ECONOMIC REPORT OF THE PRESIDENT

will strain Federal fire suppression resources. In addition to these likely
increases in expenditures, climate change is expected to reduce economic
output and diminish Federal revenue. A recent report by the U.S. Office of
Management and Budget projects that the combined detrimental impacts of
climate change on Federal revenues and expenditures by 2100 could easily
exceed $100 billion annually, when the estimates are expressed in terms of
their equivalent percentage of current U.S. GDP (OMB 2016).
Addressing Externalities
The impacts of climate change present a clear economic rationale for
policy as a means to both correct market failures and as a form of insurance
against the increased risk of catastrophic events. Climate change reflects
a classic environmental externality. When consumers or producers emit
greenhouse gases, they enjoy the benefits from the services provided by
the use of the fuels, while not paying the full costs of the damages from
climate change. Since the price of goods and services that emit greenhouse
gases during production does not reflect the economic damages associated
with those gases, market forces result in a level of emissions that is too
high from society’s perspective. Such a market failure can be addressed by
policy. The most efficient policy would respond to this market failure by
putting an economy-wide price on the right to emit greenhouse gases. In
the absence of a uniform carbon price to regulate emissions, however, other
climate policy mechanisms can improve social welfare by pricing emissions
indirectly. For example, putting in place emission limits and incentivizing
low-carbon alternatives can make carbon-intensive technology relatively
more expensive, shifting demand toward less carbon-intensive products,
and thus reducing emissions. Energy efficiency standards can reduce energy
use, implicitly addressing the external costs of emissions and resulting overconsumption
of energy. Gasoline or oil taxes help to directly address the
external costs due to emissions from the combustion of oil.
Correcting Other Market Failures
Some policies to address the climate change externality have an additional
economic benefit from addressing other market failures. For example,
reducing carbon dioxide emissions through lower carbon electricity generation
often also reduces the emissions of local and regional air pollutants that
cause damage to human health, a second environmental externality.
There are also innovation market failures where some of the returns
from investment in innovation and new product development spill over
to other firms from the firm engaged in innovation. For example, there is
substantial evidence that the social returns from research and development
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