Discounting a future of global warming

It's safe to assume that when Theresa May decided to announce yet another freeze in fuel duty last week she was thinking of her own political survival rather than the survival of the white lemuroid ringtail possum, or the thousands of other animal species on the planet which are facing extinction due to fossil-fuel driven global warming.

It seems reasonable to speculate that her own political welfare loomed somewhat larger in her calculations than the economic welfare of as yet unborn generations of Britons. Depressing it may be but such shorttermism is hardly unusual. It's innate to our species. As humans we place a higher value on jam today than jam tomorrow. We generally value our own welfare more highly than that of generations to come. We "discount" the future.

The more mature among us moderate our discounting, understanding that we will, probably, be around to live with the consequences of spending like Liberace in 2018. Most of us care about the living standards of our children and their children. But the reality is that we all discount.

Should we expect something different from policymakers? Shouldn't we expect them to take the long view, or at least to give the impression of doing so? The answer is yes, but not an unqualified one.

In 2006 a landmark UK government-commissioned report into the economics of climate change by Nicholas Stern used a (virtually) zero discount rate to put a price on the future economic damage threatened by a warming planet. Stern's cost-benefit analysis yielded the firm conclusion that urgent action to reduce emissions was warranted, even if it entailed a sizeable short-term economic cost in terms of investment in low-carbon technology and taxes on fossil-fuel pollution.

Yet William Nordhaus, who was awarded the Nobel economic gong by the Swedish Academy of Sciences on Monday for his pioneering modelling of climate feedback effects on the global economy, was unhappy with Stern's discount rates. He suggested that using a zero discount rate implied that we would take vastly expensive action today to forestall a negative economic event in 200 years' time - even though, assuming humanity survives that long, our descendants will probably be far wealthier than us.

Stern, said Nordhaus, "would justify reducing per capita consumption for one year today from $10,000 (£7,600) to $4,400 in order to prevent a reduction of consumption from $130,000 to $129,870 starting two centuries hence and continuing at that rate forever after." Which sounds like lunacy. But two can play that game of using assumptions to yield ridiculous-sounding conclusions. As Stern has countered, if one uses a discount rate of just 2 per cent "a life starting 35 years later, but otherwise the same, would have half the value of a life starting now".

Economics can't tell us the answer of what discount rate to choose when setting up a cost-benefit analysis of a policy like climate change mitigation. How highly we should value the welfare of future generations is a philosophical question.

So are we stuck? Thankfully, no. Since the Stern review was published 12 years ago the estimates of the potential economic damage of climate change have been revised upwards. We know more about potential "tipping points", after which things get very bad very quickly. The costs of action have also fallen as the cost of renewable energy generation, particular solar power, have come down. Even applying somewhat higher discount rates does not undermine the case for action today. Nordhaus has revised up his estimates of the damage from carbon pollution significantly in recent years.

Nordhaus recommends a straightforward uniform global carbon tax to curb emissions. Other economists prefer a cap and trade system of pollution permits. But provided the cap is set at an appropriately low level - and provided its coverage is sufficiently global - this should have the same impact as a tax. The key is action to make sure that businesses and households internalise the cost of pollution and change their behaviour. Think about the Conservatives' irresponsible nine years of frozen fuel duty in this context.

The climate science points in one direction, as this week's updated warning from the United Nations' Intergovernmental Panel on Climate Change. So does the economics, thanks to the work of the likes of Nordhaus and Stern. The blockage is politics.

Theresa May is right not to offer subsidised social care to well-off pensioners

It's a strange world we live in where the Tory Prime Minister scraps a subsidy for wealthy families and Labour complains that it's terribly unfair.

But that's what has happened last week with the Tory manifesto's unexpected move on social care, where Theresa May ditched the idea of capping the amounts an individual has to contribute before the state picks up the remaining tab.

It wasn't just Labour that didn't like it. Some Tory candidates are beginning to grumble, perhaps unsurprisingly given their natural support base. But the heavyweight intellectual opposition came from Sir Andrew Dilnot, the distinguished economist who chaired a major review of social care for the Coalition, who told the BBC that the removal of the cap means the system "is not providing insurance" and will "leave people helpless".

Yet "insurance" here requires some definition. What Dilnot meant is that without a cap on out-of-pocket care costs it will prove impossible for private insurance firms to design a product which will enable individuals to insure themselves against the possibility they will require expensive care in old age.

However, another element of the Conservative proposals guarantees that at least £100,000 of an individual's wealth will be ring-fenced from being used up in care charges. That seems a rather generous state insurance of assets, certainly relative to the existing effective protection of around £23,000.

The Conservative proposal may not be facilitating the type of insurance on individual care expenditure that Dilnot thinks is appropriate. But that's a case to be made, not a conclusion to be simply asserted.

It helps to look at the numbers. Around one in 10 elderly people will need to spend more than £100,000 on their care costs, with some facing costs as high as £300,000. But the median wealth of people in their seventies, the age when they are most likely to need social care, is only around £150,000. Under the Conservative reforms, the majority of elderly people who need extensive care towards the end of their life would not face any significant out-of-pocket payments. The state would end up providing for them.

What Dilnot is lamenting is the dent to hopes of seeing the creation of a private insurance market that would primarily be of benefit to those with significant assets, mainly high-value houses in the South of England. One might wonder whether providing state-sponsored risk pooling for Home Counties pensioners ought to be a Government priority. But let's imagine it was. Providing that support certainly wouldn't be free.

Dilnot proposed a £35,000 cap on out-of-pocket costs that would have required around £2bn a year of additional taxpayer funding. The Dilnot Commission's own estimates show that the biggest beneficiaries of the cap would be the wealthiest fifth of pensioners by income. 

But who would pay? Perhaps it might be funded by an increase in inheritance tax, as various think tanks have proposed. This would be socially equitable since the ones footing the bill - rich families in the South - would also be the beneficiaries of the social care reform. Remember, people cannot take their wealth with them when they die. The "insurance" we are talking about is, in the main, insurance of their children's inheritances.

Yet political reality intrudes here. There's nothing in the Conservative Party manifesto about inheritance tax. And new rules introduced by David Cameron and George Osborne mean that people will relatively soon be able to pass homes worth up to £1m to their children entirely tax-free. 

For all their redistributive fervour, there's actually nothing in the Labour manifesto about inheritance tax either. It's not on the political agenda. This is not an irrelevant detail. It has a direct bearing on the distributional impact of any government policy that subsidises social care for the better off.

Policies should not be evaluated in isolation. The bottom line is that socialisation of the risk of large care bills, as Dilnot is urging, in the absence of any increase in inheritance tax will mean larger inheritances: an increase in the flow of expensive homes passed down tax-free from parents to children.

A taxpayer-funded subsidy to the rich is objectionable enough. A subsidy that will have the effect of increasing already high levels of wealth inequality and which feeds our damaging national obsession with inherited property would be even more so. Unless she is going to reform inheritance tax, we should be relieved that May has chosen the less regressive option on social care.