Cap-and-Trade, California Style: Who Gets the Money?

As California writes the details of a statewide cap-and-trade plan for greenhouse gas emissions, it is considering a different approach for divvying up the proceeds, one that would put state residents — rather than polluters — first in line for payouts.

Billions of dollars will be at stake once the state's carbon trading system gets going in 2012.

The California plan stems from a 2006 state law, AB32, that requires the state to cut its emissions to 1990 levels by 2020. The California Air Resources Board identified a cap-and-trade program as a key strategy to reach that goal.

The board is now writing the ground rules, and a committee of economists today issued its final recommendations for how emissions permits, or allowances, should be allocated.

The key recommendations:

1. Most, if not all, of the allowances should be auctioned off.

2. The vast majority of the proceeds from those auctions should be returned to California households.

Both are 180-degree turns from the direction Congress has been heading with climate legislation.

The U.S. House-passed American Clean Energy and Security (ACES) bill would create similarly valuable emissions allowances, but it would give the majority away to polluters for free rather than auctioning them off, as President Obama had initially proposed. The giveaways became politically expedient for Congress — Rep. Rick Boucher (D-Va.), for example, demanded extensive free allowances for the coal industry in exchange for his yes vote on the bill at the committee stage.

In California, on the other hand, the Economics and Allowance Allocation Committee determined that permit auctions rather than giveaways best met its four criteria — cost effectiveness, fairness, environmental effectiveness and transparency — plus auctions could help to pinpoint the true price for carbon.

“It can be argued that households own the public good of the environment, and access to the environment by emitters is something that should be paid for,” said committee Chairman Larry Goulder, a Stanford University economics professor.

As with many progressive environmental programs, California is preparing to be a test field for the nation. One regional cap-and-trade system is already in place in the United States: the Northeast's 10-state Regional Greenhouse Gas Initiative. It has struggled with low prices in recent auctions but has provided significant proceeds for its participating states.

Goulder's committee report clearly describes the pros and cons of various elements of cap-and-trade with that national audience in mind.

"I hope that by helping define the issues, provide relevant numerical information, it can lead to more rational, effective and fair environmental policy, particularly climate policy,” Goulder said.

Dividend or Tax Cut?

In its report, the committee recommends that California set aside a small amount of allocations for three types of earmarks: avoiding leakage (companies that would otherwise leave the state to avoid regulation), a contingency fund to finance environmental remediation, and assistance to low-income households.

It specifically avoided singling out any industries where leakage might become an issue, and it noted that energy-intensive trade-exposed industries represent “a very small share” of California production. Still, a representative of the Western States Petroleum Association thanked the committee for clarifying the leakage support.

The vast majority of the allowance value should be divided into two major categories, the committee said:

• About 25% should go to finance investment and public programs, and

• About 75% should be returned to households through a direct dividend or tax rate reductions.

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