Category: Climate change
The Rising Cost of Hurricanes

The Rising Cost of Hurricanes

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The hurricane season of 2017 has been a severely damaging one. Hurricane Harvey devastated parts of Texas, Maria savaged Puerto Rico, and Hurricane Irma dealt a punishing blow to an already-reeling Florida (not to mention Nate and Jose). As I write this, Hurricane Ophelia – the tenth named storm in a season that was predicted to be “less active than usual” – is brewing in the eastern Atlantic. Whatever the cause of this increase in hurricane frequency, though climate change is a likely culprit, no one can deny that these storms are growing more costly

The World Health Organization estimates that the global cost of hurricane damage per season is rising by 6% a year. (That’s in real dollars, not nominal, by the way, so inflation doesn’t factor into it.) If storms are increasing in strength and frequency, why is more not being to mitigate the costs?

Two words: incentives and avoidance.

Economists believe that people respond to incentives. Make an activity less expensive, and more people will engage in it. Make an activity more expensive, and the level of activity will drop off. Why is that important here?

It turns out that if policy makers make it relatively inexpensive to build your house in a floodzone, lo and behold, more people are going to build their houses in floodzones. Houses that are built in floodzones are, no big surprise, more prone to flooding. According to the Economist magazine’s recent article, Harris County, Houston’s home, has allowed 8,600 homes to go up in the 100-year floodplain. (The 100 year floodplain is not, despite its name, an area where a flood is expected to occur every 100 years. A 100 year floodplain is an area that has a 1 percent chance of being flooded in any given year. That means, over the life of a 30-year mortgage, the change of a such a flood occurring is just about 26 percent.) The more houses located in a floodplain, the greater the expected cost of such a flood. Simple math.

Not only that, but by developing in the floodplain, much of that land was converted from prairie land to impermeable surfaces, like roads, driveways, and sidewalks. Coastal prairie land can absorb large amounts of rainfall. Concrete and asphalt cannot, leading to more flooding and more runoff, and more erosion of existing soil, as the velocity of the water is increased by those impermeable surfaces. The act of putting more development in vulnerable areas is a double whammy – you’re putting more homes in harm’s way, and you’re taking away the natural infrastructure that helps protect against flooding in the first place.

I also mentioned “avoidance” as one of the reasons why hurricane costs have been increasing. It’s no surprise that most people tend to avoid thinking about negative information, and that applies to getting insurance. According to the Insurance Information Institute, only 12 percent of American homeowners had flood insurance in 2016. While most banks and mortgage companies require flood insurance if your home is in a high-risk area, federal law does not require coverage in a moderate to low risk area and almost 25% of all flood-related claims come from those areas. Why is that? Maybe they see it as too expensive, or they’re putting it off. Maybe they’ve simply made a bad bet. Or perhaps they expect the federal government to foot the bill. Even if the government does cover some of the damage (and the federal government did cover about 80% of Hurricane Katrina’s damages), that still means that taxpayers may be subsidizing an increasingly risky bet.

And those bets are becoming riskier. What was once considered a 100-year storm – that is, where the probability of one occurring is one percent annually – is now occurring more frequently. Scientists estimate the likelihood of a storm of a certain size occurring based on historical figures – and we know that more intense storms are happening more often. (For a great discussion of how the US Geological Survey draws the “flood maps,” see this piece from Five Thirty Eight.)

It’s not only the insurance companies, the homeowners, or the federal government who shoulders the increasing costs of hurricanes and other natural disasters. Municipalities can see a blow to their tax base, a rise in the cost of borrowing, and even the possibility of litigation if it’s found that the municipality issued building permits or approving subdivisions that increase the potential of flooding.

What can be done to stop these costs from continuing to increase? Well, for a starter, communities need to take a good long look at their land use regulations. We need to stop subsidizing bad risks. It should be more, not less, costly to build in flood plains. We need to stop subsidizing the conversion of wetlands and other buffer zones to development. We need to preserve our natural infrastructure. And, we need to implement more resiliency efforts.

Municipalities should also make sure that businesses and homeowners fully understand the potential costs of not having flood insurance We need to make sure that the people involved in these kinds of decisions have a clear understanding of the full social and environmental costs of their actions. These moves make economic sense as well as environmental sense.

rbouvier consulting’s mission is to promote a more transparent economy by making sure that social and environmental costs are included in economic decisions. Visit our website to find out more.

Economic Resiliency in the Face of Climate Change

Economic Resiliency in the Face of Climate Change

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“Custom House Wharf Flooding at High Tide” by Corey Templeton is licensed under CC BY-NC-ND 2.0.

Climate change is expected to have a number of effects in Maine, including coastal flooding, sea level rise, and changing precipitation patterns, among others.  Many efforts are already underway to help protect communities from those effects, including zoning changes, new building requirements, armoring or elevating critical infrastructure, and the like. These efforts all fall under the heading “climate resiliency planning,” as they make a community more resilient to the disruptions wrought by changing weather patterns.

Ensuring that a local economy is resilient to climate disruption is nearly as important as physical resiliency. The local economy is a complex web of interactions between customers, workers, businesses, non-profits, and government agencies within the region. Economic resiliency planning can help to make sure that that web does not break – or, at least, is easily rebuilt – after a disaster.

Current approaches to assessing the impact of climate change too often ignore economic changes that are likely to occur.  Climate change poses physical threats to current businesses, true, but it also poses economic ones, as supply chains dry up, input prices rise, or competitive advantages shift. Focusing on preserving the economic status quo will do little good if advancing sea level rise and increasingly variable weather patterns result in a markedly changed economic landscape.

The first step in developing an economic resiliency plan for a local economy is to anticipate the likely physical changes that will accompany climate change, by taking a look at what areas of a particular municipality are likely to be impacted by certain events.  If you’re located on the coast, or if your town center is situated near a river, as is the case for many Maine towns, flooding from hurricanes or other large storms might be a priority.  Or, access may be more of an issue.  If your town has one or two main routes in and out of town, how likely are these routes to be block by high water, or by downed trees from wind damage? Many communities have already begun this work, through projections from the National Oceanic and Atmospheric Administration (NOAA) or from the United States Environmental Protection Agency.  Through this work, communities can get an idea of what physical assets are at risk from climate-related events.

Next, establish a baseline.  What are the largest employers in the municipality? What are the largest sources of tax revenue? What are the key industries, and what is the sectoral composition of the economic base? Where do most of the non-resident employers live, and what routes are they likely to take to work?  This will create a starting point to assess the local economy’s vulnerability to climate-related disruption.  The results may not always be what you think.

For example, many of Maine’s historically most important industries – agriculture, forestry, fishing, and tourism – depend heavily on the climate.  The output from these industries is likely to be directly impacted by any climate disruptions.  Agriculture, for example, could be both positively and negatively affected by climate change, as higher temperatures lead to a longer growing season, but also to increased need for irrigation.  These are the industries that are deemed “climate-sensitive in supply” by economists.

But there are also industries that are “climate-sensitive in demand” – where consumer demand for goods and services is likely to be affected by changing weather patterns or the physical effects that come with them.  Tourism, certainly, is one of these (both positively and negatively).  Energy is another.

Less obvious, perhaps, are the effects of underlying price changes and linkages between industries.  Let’s give an example.  Suppose that an increase in hot, humid weather in the northeast leads to increased demand for air-conditioning.  (Most areas in Maine now see fewer than four days a year when the heat index rises above 95 F, but that is predicted to change under most projections.)  The increased demand for air-conditioning will likely lead to increased electricity prices.  Those higher prices will ripple through the economy, affecting everything from family’s budgets to food prices to costs to businesses.

Finally, labor productivity might be affected by climate change.  Why? For those of us who have jobs in air-conditioned buildings, and as such are relatively shielded from the climate, the outdoor temperature might not affect our productivity.  But for the proportion of Maine workers who work outside, or do not have access to air conditioning, heat-related stress can be a factor, much as it is for livestock in Maine. Moreover, the effect of warmer temperatures on growing seasons works for pollen-producing plants as well, leading to increased rates of asthma and allergies. The spread of insect-borne diseases, such as Lyme, may affect productivity as well (not to mention impacting the health care sector).

Once the likely changes to the local economy are anticipated, policies can be put in place to help reduce risks.  Some of these policies might include encouraging local businesses to engage in disaster preparedness with others rather than in isolation, developing a directory of local businesses that can assist in rebuilding after a disaster, and identifying alternative procurement routes in case of a disruption in transportation infrastructure.

Planning for economic resiliency is less about rebuilding the day after a disaster, and more about planning so that economic disruptions are minimized should a disaster occur.  And it doesn’t have to be a stand-alone process.  In fact, it shouldn’t be.  Planning for economic resiliency should be integrated into planning efforts at all levels, from economic development to housing and infrastructure planning. While a disaster almost by definition is unpredictable, we do have the ability to anticipate the changes that will come with a changing climate.  We should take the time now to ensure that those changes don’t derail the local economy.
The Social Cost of Carbon: Implications for Maine (Part II)

The Social Cost of Carbon: Implications for Maine (Part II)

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My most recent blog post, “The Social Cost of Carbon: Implications for Maine (Part I),” went into some of the details behind calculating the social cost of carbon – a number that is used to illustrate the economic damages anticipated by climate change and therefore linked to carbon dioxide emissions.
This blog post will be a bit more policy oriented.  Once we arrive at a social cost of carbon, what do we do with it?  How can we use it to reduce the amount of carbon that’s emitted into the atmosphere?

Essentially, there are three policy options to reduce climate change.  One is what economists like to call “command and control.”  This is standard regulation – where each company or industry is given a standard beyond which they are not allowed to pollute.  If they are found to have polluted beyond that standard, they are then (typically) fined a certain amount.

The second and third option are what economists call “incentive-based regulation.”  Rather than give companies or industries a hard and fast limit, this type of regulation gives the regulated community an incentive to reduce emissions.  The incentive could be in the form of a subsidy for each unit of pollution reduced, or, alternatively, a tax system could be put in place.  In that case, the firm’s incentive to reduce pollution is the avoided tax on each unit. (From an economic perspective, there is actually no difference between a tax and a subsidy when it comes to determining the “efficient level” of pollution.  From a political perspective, of course, there is a huge difference.)

A third option is to implement a trading scheme.  The idea is simple: firms are distributed a certain number of permits or “rights” to pollute. (The permits could be initially distributed free of charge, or the permits could be auctioned off.)  Firms that could then reduce a unit of pollution more cheaply than the permit price would do so, and sell the unused permit on the market to other firms that have a more difficult time reducing pollution.  The firm’s incentive to reduce is the price that they get from selling their permit.  Creating a market like this is not without its difficulties, and markets for pollution have met with varying degrees of success.  One pollution market close to home is RGGI, the Regional Greenhouse Gas Initiative, which is the topic of one of my earlier blog posts.  The revenue gained from auctioning off the permits goes to energy-saving initiatives.

One of the major difficulties in both of these is to set the “right” price – too low, and not enough firms will reduce their emissions; too high, and it can create political dissatisfaction and a drag on the economy.  (A side note: unbridled carbon emissions are already creating havoc with Maine’s economy – but that will be the topic of a later blog post.)

A second major difficulty (what I like to call the “liberal’s paradox) is that implementing a carbon price will necessarily be regressive – the burden of the tax will be felt disproportionately among lower-income households.  A price on carbon – whether it’s a tax or a permit system – will raise the price of carbon-intensive goods and services, such as fossil fuels and conventionally-generated electricity.  Low-income households spend a higher percentage of their income on fuel and electricity than do higher-income households.  What to do? It turns out that what you do with the revenue from the tax (“revenue recycling”) can moderate or even negate the regressivity of the tax.

The think tank Resources for the Future (RFF) has published a series of articles addressing this very topic.  I’m going to address three possibilities for revenue recycling.  Two of them have to do with reducing taxes on other things – shifting the burden from taxing economic “goods” (like income and labor) to taxing economic “bads” (like pollution).  (After all, if part of the point of a tax is to alter behavior, why tax good things like income and employment?)  The third has to do with returning the revenue directly to the people.  So I’m going to focus on three alternatives: tax carbon, but lower the tax on labor income; tax carbon, but lower the tax on capital income; and tax carbon, but return the revenue to the people in the form of a dividend or a lump-sum rebate.

RFF analyzed these three alternatives for their impact on different income groups to see which groups were “better off” after the tax and revenue-recycling scheme, and which were “worse off.”  (It’s important to note that RFF did not analyze the effects of reducing carbon emissions – the primary goal of the tax, after all! – on the welfare of each of these groups.  It’s well-known that low-income populations are the most sensitive to climate change, and therefore the group most likely to benefit from a reduction in greenhouse gas emissions.)

What they find, summarized, is this: the labor tax recycling scenario found that almost all groups ended up slightly worse off (the groups’ welfare or well-being declined by less than a half of a percent), but that the highest income group ended up with the biggest decline in welfare.  The capital tax recycling scheme benefited the highest income group, while generating a reduction in welfare for all other income groups of less than one percent.  And the lump sum rebate scheme benefited the lowest income group by more than three percent, while harming the highest income group by almost two percent.  From an efficiency perspective, the capital tax recycling scheme is the most efficient (that is, the policy that “distorts” the economy the least).

I’ll replicate RFF’s graphic here:

Source: 2015. Williams, Roberton C., Burtraw, Dallas, and Morgenstern, Richard. “The Impacts of a US Carbon Tax across Income Groups and States.” Washington, DC: Resources for the Future).

Why such differences?  Largely, it has to do with where individuals earn their income.  Generally speaking, high-income households get a larger percentage of their income from capital (stocks, bonds, and property), while middle-income people rely more heavily on income from labor.  Low-income people typically get a larger percentage of their income from transfer payments, which not only include food stamps and unemployment insurance but also Social Security.  That explains why lowering the tax on capital would exacerbate the regressiveness of the carbon tax, while lowering the tax on labor would be slightly progressive.

What about here in Maine?  I wasn’t able to get data directly for Maine, but only for New England as a whole.  As it turns out, all the schemes end up diminishing the welfare of New England residents, but the lump-sum rebate actually performs the worst.  Why?  The answer mainly has to do with the fact that, overall, New Englanders receive a relatively high percentage of their income from capital as opposed to labor.

How about Maine, though?  Is that the case? Looking at the Bureau of Economic Analysis for 2015, I noticed that Mainers as a whole received about 60% of their personal income from wages and salaries.  An additional 22.5% comes from personal transfer receipts, which include Social Security benefits, medical benefits, veterans’ benefits, and unemployment insurance benefits.  (By far the majority of these personal transfer receipts are retirement income and income from other benefits, excluding unemployment insurance benefits and income maintenance programs such as general assistance.)  A little less than 18% comes from capital and property income.

By contrast, Connecticut receives about 66% of its personal income from wages and salaries, 12.8% from transfer payments, and over 21% from capital and property. This implies that lowering the tax on capital would not benefit the average Mainer as much as the average person from Connecticut – but without doing the calculations, I can’t be sure whether the labor tax recycling scheme or the lump sum dividend would be more or less welfare changing.

Of course, the election on November 8 may have made this a moot point.  Passing a carbon tax (or fee, as some like to call it) has had a difficult time in the past, and the election of Donald Trump has made that possibility more remote.  Any action now is likely to arise at the state level – which is why state level analysis is crucial.  Climate change will likely have a disproportionate effect on those who are least able to protect themselves.  Any actions to mitigate climate change should not increase the injury.

The Social Cost of Carbon: Implications for Maine (Part I)

The Social Cost of Carbon: Implications for Maine (Part I)

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(This will be the first in a series of blog posts on carbon emissions, their costs and implications for Maine, and existing and proposed policy prescriptions.)

Last week, an article made the rounds entitled “the social cost of carbon“. This is of special interest to me right now, because I recently began teaching Environmental Economics at the University of Southern Maine. (Being a professor used to be my full-time job. Now I’m an economic and sustainability consultant, but teaching that class one day a week keeps me up to date on the most recent articles in my field.)

The concept of “social cost” in economics is nothing new, of course.  Economists have long recognized that the production and consumption of certain goods produces negative externalities, or costs imposed on “third parties” who are not directly involved in producing or purchasing that good.  Such externalities can be called social costs, and while it’s difficult to measure such social costs, environmental economists do their best (see, for example, my recent blog post on ecosystem services).

So why this new article on the social cost of carbon, and why is it taking on a new importance now? Because the social cost of carbon has now been upheld by a federal appeals court.

The details of the case are not particularly important for our purposes here. Suffice it to say that, every time a federal agency imposes a regulation, they are required to demonstrate that the benefits of the regulation exceeds the costs.  This particular case was about improving the efficiency of commercial refrigeration equipment.  But if the government (in this case, the Department of Energy) wants to tighten efficiency standards, they need to show that the costs of meeting the new efficiency standards aren’t exceeded by the benefits.

The costs of meeting the proposed standards are relatively easy to calculate. Refrigeration equipment companies might have to use new technologies or inputs, which are presumably more expensive than current methods. But how to calculate the benefits of tighter energy standards?  Enter the social cost of carbon.

The social cost of carbon is, according to the EPA, “meant to be a comprehensive estimate of climate change damages and includes, among other things, changes in net agricultural productivity, human health, property damages from increased flood risk and changes in energy system costs.” Yet the EPA admits that the social cost of carbon does not include all damages, because “of a lack of precise information on the nature of damages and because the science incorporated into these models naturally lags behind the most recent research.”

The economic and scientific calculations that went into arriving at  the social cost of carbon are mindboggling. The estimates used three well-known (well, well-known in certain circles) integrated assessment models that consider the linkages between climate processes and economic growth. These models translate emissions into atmospheric greenhouse concentrations, from there into changes in temperature, and finally from there into economic damages.

It is an ambitious undertaking, and some would say an impossible one. There are so many uncertainties in any step along that chain. For example, the models are ill-equipped to deal with non-linearities or “tipping points.”.  In addition, the damages from an additional unit of CO2 is unlikely to have a linear effect (as a price per ton of carbon would imply), but increase as more carbon is emitted into the atmosphere. Dealing with future costs is difficult as well, as it involves “discounting the future,” a sticky ethical and legal problem as well as an economic one.

I am of the school of thought that “some number is better than no number.” Yes, the social cost of carbon as it stands now is highly imperfect and probably a gross under-estimate of the full social damages caused by a ton of carbon dioxide in the atmosphere.  However, it is better than assigning a cost of zero, which would be the implicit price had the social cost of carbon not been considered.

This blog is supposed to focus on the links between the economy and the environment in Maine. So far this blog post hasn’t done that – but be  patient!. The next blog post will focus on some of the possible solutions in terms of mitigation of climate change via a tax or a trading scheme (specifically for Maine), and the last will sketch out what’s at stake for the state. Stay tuned!

Contact

Rachel Bouvier
rachel@rbouvierconsulting.com
207-272-8692