Congressional Policy Brief Series

Containing the Costs of Climate Policy

Containing the Costs of Climate Policy

Updated: June 2017

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This policy brief outlines various options for containing costs under a cap-and-trade program to reduce greenhouse gas (GHG) emissions. Although cap and trade is generally considered a more cost-effective approach than traditional regulation, excessive allowance prices are a concern. High allowance prices could mean high compliance costs for regulated firms and high energy prices for consumers. A number of the design elements of a cap-and-trade policy including the stringency of the emission reduction targets and the distribution of allowance value will influence the cost of the policy for consumers. However, uncertainty regarding allowance prices, and in particular, short-term price volatility and persistently high prices, are of concern to stakeholders. Policy options to address these concerns include allowing facilities to bank allowances, permitting firms or the government to borrow allowances from future allocations, allowing (or expanding) the use of offsets, allowing the use of multi-year compliance periods, setting a ceiling on allowance prices, or even relaxing the cap or emission targets associated with the policy in times of high prices. Each of these options has strengths and weaknesses and their desired results must often be weighed against the reduced certainty of meeting the environmental objective. To ensure the viability of any cap-and-trade program, policymakers will likely want to include a variety of cost-containment mechanisms.

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Addressing Competitiveness in U.S. Climate Change Policy

November 2008

This brief examines policy options for addressing competitiveness concerns arising from the establishment of a mandatory domestic program to limit greenhouse gas emissions. These concerns center on energy-intensive industries that compete globally and could face higher costs under a domestic climate program while key competitors do not. Studies find little evidence of significant competitiveness impacts on U.S. firms from past environmental regulation, and forecast relatively modest impacts on a narrow set of industries under a U.S. cap-and-trade program with modest emission allowance prices. In the long run, international agreements offer the best recourse against competitiveness concerns. As an interim measure, a domestic climate program could mitigate competitiveness impacts through options such as: excluding trade-exposed firms from regulation; compensating firms for regulatory costs through free allocation of emission allowances; compensating firms, while providing incentive for production and emission reduction, through output-based allocations; and placing taxes or other requirements on goods imported from countries with weaker emission controls. These approaches vary in their effectiveness in reducing competitiveness impacts, in their impact on the environmental integrity and economic efficiency of a domestic climate program, and in their influence on international relations and prospects for an effective international climate framework.

 

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

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Greenhouse Gas Emission Reduction Timetables

November 2008

This brief describes issues relevant to the timetable for reducing U.S. emissions of greenhouse gases (GHGs) under a cap-and-trade program. The first issue is whether reductions are sufficiently deep to have a meaningful effect on the global climate. Scientific evidence suggests that global reductions of 50 to 85% by 2050 are needed to avoid the most serious consequences of climate change, and policymakers need to decide what share of the global emission reduction burden will be shouldered by the United States. Second, while existing technologies can be used to make significant near-term emission reductions, new technologies will be needed to achieve deep long-term reductions. Policymakers can stimulate technology development with a sufficiently stringent timetable that covers several decades. Cost minimization is the third issue. Many existing technologies can be used to reduce emissions almost immediately at little cost. However, in some capital-intensive situations, such as a major change to a factory’s production process, costs may be reduced if emission reduction requirements can be matched with the natural lifecycle of the equipment or similarly, if firms and consumers have time to adjust purchasing patterns to reflect higher prices for GHG-intensive goods. Fourth, when it comes to the mechanics of setting a reduction timetable, policymakers must specify not only the start and end dates for the reduction pathway, but also the target for each intervening year. Given the environmental importance of cumulative emissions, less aggressive near-term action will necessitate deeper reductions in later years. Policies enacted by others suggest a blended strategy: near-term reduction targets based on technical feasibility and long-term targets based on environmental objectives. Finally, while a multi-decade emission reduction timetable will provide regulatory certainty, enhance innovation, and minimize cost, the reality is that new scientific, technical, or economic data may necessitate changes to the timetable. Policymakers need to manage the trade-off between long-term predictability and the flexibility to adapt to new information.

 

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Scope of a Greenhouse Gas Cap-and-Trade Program

November 2008

This brief describes issues involved in choosing the set of greenhouse gases (GHGs), emission sources, and sectors of the economy included in a cap-and-trade program. Trade-offs between three primary criteria determine whether a source should be included in a cap-and-trade program: broader coverage, measurability of emissions, and ease of administration. Policymakers also face choices in determining which entity in each sector must hold allowances at the conclusion of each compliance period (the point of regulation)—either upstream, where the carbon dioxide or GHGs first enter the economy, or downstream at the location where GHGs are emitted, or somewhere in between. The choice of upstream or downstream depends partly on measurability and concerns about administration, and could have important impacts on the economic incentives for emission reductions. Additional choices include whether to regulate small sources, to expand program scope over time by “phasing in” additional sectors or GHGs, and whether to pursue complementary policies that can provide additional emission reduction opportunities. Special considerations are also important in defining the scope for each sector of the economy. The power sector requires special treatment to ensure proper incentives for carbon capture and storage and to avoid double-counting emissions from natural gas use. The transportation sector may be difficult to regulate downstream, but fuels can be included upstream and complementary policies play a particularly important role in this sector. High global warming potential gases are generally easier to include upstream, but adjustments may be necessary depending on the category of industrial use. Residential and commercial use of natural gas can be covered upstream or through those delivering natural gas, or can be addressed through efficiency standards.

 

 

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Greenhouse Gas Offsets in a Domestic Cap-and-Trade Program

November 2008

This brief presents the key issues and identifies options for the incorporation of greenhouse gas (GHG) offsets into emerging U.S. climate change policy. A GHG offset represents a reduction, avoidance, destruction, or sequestration of GHG emissions from a source not covered by an emission reduction requirement. The elimination of GHG emissions can be converted into tradeable offset credits, and cap-and-trade programs can be designed to permit firms to use these credits to meet their compliance obligations. A carefully crafted and implemented offset program can significantly reduce cap-and-trade compliance costs by providing lower cost emission reduction options. Yet, while economic modeling has shown that incorporation of offsets into a cap-and-trade program can significantly reduce costs and allowance prices, their inclusion is not without controversy or complication. Some are concerned that offset inclusion will reduce the price signal to the point that the innovation and technological change needed to address the climate problem will be diminished. Others focus on the difficulty associated with substantiating offsets as real emission reductions. Important considerations in designing offset programs include the way in which offsets are defined; the types, location and quantity of offsets allowed; and the methods for assessing and crediting projects. Generally speaking, offset projects come in three distinct types: 1) direct emission reductions, 2) indirect emission reductions, and 3) sequestration. Before a project can create an offset credit, the emission reductions should meet all of the following criteria: they must be real, measurable, additional, permanent, monitored, independently verified, measured from a credible baseline, not represent leakage, and be able to convey as a clear property right. Additionality is perhaps the most important yet complicated issue, as it requires an assessment of what would have happened in the absence of the project. Offset project assessments can be either project specific or standardized. A hybrid assessment approach, which uses some standardization methodologies but allows for a degree of flexibility in assessing projects, may be the most effective. Each of these important factors for creating high quality offsets are discussed in this brief.

 

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On March 6, 2009, the Pew Center held a Hill briefing on domestic offsets in a cap-and-trade system.  Learn more here.

 

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Greenhouse Gas Emissions Allowance Allocation

November 2008

This policy brief outlines various options for distributing greenhouse gas emission allowances under a cap-and-trade program. Allowances represent a significant source of value and can be used to compensate firms or individuals affected by climate change policy or to raise funds for other socially desirable policy objectives. The basic allocation decision involves whether to freely allocate emission allowances, and if so, to whom, and whether to auction allowances, and if so, how to distribute the revenues. A number of recent cap-and-trade proposals begin with a combined approach that provides some allowances for free and auctions the rest, with the share of auctioned allowances rising over time. If free allocation is chosen, the basis for distribution must be determined. Options include granting allowances based on historical emissions (“grandfathering”), on levels of an output or input, or on an environmental performance “benchmark;” each has implications in terms of who benefits from the value of the allowances. If allowances are auctioned, in addition to deciding how the revenue generated by the auction will be used, policymakers will need to determine the type and frequency of the auction. Many of the same objectives can be met using either auction revenues or free allocation, including easing transition for affected firms and consumers and supporting new technologies. However, allocation decisions will sometimes entail trade-offs among the competing goals of achieving an equitable distribution of economic impacts, ensuring political feasibility, and minimizing overall program cost. Allowance allocation presents both a challenge and an opportunity: no allocation formula will satisfy everyone, yet allocation decisions can be made in ways that ease the transition to a low-carbon economy and enhance the likelihood of meaningful action on climate change.

 

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Tax Policies to Reduce Greenhouse Gas Emissions

November 2008

This brief outlines the motivation for and key features of a tax designed to reduce emissions of greenhouse gases (GHGs). The two most commonly discussed market-based instruments for reducing GHG emissions are a cap-andtrade system and a GHG (carbon) tax. These mechanisms function in a similar way by establishing a price for GHG emissions. They both correct the market failure that exists when the value of environmental damages is not included in the market price of fossil fuels and other activities that release GHGs. A GHG tax and cap-and-trade approach are compared, with consideration given to how effective each policy instrument may be at meeting key objectives. These objectives include environmental integrity, cost-effectiveness, and distributional equity, and will inevitably involve political considerations. Fundamental design issues of a GHG tax policy are explored, including who would pay the tax and how to set an appropriate tax rate. There are a number of options for determining the appropriate level for a tax, including setting it to equal some estimate of the social cost of carbon or pursuing the long-run goal of stabilizing the concentration of GHGs in the atmosphere. A tax can be levied at various points throughout the energy supply chain, but most proposals call for an upstream tax on fuel suppliers in order to maximize the scope of coverage, which lowers costs, and for administrative simplicity. This brief also reviews existing GHG taxes in Europe and North America, along with several recent U.S. legislative carbon tax proposals. Finally, other pricing strategies to reduce GHG emissions in the transportation and electricity sectors are examined.

 

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Policies to Reduce Emissions from the Transportation Sector

November 2008

This brief discusses public policy tools available to reduce greenhouse gas (GHG) emissions from the transportation sector. Reducing GHG emissions from transportation, which comprise one third of total U.S. CO2 emissions, will need to be a key part of any strategy to limit economy-wide emissions. Transportation energy use and emissions are determined by three elements: the fuels used to power the vehicles, characteristics of the vehicles themselves, and total miles traveled. Of the various transportation modes, passenger vehicles consume the most energy, followed by truck, rail and ship transport of freight, and then air travel. To reduce emissions, the sector can be included in a multi-sector cap-and-trade program or managed through sector-specific measures, or both. The critical issues for transportation policy are understanding market imperfections, where individuals are somewhat insensitive to changes in fuel price and tend to undervalue fuel economy. This makes it difficult to harness market forces (such as a cap-and-trade program) to drive investment in long-term transportation technology. To guarantee significant emission reductions from the transportation sector, especially in the short term, sector-specific policies can complement (or substitute for) the cap. These policies will need to focus on all three elements of the sector for major emission sources within the transportation sector. Policy tools include pricing policies (e.g., taxes, tolls, and congestion changes), standards (e.g., fuel economy standards), and funding for research, development, and deployment. Policies for the transportation sector will have to address several objectives at the same time: energy security and GHG reduction goals, a transition to low carbon fuels and alternative vehicle types, and an alignment of infrastructure and land use planning with GHG goals.

 

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Addressing Emissions From Coal Use in Power Generation

November 2008

Coal is a cheap and abundant resource, and carbon dioxide (CO2) from coal use is responsible for about 40 percent of global greenhouse gas (GHG) emissions from fossil fuel use. The United States and China are by far the largest emitters of CO2 from coal consumption, accounting for nearly 60 percent of global CO2 emissions from coal, with India a distant third. The United States currently relies on coal for roughly half of its electricity generation resulting in roughly one third of total U.S. emissions. China generates 80 percent of its electricity from coal, and in recent years, emissions from coal use have grown five times faster in China than in the United States. With enough coal reserves to meet current consumption levels for centuries, the United States and the rest of the world face the challenge of reconciling the realities of coal use with the dangers posed by climate change.

Carbon capture and storage (CCS) is a means to meet this challenge. If widely deployed, CCS could allow the world both to continue to exploit its cheap and abundant supply of coal and to adequately address the threat of climate change. CCS works by separating CO2 from other gases in the exhaust stream at power plants and industrial facilities, compressing the CO2 to pressures suitable for pipeline transport, and injecting the CO2 into deep geologic formations where it can be safely and indefinitely stored.

Although components of the CCS suite of technologies have been used in a variety of situations, the entire suite has not been deployed at a commercial scale at any coal-fueled power plant to date. Deployment has not proceeded for a number of reasons, primarily the high costs of installing and operating CCS technologies and the absence of government policies that place a financial cost on GHG emissions. In addition, uncertainties remain concerning actual cost and performance of CCS technologies at commercial scale. Finally, CCS deployment requires an appropriate regulatory system for CO2 storage, including long-term liability.

This brief describes the potential role of government in facilitating widespread and more rapid deployment of CCS through a number of means including: providing financial incentives for initial CCS projects through the use of bonus allowances under a cap-and-trade program, or a fund generated by charges on electricity or fossil-fuel based sources of electricity; setting GHG emission performance standards for coal generators or electricity providers; and establishing the required regulatory and liability frameworks for CO2 storage.

 

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Technology Policies to Address Climate Change

November 2008

This brief presents public policy tools available to provide support for research, development, demonstration, and deployment (RDD&D) of technologies that reduce greenhouse gas emissions. An emissions price induced by a cap-and-trade program can provide an incentive to “pull” new technology into the marketplace, while public funding for technology can provide a “push” with the two approaches more powerful in tandem than either alone. Economic theory provides the rationale for public expenditure on RDD&D, which can compensate for several market failures that would otherwise generate sub-optimal investments from the private sector. The appropriate policy tool depends on the stage of development for a particular technology and the scale of a project. Direct public expenditures, channeled through organizations such as the Department of Energy or the National Science Foundation, have a long history of funding earlier stages of research and development, and make up the bulk of current technology dollars. Some technologies to address climate change, such as next-generation nuclear power and carbon capture and storage, require a larger investment for early projects than private industry is likely to make, and could benefit from public funding of demonstration projects. The federal government can also provide inducements for private industry to invest in RDD&D with mechanisms such as investment tax credits. Indirect policies that can support technology deployment include standards that require a minimum performance or a market share requirement, and programs that identify and certify top efficiency performers in the marketplace. Funding sources for technology programs include appropriations from general revenues and dedicated revenues, perhaps from climate- or energy-related sources such as allowance auctions or dedicated energy taxes. Regardless of the source, funding must flow through and to multiple institutions that manage, select, and perform the actual RDD&D options. Each institutional option has strengths and weaknesses.

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