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The Daly-Correa tax: background and explanation

Under the heading, “Oil nations asked to consider carbon tax on exports,” John Vidal writes in The Guardian:

The Ecuadorean president, Rafael Correa, proposed a carbon tax at a summit of Arab and South American countries in October in Peru which included the heads of state and energy ministers of nine of Opec’s 12 countries. The Guardian understands the proposal was taken seriously and not dismissed out of hand. The idea was first mooted in 2001 by former World Bank senior economist Herman Daly — leading it to be dubbed the “Daly-Correa tax” — and will be further discussed by Opec countries at the UN climate talks which open on Monday in Doha.

Whether or not it will be discussed at Doha, I think it is worthwhile to explain the idea as it was presented to an OPEC Conference in Vienna in 2001. It elicited little interest on that occasion, but in 2007 was in large part adopted by President Rafael Correa of Ecuador, after being presented to him and his minister of planning, Fander Falconi, by ecological economist Professor Joan Martinez-Alier. Below is the relevant part of my speech at the OPEC conference.*

How might OPEC fit into the emerging vision of sustainable development? Permit me to speculate.

Sources of petroleum throughput derive from private or public (national) property; sinks are in an open access regime and treated as a free good. Therefore, rents are collected on source scarcity, but not on sink scarcity. Different countries or jurisdictions collect scarcity rents in different ways. In the U.S., for example, Alaska has a social collection and sharing of source rents, institutionalized in the Alaska Permanent Fund whose annual earnings are distributed equally to all citizens of Alaska. Other states in the U.S. allow private ownership of sources and private appropriation of source rents.

New institutions are being designed to take the sink function out of the open access regime and recognize its scarcity (Kyoto). Tradable rights to emit carbon dioxide, requiring first the collective fixing of scale and distribution of total emission rights, are actively being discussed. Ownership of the new scarce asset (emission rights) could be distributed in the first instance to the state, which would then redistribute the asset by gift or auctioned lease.

Ideally sink capacity would be defined as a separate asset with its own market. This would require a big change in institutions. Assuming it were done, the source and sink markets for petroleum throughput, though separate, would be highly interdependent. Sink limits would certainly reduce the demand for the source, and vice versa. The distribution of total scarcity rent on the petroleum throughput between source and sink functions would seem to be determined by the relative scarcity of these two functions, even with separate markets. Alternatively, sink scarcity rent could also be captured by a monopoly on the source side, or source scarcity rent could also be captured by a monopoly on the sink side.

To give an analogy, municipal governments, in charging for water, frequently price the source function (water supply) separately from the sink function (sewerage), thus charging different prices for inflow and outflow services related to the same throughput of water. In deciding their water usage, consumers take both prices into account. To them it is as if there were one price for water, the sum of the input and output charges. Likewise the petroleum throughput charge would be the sum of the price of a barrel of crude oil input from the source and the price of carbon dioxide output to the sink from burning a barrel of petroleum. One could consolidate the two charges and levy them at either end, since they are but two ends of the same throughput. This would be a matter of convenience. Since depletion of sources is a much more spatially concentrated activity than pollution of sinks, it would seem that the advantage lies with levying the total source and sink charge at the source end. This is especially so since the sink has traditionally been treated as an open access free good, and changing that requires larger institutional rearrangements than would a sink-based surcharge on the source price. OPEC, given sufficient monopoly power over the source, would be well positioned to function as an efficient collector of sink rents for the world community.

Could it also serve as a global fiduciary for ethically distributing those rents in the interests of sustainable development, especially for the poor? OPEC, assuming it could increase its degree of monopoly of the source, may be in a position to preempt the function of the failing Kyoto accord by incorporating sink rents (and even externalities) into prices at the source end of the petroleum throughput.

Of course OPEC does not have a monopoly on petroleum, much less on fossil fuels. It does not, even indirectly, control non-petroleum sources of carbon dioxide. So it would be easy to overestimate OPEC’s monopoly power, and the scheme suggested here does require an increase in its monopoly power. However, modern mass consumption nations such as the U.S. apparently do not have the discipline to internalize either externalities or scarcity rents into the price of petroleum. Exclusion of developing countries from the Kyoto accord, while understandable on grounds of historical fairness, undermines the prospects for accomplishing the goal of the treaty, namely limitation of global greenhouse gas emissions to a sustainable level. OPEC, assuming it had sufficient monopoly power, might be able to provide this discipline for both North and South.

The South, as well as the North, would have to face the discipline of higher petroleum prices in the name of efficiency, but would, in the name of fairness receive a disproportionate share of the sink rents. There would be a net flow of sink rents from North to South. The size of those rents would depend on OPEC’s degree of monopoly power. The distribution of the rents would be in large part decided by OPEC — a large ethical responsibility which many would be unwilling to cede to OPEC, and which OPEC itself may not want. The obvious alternative to such a global fiduciary authority, however, has already failed. The inability to reach an agreement on international distribution of carbon dioxide emission rights was the rock on which Kyoto foundered. It is hard to see how such an agreement could be reached, either as a first step toward emissions trading, or as a fixed non-tradable allocation.

It is in OPEC’s self-interest to preempt the emergence of a separate market for sink capacity, which could surely lower source demand and prices. While this gives OPEC a motivation, it also calls into question the legitimacy of the motivation as pure monopolistic exploitation. A legitimating compromise, as indicated above, would be for OPEC to behave as a self-interested monopolist on the source side, but as a global fiduciary on the sink side — that is, as an efficient collector and ethical distributor of scarcity rents from pricing the sink function. OPEC countries own petroleum deposits, but not the atmosphere. OPEC has a right to its source rents, but no exclusive right to sink rents. However, it may well have the power to charge and redistribute sink rents as a global fiduciary — exactly what Kyoto wants to do, but lacks the power to do. In addition to effecting this transfer, the expanded role of OPEC as global fiduciary might increase the willingness of other petroleum producers (e.g., Norway) to join OPEC, thus increasing its monopoly power and ability to function as here envisioned. In addition, the fiduciary role might provide ethical reasons for OPEC members to adhere to the cartel, when tempted by short-term profit opportunities to cheat.

Actually the existing OPEC Development Fund is already a step in this direction. Expansion of this fund into a global fiduciary institution for collecting and distributing sink rents, as well as the existing source rent contributions generously made by OPEC countries, is what is envisaged in this suggestion.

Just how total rents are determined and divided between source scarcity and sink scarcity is a technical problem that economists have not tackled because they have not framed the problem this way. Economists have focused on capturing source rents through property rights, and then internalizing the external sink costs of pollution through taxes. Only recently has there emerged a theoretical discussion of property rights in atmospheric sink capacity — whether these should be public or private, the extent to which trade in such rights should be allowed, and so on. As an initial rule of thumb we might assume that, since the sink side is now the more limiting function, it should be accorded half or more of the total throughput scarcity rents. In other words, sink rents should be at least as much as source rents.

Sink rents would go to an expanded OPEC Development Fund dedicated entirely to global sustainable development in poor countries (especially investments in renewable energy and energy efficiency). Source rents would continue to accrue to the country that owns the deposits, and presumably be devoted to national sustainable development. The focus here is on a new public service function for OPEC of efficiently collecting and ethically distributing sink rents in the interest of global sustainable development. Where Kyoto has failed, OPEC might succeed as a stronger power base on which to build the fiduciary role — a power base that sidesteps the inability of nations to agree on the distribution of carbon dioxide emission rights among themselves.

Although any exercise of monopoly power is frequently lamented by economists, the early American economist John Ise had a different view in the case of natural resources: “Preposterous as it may seem at first blush, it is probably true that, even if all the timber in the United States, or all the oil, or gas, or anthracite, were owned by an absolute monopoly, entirely free of public control, prices to consumers would be fixed lower than the long-run interests of the public would justify.” Ise was referring only to the source function. The emerging scarcity of the sinks adds strength to his view. The reasonableness of Ise’s view is enhanced when we remember that for a market to reflect the true price, all interested parties must be allowed to bid. In the case of natural resources the largest interested party, future generations, cannot bid. Neither can our fellow non-human creatures, with whom we also share God’s creation, now and in the future, bid in markets to preserve their habitats. Therefore resource prices are almost certainly going to be too low, and anything that would raise the price, including monopoly, can claim some justification. Nor did Ise believe that the resource monopolist had a right to keep the entire rent, even though the rent should be charged in the interest of the future.

The measurement of the two different rents presents conceptual problems. The source rents are in the nature of user cost — the opportunity cost of non-availability in the future of a non-renewable resource used up today. Assuming that atmospheric absorptive capacity is a renewable resource, the sink rent would be the price of the previously free service when the supply of that service is limited to a sustainable level. If we assume separate markets in both source and sink functions we would theoretically have a market price determined for each function. Since the functions are related as the two ends of the same throughput, the source and sink markets would be quite closely interdependent. The separate markets could be competitive or monopolistic, and differing market power would largely determine the division of total throughput rent between the source and sink functions. For example, if, following a Kyoto agreement, the total supply of sink permits were to be determined by a global monopoly, that monopoly would be in a stronger position to capture total throughput rent on petroleum than would a weak cartel that controls the source. OPEC is surely aware of this.

What might the WTO and the World Bank think of such a suggestion? Since these two institutions are well represented at this conference, this question is more than just rhetorical. So far the WTO and the World Bank have been dedicated to the ideology of globalization — free trade, free capital mobility, and maximum cheapness of resources in the interest of GDP growth for the world as a whole, including mass-consumption societies. In their view maximum competition among oil-exporting countries resulting in a low price for petroleum is the goal. Trickle down from growth for the rich will, it is hoped, someday reach the poor. I suspect the free-trading globalizers consider themselves morally superior to the OPEC monopolists. But which alternative is worse:

  1. Price- and standards-lowering competition in the interest of maximizing mass consumption by oil-importing countries by minimizing the internalization of environmental and social costs with consequent destruction of the atmosphere, and ruination of local self-reliance by a cheap-energy transport subsidy to the forces of global economic integration, or
  2. Monopoly restraints on the global overuse of both a basic resource and a basic life-support service of the environment, with automatic protection of local production and self-reliance provided by higher (full-cost) energy and transport prices, and with sink rents redistributed to the poor?

Monopoly restraint results not only in conservation and reduced pollution, but also in a price incentive to develop new petroleum-saving, and sink-enhancing, technologies, as well as renewable energy substitutes. Unfortunately there would also be an incentive to use non-petroleum fossil fuels such as coal, which would be a very negative effect from the point of view of controlling carbon dioxide. Independent national legislation limiting emissions from coal (and natural gas) may well be a necessary complement.

Ideally most of us would prefer a genuine international agreement to limit fossil fuel throughput, rather than a monopoly-based restriction imposed as a discipline by a minority of countries only on petroleum. But the Western high consumers, especially the U.S. as resoundingly reconfirmed in its recent election, have conclusively demonstrated their inability to accept any restrictions that might reduce their GDP growth rates, even in the likely event that GDP growth has itself become uneconomic. The conceptual clarity and moral resources are simply lacking in the leadership of these countries. Perhaps the leadership reflects the citizenry. But perhaps not. The global corporate “growth forever” ideology is pushed by the corporate-owned media, and rehearsed by corporate-financed candidates in quadrennial television-dominated elections.

A lack of moral clarity and leadership in the mass-consumption societies does not necessarily imply the presence of these virtues in the OPEC countries. Do there exist sufficient clarity, morality, restraint, and leadership in the OPEC countries to undertake this fiduciary function of being an efficient collector and an ethical distributor of sink scarcity rents? As argued above, there is surely an element of self-interest for OPEC, but to gain general support OPEC would have to take on a fiduciary trusteeship role that would go far beyond its interests as a profit-maximizing cartel. But a strong moral position might be just what OPEC needs to gain the legitimacy necessary to increase and solidify its power as a cartel. Could such a plan, put forward by OPEC, provide a stronger power base for the goals that Kyoto tried and failed to institutionalize? Might the WTO and World Bank recognize that sustainable development is a more basic value than free trade, and lend their support? I do not know. Maybe the whole idea is just a utopian speculation. But given the post-Kyoto state of disarray and the paucity of policy suggestions, I do believe that it is worth initiating a discussion of this possibility.

If sustainability is to be more than an empty word we have to evolve mechanisms for constraining throughput flows within environmental source and sink capacities. Petroleum is the logical place to begin. And OPEC is the major institution in a position to influence the global throughput of petroleum.

* “Sustainable Development and OPEC,” Chapter 15 in Herman E. Daly, Ecological Economics and Sustainable Development, Edward Elgar Publishers, Cheltenham, UK, 2007.

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