When it comes to setting a price on carbon emissions, a common perception is that broader is better — meaning a carbon price that spans all major sources of emissions will be the most cost-effective approach. A recent working paper titled “Is Broader Always Better? Preexisting Distortions, Emissions Elasticities, and the Scope of Emissions Pricing” by Washington-based Resources for the Future challenges this assumption.
The paper, authored by Lawrence H. Goulder, Marc A.C. Hafstead, and Roberton C. Williams III, uses both analytical and numerical models to explore how the cost-effectiveness of carbon pricing policies can vary depending on the breadth of their coverage. It compares an economy-wide carbon tax with narrower policies that target specific sectors, such as only the power sector or excluding energy-intensive trade-exposed industries.
One of the key findings is that, under certain conditions, a narrower carbon-pricing policy can actually be more cost-effective than a broader one. This surprising result arises due to differences across sectors in pre-existing tax distortions and the elasticity of a sector’s emissions in response to a carbon price. For example, sectors with higher existing tax burdens (such as the power sector) might experience more significant cost distortions under an economy-wide carbon price, making a sector-specific tax potentially more efficient.
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The research also shows that the relative cost-effectiveness of broader versus narrower carbon-pricing policies also depends on the stringency of the emissions-reduction target. While broader policies generally become more cost-effective as the emissions-reduction target becomes more ambitious, narrower policies may offer advantages at lower levels of stringency.
Based on these findings, the authors suggest that policymakers should not automatically dismiss narrower carbon-pricing policies as being less efficient. Instead, they propose a more nuanced approach that takes into account the specific economic conditions, sectoral emissions elasticities, and existing tax distortions.
The authors write:
Our analytical model shows that the situation is very different in realistic economies involving prior distortionary taxes. Such taxes imply that marginal costs of abatement can differ significantly across sectors, even for initial (infinitesimal) abatement in each sector. The model identifies the distortionary costs and the associated (and differing) marginal costs of abatement. It reveals circumstances in which policy costs can be reduced by exempting a sector with particularly high tax-interaction effects.
“Is Broader Always Better? Preexisting Distortions, Emissions Elasticities, and the Scope of Emissions Pricing,” by Lawrence H. Goulder, Marc A.C. Hafstead, & Roberton C. Williams III, Resources for the Future, August 2024.
Read the full working paper originally published by Resources for the Future on Aug. 28, 2024.
