Equating marginal costs of carbon reduction and sequestration across the economy is an economically efficient solution in an idealized economy where all other prices appropriately reflect the real marginal cost of goods. Taxes, subsidies and unregulated externalities (positive or negative) result in prices not reflecting the full marginal cost of all inputs, and therefore an idealized policy that results in equating marginal costs of carbon reduction among countries or across sectors may not be the most cost-effective policy (Babiker et al., 2004; Paltsev et al.,
2005). Ancillary benefits of both carbon sequestration and emissions reductions are often cited. Emissions reductions by fuel switching may reduce the emissions of many other air pollutants (Matus et al.,
2006). Carbon sequestration may reduce soil erosion and leaching of agricultural chemicals, thereby reducing water pollution (e.g. Marland et al., 2005). Some fuels are taxed heavily in some countries (Paltsev et al., 2005); many countries have significant agricultural subsidies. All of these externalities and distortions mean that equating carbon prices across sectors and economies is unlikely to result in the economic efficiency the simple textbook story suggests. The 'first-best' solution in economics literature in these cases is to work to get rid of the other distortions by appropriately pricing other externalities or to reduce the distorting effects of taxation. Where these distortions are and how to get rid of them needs research and policy attention.
We would argue, however, that we need to avoid the often first impulse of adding a mark-up or mark-down on carbon prices from activities with different pre-existing distortions or ancillary benefits. The danger of such mark-ups or mark-downs is that the ancillary benefits or extra costs are likely to vary by fuel (in the case of fossil emissions) and by particular site and sequestration option for land use activities. The correct mark-up or mark-down will also likely change over time. Thus, it seems preferable to work towards fixing the other problems directly, and pricing the 'partial interest' in the carbon mitigation options for its climate benefit. Recognizing and pricing 'partial interests' is not a new concept (see Wiebe et al., 1996 for a careful discussion of pricing partial interests in land related to environmental goals). There may be reasons to make exceptions, but it seems preferable to keep the climate policy instrument clearly focused on climate policy rather than to use it to jointly solve a myriad other problems for which it may be a relatively poor instrument. Again the existence of ancillary benefits or costs is not unique to either land use sources or sinks.
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