Some limitations of carbon taxes

Gar Lipow, a writer with the online environmental magazine Grist, wrote a good critique of carbon taxes back in November 2006. He basically explains the price inelasticity of energy demand issue in more detail, and argues that carbon taxes aren't as efficient as standards, regulations and public works programs for achieving changes in energy use that require a lot of capital investment. His conclusion - carbon taxes are at best a supplementary measure rather than a climate change silver bullet, and they need to be applied judiciously.

Here is a more detailed summary of the points he makes about inelasticity (apologies for any economics mistakes):

Capital versus operating costs: Price signals such as a carbon tax will affect short term operating cost decisions more than capital investment decisions. The price inelasticity of energy capital cost decisions is very high (around 60%) according to Lipow. And the problem is, many of the big choices we need to make as a society to reduce greenhouse gas emissions are capital-intensive, and in fact replace operating costs with capital costs. For example, insulating an old house requires a big initial expense but pays for itself through operations savings.
Lipow argues that in many cases it would be cheaper for consumers and society to achieve these changes through public works programs and standards rather than raising energy prices to the point where the market finally makes the same changes.

Why are capital investments so insensitive to the price of energy? Lipow covers this in some detail. Here are his factors:

1. Split incentives. Landlords pay for insulation, but renters pay for heating, for example. Under the same category, limited access to capital. Homeowners may not want to take out a big loan for a capital investment because they need to keep their credit margin for other contingencies.
2. Corporate split incentives - Situations where the decision-maker in a position to invest in energy capital costs won't receive the benefits from reduced operating costs (they will go to another department, etc.)
3. Noise - the fact that for many purchasing decisions, energy use is only one of many factors, and not the deciding one. Home buyers, vehicle purchases, etc.
4. Chicken-egg situations
1. a technology (for example solar) could be made cheaper once production passes a certain threshold, but it can't because as existing scales, its too expensive to generate a market. The solution Lipow proposes - massive government funded large scale production, bringing down costs to the point where solar can get a larger market scale. At this point, in theory, other manufacturers come in and the market generates its own momentum. The initial government plant doesn't have to be that efficient - its more like a sacrificial lamb to break the deadlock.
   
2. a large-scale infrastructure-intensive technology that has been proven at the model level, but requires actual adoption by a large municipality/regional government to be actually proven. Lipow refers to a transit technology called Cybertran.
   

Link to the Grist article.