The Costs of Reducing Greenhouse Gas Emissions

November 23, 2009

The consumption of fossil fuels and deforestation are producing increasingly large quantities of greenhouse gases, particularly carbon dioxide (CO2). Most experts expect that the accumulation of such gases in the atmosphere will result in a variety of environmental changes over time Although the magnitude and consequences of such developments are highly uncertain, researchers generally conclude that a continued increase in atmospheric concentrations of greenhouse gases would have serious and costly effects.

Reducing emissions, through a cap-and-trade program or regulations for example, would impose a burden on the economy by lessening the use of fossil fuels and altering patterns of land use. Today CBO released a brief discussing the economic costs of reducing greenhouse-gas emissions in the United States, describing the main determinants of costs, how analysts estimate those costs, and the magnitude of estimated costs. The brief also illustrates the uncertainty surrounding such estimates using studies of a recent legislative proposal, H.R. 2454, the American Clean Energy and Security Act of 2009.

What Determines the Costs of Reducing Emissions?

The costs of reducing emissions would depend on several factors: the growth of emissions in the absence of policy changes; the types of policies used to restrict emissions and the magnitude of the reductions achieved by those policies; the extent to which producers and consumers could moderate emission-intensive activities without reducing their material well-being; and the policies pursued by other countries.

Emissions in the Absence of Policy Changes.Experts generally expect that, in the absence of policy changes to reduce them, domestic greenhouse-gas emissions will grow substantially in the next few decades. (See CBO's 2009 publication, Potential Impacts of Climate Change in the United States.) However, long-term trends in emissions are notoriously difficult to project because they will be influenced by population and income growth, by advances in technology, and by the availability and price of fossil fuels. The more rapidly that emissions are projected to grow without policy changes, the greater the changes that would be required and the greater the mitigation costs that would be incurred to keep emissions below any specific level.

Types of Policies Adopted. A basic choice facing policymakers is whether to adopt conventional regulatory approaches, such as setting standards for machinery, equipment, and appliances, or to employ market-based approaches, such as imposing taxes on emissions or establishing cap-and trade programs (which, over a period of time, restrict the quantity of emissions that can be produced through the allocation of allowances to emit CO2). Experts generally conclude that market-based approaches would reduce emissions to a specified level at significantly lower cost than conventional regulations. Whereas conventional regulatory approaches impose specific requirements that may not be the least costly means of reducing emissions, market-based approaches would provide much more latitude for firms and households to determine the most cost-effective means of accomplishing that goal.

Policymakers face many other critical decisions. Specifically, they must choose which types of emissions to control, and when and how much to reduce them. Further, if policymakers decided to adopt market mechanisms to control emissions, they would face decisions about which type of mechanism to use (a carbon tax vs. a cap-and-trade system, for example), as well as how to allocate allowances in a cap-and-trade program or how to use the revenues generated by taxes on emissions. For a more detailed discussion of the issues facing policymakers in designing a plan to reduce CO2 emissions, see the following CBO publications:

The Response of the Economy. By gradually increasing the prices of fossil fuels and other goods and services associated with greenhouse-gas emissions, market-based policies would induce firms and households to change their practices-in the short run, by driving slightly less, adjusting thermostats, and switching fuels in the power sector; and in the long run, by buying more-efficient vehicles and equipment, for example. Rising costs of emission-intensive activities would tend to dampen overall economic activity by reducing the productive capacity of existing capital and labor, by reducing households' income (which, in turn, would tend to reduce consumption and saving), and by reducing real (inflation-adjusted) wages. The more easily that producers and consumers can respond to price changes by altering their production techniques and behavior and by bringing low-emission fuels and technologies to market, the lower the costs of reducing emissions would be. (See CBO's 2003 study, Economics of Climate Change: A Primer.)

Efforts by Other Countries. The stringency of other nations' efforts to reduce emissions could strongly influence the costs of reducing them in the United States. As long as a significant percentage of the world's economy did not restrict greenhouse-gas emissions, a portion of any reductions achieved in the United States would probably be offset by increases in emissions elsewhere. Such "leakage" could be avoided if most countries restricted emissions at the same time. Even so, the policies used in other countries would influence costs in the United States.

How Large Are Estimated Costs?

In recent years, a few legislative proposals for long-term emission reductions have been analyzed using several different models, providing an opportunity to compare cost estimates and to understand the sources of differences in estimates. Most recently, several groups have released estimates of the economic impact of H.R. 2454, the American Clean Energy and Security Act of 2009. That bill would create two cap-and-trade programs for greenhouse-gas emissions-a large one applying to CO2and most other greenhouse gases, and a much smaller one applying to hydrofluorocarbons-and would make further significant changes in climate and energy policy.

Some of the findings of the leading models are similar. In nearly all of the reported scenarios, changes in the demand for energy and reductions in overall energy use are modest through 2025. However, the projected allowance prices vary substantially.

The aggregate employment effects of H.R. 2454 are likely to be modest over the long term. However, the legislation would cause a significant, although gradual, shift in the composition of employment over time, with potentially substantial adverse effects for some workers, families, and communities. Production and employment would shift away from industries related to the production of carbon-based energy and energy-intensive goods and services and toward the production of alternative and lower-emission energy sources.

All of the models reporting macroeconomic impacts project that the emission reductions required by H.R. 2454 would slightly dampen the growth of GDP over the long term. Quantitative estimates of the losses in GDP and consumption vary among studies, depending in large part on differences in assumptions about the availability of offsets (reduced availability of offsets increases the emission reductions required in the energy sector and thus increases economic costs) and differences in assumptions about the sensitivity of energy use to changes in prices (reduced sensitivity increases the price hikes required to reach emission targets and thus increases economic costs).

For a more detailed discussion, see CBO's analysis of H.R. 2454 in the following cost estimates and publications:

This issue brief was prepared by Robert Shackleton of CBO's Macroecononic Analysis Division.