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Carbon Pricing Drives Innovation

Friday, October 4, 2019

The easiest way to reduce emissions is to avoid producing them in the first place. Because a carbon fee makes it more profitable to avoid carbon emissions, it encourages businesses and individuals to conserve energy, reduce emissions, and develop innovative technology.

The possibilities for innovation are manifold and include efficiency measures; changing habits or processes; making use of waste, residue, and byproducts for energy; and switching to renewable sources. Many of these responses are relatively obvious and easy to implement once incentives are set. But more significantly, there’s an entire category of yet-to-be-imagined solutions. A rising price path for carbon puts companies on notice that there is a market for low-carbon and efficient technologies—and that market isn’t going away. This market certainty is the biggest factor driving businesses to invest scarce research dollars in the hopes of commercializing new technologies while reducing their carbon fees via reduced emissions. In this way, a carbon fee encourages widespread innovation and diffusion of low-carbon and efficiency technologies.

A carbon fee encourages innovation everywhere, all the time. If well-designed, it reaches every person and business in the economy, incentivizing them to find ways to cut emissions. It reaches into homes, offices, factories, and cars—not just power plants. It is a transparent signal and it doesn’t go away: regardless of what steps people have already taken to reduce emissions, they are still incentivized to do more. As such, it is a far more persistent and pervasive innovation signal than any other climate policy.

A carbon fee gives companies the incentive and the flexibility to innovate. Regulations spur innovation up to a point: once a company is in compliance with a regulation, the incentive to do more vanishes. With a carbon fee, a company is continually pushed to avoid emitting carbon because it improves the bottom line. The model also affords companies the flexibility they need to reduce emissions in the way that best suits them. With a carbon fee, companies are rewarded equally—and no one tells them how to do it. They are free to innovate new processes, adapt old ones, substitute inputs, or dream up new solutions. The combination of powerful incentive and maximum flexibility is the ideal context for coming up with the most promising solutions. Companies may go down obvious paths or choose simple workarounds. Or they may come up with something revolutionary.

Innovation also lowers the cost of reducing emissions. In a competitive economy, companies are under intense pressure to reduce costs and improve quality. Faced with a national carbon fee, companies will be heavily incentivized to find the cheapest ways to avoid generating carbon emissions. A national fee will encourage many forms of innovation, including breakthroughs in clean technologies. In the context of steadily rising carbon prices, low-carbon technologies will scale quickly, bringing down the cost. This will ensure they are widely adopted, which will lower the overall cost of reducing emissions across the economy.

A carbon fee embraces the inherent volatility of energy transition. The path to a global energy transition is highly uncertain. It’s impossible to know what discovery or next big idea will move the economy in a low-carbon direction. The best policies for accelerating the transition to a low-carbon future should be flexible and embrace uncertainty. A carbon fee is the most neutral policy because it rewards everyone in the economy equally for conserving one unit of CO2 emissions. It starts a race to develop low-carbon technologies without giving any particular technology a head start. As a result, the sky is the limit for finding solutions to reduce emissions.

Subsidies lead to inferior solutions. Producer subsidies benefit certain known technologies and then shield them from the market’s winnowing forces. The problem with that approach is that competition tends to improve ideas, so picking technology “winners” risks locking out solutions that may be more cost- or carbon-efficient. Subsidies also rely on a poor framework for innovation. Unlike subsidies, which are designed by bureaucrats in Washington, D.C., a carbon fee leaves it to American innovators—from retirees tinkering in their garages to scientists in labs—to dream up new energy sources or find ways to get rid of a ton of carbon from an industrial process. And with subsidies, the risk of the investment is shouldered by taxpayers rather than the private sector.

A carbon fee is a sustainable innovation policy. Weaning the global economy from fossil fuels is a mammoth project that will require large-scale infrastructure substitution and technology innovations across every sector of the economy. The level of government support needed to spur such innovation through subsidies or federal R&D investment is too large to fathom and likely wouldn’t be politically sustainable over time. Without a carbon fee, any technologies developed or commercialized with federal support would be constantly vulnerable to competition from cheap fossil fuels, creating the need for yet more support. A far more sustainable solution is to incentivize millions of households and businesses to avoid a steadily rising carbon fee. Rather than burdening taxpayers, the carbon fee model creates large-scale demand for carbon-efficient goods and taps the vast resources of the private sector to meet that demand.