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Climate Change Information Sheet 24
Crafting policies that are cost-efficient

The costs of climate change policies can be minimized through "no regrets" strategies. Such strategies make economic and environmental sense whether or not the world is moving towards rapid climate change. They can involve removing market imperfections (such as counter-productive fossil fuel subsidies), creating supplementary benefits (greater industrial competitiveness through energy efficiency), and generating "double dividends" (when revenues from taxes or other climate change instruments are used to finance reductions in existing distortionary taxes). While no-regrets policies are certainly justified, the precautionary principle and the level of net damage expected from climate change also justify adopting policies that go beyond no regrets.

Although immediate action may sometimes seem more expensive than waiting, delays could lead to greater risks and therefore greater long-term costs. Governments can choose whether to phase-in emissions cuts slowly or rapidly. This choice must balance the economic costs of early actions (including the risk of prematurely retiring some still usable capital stock) against the corresponding costs of delay. One risk of delay is that it would "lock-in" the currently available models of high-emissions capital equipment for many years to come; if people then become convinced of the need for more rapid emissions reductions, these investments would have to be prematurely retired at a large cost. An earlier push to control emissions would increase the long-term flexibility of how humanity works toward stabilizing atmospheric concentrations of greenhouse gases.

Many variables need to be considered in the cost equation. The internationally-agreed timetables and targets for emissions reductions, global population and economic trends, and the development of new technologies will all play a role. Policymakers must also heed the rate of capital replacement (which relates to the natural lifetime of equipment), the range of discount rates that economists use for putting a current value on future benefits (which affects investment decisions), and the possible actions of industry and consumers in response to climate change and related policies.

Many cost-effective policies involve sending the appropriate economic and regulatory signals to national markets. Policies to reduce price distortions and subsidies can increase the efficiency of energy, transport, agricultural, and other markets. Consistent and appropriate signals will encourage research and give producers and consumers the information they need to adapt to future constraints on greenhouse gas emissions. Some of the greatest benefits of climate policies may be realized in developing countries that are experiencing rapid economic growth and in countries with economies in transition to a market economy.

Economic incentives can be used to influence investors and consumers. If they are market-based, incentives can often be more flexible and efficient than regulatory policies alone. For example, deposit-refund systems can encourage people to trade-in their cars and appliances for more energy-efficient models. Technology and performance standards can reward manufacturers for selling climate-friendly goods, or penalize those who do not. Targeted subsidies, voluntary agreements linked to appropriate targets, and direct government investment can also be cost-effective in shaping the behavior of both consumers and producers.

Introducing or removing taxes or subsidies can incorporate climate change concerns into prices. For example, a tax on the carbon content of oil, coal, and gas would discourage fossil-fuel use and so reduce carbon dioxide emissions. Carbon taxes have already been tried by a number of industrialized countries. Many economists believe that carbon taxes could achieve reductions in CO2 emissions at minimum cost; however, because taxes give individuals and companies the flexibility to choose how to respond, they would be less effective at ensuring that a prescribed emissions level is reached. To be effective, the tax must be well designed and administered. A number of economic studies show that if such taxes are revenue neutral and replace taxes that inhibit investment and employment, they can in some cases result in net economic gains. Although such taxes tend to be somewhat regressive, requiring poorer households to pay a higher share of their income on energy bills than rich ones, other taxes and transfers can be adjusted to offset this negative impact.

Tradable emissions permits could also offer a cost-efficient and market-driven approach. This is how a national system can work: A government determines how many tonnes of a particular gas may be emitted each year. It then divides this quantity up into a number of tradable emissions entitlements – measured, perhaps, in CO2-equivalent tonnes – and allocates or sells them to individual firms. This gives each firm a quota of greenhouse gases that it can emit. Then the market takes over. Those polluters that can reduce their emissions relatively cheaply may find it profitable to do so and then sell their permits to other firms. Those that find it expensive to cut emissions may find it attractive to buy extra permits. The 1997 Kyoto Protocol establishes an emissions trading system for governments at the international level.

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