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

Economists Recommend Paying People Before Polluters

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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.

A dividend would be similar to the Alaska Permanent Fund, which returns oil-extraction royalties to Alaska residents on a per-capita basis. In California’s case, the annual payment would be around $100 per person in the early years of the program, rising to close to $300 by 2020, according to the committee’s estimates.

“From a fairness standpoint, dividends have two main attractions,” the committee wrote. “First, they have a progressive effect on the income distribution because they reduce income inequality since all residents receive the same dollar amount regardless of their income level. Second, they offer coverage based on the principle of common ownership of nature’s wealth. In terms of simplicity, dividends are an exceptionally transparent use of allowance value.”

The point of the dividend would be to reduce the impact of greenhouse gas emissions controls on households. Similar proposals have been offered at the federal level by Rep. Chris Van Hollen (D-Md.) and Sens. Maria Cantwell (D-Wash.) and Susan Collins (R-Maine) but have so far made little progress.

The California committee didn’t gloss over the fact that emissions caps and permit requirements will lead to higher prices for residents in utility costs and gas prices in a state where prices are already high, a concern that several NGOs have stressed during the hearings. As Nancy Ryan, an economist with the state Public Utilities Commission and a member of the committee, put it, it’s well known that the expenses might start at the industry level but “these costs get passed through.”

Returning that value to households helps to cover the passed-on costs and also improves efficiency, particularly lowering the cost of the program. The committee also noted, however, that changing behavior is part of the goal of AB32. The law is intended to encourage energy efficiency, and that’s what higher energy prices do.

Another option is to use the proceeds to reduce income taxes or sales taxes, or to prevent future increases in those rates.

“A principle attraction of using auction revenue to cut marginal rates is the ability to lower the cost of a cap-and-trade program,” the committee wrote. “Income and sales taxes lead to reduced production and incomes by reducing work incentives as well as incentives to save and invest. … They influence behavior in ways that are less productive or less beneficial to consumers overall.”

Heading for 2012

The committee’s recommendations now go to the Air Resources Board, which will determine other details, such as the total quantity of allowances to be distributed and the range of sectors covered, as well as making a final determinations on the distribution method and the end use of the proceeds.

It will also have to take into account future regional and potentially national programs and ways to incorporate other jurisdictions if the Western Climate Initiative states launch a regional trading program.

“At the start of this, I was almost certain a national program would be implemented and this would be just a stop-gap for that program. I’m less and less convinced,” said Chris Knittel, a committee member and economist at the University of California, Davis. “I hope this raises the debate for a national program or at least a regional program.”

Dan Kammen, a committee member and professor of energy and natural resources at the University of California, Berkeley, noted that the committee’s report and its recommendations reflect both the dangers California faces from climate change and the value of the new economic engine that energy efficiency and the clean tech sector are creating. It also offers a clear route to follow.

“The failure of Copenhagen highlights the really critical nature of making progress here,” Kammen said. “We have something everyone can understand, even if they don’t agree with various pieces of it. The way the committee dealt with cap and dividend put it in a very practical and workable form.”


See also:

California’s Cap-and-Trade Plan Shies Away from Free Permits

Low Carbon Prices: Just a Phase or an Indictment of Cap and Trade?

Study: Carbon Cap Has Little Impact on Small Businesses

Lawyers Advising Clients to Prepare for Economy-Wide GHG Regulation

Cap and Trade in Perspective: Stopping Acid Rain

Cap and Trade in Perspective: Carbon Trading in the Northeast

Cap and Trade in Perspective: The European Version