Scarcity vs. Pollution in Public Policy toward Fossil Fuels

Most policy exercises that model the optimal control of greenhouse gas emissions have focused almost exclusively on the pollution problem in isolation from the fossil fuels scarcity problem. We argue that this approach misses important interactions between the two issues and, contrary to what is claimed, will lead to sub-optimal policies, at least within the framework of the models employed. To demonstrate, we employ an intertemporally optimizing model of economy and climate, with carbon resource scarcity and a backstop technology. Using plausible parameter values, we conclude that the initial resource shadow price is approximately twice the value of the pollution shadow price. Therefore, the optimal carbon tax is approximately three times what would be recommended if we focused solely on the pollution problem. This result is robust to changes in the values of key parameters, including the social discount rate and the backstop price.