Cost Containment for Climate Policy Requires Linked Technology Policies

Safety valves, discretionary advisory boards, and other cost containment mechanisms enhance the political feasibility of stringent climate policy by limiting firms’ and households’ exposures to higher than anticipated costs associated with reducing greenhouse gas emissions. However, cost containment comes at a price; it increases the risk of climate-related damages and it also discourages investments in low-carbon innovation. Using a highly stylized model of the cost of climate policy, this paper finds that currently proposed cost containment mechanisms will increase emissions by 11–70% by 2030. Because these clauses limit the payoffs to innovation for low-carbon energy technologies, they will reduce our societal capacity to affordably mitigate climate change through technology improvement. If cost containment measures are to be employed at levels currently being discussed in policy debates, then complementary policies to invest in technology improvement directly, such as R&D, will be needed; crucially, they also need to be linked. One way to resolve the impasse between increased risk of damages and reduced incentives for innovation is to create a technology development fund with contributions indexed to the amount by which the market price for carbon exceeds the price cap. Simulations of such a proposal are used to show some of the anticipated impacts and point to important sensitivities.