Marc Rigsby
Energy Law
Cap-and-Trade in the United States: What Type of System (if any) Should We Use?
What is Global Warming?
Global warming is the gradual increase in global average temperature. It is a controversial topic. Within the scientific community there is a general consensus that the Earth’s temperature has increased over the last several decades. The Environmental Protection Agency (EPA) reports an average surface temperature increase of about 1º Fahrenheit since the 1970s, and says that the Earth’s surface is “currently warming at a rate of about 0.29ºF/decade or 2.9ºF/century.”[1] Moreover, according to the EPA the eight warmest years on record (between 1880 and 2008) have all occurred since 2001.[2] However, despite the acknowledgment by many that the temperature is in fact rising, there is an ongoing and heated (no pun intended) debate regarding its cause.
What is causing the global average temperature to increase?
The conventional and oft-repeated story is that global warming is a result of human activity, or, more specifically, the increase in the concentrations of atmospheric greenhouse gases.[3] Greenhouse gases are global pollutants that contribute to climate modification by absorbing long-wave (infrared) radiation from the Earth, thereby trapping heat that would other radiate into space.”[4] Notable “greenhouse” gases include water vapor, methane, chlorofluorocarbons, and, most notably, carbon dioxide. Carbon dioxide is constantly and very naturally being emitted into the atmosphere by outgassing from volcanoes, combustion and natural decay of organic matter, and respiration of aerobic organisms.[5] However, the burning of fossil fuels (i.e., oil, coal, and natural gas for use in the transportation and industrial sectors) has lead to unnaturally high levels of atmospheric carbon dioxide, and thus, global warming.
Opponents (read: skeptics) have a different take. Scientists on the other side of the debate believe that global warming is nothing more than the result of “natural variability, where a planet goes through phases of warming and cooling.”[6] Regardless, if the temperature continues to increase it will have visible and potentially catastrophic consequences. For example, rising temperatures could lead to the melting of glaciers and a subsequent rise in the sea level, changes in weather patterns and the intensity and frequency of extreme weather events, as well as a changes in the composition of land biomes and biodiversity.
Whether or not human activity really is the culprit, the fear of anthropogenic global warming has been, and continues to be, at the forefront of the political arena. Liberal and conservative policy-makers alike have suggested various measures for reducing domestic greenhouse gas emissions, namely, by reducing our use of fossil fuels in favor of alternative energy sources. Although recent regulatory proposals have been unsuccessful (see below), I think that there is a regulatory framework which can effectively reduce the emissions of greenhouse gases - specifically, carbon dioxide - and simultaneously catalyze the alternative energy industry (which will have the effect of further reducing greenhouse gas emissions).
What measures have been proposed to control carbon dioxide emissions? Are there some already in place?
In June 2009, Democrats in the U.S. House of Representatives had passed a bill implementing a national cap-and-trade program. However, that bill ultimately died in the Senate.[7] In December 2010, the Obama administration again tried to push through alternative carbon controls, this time using the EPA and the Clean Air Act (CAA) as its vehicle.[8] However, the so-called “back door” carbon controls, as Republicans referred to it, was eventually shot down as well with the passing of the Energy Tax Prevention Act.[9][I’m confused – Obama signed this law?] In short, there is presently no national system, including cap-and-trade, for controlling carbon emissions in place within the United States.
However, there is a national cap-and-trade system for sulfur dioxide emissions - known as the Acid Rain Program - which, until recently, had a single, national trading system.[10] In 2011, the trading program was divided into four separate regional trading programs.[11] Another example of a cap-and-trade program in the United States - and one dealing with carbon dioxide - is the regionally based Regional Greenhouse Gas Initiative (RGGI). The RGGI is “a cooperative effort by ten Northeast and Mid-Atlantic states to limit greenhouse gas emissions. RGGI is the first mandatory, market-based CO2 emissions reduction program in the United States.”[12] Although the RGGI has its downsides (i.e., pricing every ton of carbon), it has also successfully reduced carbon emissions.[13] So while there is not a national carbon cap-and-trade program, nor any plans for one (regulatory or otherwise), there are models for a national system. [what about the European system?]
What are the options for controlling carbon emissions?
There are several types of incentive-based, policy options for controlling carbon dioxide emissions, including tax programs and various iterations of cap-and-trade programs.[14] Price-based incentives refers to taxes on emissions, which “would raise the cost of emitting greenhouse gases, thereby encouraging households and firms to cut their emissions as long as the cost of doing so was less than the tax. That approach would set an upper limit on the cost of emissions reductions (at the level of the tax) but would not ensure than any particular emissions target was met.”[15] On the other side, a quantity-based economic incentive system, such as cap-and-trade, would set an overall limit on the level of greenhouse gas emissions but leave the decisions of where and how the necessary reductions should take place to households and firms.[16] Under that approach, policymakers would establish an overall cap on emissions but allow regulated firms to trade rights to those emissions, called allowances. Trading allowances would permit firms that could reduce their emissions more cheaply to sell their excess allowances to firms that faced higher costs to reduce their emissions. Unlike a tax, there is a definite upper limit on the amount of emissions. Perhaps similar to a tax, however, is that the cost of reducing emissions could rise and fall depending on the economic and environmental climate, including “fluctuations in energy markets, the weather, and the technologies available for reducing emissions.”[17]
What is the best system?[how define best?]
Comparing a tax program with a cap-and-trade program, it is obvious that there are trade-offs to both. A tax program would certainly put an increased cost on carbon emissions, and therefore force firms to reduce their carbon-yielding production. However, the amount by which carbon emissions are reduced would not be completely certain because there is not a set cap. Instead, firms would produce as long as the costs of doing so were less than the tax and they would have the ability to produce beyond the desired threshold should they decide to absorb further costs. So, while carbon reductions would certainly be realized, the exact size of the reduction would be somewhat uncertain. On the plus side, a tax programs would be relatively straightforward - taxes are universally understood and could, theoretically, be adopted and put into effect quickly. A cap-and-trade model also has its advantages and disadvantages.
A cap-and-trade program would more successfully set an upper limit on carbon emissions, because each year the government would decide on a precise cap. Of course, the carbon emitting firms could always exceed the cap, but that is unlikely because they would have to pay a fine. Since they are already paying to emit, they would be hard-pressed to pay even more. Firms could certainly trade allowances back and forth and decide on their individual carbon emissions, but the aggregate level would be controlled and could more effectively be lowered to the desired level. One of the common criticisms of cap-and-trade programs is that they are difficult to understand and would likely be difficult to implement.[to whom would apply?] Although ordinarily it might take a while to put the system in place, successful cap-and-trade programs already exist throughout the country. With models like the U.S. Acid Rain Program and the RGGI, the infrastructures for pollutant monitoring, allowance distribution, and the like are already in place and may serve as models for a national system.
What are the variations of a cap-and-trade program?
There are several design decisions that must be considered in implementing a cap-and-trade program, for example, whether to implement the system upstream or downstream, how to allocate allowances (or permits), and if a “safety valve” and/or “circuit breaker” should be a part of the system.[18] Let’s first look at the downstream/upstream distinction. Downstream refers to the traditional approach of capping carbon emissions at the end-user level: at the factories where fossil fuels are actually combusted.[19][and at businesses and houses that use natural gas?] Upstream refers to where carbon is essentially entering the economy, “when fossil fuels are imported or produced domestically.”[20] [but what incentive is there upstream to become more carbon efficient?]The table below summarizes the advantages and disadvantages of both approaches.
Downstream / UpstreamEase of Implementation / Would require monitoring and regulating more entities, could be prohibitively expensive / Although carbon is ultimately emitted by hundreds of millions of sources, it enters the economy through a relatively small number of fossil fuel suppliers
Could cap virtually all fossil fuel based carbon emissions in the U.S. while minimizing government’s administrative costs and the private sector’s reporting costs
Carbon-Target Certainty / A system that was not extremely costly could cap only a subset of carbon emissions, while not limiting emissions from sources outside the cap / Could ensure economy-wide emission target would be met because it would cover virtually all sources of emissions
Cost-Effectiveness / A comprehensive downstream trading program would entail very high administrative costs / Would limit fossil fuel production, leading to higher prices for those fuels and for energy-intensive goods and services. The higher prices would give the entire economy incentives to reduce carbon emissions
[21]
Another design decision is how to effectively allocate allowances. There are two primary options for the allocation of carbon dioxide allowances. The government can give away allowances, or they can auction off the allowances. Furthermore, if they are given out it must be decided on what basis they are given out, for example, based on historical carbon emissions, anticipated carbon emissions, etc.[22] By auctioning off carbon allowances, policymakers could partially offset the so-called tax by using the revenues of sold carbon permits to lower some of the existing taxes. The money raised from auctions could also be funneled towards investments in alternative energy sources. This is one benefit to using an auction system. However, a cap-and-trade program is inherently regressive. [was this true for the sulfur program?]With a cap-and-trade system the relative price of energy-intensive goods will rise, and as a result the relative income of energy-intensive users will fall. In particular, less wealthy firms will spend a larger proportion of their income on purchasing carbon permits from other firms. If the auction system was used, it would only worsen the situation and make the effective regressive tax of carbon permits even steeper for these less wealthy firms. If, however, the permits were given away then it would help mitigate the regressive nature of carbon permits. [what about allocating to energy-intensive users – a wash?]
The final design question in a cap-and-trade program is whether or not a hybrid feature, such as a “safety valve” or “circuit breaker,” should be used.[23] A cap-and-trade program allows for the trading of allowances, thus creating a market for these “goods.” The price of these goods, like the goods in any other market, are subject to the whims of supply and demand. As the demand for carbon allowances increases, or as the supply decreases, the price will inevitably rise. With a “safety valve,” the government essentially sets a price ceiling on allowances.[24] If the price of allowances reaches a particular height, then the government will increase the supply of allowances (even if it means exceeding the cap) in order to maintain the price level. The “safety valve” makes sure that carbon allowances do not become prohibitively expensive, and it ensures continued economic growth.
A “circuit breaker” operates a little bit differently. With any cap-and-trade system, the government will gradually lower the overall cap of carbon emissions. When the cap is lowered, the supply of allowances decreases and, consequently, the price of an allowance may increase as a result. In some instances, the cap (or, supply of carbon allowances) may be lowered too fast and cause the resulting price to become prohibitively expensive. With a “circuit breaker,” the government again sets a trigger price. However, rather than flooding the market with allowances to maintain that trigger price, when the market price of an allowance hits the trigger price the government simply freezes the carbon cap level. By stalling any further reductions in the overall cap, the government allows demand to catch up with supply, and waits for the price to drop. The price may temporarily stay above the trigger price, but ultimately it will go back down as firms adjust their practices (and emissions). When the allowance price returns to a level safely below the trigger price, the government will resume reducing the carbon cap.
What system should we use in the United States?
I think that the U.S. should implement a national [downstream?] cap-and-trade program for controlling carbon emissions. I am aware of its potential economic effects - the price of energy will increase, and that will, in turn, trickle down and be passed on to businesses at every level, as well as consumers. However, the negative economic effects would only occur in the short-run. In the long-run, not only would the country (and world) be better off because of our reduced carbon emissions - which could help curb global warming - but I think our economy would be better off as well. There are a few reasons I believe this is the case. First, by forcing firms to reduce their carbon emissions, we are forcing them to operate more efficiently. A more efficient firm saves money. Second, and more importantly, by forcing firms to reduce their carbon emissions (and thus increasing the price of fossil fuels) we are simultaneously encouraging the use alternative energy sources. This will have the effect of catalyzing the alternative energy industry, because wind energy, solar energy, geothermal energy, and every other “alternative” type of energy will become more attractive. Alternative energy sources represent a huge industry whose growth can help boost employment and the economy.
I also have an opinion on the design decisions that we should utilize. I think that the U.S. should cap carbon going upstream, because it appears far simpler, and because the psychological effect of knowing our fossil fuel inputs are being limited should further spur development in alternative energy. [what is being traded?] I think allowances should be auctioned, because although it might help the exacerbate the regressive nature of the carbon “tax,” the profits generated can, again, help fund alternative energy sources and potentially offset government taxes in other areas. Finally, from a policy standpoint I prefer the “circuit breaker” to the “safety valve,” because the latter seems like a system that could be abused as firms demand more permits and drive up their price until the government is forced to flood the market with more permits, which is counter-productive.
How should we implement it?
This is essentially a question of legislation versus regulation. I mentioned earlier that Obama tried to pass a bill [he let it die in the Senate after three Senators, including Lindsay Graham, were willing to support it]through Congress which would have implemented a carbon cap-and-trade system. The bill ultimately failed. The EPA subsequently tried to control carbon emissions via direct regulation under the CAA. Thus far it has been blocked from doing so. But what is the better approach? The downsides to regulation are numerous: “Regulation by the EPA requires plant-by-plant determinations. Numerous industries would be caught in the regulatory web. Levels of control technology would have to be set in individual rulemaking proceedings for specific industries that would be time consuming and contentious. One unstated assumption...is that litigation - perhaps slowing progress for years - would inevitably follow.”[25]