Policy Documents

What Is the Right Price for Carbon Emissions?

Bob Litterman –
June 11, 2013

This article in Regulation Magazine (Vol. 36, No. 2) notes that concern over climate is growing. Policymakers face a difficult question: How much should society spend today to protect future generations against the unknown risks emissions create? Two issues make determining the appropriate price of carbon emissions a particularly difficult question for economists. First, the unusually long time before environmental damages are expected to be realized makes them difficult to value today. Second, the potential for a low-probability, high-damage scenario to occur is fundamentally uncertain.

There is no disagreement among economists on the benefits of pricing carbon emissions. Prices create the appropriate incentives for producers and consumers to reduce emissions and shift them to higher-value uses. They do this by internalizing the externality of future damages created by economic activities that produce emissions. Relying on prices to allocate scarce resources is vastly superior to the command-and-control approaches of current policies, which rely on public subsidies and mandates to use particular alternatives to fossil fuels.

What is the correct tax on emissions? The views range from $5 per ton of carbon dioxide at the low end (around 4 cents per gallon of gas) to over $100 per ton (as much as $1 per gallon). The current consensus of economists is at the low end of this wide range. 

The big question is what Is the Right Price for Carbon Emissions?



Bob Litterman is a partner at Kepos Capital, a New York–based hedge fund.