Economics

Advancing public and private policymakers’ understanding of the complex interactions between climate change and the economy is critical to taking the most cost-effective action to reduce greenhouse gas emissions. Read More
 

Welcome To Our Blog

Welcome to our new blog. This blog presents ideas and insights from the Center and its experts on topics critical to the climate conversation. These topics include domestic and international policy, climate science, low-carbon technology, economics, corporate strategies to address climate change, and communicating these issues to policymakers and the public. Our bloggers include policy analysts, scientists, economists, and communication specialists – all of whom are working to advance solutions to our climate and energy challenge.

Thank you for visiting our blog, and check back often for more timely posts.

Tom Steinfeldt is Communications Manager

New Administration Puts Carbon Reduction on the Agenda

Featured in MetalMag's June edition.  See page 66.

New Administration Puts Carbon Reduction on the Agenda

By Andre de Fontaine

During the past decade, climate change steadily has moved up the political agenda. Now, with a new administration in Washington, D.C., that has demonstrated a clear commitment to action, comprehensive climate-change legislation appears ripe for passage within the next couple years. As a result, many industries are appropriately wondering what the new regulatory environment will mean for their businesses.

First, it is important to note that reducing greenhouse-gas (GHG) emissions will impose a cost to society, though that cost is likely to be small and manageable within the context of the overall economy. These costs must also be balanced against the costs of unabated climate change, which are projected to be much greater than taking action now. Still, there likely will be distributional impacts as the U.S. transitions to a low-carbon economy, with certain industries being able to handle the transition with greater ease than others.

The green-building industry widely is expected to be a major beneficiary of public policies to reduce greenhouse-gas emissions because policymakers recognize two related facts. First, the country’s existing buildings are major contributors to climate change, accounting for about 43 percent of U.S. GHG emissions; and second, a number of low-cost mitigation options available involve improving the efficiency of new and existing buildings. Additionally, as the nation is mired in a serious economic downturn, efforts to stimulate the economy are increasingly focused on green buildings as a major source of new jobs in the coming years.  For example, the recently enacted American Recovery and Reinvestment Plan of 2009 contained billions for weatherization assistance for low-income households, grants for states to improve the efficiency of residential, commercial and government buildings, and tax credits for energy efficiency improvements to existing homes.

While these stimulus provisions will benefit the green building sector in the near term, longer-term policy, in the form a cap and trade system for GHGs is also on the horizon. How does a cap-and-trade program work? The government sets an annual cap on allowable emissions, which declines over time. It then distributes allowances to entities– free of charge, through an auction, or a combination of the two – to entities included in the program. These typically are major emitters, like power plants and large manufacturing facilities. The total number of allowances distributed must match the total emissions allowed under the cap. 

Regulated firms must hold and submit to the government one allowance for each ton of GHGs they emit. This creates a market for allowances—a carbon market—and an economic incentive for firms to reduce emissions. Those that easily can cut emissions can position themselves to purchase fewer allowances and/or sell excess allowances to firms that face higher reduction costs.

Buildings would not be directly regulated under the cap, but they could be impacted by increases in electricity and fuel costs attributable to the price of carbon. These higher energy prices will, over time, make investments in efficiency more attractive in the buildings sector.

This year the prospects for aggressive government action appear better than ever. President Obama has made clear his commitment to cap-and-trade legislation and related clean-energy policies, and key members of the U.S. Congress have pledged fast action in moving climate change legislation forward. Adding to the momentum for action is a strong push from the business community. This especially is noticeable in the advocacy efforts of the U.S. Climate Action Partnership, a unique coalition of 25 businesses and five nongovernmental organizations that is calling on Congress to pass comprehensive climate legislation this year.

Even as the country faces a significant economic challenge, business and political leaders increasingly are vocal about their commitment to addressing climate change--not at a later date, but right now. The green-building industry uniquely is positioned to ride this wave and make a major contribution in the country’s transition to a low-carbon future.


Andre de Fontaine is a Markets and Business Strategy Fellow at the Pew Center on Global Climate Change.  He works with the Center's Business Environmental Leadership Council (BELC), a group of 43 largely Fortune 500 corporations that have partnered with the Pew Center to address issues related to climate change.  He also engages in Pew Center analytic work on climate-related markets and investment issues.

 

(See page 58 for the article)by Andre de Fontaine, Markets & Business Strategy Fellow— Appeared in Eco-Structure magazine, June 2009
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Eileen Claussen discusses the costs of cap and trade

OnPoint Interview with Eileen Claussen
Tuesday, June 9th, 2009

Watch the interview here.
Watch Video

With a number of studies showing varying statistics on how much a federal cap-and-trade program will cost the average American, how can Congress accurately assess the true impact? President of the Pew Center on Global Climate Change, Eileen Claussen, breaks down the numbers and discusses disparities among the studies. She explains why she does not believe there is an economic argument against cap and trade and gives her take on how inaccurate numbers and modeling may negatively affect Americans' perception of climate legislation.

 

Maintaining Carbon Market Integrity: Why Renewable Energy Certificates Are Not Offsets

Maintaining Carbon Market Integrity: Why Renewable Energy Certificates Are Not Offsets

A brief by the Offset Quality Initiative
June 2009

 

 


Brief

Executive Summary

This brief explains how and why renewable energy certificates (RECs) differ from greenhouse gas (GHG) emission offsets (offsets). While the Offset Quality Initiative (OQI) is a strong supporter of renewable energy and believes it has a critical role to play in addressing climate change, OQI does not believe that RECs sold in voluntary green power or mandatory renewable energy portfolio standard (RPS) markets should be treated as equivalent to GHG offsets. REC programs fail to meet two basic definitional requirements of emissions offsets: First, they do not adequately establish a clear and unambiguous claim of ownership to emission reductions. Second, they fail to adequately establish that RECs are associated with offsetting emission reductions. Specifically, REC programs do not ensure that emission reductions are additional to what would have occurred in the absence of a REC market.

In order to ensure that markets for RECs function appropriately and do not undermine the effectiveness and integrity of markets for GHG emissions reductions, OQI recommends the following:

  • RECs should not be treated as equivalent to GHG offsets.
  • The definition of a REC should be clearly established and consistently applied. A suggested definition would be the following: “A Renewable Energy Certificate (REC) is the unique and exclusive proof that one megawatt-hour of electricity has been generated from a qualified renewable resource connected to the grid.”
  • It is inappropriate to treat RECs as an environmental commodity that conveys ownership of indirect “emission attributes” such as GHG emission reductions. OQI strongly recommends against the inclusion of indirect or derived “environmental attributes” or “benefits” in any definition of a REC, including those used in the various certificate tracking systems (e.g., Generation Attribute Tracking System [GATS] and Western Renewable Energy Generation Information System [WREGIS]).
  • Purchasers of RECs should not make GHG emission reduction claims associated with the retirement of RECs.



In addition to the Pew Center on Global Climate Change, OQI members include The Climate Trust, Climate Action Reserve (formerly CCAR), Environmental Resources Trust/Winrock International, Greenhouse Gas Management Institute, and The Climate Group. OQI was founded in November 2007 to provide leadership on greenhouse gas offset policy and best practices. OQI is a collaborative, consensus-based effort that brings together the collective expertise of its six nonprofit member organizations.

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Press Release: Analysis Projects Modest Competitiveness Impacts Under Cap and Trade

Press Release - May 6, 2009

Contact: Tom Steinfeldt, (703) 516-4146 

Press Teleconference Audio


PEW CENTER ANALYSIS PROJECTS MODEST COMPETITIVENESS IMPACTS
UNDER A U.S. GREENHOUSE GAS CAP-AND-TRADE PROGRAM

Report Outlines Policy Options to Ease Potential Impacts
on Energy-Intensive Manufacturers

Washington, DC – A close look at the historical relationship between energy prices and U.S. production and consumption of energy-intensive goods suggests that energy-intensive manufacturers are likely to face only modest “competitiveness” impacts under a U.S. greenhouse gas cap-and-trade program, according to a new analysis released today by the Pew Center on Global Climate Change.

The Pew Center study projects that U.S. energy-intensive manufacturing industries would on average lose 1 percent of their annual production to imports assuming a CO2 price of $15 per ton in the United States and no carbon price in other countries.  Both the U.S. Energy Information Administration (EIA) and the Environmental Protection Agency (EPA) have projected CO2 prices of approximately $15 per ton under cap-and-trade programs proposed in Congress.

The authors conclude that the projected impacts can be addressed through policies targeted to energy-intensive sectors.  They outline a range of policy options, including: compensating energy-intensive sectors covered by a mandatory cap for their regulatory costs; excluding those sectors from the cap-and-trade program; and using border adjustment measures to equalize costs for domestic and imported energy-intensive goods.

“This is one of the most sophisticated efforts ever to quantify the potential competitiveness impacts on energy-intensive industries.  The analysis shows clearly that, at the price level studied, the potential impacts are very modest and very manageable,” said Pew Center President Eileen Claussen.  “Policymakers have a range of policy tools to mitigate the modest economic impacts that may be foreseen.  The bottom line is that fear of competitive harm should not stand as an obstacle to strong climate policy.”

The report is authored by economists Joseph E. Aldy and William A. Pizer, who were affiliated with Resources for the Future, a think tank in Washington, D.C., at the time the analysis was undertaken.  Both have since taken positions in the federal government.

The report, “The Competitiveness Impacts of Climate Change Mitigation Policies,” bases its projections on an econometric analysis of the historical relationship between fluctuations in energy prices and shipments, trade, and employment within energy-intensive manufacturing industries.  The analysis draws on 20 years of data for more than 400 energy-intensive subsectors.

Based on the historical relationships identified, the authors estimate the likely impacts of energy price increases at the levels associated with a CO2 price of $15 per ton.  An EIA analysis cited in the report projects a CO2 allowance price of $16.88 per ton in 2012 under the Lieberman-Warner cap-and-trade proposal considered last year in Congress (S.2191).  A preliminary EPA analysis of the draft Waxman-Markey climate and energy bill released in April projects an allowance price of $13 to $17 in 2015.

In assessing the potential impacts on energy-intensive manufacturers, the analysis distinguishes “competitiveness” impacts – the loss of market share to foreign competitors facing no carbon price – from the broader economic impacts these sectors may face under a mandatory greenhouse gas policy. 

For U.S. manufacturing as a whole, the analysis estimates an average production decline of 1.3 percent, and a decline in consumption of 0.6 percent, suggesting only a 0.7 percent shift in production overseas.  For energy-intensive industries (those with energy costs exceeding 10 percent of shipment value), output and consumption are projected to decline 4 percent and 3 percent, respectively, suggesting a 1 percent shift in production.  The findings indicate that most of the projected economic impact reflects a move towards less emissions-intensive products, rather than an increase in imports or a shift of jobs or production overseas.

Looking at specific sectors, the report estimates a “competitiveness” impact of 0.6 percent for bulk glass; 0.7 percent for aluminum and cement; 0.8 percent for iron and steel; and 0.9 percent for paper and industrial chemicals.  The authors note that the analysis assumes similar behavior among industries with similar energy intensity, and that at any given level of energy intensity, some industries may face impacts higher than the calculated average.

The analysis contributed to a recent Pew Center policy brief, “Addressing Competitiveness in U.S. Climate Change Policy,” which further examines available policy options.  It also was cited by Claussen in recent testimony before the Energy and Environment Subcommittee of the House Energy and Commerce Committee.

Claussen noted that the competitiveness provisions of the Waxman-Markey discussion draft – which would use output-based rebates to compensate energy-intensive manufacturers for increased costs, and resort to border measures only if the President determines the rebates have been ineffective – are largely consistent with earlier Pew Center recommendations. 

“The draft provides a very sound framework for managing what we now know are relatively modest risks,” said Claussen.

The new report, and additional information on global climate change and the Pew Center, are available at www.c2es.org.

###

The Pew Center was established in May 1998 as a non-profit, non-partisan, and independent organization dedicated to providing credible information, straight answers, and innovative solutions in the effort to address global climate change. The Pew Center is led by Eileen Claussen, the former U.S. Assistant Secretary of State for Oceans and International Environmental and Scientific Affairs.

The Competitiveness Impacts of Climate Change Mitigation Policies

The Competitiveness Impacts of Climate Change Mitigation Policies

May 2009

By:
Joseph E. Aldy and William A. Pizer
Resources for the Future


A close look at the historical relationship between energy prices and U.S. production and consumption of energy-intensive goods suggests that energy-intensive manufacturers are likely to face only modest “competitiveness” impacts under a U.S. greenhouse gas cap-and-trade program, according to this report.

 

Press Release

Audio of report release press teleconference

Download the entire report (PDF)

 

Also see Eileen Claussen's Congressional Testimony on Competitiveness

Review of Proposed Options for Addressing Industrial Competitiveness Impacts (PDF)

Joseph E. Aldy
William Pizer
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Assessing the Benefits of Avoided Climate Change

Promoted in Energy Efficiency section: 
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This workshop considers what useful insights can be gleaned now about quantifying the benefits of reducing greenhouse gas emissions. The workshop’s objectives are to develop a set of practical recommendations that decision makers can employ in the near-term and to outline a research path to improve decision making tools over time.

Workshop: Assessing the Benefits of Avoided Climate Change: Cost-Benefit Analysis and Beyond
May 2010

Op-Ed: Goals Can Be Met Without Auctioning Emission Allowances

By: Eileen Claussen and Jim Rogers
March 31, 2009

This article originally appeared in the National Journal's Energy & Environment Experts Blog.

Let’s get one thing straight: Though not perfect, we like the way President Obama and his team are addressing the potential catastrophe of climate change.

The Administration unequivocally accepts the underlying science. They realize that the cost of not acting will be far greater than the cost of taking responsible action – and that the longer we wait, the greater the costs will be for American consumers. Their emissions goals are ambitious but achievable, as is the timetable to meet them. And we agree that cap and trade is the right way to go. It’s based on common sense capitalism: it puts a price on carbon and rewards facilities that can reduce carbon dioxide and other greenhouse gases at the lowest cost, even as it provides incentives for others to find more economic ways to reduce their own emissions.

Where we temporarily part ways is when it comes to the Administration’s proposal calling for a full auction of emission allowances. How these allowances are distributed doesn’t change the overall environmental goal set by the cap. We believe it is critical that a number of them be used to reduce price impacts on households and businesses – in the early years of the program.  Just this week Chairmen Waxman and Markey released a discussion draft of energy and climate legislation that leaves open how we can best address this critically important issue.

In all states, electricity is distributed by local companies regulated by public service commissions whose fundamental purpose is to protect consumers and keep electricity rates low.  We recommend protecting households and businesses that purchase electricity from utilities by providing allowances to the regulated distribution companies during a transition period.

There is little question that an auction, in which allowances to emit specified amounts of carbon are sold to the highest bidders, will result in a price spike for electricity in some regions. That price spike will hit households and businesses the hardest, and for some, it will be very tough to manage.

We believe we need a climate change plan that protects against price spikes in electricity bills. Our plan would effectively curb carbon, limit the risk of price volatility, target relief to those who need it most, and take advantage of the distribution companies’ and public service commissions’ ability to deliver energy efficiency.

During the transition period from granting allowances to a full auction, there would be no windfall for utility companies or their investors. The legislation itself and actions by public service commissions would guarantee it.  On the flipside, there would not be huge price increases for electricity in coal-fueled states and a much smoother transition to a cleaner economy. If this approach is not taken, the whole argument for climate change legislation could be moot – senators and representatives from those states might effectively kill legislation mandating cap and trade.

Overall, we think a cap-and-trade system that shifts from granting allowances to a full auction over time will provide the most reasonable transition to the low-carbon and thriving economy we all desire.  To help ensure a smooth transition, granting allowances and auction revenues should be used to help cushion workers, households, and vulnerable industries from volatile prices.  It should also support the development of critical low-carbon technologies like carbon capture and storage, and assist in efforts to better adapt to the climate change we are already beginning to experience.

With a price on carbon, energy companies will more rapidly invest in clean technologies, as long as they can be certain that future regulations neither bankrupt them nor mandate that they bet on specific untried technologies. It will also help them look deeper into renewable sources of energy, be they solar, wind, hydropower, or even agricultural waste. They will rethink nuclear power which, despite its scary image, is actually a safe, clean way to generate electricity.

We know that some of those technologies still need the kinks worked out, and that others remain prohibitively expensive. But this is where the government could use some of the revenues that it gets from auctioning allowances to other emitters now, and to utilities and competitively challenged manufacturers down the road.

We’re not ostriches, and we’re not Pollyannas. We know there is a cost to addressing climate change, and that this cost will filter down to big business, to small business, and to households. Utilities that buy carbon allowances or shift to lower-carbon generating options will have to increase their rates, but energy efficiency can lower customer bills even in the face of rate increases. And there will be far less economic upheaval if higher prices come gradually, which our transition program would ensure.

Appeared in the National Journal Energy & Environment Expert Blog— by Eileen Claussen and Jim Rogers

Workshop: Assessing the Benefits of Avoided Climate Change

Promoted in Energy Efficiency section: 
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Hyatt Regency on Capitol Hill, Washington, D.C.
March 16-17, 2009

The U.S. government is considering a range of near-term actions to address the risks of climate change. The Obama administration and key members of Congress intend to make climate legislation a top priority this year. The earliest action, however, may come from federal agencies being pressured by the courts and states to consider limiting CO2 emissions under existing legislative authority. A key element of federal rulemaking is assessing the costs and benefits of proposed policies. While the costs of reducing greenhouse gas emissions have received much attention from analysts and policymakers, far less attention has been directed at quantifying the benefits of such reductions. In spite of remaining uncertainties, the analytical community should offer practical guidance for informing near-term decisions. Drawing from the environmental economics, impacts, vulnerability, and risk assessment communities, this workshop considers what useful insights can be gleaned now about quantifying the benefits of reducing greenhouse gas emissions. The workshop’s objectives are to develop a set of practical recommendations that decision makers can employ in the near-term and to outline a research path to improve decision making tools over time.

PDF version of Agenda

List of Participants 

Speaker Bios

 

Symposium – Assessing the benefits of avoided climate change in government decision making

Opening Remarks
Eileen Claussen, President, Pew Center on Global Climate Change
Video:  WMV     PDF

Keynote Address
Dina Kruger, Director, Climate Change Division, Office of Air and Radiation, U.S. EPA

Panel 1: Perspectives on Government Decision Making for Climate Change
Moderator: Steve Seidel, Vice President for Policy Analysis, Pew Center

  • Martha Roberts, EDF: Incorporating the benefits of climate protection into federal rulemaking
    Video:  WMV     Slides
  • Christopher Pyke, CTG Energetics: A proposal to consider global warming under NEPA
    Video:  WMV     Slides
  • James Lester/Joel Smith, Stratus Consulting: Case studies on government decisions to limit greenhouse gas emissions – California, Australia, United Kingdom
    Video:  WMV     Slides     Paper
  • Paul Watkiss, Paul Watkiss Associates: Social cost of carbon estimates and their use in UK policy
    Video:  WMV     Slides

Panel 2: Challenges to Quantifying Damages from Climate Change
Moderator: Jeremy Richardson, Senior Fellow for Science Policy, Pew Center

  • Mike MacCracken, Climate Institute: Overview of challenges to quantifying impacts
    Video:  WMV     Slides     Paper
  • Kristie Ebi, ESS, LLC: Social vulnerability and risk
    Video:  WMV     Slides     Paper
  • Tony Janetos, Joint Global Change Research Institute: Ecosystems and species
    Video:  WMV     Slides
  • Jon O’Riordan, University of British Columbia: Valuation of natural capital
    Video:  WMV     Slides


Lunch Speaker

Gary Yohe, Wesleyan University: The long view: developing a new decision making framework based on the IPCC’s ‘iterative risk management’ paradigm
Video:  WMV     Slides     Paper

 

Panel 3: The Role of Uncertainty in Assessing the Benefits of Climate Policy
Moderator: Jay Gulledge, Senior Scientist/Science & Impacts Program Manager, Pew Center

  • Brian O’Neill, NCAR: Uncertainty and learning – implications for climate policy
    Video:  WMV     Slides
  • Joel Smith, Stratus Consulting: Dangerous climate change: an update of the IPCC reasons for concern
    Video:  WMV     Slides
  • Michael Mastrandrea, Stanford University: Assessing damages with integrated assessment models
    Video:  WMV     Slides     Paper
  • Chris Hope, University of Cambridge: Social cost of carbon and optimal timing of emissions reductions under uncertainty
    Video:  WMV     Slides     Paper

 

Panel 4: Advances in the Economic Analysis of the Benefits of Climate Policy
Moderator: Liwayway Adkins, Senior Fellow, Economics, Pew Center

  • Steve Rose, EPRI: Federal decision making on the uncertain impacts of climate change: Working with What You Have
    Video:  WMV     Slides     Paper
  • Richard Howarth, E3 Network: The need for a fresh approach to climate change economics
    Video:  WMV     Slides     Paper
  • David Anthoff, ESRI: National decision making on climate change and international equity weights
    Video:  WMV     Slides
  • Steve Newbold, U.S. EPA: Climate response uncertainty and the expected benefits of GHG emissions reductions
    Video:  WMV     Slides     Paper

 

Click here for more information about the workshop, including expert reports and proceedings.

Cap and Trade vs. Taxes

Climate Policy Memo #1: Cap and Trade vs. Taxes

Download this Policy Memo (PDF)

Cap and trade and a carbon tax are two distinct policies aimed at reducing greenhouse gas (GHG) emissions.  Each approach has its vocal supporters.  Those in favor of cap and trade argue that it is the only approach that can guarantee that an environmental objective will be achieved, has been shown to effectively work to protect the environment at lower than expected costs, and is politically more attractive.  Those supporting a carbon tax argue that it is a better approach because it is transparent, minimizes the involvement of government, and avoids the creation of new markets subject to manipulation. This note explores both the fundamental similarities between cap and trade and tax regimes, but also the important differences between them.

 

IMPORTANT SIMILARITIES BETWEEN CAP AND TRADE AND TAXES

Both correct a market failure. Both cap and trade and a tax have as their objective the correction of an existing market failure.  Currently, sources responsible for GHG emissions do not have to pay for the damages they impose on society as a whole. The failure to internalize these costs leads to greater levels of emissions than would be socially optimal.

Both put a price on carbon. By placing a price on carbon, and thus correcting the market failure, both approaches create an incentive to develop and invest in energy-saving technologies.  This will encourage the shift to a lower carbon economy.

Both take advantage of market efficiencies. Unlike direct regulations, both harness market forces to achieve the lowest cost reductions in GHG emissions. 

Both can generate revenue. A tax by definition is designed to raise revenue, but a cap-and-trade system, to the extent that allowances are auctioned, can also raise similar amounts of revenue.  How such revenues are used becomes an important issue in both systems.  Some proposals rebate the revenue directly back to consumers, some use part of the revenues to ease the transition to a low carbon economy (e.g.  for consumers, energy-intensive manufacturers, research development and deployments, etc.) and some combine both approaches. 

Both impose a compliance obligation on a limited number of firms. Depending on who pays the tax or is responsible for holding allowances, the number of firms directly impacted by these systems can be large or small.  Most proposals focus on a limited number of firms with the goal of maximizing emissions coverage and reducing administrative costs.

Both necessitate special provisions to minimize adverse impacts. By putting a price on carbon, both systems raise concerns about adverse impacts on energy-intensive firms and manufacturing states, and on workers and communities that historically have been dependent on fossil fuels.  For example, both could result in large wealth transfers from coal and manufacturing states to other parts of the country.  However, through special tax provisions or the use of allowance value, either can be designed in a way to mitigate adverse impacts on disadvantaged groups. Similarly, both systems would require special provisions to avoid imposing requirements on GHGs that are consumed as feedstocks or to provide credit for reductions that result from capturing and storing carbon or expanding carbon sinks.

Both require monitoring, reporting and verification. Both systems require similar data on emissions, reporting and verification of that data, and enforcement in the event of noncompliance.

 

IMPORTANT DIFFERENCES

Cost certainty v. environmental certainty. By setting a cap and issuing a corresponding number of allowances, a cap-and-trade system achieves a set environmental goal, but the cost of reaching that goal is determined by market forces.  In contrast, a tax provides certainty about the costs of compliance, but the resulting reductions in GHG emissions are not predetermined and would result from market forces. 

Compliance flexibility for firms.  A tax requires a firm each year to decide how much to reduce its emissions and how much tax to pay.  Under a cap-and-trade system, borrowing, banking and extended compliance periods allow firms the flexibility to make compliance planning decisions on a multi-year basis.

Impact of economic conditions. Changes in economic activity impact a firm’s behavior under either system.  Under a cap-and-trade system, reduced economic growth would lower allowance prices.  Under a tax, government action to lower the amount of the tax, not market forces, would be required to reduce the carbon price seen by firms.   In times of economic expansion, the opposite would be true – under cap and trade, allowance prices would rise based on market forces, but taxes would remain the same unless adjusted through government action.  In this sense, cap and trade can be seen as providing a self-adjusting price, high when the economy is doing well and low when the economy is in a downturn.  A tax in contrast is not self-adjusting.

Linkage to other systems. Ideally, a global price for carbon would develop and allow cost efficiencies to be realized across borders. While we are a long way from a global system, several trading regimes are already operating, expanding, or are planned which could allow international linkages across systems in the future.  Far fewer jurisdictions have either instituted or are considering carbon taxes and the notion of an international carbon tax has been considered but generally rejected as not realistic.

Experiences to date:  Cap and trade has become the cornerstone of successful efforts to achieve low-cost reductions in sulfur dioxide emissions in the United States.  For GHGs, this same approach is also being relied upon in the European Union (EU).  The EU has implemented a GHG cap-and-trade program covering thousands of sources and has created a market with millions of transactions producing a market price for carbon determined through supply and demand.  Following a trial period, during which a number of start-up challenges were encountered (e.g., lack of data, different approaches across Member States), the EU has succeeded in establishing the building blocks for a successful trading regime.  Cap and trade is also being used in three regional trading programs in the United States and Canada.  The use of taxes aimed at reducing GHG emissions has initially been used in several countries, including Norway, Sweden and Germany that are now relying increasingly on emissions trading.  Carbon taxes have also been used in a few local governments in the United States and Canada.   A carbon tax was considered by the Clinton Administration in 1992, but quickly became loaded down with special exemptions, was redirected away from carbon to be a BTU tax to avoid burdening coal, and was ultimately enacted as a few pennies tax on gasoline.

This review of cap and trade and taxes suggests that many of the longstanding myths about these approaches fail to recognize advances in design options aimed at addressing earlier concerns.  While a tax regime sounds simpler in theory, history suggests that special provisions would be added, for example, to avoid adversely impacting specific regions, to exempt feedstocks and to mitigate competitiveness concerns.   While a cap-and-trade regime doesn’t directly provide price certainty, recent proposals include temporal flexibility (e.g., banking, borrowing, and multi-year compliance periods) as well as floor prices and offset provisions that would dampen price volatility.  In the end, history suggests that it is unlikely that a tax would result in a simpler system.  The greater flexibility for firms and greater certainty that environmental objectives will be met appear to be the greatest strengths of a cap-and-trade policy.

Congressional Policy Brief Series
 

This series was made possible through a generous grant from the Doris Duke Charitable Foundation, but the views expressed herein are solely those of the Pew Center on Global Climate Change and its staff.

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