Sitting right behind health care on the President's agenda is climate change legislation. Any meaningful change will take one of two forms: either cap and trade or a carbon tax. Republicans will attack this bill as raising taxes on working American families. And, in a very real sense, they will be right.

Ask yourself a question: why do we use fossil fuels now? Why doesn't everybody have solar panels and wind turbines? Cost, as always, is the answer. Energy from fossil fuels is cheaper to generate than energy from the sun. Yes, the fuel for solar energy is "free", but the cost of generation doesn't just include the raw fuel, but also the capital cost of the generation equipment. A typical coal power plant is a Kia, and solar panels are, say, a Jaguar. Or, if you prefer irony, a Hummer.

If the government wants to incentivize the purchase of green energy, then they either need to increase the cost of dirty power or reduce the cost of clean power to level the playing field. There are three mechanisms that they can use:

1)    Reduce the cost of the generation equipment with subsidies.
2)    Provide subsidies for the production of alternative power, increasing its value relative to dirty power.
3)    Increase the cost of dirty power through taxes.

That's it. Those are the variables that can be modified by the government. Either cap and trade or a carbon tax fall into category 3. In order for carbon to actually be reduced, the cost of carbon must increase until clean generation is cheaper.

Let me quickly address some typical complaints. First, liberals: "People are installing solar power right now! Why can't we all just do the right thing. No, not smash pizzeria windows with garbage cans. Why can't we all just buy solar panels and hold hands and make the world a better place?"

To which I reply, shut your pie hole, hippie. That's not how the world works. If you are willing to pay more for solar power than for dirty coal, then that's a luxury expense. If you can afford it, and that's how you want to spend your money, then you are free to do so. But people who can't afford it, or, more importantly, businesses that have to keep their prices low to remain competitive, won't impose this cost on themselves.

And conservatives: "It isn't the government's role to take MY money and give it to some hippies who want solar panels. I should be able to purchase whatever power is cheapest and let the market dictate whether or not alternative power should survive."

And I almost agree with that point of view, except that the current market evaluation ignores part of the cost of that cheap dirty power. Tim Harford, the official economist of ObscureCraft (since he is the only one I have read) talks in his book, The Undercover Economist, about the cost of externalities. The example he uses is driving. When I drive, there is a tangible cost to me: the purchase of the car, the maintenance, the gas, and the taxes. But when I drive, I impose on others. I clog up the streets, I help create traffic, I emit pollution, and sometimes (all the time) I drive like a total asshole. Each of those actions has a cost to others. Pedestrians and bicyclists are less safe, ice caps melt a little bit more, noise, etc. Clearly I am making other people less well off than they would have been if I didn't drive. I have therefore created a cost to them that I am not paying. This is called an externality cost.

In the example of power, the dirty power has an externality cost in climate change, the consumption of finite natural resources, and the global social cost of sustaining petro-dictatorships, to name a few examples. But these externalities are not built into the cost of dirty power. If we truly accounted for the full cost of dirty power, there's a good chance that renewable energy would come out ahead.

Climate change legislation will raise taxes on working families. It will increase the cost of dirty power until it becomes cheaper to buy clean power. That is what it must do to have any effect. But the extra cost for dirty power is a tangible representation of the externality cost we are already paying.

Actually valuing these externalities is one of the hardest questions in economics. In part 2, I'll talk about a California program that might have come up with an answer.