09/30/2013 07:16 EDT | Updated 11/30/2013 05:12 EST

Want Cheaper Alternatives to Fossil Fuels? Tax the Product That's Actually Causing the Harm

Climate change is a market failure. To address it, you need to understand the concept of externalities. These are costs or benefits that result from the use of a product but are not reflected in that product's price. In the context of fossil fuels, we often hear these expressed as "hidden costs".

Let's take a moment to explore an example of an externality by looking at a litre of gasoline that costs a consumer $1.35 at the pump. In this price are various costs that the producer had to incur to bring the product to market. The company had to pay for machines, labour, and energy to extract the oil. They had to ship it, refine it and bring it to retailers. On top of all these costs is a profit margin and taxes. In the end, this is what makes up the $1.35/L price to the consumer.

But there are a variety of costs associated with our use of gasoline that are outside of this $1.35/L. For example, our use of fossil fuels contributes to climate change, which causes a rise in sea level and necessitates the spending of billions of dollars in upgrades to our coastal infrastructure. This is a cost that should be reflected in the price of fossil fuels but has been externalized and is instead paid for by all of us. Carbon taxes and cap-and-trade regimes seek to internalize these harms to convey the "true cost" of the product to the marketplace.

While many of us dislike the idea of paying taxes, we are actually already being taxed for our fossil fuel use by collectively paying for upgrades to our infrastructure. Taxing the product that's actually causing the harm would cause markets to shift; we would become more interested in seeking less costly solutions to meet the needs that are presently being met by fossil fuels.

If you're serious about letting markets work, something like a carbon tax becomes a no-brainer. Governments who fail to implement such measures are aiding and abetting market failure.

2013-08-13-Nozzle_rounded_corners_low.jpg But pricing the concrete and rebar used in upgrading our infrastructure is only part of the picture. My organization asks: how do we capture externalities like the loss of a species or human suffering? While economists have developed models for pricing life, we question whether price is the optimal vehicle for communicating these externalities to the marketplace.

It seems that, in order for arguments to be taken seriously, our system requires us to calculate the economic impact of the loss of a species instead of recognizing its intrinsic value. We shoe-horn values like the survival of a species or human well-being into price instead of acknowledging that price is an inadequate language for communicating these values. Our idea of putting warning labels on gas nozzles is simply a qualitative way of capturing and communicating externalities to the marketplace.

Interestingly, there is research that shows pricing certain externalities may even turn off moral behaviour. When daycares in Israel began fining parents for being late, they found that lateness actually increased:

"Certain cues can switch moral behaviour on or off," says Samuel Bowles, director of the Behavioural Sciences Program at the Santa Fe Institute in New Mexico. "Charging for things often switches off moral behaviour." Bowles concluded that fines can undermine a parent's sense of ethical obligation to be on time for the teachers. And lateness becomes "just another commodity" to purchase.

Our choice of policy tends to be guided by our worldview. If we believe that we are self-interested, wealth-maximizing beings, then we'll likely build from this foundation to advocate for pricing tools. But if we also believe that we are moral, empathetic beings who care for the well-being of others, then we may develop a complementary instrument like our warning labels.

But what if, conversely, our choice of intervention also nurtures a particular worldview? I think this is where our idea can contribute to an important cultural shift.

Price signals affect our wallet; they answer the question "How does this affect me?" Our qualitative signal answers the question, "How does this affect others?" While both approaches capture and convey the hidden costs of fossil fuel use, each approach nurtures a different focus. Albert Einstein wrote:


A human being is a part of the whole, called by us "Universe," a part limited in time and space. He experiences himself, his thoughts and feelings as something separated from the rest, a kind of optical delusion of his consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest to us. Our task must be to free ourselves from this prison by widening our circle of compassion to embrace all living creatures and the whole of nature in its beauty.

Perhaps at the heart of the climate crisis and various global challenges is a failure to appreciate Einstein's observation. While I believe we need a carbon tax or some form of pricing mechanism to address this market failure, I also think that our warning labels can play a crucial complementary role. They widen our circle of compassion by highlighting and nurturing this sense of interconnectedness. I believe they will contribute to a cultural shift that will help us create a better world for ourselves, our children and our grandchildren.