An effective green policy needs sound economics

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There are plenty of weight-loss schemes promising quick, painless ways to shed pounds. If you want a surefire way to lose five pounds in one day – and keep it off – here's the solution: Have all your unnecessary body parts removed. Your appendix, wisdom teeth, extra ribs, pinkie toes, second kidney. Yank them all out and you'll be permanently five pounds lighter, guaranteed!

No one would do this of course, because the costs – financial and physical – would far outweigh the benefits.

Economists know all about this. Classical microeconomics teaches that the optimal point of production occurs when the marginal cost of producing the last good is equal to the marginal revenue (or benefit) received. In the example of surgical weight loss, the marginal cost (the cost of the operation and the physical recovery time) is far in excess of the marginal benefit (the advantage of weighing five pounds less).

So why is the U.S. Environmental Protection Agency talking about a new, ultralow-sulphur gasoline? In its proposed Tier 3 Motor Vehicle and Fuel Standards, the sulphur content in consumer gasoline would be reduced from the current 30 parts per million to 10 ppm starting in 2017. The idea is to reduce smog and improve health benefits for Americans.

It would have the desired results, no doubt, but do the marginal costs equate to the marginal benefits?

According to the EPA, the plan would add about 1 cent to the price of a gallon of gasoline, and about $130 (U.S.) to the price of a car, for a total cost to the economy of about $3.4-billion annually. Critics suggest the costs could be much greater. However, the EPA says the monetized health benefits would be between $8-billion and $23-billion annually by 2030 – a large and ill-defined range.

So, do the math. Assume that the health benefits are at the mid-point of the range –$15-billion a year by 2030. Given the known costs of at least $3.4-billion starting in 2017, it would still take decades for the plan to start paying off. If the costs were higher, and the monetized health benefits less, it would take longer.

Reducing emissions and improving air quality through legislation is critically important. But plans such as that for ultralow sulphur gasoline do it at a cost well in excess of potential benefits. It's the equivalent of removing your appendix to shed a pound of body weight. In terms of legislation to clean the air, there is much lower hanging fruit that would be far more effective – and at a far lower cost. Waiting until well into the 2030s to reap any health or economic benefits is simply too high a price.

Consider the U.S. coal-fired electricity system, which spews more carbon into the atmosphere than almost everything else combined.

Laws to curb coal-fired electricity by expediting conversion to natural gas would result in a much greater bang for the buck – the marginal costs would equal the marginal benefits much sooner. Legislators know this. Environmentalists know this. Business leaders know this. But few leaders are willing to tackle the coal industry head on because of the political fallout that would ensue.

The EPA's ultralow-sulfur gasoline proposal comes with less political risk. The auto makers might moan and groan because much of the burden of the program will fall on them through higher vehicle production costs (which will show up in the sticker price). But after the government bailouts a few years ago, the auto industry has little social or political capital to plead its case. And consumers probably won't wince at an extra penny per gallon.

Political ease, however, should not be the litmus test of good policy. Lawmakers need to tackle carbon emissions, air quality, and smog – but the actions taken need to produce results commensurate with their costs. Marginal costs should equal marginal benefits.

To every problem there is an economic answer, and then there's a political answer. Unfortunately, politics nearly always wins out.

Todd Hirsch is the Calgary-based chief economist of ATB Financial and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.