The Public Financing of Climate Resilience Investments
An Analysis of the Biden Administration's New Proposed Investments
When you buy a pizza, you pay for it using your after-tax earnings. When you buy an air conditioner, you pay for it using your after-tax earnings. In places where it has been traditionally cool in summer, such as Berkeley California, more people are installing central air conditioning to protect themselves from rising summer heat. These private investments payoff on hot days because one’s home is more comfortable with such indoor temperature control.
Going forward, a larger share of our tax dollars will be used by Government at the State and Federal level to pay for local public goods to protect nearby residents and their real estate from climate risks such as flooding and extreme weather.
What role should the Federal Government play here? This point takes on new importance as the Biden Administration announces its intent of putting large amounts of $ into paying for local resilience projects.
Back in 2017, I wrote a detailed Hamilton Project Paper exploring the challenge of protecting urban people and urban places from rising climate risk. I want to repeat several of the key points here.
Point #1
The Federal Government has the human capital and the scale of cumulative experience to help local governments tailor the right civil engineering solution to mitigate the challenge their specific area faces.
Point #2
Federal $ is not free. Someone must be taxed to raise that $. In effect, the Federal Government is taxing economic activity on “higher ground” to subsidize protection of places at risk. To a microeconomist, this smells bad. In an extreme case of enormous subsidies to the risky areas whose infrastructure needs to be upgraded, everyone would move from the higher ground to the risky areas! Peltzman!!
Point #3
Economists study fungible budget constraints. A cynic might wonder whether the Biden Administration is proposing a set of projects that spatially target areas where voters in the 2024 Presidential Election swing areas live. Is this a type of vote buying? Will the areas receiving these projects now invest less of their own $ on resilience projects because they can now bill the Federal Government? As areas are encouraged to spend “other people’s money”, does this crowd out spending their own money on climate resilience? Municipal bond markets exist and localities can borrow $ to finance their resilience goals.
Point #4 I discuss poor areas at length in my 2017 piece. These areas have the least capacity to invest in resilience public goods. My 2023 co-authored piece highlights the challenges these areas face. In reading this entry, I want you to be thinking about non-poor areas.
Given that real estate owners in at risk areas ultimately bear the economic incidence of playing defense against threats ranging from crime to flooding, property owners should be paying for their own local and regional defenses. State governments have the capacity to internalize cross-boundary externalities and the state Governor has the right incentive to use his/her clout to encourage local public goods co-ordination.
The Federal Government should offer its expertise but every state has the fiscal capacity to finance its own defenses.
If poor people face significant risks in the areas they live, the Federal Government could pay for housing vouchers to allow the poor to migrate to higher ground and rent properties in other areas.
A FINAL POINT. If areas are encourage to pay for their own defenses, then they have the right incentives to confront the fundamental tradeoffs of how they spend their own money. If an area chooses to invest little in coastal defense, then the key here is to avoid the asymmetric information issue. Potential migrants and potential home buyers in the area will have to do their homework about whether the area is risky or not. A climate risk rating industry is taking shape now. They are key players in educating us about the new geography of risk.
If we are “adults”, then we do our homework before we invest and move our families to an area. We vote for elected officials who use our tax $ responsibly and invest in those projects whose present discounted value of expected benefits exceed the upfront costs. We rely on the Federal Government for expertise. We do not rely on the Federal Government to send us “free money” (which represents the tax revenue from others in the economy).
Climate change adaptation should not be used as an implicit approach to redistribute income. The policy decision over the optimal redistribution of income should be separated from the challenge of adapting to climate change.