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In a newly published article in the scientific journal “International Economic Review”, some authors study how...

In a newly published article in the scientific journal “International Economic Review”, some authors study how carbon taxation could help reducing the climate change problem. They find that:

Carbon taxation is mostly studied in social planner or infinitely‐lived‐agent models, which obscure carbon taxation's potential to produce a generational win win. This paper's large‐scale, dynamic 55‐period, overlapping generations model calculates the carbon‐tax policy delivering the highest uniform welfare gain to all current and future generations. Our model features coal, oil, and gas, increasing extraction costs, clean energy, technical and demographic change, and Nordhaus' (2017) carbon/temperature/damage functions. Assuming high‐end carbon damages, the optimal carbon tax is $70, rising annually at 1.5 percent. This policy raises all generations' welfare by almost 5 percent. However, doing so requires major intergenerational redistribution.

c.It is said that the model leads to “highest welfare gains”. How is welfare measured according to economists?

Solutions

Expert Solution

The impact of humans on the planet has been so great that scientists have coined a new term for the geological era mankind has entered in to – the Anthropocene: the age of man. Arguably, manmade climate change is, and will continue to be, the most prominent feature of this era.

Carbon taxation has been studied primarily in social planner or infinitely lived agent models, which trade off the welfare of future and current generations. Such frameworks obscure the potential for carbon taxation to produce a generational win-win. This paper develops a large-scale, dynamic 55-period, OLG model to calculate the carbon tax policy delivering the highest uniform welfare gain to all generations. The OLG framework, with its selfish generations, seems far more natural for studying climate damage. Our model features coal, oil, and gas, each extracted subject to increasing costs, a clean energy sector, technical and demographic change, and Nordhaus (2017)'s temperature/damage functions. Our model's optimal uniform welfare increasing (UWI) carbon tax starts at $30 tax, rises annually at 1.5 percent and raises the welfare of all current and future generations by 0.73 percent on a consumption-equivalent basis. Sharing efficiency gains evenly requires, however, taxing future generations by as much as 8.1 percent and subsidizing early genrations by as much as 1.2 percent of lifetime consumption. Without such redistribution , the carbon tax constitutes a win-lose policy with current generations experiencing an up to 0.84 percent welfare loss and future generations experiencing an up to 7.54 percent welfare gain. With a six-times larger damage function, the optimal UWI initial carbon tax is $70, again rising annually at 1.5 percent. This policy raises all generation welfare by almost 5 percent. However, doing so requires levying taxes on and giving transfers to future and current generations ranging up to 50.1 percent and 10.3 percent of their lifetime consumption. Delaying carbon policy, for 20 years, reduces efficiency gains roughly in half.

Cognisant of the many facets of climate change, this report looks through the lens of economics, that is, the social science that measures the economic impact of climate change and the costs and benefits of trying to mitigate it and adapt to it. Climate change insights from the natural sciences are a point of departure for this perspective. Moreover, the economics of climate change typically account for people’s risk perceptions, while the issue of intergenerational equity is central to the economics of climate change. This is true, too, for trade-offs between the welfare of a nation broadly defined.


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