Green Growth and New Models of Prosperity
Policy Instruments (Part 1)
Berlin, 21 June 2013 Vorlesung im SS2013 an der Technischen Universität Berlin Fakultäten Planen, Bauen Umwelt & Wirtschaft und Management
Prof. Dr. Ottmar Edenhofer Contents: Lecture Plan
Date Topic 12.4. 19.4. 26.4. 03.5. 10.5. 17.5. 24.5. 31.5. 7.6. 14.6. 20.6., 4-6 pm, Over-/Underinvestment H1012 Commons 21.6. Policy Instruments (Part 1) 26.6., 2-4 pm, Policy Instruments (Part 2) H1012 28.6. (cancelled) 5.7. (cancelled) 12.7. Horizontal and Vertical Fiscal Federalism
2 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
3 Bibliography for this Area
Perman et al, Natural Resource and Environmental Economics, Chapters 5-8
Edenhofer, Ottmar; Linus Mattauch and Jan Siegmeier (2013). Hypergeorgism: When is Rent Taxation as a Remedy for Insufficient Capital Accumulation Socially Optimal?. Cesifo Working Paper 4144.
George, Henry (1879/1912) Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy . 4th edition. [Available at: www.econlib.org/library/YPDBooks/George/grgPP.html]
Mattauch, Linus; Jan Siegmeier; Ottmar Edenhofer and Felix
Creutzig (2013). Financing public capital through land rent taxation: A macroeconomic Henry George Theorem, mimeo
4 Motivation
Consider the case of climate change: global cost-benefits-analysis delivers optimal emission-path. Does this mean we are done ?
5 Motivation
Consider the case of climate change: global cost-benefits-analysis delivers optimal emission-path. Does this mean we are done ?
The implementation of this emission-path calls for policy instruments.
6 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
7 Externality: Definition
“An external effect, or an externality, is said to occur when the production or consumption decisions of one agent have an impact on the utility or profit of another agent in an unintended way, and when no compensation/payment is made by the generator of the impact to the affected party.” (Perman)
8 From Externality To Market Failure
Example: Smoking person, individual optimization
mC
mB
S* Indivdually optimal level of smoke
9 From Externality To Market Failure
Example: Smoking person, individual optimization
Level of smoke S* mC + mC(others) incures cost for mC another person
mB
S* Indivdually optimal level of smoke
⇒ Social planner would choose lower level of smoke
10 From Externality To Market Failure
- Definition externality: private costs social costs - Positive vs. negative externality - In the presence of externalities, markets do not lead to socially efficient outcomes = market failure
Source: Perman 11 Externalities & Market Failure
12 Externalities & Market Failure: Consequences
If unregulated, externalities can influence the provision of goods:
Externality Good Harvesting of a fishery Fishing grounds in international oceans
Emission of sulfur oxides etc. Air quality Emission of free radical catalysts Ozone layer Emission of Greenhouse gases Stable climate system
Much of these exhibit the properties of public goods.
13 Public Goods Problem
Classification of goods Rivalrous Non-rivalrous
Excludeable Private Good Congestible Resource (Car) (Wilderness Area) Non-excludeable Open-Access Resource Public Good (Ocean fishery) (Stable Climate)
“Much of environmental and resource economics .. is concerned with identifying and correcting market failure in relation to the services that the environment provides to the economy.” (Perman)
Stern (2006) has called climate change the result of the „greatest market failure that the world has seen“
14 Public Goods Problem
The efficient level of supply for a public good.
£ MRUSA + MRUSB = MWTPA + MWTPB
MC = MRT
MRUSB = MWTPB
MRUSA = MWTPA
Source: Perman et al
X 15 X* Public Goods Problem
For an efficient provision of the public good, “the government needs to know the preferences, in terms of marginal willingness to pay, of all relevant individuals. It is in the nature of the case that those preferences are not revealed in markets.” (Perman)
16 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
17 Instruments to Control Pollution
Solutions implemented by the government can be classified:
I. Command and Control - prohibition - mandatory targets - technology standards
I. Market-Based Instruments - price instruments: taxes, subsidies - quantity instruments: tradable permits, tradable performance standards - mix of price & quantity: permit trade with safety valve 18 Policy Instruments in Climate Change
Source: IPCC 2007 19 Example: Pigouvian Tax Figure 5.14 Taxation for externality correction.
£
SMC PMCT
PMC
PY t Source: Perman et al
Y 0 20 Y* Y0 Examples of Policy Instruments Currently in Use
Source: Perman et al
21 Policy Instruments: Selection Criteria
Source: Perman et al
22 Policy Instruments Score Differently Under the Different Criteria
23 Source: IPCC 2007 Policy Instruments: Selection Criteria
Command & Control vs. Market-Based Instruments: - Social costs increase gradually / steeply - Firms have heterogeneous costs - Information asymmetry: firms hiding private costs - Few / many regulated firms - Enforcing regulation: may be easier/cheaper with technology standard than with target
24 Policy Instruments: Selection Criteria
Command & Control vs. Market-Based Instruments: • Market based instruments use markets to ensure cost effectiveness • A given reduction target is reached in a cost-effective way only if marginal abatement costs across all regulated entities are equalized.
25 Policy Instruments – Emissions Trading
€ MAC B MAC A €
B P
A P
Reduction by A Reduction A Reduction B Reduction by B
26 Policy Instruments – Emissions Trading
€ MAC B MAC A €
P P
Reduction by A Reduction A Reduction B Reduction by B
27 Policy Instruments: Selection Criteria
Command & Control vs. Market-Based Instruments: • Market based instruments can be powerful when information of regulator (government) is incomplete • BUT there are also circumstances in which markets will fail to be efficient (market power, firms‘ influence on allocation, time inconsistency)
28 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
29 Role of Uncertainty
Source: Perman at al (2003) 30 Policy Instruments – Emissions Trading vs. Tax
Under ideal conditions, in particular when costs and benefits of abatement are known with certainty, price instruments (=tax) and quantity instruments (=emissions trading) are equivalent. Outside such a deterministic world, this symmetry breaks down. This is the prominent „prices vs quantities“ debate.
31 ‚Prices vs. Quantities‘ under Uncertainty
Both benefits from pollution and cost of abatement may be uncertain (for regulator, even for firms)
Regulator faces dilemma: - price instrument would fix (marginal) costs, but leaves quantity uncertain - quantity instrument fixes level of pollution/emissions, but leaves cost uncertain
32 ‚Prices vs. Quantities‘ under Uncertainty
Weitzman (1974): if slope of marginal costs > slope of marginal benefits, then choose price instrument (and vice versa)
- Relevance in Climate Change? - Second-best if “lock-in” of cap-and-trade? (safety valve)
33 Prices vs. Quantities: Weitzman Argument
Source: Perman at al (2003) 34 Prices vs. Quantities: Short-Run vs. Long-Run
Short-term Long-term
Source: Stern Review (2006) 35 Why the Weitzman Argument Falls Short
• The Social Planner plays against uncertainty of nature and technological development
• For the design of policy instruments, the game between firms and regulator is much more important: – Design intertemporal, dynamic incentive structure – Consider asymmetric and costly information for firms and regulators – Consider the role of (incomplete) future markets for long-term planning decisions
• Conventional (linear) price instruments fail: – To be discussed soon: Supply side dynamics and intertemporal arbitrage condition -> The Green Paradox (Sinn 2008)
36 Tax vs. Cap-and-Trade – Political Economy
• Only taxes and auctioned permits raise government revenue double dividend effect
• Financial sector interest in trading powerful interest group
• Tradable permits are an asset. Permit owners have vested interest in continuation of the scheme
• Grandfathering enhances acceptability of trading in transition period
• Quantities can be controlled directly
37 Conclusions on Symmetry-Breakers (i)
Under ideal conditions, outcomes can be efficient with (i) tax, (ii) cap-and-trade, or (iii) bargaining solution (Coase)
- Ideal conditions: complete and enforceable property rights, perfect foresight, all agents have all information on prices and on their ‘damage’ function, etc. etc. Whenever one or more of these conditions is violated, the ‘symmetry’ between these three approaches breaks down
38 Conclusions on Symmetry-Breakers (ii)
Symmetry-Breaker Implications Reference Uncertain costs & benefits ‚Weitzman rule‘: relative Weitzmann (1974) slopes of mB and mC decides Endogenous technology Modified ‚Weitzman rule‘ Krysiak (2008) choice of firms in face of uncertainty Intertemporal profit ‚Green paradox‘ effect Sinn (2008), Edenhofer and maximization by fossil fuel possible under tax. On the Kalkuhl (2011) resource extractors safe side with cap-and- trade. Costly public financing with Taxes (or short-lived Baldursson and von der imperfect commit-power of permits) are preferable for Fehr (2008) government government Market power in R&D Taxes dominate permit Requate (2005) sector trade in most cases Uncertainty and imperfect Tradable permits better Montero (2002) enforcement than tax 39 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
40 Recall lecture 9, on “Over- and underinvestment”: Can Revenue-Generating Stocks Finance other Investments?
Social welfare
Private Transport Hospitals Schools, Natural Capital Infra- etc. Universities capital Stock structure
Open access Exhaustible resources: resources:
determine rate decide on rate of use of extraction
regulation of scarcity rent use creates rent from extraction (Partial) These rents can then be appropriation invested in public capital of resource rents (by taxation, state ownership, etc.)
41 Rent Taxation and Public Investment
We now consider rent taxation in some more (theoretical) detail:
1. Basics of (land) rent taxation: Henry George, the naïve efficiency argument and its qualifications
2. Are (land) rents sufficient to finance a public good?
42 Basics: Henry George (1839-1897)
• The ideas of Henry George are the basis of a framework of land rent taxation
• Regarded as one of the pre-eminent economists of his time.
• Radical proponent of a land-value tax.
• Disagrees with Malthus: it is about unequal resource distribution, not resource limits.
• Georgism: people should own what they create, but everything found in nature, most importantly land, belongs equally to all humanity.
• Polled second in 1886 New York mayor election, more than Theodore Roosevelt. 43 Basics: Henry George
“Progress and Poverty” (1879/1912):
“ Poverty deepens as wealth increases, and wages are forced down while productive power grows, because land, which is the source of all wealth and the field of all labor, is monopolized. [...] This, then, is the remedy for the unjust and unequal distribution of wealth apparent in modern civilization, and for all the evils which flow from it:
We must make land common property.
[...] I do not propose either to purchase or to confiscate private property in land. The first would be unjust; the second, needless. [...] It is not necessary to confiscate land; it is only necessary to confiscate rent. Now, insomuch as the taxation of rent, or land values, must necessarily be increased just as we abolish other taxes, we may put the proposition into practical form by proposing
To abolish all taxation save that upon land values."
(Bk. 6, ch.2, x2-3 & bk. 8, ch. 2 x12-17)
44 Basics: Why (Land) Rent Taxation?
• Normative / justice argument: „Nature“ belongs to all
• (Naïve) Efficiency argument: Tax on capital (interest) makes saving less attractive reduces supply of capital as an input factor for production Tax on labor makes working less attractive (more leisure time!) reduces supply of labor Tax on a fixed factor (rent) such as land doesn’t affect its supply non-distortionary tax
• Henry George’s single-tax movement: Replace all taxes by a tax on land rents
45 Basics: Why (Land) Rent Taxation?
(Naïve) Efficiency argument: Taxing a totally inelastic production factor… • produces no net welfare loss, • does not distort the resource allocation, • resource owners bear the full cost of the tax. (Quesnay (?), Ricardo, George, Friedman)
Part 2 (on financing public goods) essentially reflects the naïve view on rent taxation.
Source: Wikipedia
46 Basics: Qualifications and an Extension
• Feldstein (1977): Land rent taxation is distortionary if land owners have options: landlords also supply other factors such as capital or labor income effect: lower income from land rents affects other supply decisions land and capital are alternative assets for saving land rent tax changes relative prices, some of the tax is shifted on capital land and capital are associated with different risks effect on portfolio decisions
• Edenhofer et al. (2013): Land rent taxation is distortionary, but this may actually increase social welfare (Part 3)
47 Contents Part I
Policy Instruments and the Commons (Part I): Foundations and Static Analysis
• Externalities and Market Failure - Definition - Public good (commons) problem
• Instruments to Control Pollution - Instruments & selection criteria - Prices vs. quantities
• Rent Taxation and Public Investment - Basics of (land) rent taxation - Are (land) rents sufficient to finance a public good?
48 Rent Taxation and Public Investment
Earlier formal “Henry George Theorems” (HGT): • Stiglitz 1977, Arnott and Stiglitz 1979, Atkinson and Stiglitz 1980 • Identify single taxes that suffice to finance a (local) public good, but are not necessarily on land (static setting)
Here, two sub-questions: 1. Size of the land rent relative to the optimal (=social planer) level of a public good? 2. Can a government use a land rent to tax to finance the optimal level (decentralized solution)? • For now, abstract from inequality, population dynamics, etc. and assume identical, infinitely-lived agents (or equivalently: dynasties of perfectly altruistic, finitely-lived individuals that bequeath their entire wealth to their descendants, and no new entrants such as migrants)
49 Land Rent in Principle Sufficient to Finance a Public Good? (1/2) A Ramsey model with land and public capital for the social planer case:
50 Land Rent in Principle Sufficient to Finance a Public Good? (2/2)
Mattauch, Siegmeier, Edenhofer (2013) 51 Optimum Reproduced by a Land Rent Tax? Decentralized Solution (1/2)
Infinitely-lived, identical individuals:
buy & sell land flow of land rents s.t.
yields and the no-arbitrage condition
Note that the land market is „virtual“ in the steady state: • Agents hold the optimal share of land once and forever (perfect foresight; identical agents same share, but this is not crucial). • The land price reflects future income from land, but nobody trades! Land owners do no real choice regarding asset portfolio composition. • Naïve efficiency argument holds, the entire rent can be captured by a tax!
Mattauch, Siegmeier, Edenhofer (2013)
52 Optimum Reproduced by a Land Rent Tax? Decentralized Solution (2/2)
Mattauch, Siegmeier, Edenhofer (2013)
53 Empirics (1/2): Land and Wealth
Source: Caselli and Feyrer (2007), based on World Bank (2006) 54 Empirics (2/2): Magnitude of Resource & Land Rents vs. Public Investment Recall lecture on over- and underinvestment:
30% Non-producible factors' share in income and public investment 25%
20% non-producible factors' income share [% of GDP, 1996] public investment [% of GDP, aver. 2006-2011] 15%
10%
5%
0%
Data sources: (1) Non-producible factors’ income share: Caselli and Feyrer (2007); (2) Public investment: OECD (2013); ISO3 country codes.
Rent taxation could be an important contribution to financing public goods!
55 Rent Taxation and Public Investment
We now consider rent taxation in some more (theoretical) detail:
1. Basics of (land) rent taxation: Henry George, the naïve efficiency argument and its qualifications
2. Are (land) rents sufficient to finance a public good?
3. A dynamic effect of (land) rent taxation: The portfolio (Feldstein) effect
4. Other issues: Intergenerational equity, infrastructure and land prices, cities
5. Land rents vs. resource rents: Are the results transferable?
56 References ‘Land Taxation and Public Investment’
• Arnott, Richard and Joseph Stiglitz (1979). Aggregate Land Rents, Expenditure on Public Goods, and Optimal City Size. Quarterly Journal of Economics 93(4): 471-500.
• Atkinson, Anthony and Joseph Stiglitz (1980). Lectures on Public Economics. New York: McGraw-Hill.
• Caselli, Francesco and James Feyrer (2007). The marginal product of capital. The Quarterly Journal of Economics 122(2): 535-568.
• Edenhofer, Ottmar; Linus Mattauch and Jan Siegmeier (2013). Hypergeorgism: When is Rent Taxation as a Remedy for Insufficient Capital Accumulation Socially Optimal?. Cesifo Working Paper 4144.
• Feldstein, Martin (1977). The surprising incidence of a tax on pure rent. A new answer to an old question. Journal of Political Economy 85(2): 349-260.
• George, Henry (1879/1912) Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy . 4th edition. [Available at: http://www.econlib.org/library/YPDBooks/George/grgPP.html]
• Mattauch, Linus; Jan Siegmeier; Ottmar Edenhofer and Felix Creutzig (2013). Financing public capital through land rent taxation: A macroeconomic Henry George Theorem, mimeo.
• OECD, 2013. Economic policy reforms: Going for growth 2013. Policy report, table \Public investment: Percentage of GDP", DOI:http://dx.doi.org/10.1787/growth-2013-graph177-en, retrieved 2013/04/09.
• Stiglitz, Joseph (1977). The theory of local public goods. In: The Economics of Public Services M.S. Feldstein and R.P. Inman (eds). London: MacMillan.
57 Website
Slides used during the lecture and other relevant material will be made available online: http://www.climatecon.tu-berlin.de/menue/teaching/climate_change_economics/lectures_ss/
http://www.climatecon.tu-berlin.de/
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