emissions not amenable to taxation, such as agricultural emissions of methane. He also recommends updating current environmental regulations of GHG emissions, supporting research and development, and addressing the regulatory and institutional barriers, such as state resistance to interstate transmission lines. Metcalf stresses the importance of providing consistency in regulatory analysis — most notably the calculation of damages from GHG emissions and the treatment of co-benefits — as well as eliminating many energy-related tax breaks.

Finally, Metcalf discusses the economic evidence on the macroeconomic impact of a carbon tax. Economic analysis shows that while job creation or economic growth would not be adversely affected, carbon taxes would substantially change the composition of jobs in the economy. However, a carbon tax could raise $2.2 trillion net revenue over a 10 year window and modest amounts of this collected revenue could be used to ease the burden of this change and help the U.S. efficiently transition to a new economy.