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The global financial crisis, a deepening global recession, and continued turmoil in credit markets drive home the importance of developing a global climate architecture that can withstand major economic disruptions. A well-designed global climate regime and the attendant domestic policies in participating countries need to be resilient to large and unexpected changes in economic growth, technology, energy prices, demographic trends, and other factors that drive costs of abatement and emissions. Ideally, the climate regime would not exacerbate macroeconomic shocks, and would possibly buffer them instead, while withstanding defaults by individual members. Because climate policy must endure indefinitely in order to stabilize atmospheric concentrations of greenhouse gases (GHGs), all sorts of shocks will occur at some stage in the policy's existence. Anticipating such shocks may mean rejecting policies that might reduce emissions reliably in stable economic conditions but would be vulnerable to collapse—with consequent deterioration in environmental outcomes—in volatile conditions.
Macroeconomic volatility is the practical manifestation of an issue that has received considerable attention in the theoretical literature on the design of environmental policies: uncertainty about the costs and benefits of reducing emissions. In particular, macroeconomic shocks can cause the cost of regulation to be much higher or lower than anticipated. Unexpectedly stringent and costly regulations may become political lightning rods. Recent world events, for example, highlight the fact that economic surprises can subject governments to enormous pressures to relax or repeal taxes or other policies perceived to impede economic growth.
The first step toward meaningful progress on climate change is to be realistic about institutions – both about how existing institutions, such as national governments, can be brought to bear on the problem, and also about the prospects for creating powerful new international institutions. It is, in essence, a decision about whether it is more productive to bring existing tools, however imperfect, to bear on the problem or to design new and better tools at the international level. The latter course has attractions, but the risk is that the design process may go on indefinitely – with greenhouse gas emissions rising unchecked – without producing a viable new institution. Such has been the case over the last decade as attention has focused on designing the Kyoto Protocol, an elaborate new international institution without any real precedent that may do nothing to slow emissions.
In this chapter we argue that a better alternative would be to tackle climate change with simpler policies that can be carried out by national governments immediately. As David Victor noted in chapter 4, that process is happening by default already. We discuss key characteristics needed in an effective approach to climate change and argue that prospects for creating a powerful international institution to control greenhouse gas emissions are dim at best. We then outline one policy, an internationally coordinated system of national policies based on a hybrid tradable permit mechanism, that can be implemented with minimal development of new international institutions.
In this chapter we present a new intertemporal general equilibrium model for analyzing the economic impact of tax policies in the United States. We preserve the key features of more highly aggregated models like that of Jorgenson and Yun (1990, 1991a). One important dimension for disaggregation is to introduce a distinction between industries and commodities in order to model business responses to tax-induced price changes. We also distinguish among households by level of wealth and demographic characteristics, so that we can model differences in household responses to tax changes and examine the distributional effects of taxes.
We model demands for different types of capital services in each of thirty-five industrial sectors of the U.S. economy and the household sector. These demands depend on tax policies through measures of the cost of capital presented by Jorgenson and Yun (1991b) that incorporate the characteristic features of U.S. tax law. The cost of capital makes it possible to represent the economically relevant features of highly complex tax statutes in a very succinct form. The cost of capital also summarizes information about the future consequences of investment decisions required for current decisions about capital allocation.
To illustrate the application of our new model, we simulate the economic impacts of fundamental tax reforms. We focus on the effects of substituting a tax on consumption for corporate and individual income taxes at the federal, state, and local levels.
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