Carbon Dioxide Trading in the United States - A Look Ahead
To date, United States policymakers have remained steadfastly agnostic on the issue of anthropogenic climate change.
In keeping their faith of doubt, they have refused to even attempt to regulate carbon dioxide emissions.
Binding caps on such emissions have been out-of-the-question.
However, barring credible new scientific evidence against anthropogenic climate change, things will likely change after the 2008 Presidential election.
The spread of carbon trading worldwide, rise of state-based initiatives within the United States, growing support within the private sector for carbon dioxide emissions limits, and the April 2007 decision by the U.
S.
Supreme Court that the Environmental Protection Agency (EPA) currently possesses the authority to regulate greenhouse gas emissions under the Clean Air Act, suggest that the present U.
S.
"laggardship" relative to much of the rest of the Developed World on the issue of anthropogenic climate change may be in its closing days.
Afterward, absent credible new scientific evidence that discounts the role of carbon dioxide in the decades-long trend of observed worldwide warming, the U.
S.
is likely to adopt carbon dioxide emissions limits.
The centerpiece of any such emissions limits will be a carbon dioxide trading system.
As a result, it makes sense to examine how such a system might work.
Under such a system, policymakers would cap the maximum allowable emissions of carbon dioxide over a specified period of time.
The federal government would then create allowances that correspond to the cap.
Organizations that emitted a significant amount of carbon dioxide would be required to hold such allowances.
They could also buy additional allowances to cover emissions of carbon dioxide in excess of what is permitted under the allowances they hold or sell their allowances to other individuals or entities if they emit less carbon dioxide than is covered by their allowances.
Such a system is premised on the well-established principle of comparative advantage.
Applying that theory, two hypothetical companies might be required to reduce their annual carbon dioxide emissions by 1,000 tons per year.
One company could do so at a cost of $50 per ton, while the second could only do so at cost of $100 per ton.
If, the first company could achieve a reduction of 2,000 tons, then it would make sense for it to do so, and sell the allowance of the extra 1,000 tons to the second company for a price above $50 per ton.
It would make sense for the second company to purchase the allowance, so long as it could do so at a price of less than $100 per ton.
That way, both companies could comply with the overall cap and the total cost of meeting the targeted reduction of 2,000 tons would be lower than if each company had to achieve a 1,000-ton reduction on its own.
For example, if the allowance for 1,000 tons were sold at a price of $75 per ton, the first company would realize a $2,500 profit from the transaction.
At the same time, the second company's cost of compliance would be $2,500 less than if it had to meet the target on its own.
In creating such a system, U.
S.
policymakers would have two major options.
The allowances could be issued for free to energy producers and other organizations that emit a significant amount of carbon dioxide or the allowances could be auctioned as the federal government has done with regard to licenses for the electromagnetic spectrum.
Afterward, the federal government could opt for targeted or broad-based tax relief to mitigate the economic costs of the carbon dioxide emissions cap.
An April 25, 2007 issue brief published by the Congressional Budget Office (CBO) found that the auction of carbon dioxide emissions accompanied by broader tax relief would have the least adverse impact on the economy.
Under an assumption of a 15% cut in carbon dioxide emissions in 2010, the GDP would be reduced by 0.
13% under the auction/broad-based tax relief formula.
However, the lowest household income quintile would experience a 2.
6% to 3.
0% reduction in average after-tax income.
The highest quintile would see an increase of 0.
4% to 1.
6%.
A combination of auctioned allowances coupled with an "equal lump-sum rebate" provided to each household would have the least impact on personal incomes.
That formula would yield a gain of 1.
8% in after-tax income for the lowest quintile and a loss of 0.
7% for the highest quintile.
However, the GDP would be 0.
34% lower.
Granting the allowances to producers at no cost would have an adverse impact on all but the top household income quintile and on overall economic growth.
The four lowest income quintiles would see their after-tax income fall 1.
4% to 3.
0%.
The highest quintile would have an increase of 1.
4% to 1.
9%.
GDP would be 0.
28% to 0.
34% lower.
U.
S.
historic experience suggests carbon dioxide trading could be effective in meeting the emissions targets that would be established by policymakers.
Market-based trading of pollution allowances had been proposed as far back as the 1960s.
Tradeable allowances were featured in eliminating leaded gasoline and ozone chlorofluorocarbons (CFCs).
They were employed to substantially cut sulfur dioxide emissions that had been responsible for acid rain.
The application of allowances in reducing sulfur dioxide emissions was the most ambitious use of such instruments to date.
That makes the experience with that program particularly instructive.
In 1990, Title IV of the Clean Air Act amendments mandated that nationwide sulfur dioxide emissions be slashed to 50% below 1980 levels.
As that legislation advanced toward enactment, various producers argued that the objective was not feasible.
On November 13, 1989, The New York Times reported, "Those that burn natural gas and low-sulfur oil instead of high-sulfur coal are complaining because the Bush proposal would require them to cut pollution from existing plants if they want to build new ones.
This they say, is nearly impossible because there is little room left for improvement...
The oil-burning utilities...
say the bill does not recognize their costly efforts, mostly to control sulfur dioxide, a pollutant released into the air when the sulfur in coal or oil is burned.
" Similar complaints are all but certain once Congress undertakes legislation that would cap U.
S.
carbon dioxide emissions even as such reductions would be far less aggressive than the required cuts in sulfur dioxide emissions were.
Less than a decade later, nationwide sulfur dioxide emissions targets had been exceeded, and at lower-than-expected costs.
Robert N.
Stavins, Professor of Public Policy at Harvard University, observed in a 1998 Journal of Economic Perspectives article, "The SO2 allowance trading program has performed successfully.
Targeted emissions-reductions have been achieved and exceeded; ...
Total abatement costs have been significantly less than they would have been in the absence of the trading provisions...
Prospective analysis in 1990 suggested that he program's benefits would approximately equal its costs...
, but recent analysis indicates that benefits will exceed costs by a very significant margin.
" In April 2000 the U.
S.
General Accounting Office (now Government Accountability Office) observed that the trading allowances had allowed electric utilities "to achieve required sulfur dioxide emissions reductions at a lower-than-expected cost.
" Stavins also offered a number of insights from that program.
He highlighted research that found that had the allowances been auctioned--they were provided for free to the producers that emitted sulfur dioxide--the costs of the sulfur dioxide trading would have been 25% lower than they were.
He also noted that the absolute limit on sulfur dioxide emissions worked well and that monitoring and enforcement was important.
The Clean Air Act provided stiff penalties against violators.
Stavins advised that carbon dioxide trading allowances be targeted at the carbon inputs of fossil fuels.
He explained: To the limited degree that any previous trading program can serve as a model for the case of global climate change, some attention should be given to the tradeable-permit system that accomplished the U.
S.
phaseout of leaded gasoline.
The currency of that system was not lead oxide emissions from motor vehicles, but the lead content of gasoline.
So too, in the case of global climate, great savings in monitoring and enforcement costs could be had by adopting input trading linked to the carbon content of fossil fuels.
This is reasonable in the climate case, since--unlike in the SO2 case--CO2 emissions are roughly proportional to the carbon content of fossil fuels and scrubbing alternatives are largely unavailable, at least at present.
All said, carbon dioxide trading is likely to be introduced in the United States.
Historic experience suggests that such a program can be effective in meeting targeted reductions in carbon dioxide emissions.
An optimally-designed program would entail the auctioning of allowances, accompanied by broad-bases tax relief, possibly a transitional tax rebate program for households in the lowest one or two income quintiles, strict monitoring, severe penalties for violators, and, rather than focusing on outputs, the program could target inputs.
In keeping their faith of doubt, they have refused to even attempt to regulate carbon dioxide emissions.
Binding caps on such emissions have been out-of-the-question.
However, barring credible new scientific evidence against anthropogenic climate change, things will likely change after the 2008 Presidential election.
The spread of carbon trading worldwide, rise of state-based initiatives within the United States, growing support within the private sector for carbon dioxide emissions limits, and the April 2007 decision by the U.
S.
Supreme Court that the Environmental Protection Agency (EPA) currently possesses the authority to regulate greenhouse gas emissions under the Clean Air Act, suggest that the present U.
S.
"laggardship" relative to much of the rest of the Developed World on the issue of anthropogenic climate change may be in its closing days.
Afterward, absent credible new scientific evidence that discounts the role of carbon dioxide in the decades-long trend of observed worldwide warming, the U.
S.
is likely to adopt carbon dioxide emissions limits.
The centerpiece of any such emissions limits will be a carbon dioxide trading system.
As a result, it makes sense to examine how such a system might work.
Under such a system, policymakers would cap the maximum allowable emissions of carbon dioxide over a specified period of time.
The federal government would then create allowances that correspond to the cap.
Organizations that emitted a significant amount of carbon dioxide would be required to hold such allowances.
They could also buy additional allowances to cover emissions of carbon dioxide in excess of what is permitted under the allowances they hold or sell their allowances to other individuals or entities if they emit less carbon dioxide than is covered by their allowances.
Such a system is premised on the well-established principle of comparative advantage.
Applying that theory, two hypothetical companies might be required to reduce their annual carbon dioxide emissions by 1,000 tons per year.
One company could do so at a cost of $50 per ton, while the second could only do so at cost of $100 per ton.
If, the first company could achieve a reduction of 2,000 tons, then it would make sense for it to do so, and sell the allowance of the extra 1,000 tons to the second company for a price above $50 per ton.
It would make sense for the second company to purchase the allowance, so long as it could do so at a price of less than $100 per ton.
That way, both companies could comply with the overall cap and the total cost of meeting the targeted reduction of 2,000 tons would be lower than if each company had to achieve a 1,000-ton reduction on its own.
For example, if the allowance for 1,000 tons were sold at a price of $75 per ton, the first company would realize a $2,500 profit from the transaction.
At the same time, the second company's cost of compliance would be $2,500 less than if it had to meet the target on its own.
In creating such a system, U.
S.
policymakers would have two major options.
The allowances could be issued for free to energy producers and other organizations that emit a significant amount of carbon dioxide or the allowances could be auctioned as the federal government has done with regard to licenses for the electromagnetic spectrum.
Afterward, the federal government could opt for targeted or broad-based tax relief to mitigate the economic costs of the carbon dioxide emissions cap.
An April 25, 2007 issue brief published by the Congressional Budget Office (CBO) found that the auction of carbon dioxide emissions accompanied by broader tax relief would have the least adverse impact on the economy.
Under an assumption of a 15% cut in carbon dioxide emissions in 2010, the GDP would be reduced by 0.
13% under the auction/broad-based tax relief formula.
However, the lowest household income quintile would experience a 2.
6% to 3.
0% reduction in average after-tax income.
The highest quintile would see an increase of 0.
4% to 1.
6%.
A combination of auctioned allowances coupled with an "equal lump-sum rebate" provided to each household would have the least impact on personal incomes.
That formula would yield a gain of 1.
8% in after-tax income for the lowest quintile and a loss of 0.
7% for the highest quintile.
However, the GDP would be 0.
34% lower.
Granting the allowances to producers at no cost would have an adverse impact on all but the top household income quintile and on overall economic growth.
The four lowest income quintiles would see their after-tax income fall 1.
4% to 3.
0%.
The highest quintile would have an increase of 1.
4% to 1.
9%.
GDP would be 0.
28% to 0.
34% lower.
U.
S.
historic experience suggests carbon dioxide trading could be effective in meeting the emissions targets that would be established by policymakers.
Market-based trading of pollution allowances had been proposed as far back as the 1960s.
Tradeable allowances were featured in eliminating leaded gasoline and ozone chlorofluorocarbons (CFCs).
They were employed to substantially cut sulfur dioxide emissions that had been responsible for acid rain.
The application of allowances in reducing sulfur dioxide emissions was the most ambitious use of such instruments to date.
That makes the experience with that program particularly instructive.
In 1990, Title IV of the Clean Air Act amendments mandated that nationwide sulfur dioxide emissions be slashed to 50% below 1980 levels.
As that legislation advanced toward enactment, various producers argued that the objective was not feasible.
On November 13, 1989, The New York Times reported, "Those that burn natural gas and low-sulfur oil instead of high-sulfur coal are complaining because the Bush proposal would require them to cut pollution from existing plants if they want to build new ones.
This they say, is nearly impossible because there is little room left for improvement...
The oil-burning utilities...
say the bill does not recognize their costly efforts, mostly to control sulfur dioxide, a pollutant released into the air when the sulfur in coal or oil is burned.
" Similar complaints are all but certain once Congress undertakes legislation that would cap U.
S.
carbon dioxide emissions even as such reductions would be far less aggressive than the required cuts in sulfur dioxide emissions were.
Less than a decade later, nationwide sulfur dioxide emissions targets had been exceeded, and at lower-than-expected costs.
Robert N.
Stavins, Professor of Public Policy at Harvard University, observed in a 1998 Journal of Economic Perspectives article, "The SO2 allowance trading program has performed successfully.
Targeted emissions-reductions have been achieved and exceeded; ...
Total abatement costs have been significantly less than they would have been in the absence of the trading provisions...
Prospective analysis in 1990 suggested that he program's benefits would approximately equal its costs...
, but recent analysis indicates that benefits will exceed costs by a very significant margin.
" In April 2000 the U.
S.
General Accounting Office (now Government Accountability Office) observed that the trading allowances had allowed electric utilities "to achieve required sulfur dioxide emissions reductions at a lower-than-expected cost.
" Stavins also offered a number of insights from that program.
He highlighted research that found that had the allowances been auctioned--they were provided for free to the producers that emitted sulfur dioxide--the costs of the sulfur dioxide trading would have been 25% lower than they were.
He also noted that the absolute limit on sulfur dioxide emissions worked well and that monitoring and enforcement was important.
The Clean Air Act provided stiff penalties against violators.
Stavins advised that carbon dioxide trading allowances be targeted at the carbon inputs of fossil fuels.
He explained: To the limited degree that any previous trading program can serve as a model for the case of global climate change, some attention should be given to the tradeable-permit system that accomplished the U.
S.
phaseout of leaded gasoline.
The currency of that system was not lead oxide emissions from motor vehicles, but the lead content of gasoline.
So too, in the case of global climate, great savings in monitoring and enforcement costs could be had by adopting input trading linked to the carbon content of fossil fuels.
This is reasonable in the climate case, since--unlike in the SO2 case--CO2 emissions are roughly proportional to the carbon content of fossil fuels and scrubbing alternatives are largely unavailable, at least at present.
All said, carbon dioxide trading is likely to be introduced in the United States.
Historic experience suggests that such a program can be effective in meeting targeted reductions in carbon dioxide emissions.
An optimally-designed program would entail the auctioning of allowances, accompanied by broad-bases tax relief, possibly a transitional tax rebate program for households in the lowest one or two income quintiles, strict monitoring, severe penalties for violators, and, rather than focusing on outputs, the program could target inputs.
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