What Would Milton Friedman Do About Climate Change? Tax Carbon

Leading economists at the "Mecca" of free-market economics, the University of Chicago, evoked their most prominent predecessor, Milton Friedman, last week in advocating a price on carbon to address climate change.
At a forum called "What Would Milton Friedman Do About Climate Change?" former U.S. Rep Bob Inglis (R-SC) opened the discussion by playing a 1979 clip of Milton Friedman on the Phil Donahue Show:
Phil Donahue: Is there a case for the government to do something about pollution?
Milton Friedman: Yes, there's a case for the government to do something. There's always a case for the government to do something about it. Because there's always a case for the government to some extent when what two people do affects a third party. There's no case for the government whatsoever to mandate air bags, because air bags protect the people inside the car. That's my business. If I want to protect myself, I should do it at my expense. But there is a case for the government protecting third parties, protecting people who have not voluntarily agreed to enter. So there's more of a case, for example, for emissions controls than for airbags. But the question is what's the best way to do it? And the best way to do it is not to have bureaucrats in Washington write rules and regulations saying a car has to carry this that or the other. The way to do it is to impose a tax on the cost of the pollutants emitted by a car and make an incentive for car manufacturers and for consumers to keep down the amount of pollution.
Two current economics professors elaborated on Friedman's view and applied it to the 21st Century problem of human-induced climate change.
"What's happening when we turn on the lights, when the power is derived from a coal plant, or when we drive our car, is that carbon dioxide is emitted into the air, and that's sprinkling around damages in Bangladesh, London, Houston," said Michael Greenstone, the Milton Friedman Professor of Economics at the University of Chicago and the director of the Energy Policy Institute of Chicago.
"And those costs are real, and they're not being reflected in the costs of that electricity or the tank of gas. Emitting carbon dioxide into the atmosphere does allow you to produce electricity more cheaply, but there's a whole other set of people who are being punished or penalized. It's a poor idea of economics."
Greenstone and Steve Cicala, an assistant professor in the Harris School of Public Policy, argued that the market for energy operates without accounting for its full costs — without compensating people throughout the world who experience damages caused by the emission of greenhouse gases during the production of energy.
Cicala defined an "externality" as an effect on a third party caused by the mutually beneficial exchange that occurs in a free market. For example, there's a benefit to the power company when it produces electricity and sells it to the consumer, and there's a benefit to the consumer when electricity is available for purchase.
But when a third party not participating in that exchange suffers costs without compensation, the market has produced a negative externality.
"It is theft," Cicala said. "That's a loaded term, but if anyone can come up with a better term for taking something from people without their consent and without compensating them, I'm happy to use that term."
The free market solution to this problem would be the creation of another market, Cicala and Greenstone said—a market in carbon.
Bob Inglis played another clip of Friedman:
What we need is an adjustment mechanism that will enable us to adapt to what happens as it develops. Everybody in this room knows there is such a system, namely the price mechanism. If we have a problem today, in the air, with pollution, it is solely in my opinion because that system has not been allowed to work."
"He's exactly right," said Greenstone. "The price system isn't working in the energy sector right now exactly because carbon is priced at zero."
The problem isn't the U.S. has no carbon policy, Greenstone said, but that it has a poor carbon policy—"that it's fine to pollute." By introducing a price on carbon, the government could create a market for free enterprise solutions.
"It would be very hard for companies to raise money for innovation when there's no market for it. And this is a case where the government can set the market and then get out of the way and let the private sector figure out what's the best way to get to low carbon energy."
Whenever government gets involved in externalities caused by a market, some people object to government intervention, but Cicala said the government would not be intervening in a market:
"People say isn't it the case that with regulation you're intervening in this market? It's not the case. There is no market," he said. "The intervention of the government is to create a market and then get out of the way and let the market figure out the efficient allocation. The problem is there is no market for carbon."
Cicala outlined two possibilities for creating a carbon market. The first is to cap carbon emissions at a certain level and then allow the market to determine the cost of carbon by trading carbon offsets. That solution—"cap and trade"—is uncontroversial among economists, he said, but it failed in Congress in 2011.
The second would be to estimate the price of carbon and tax it.
Estimating the cost is tricky, Greenstone said, but scientists and economists have models for projecting the cost of each added ton of carbon on agricultural losses, mortality, sea-level rise, storm surge, and other climate effects.
"It's a complicated task but I think the best evidence suggests that it's probably around $40 a ton," he said. The U.S. government has projected the cost of carbon emissions at $37 per ton.
One audience member challenged the economists at this point, saying Friedman would not be so cavalier about a tax when there is uncertainty about its optimum level and likely effects.
"There is uncertainty," Cicala replied. "There is no question. Name me another policy where there was no uncertainty."
The uncertainty, Cicala said, "should have us terrified"—not terrified of the effects of a price on carbon, but terrified of the effects of increased carbon concentrations in the atmosphere and ocean.
The forum was sponsored by the University of Chicago's Institute of Politics, Green Ecnomonics Group, and the Energy Policy Institute of Chicago. The moderator, Inglis, is now executive director of the conservative Energy & Enterprise Initiative.
According to Greenstone, who came to the University of Chicago last year from the Massachusetts Institute of Technology, economists agree broadly on the benefits of a carbon price.
"The media always reports that there's near consensus among scientists about the effect of human activity on the climate. What gets less attention is that I think there's even greater consensus, starting from Milton Friedman and going to the most left-wing economist you can find, that the obvious practical solution is to put a price on carbon. It's not controversial."