Abstract: Over the last half decade, a variety of federal legislative proposals for limiting greenhouse gas (GHG) emissions have been put forward, most of which would set a price on carbon. As of early 2013, the one politically plausible policy appears to be a carbon tax, passed as part of a larger fiscal reform package. Meanwhile, the US Environmental Protection Agency has begun regulating GHG emissions from a variety of sources using its authority under the Clean Air Act. It may be necessary to choose between these two policies, however. The Waxman–Markey cap-and-trade bill that failed in 2009 would have preempted much of this authority, and it appears likely that a carbon tax law would do the same. But how can one make this choice? What are the key questions and issues to consider? The purpose of this paper is to compare these policies. Our aim here is therefore not to determine whether an exchange is wise or unwise. Instead, our intention is to give policymakers and other interested readers an impartial assessment of both policies and, in particular, the features that are important to a comparative evaluation. We don’t give answers, but hope at least to give the right questions to ask.

Abstract: A carbon tax will interact with other policies that are intended to reduce carbon dioxide emissions and encourage clean sources of energy and energy efficiency. This paper examines these policy interactions. A well-designed carbon tax can be an efficient instrument for reducing emissions, yet whether it will be implemented in an efficient manner is uncertain. A legislatively determined tax may not fully reflect up-to-date scientific and economic information. Behavioral and institutional factors suggest that a tax may not have its fully intended effect. These considerations suggest that climate policy should and will continue to be a complex mix of regulaions at various levels of government, even with a carbon price. Nonetheless, the possibility of unintended interactions among policies remains. The role for policies to encourage renewables and energy efficiency depends on the stringency of the carbon tax and presence of externalities related to technological learning and the energy efficiency gap.

Abstract: National and subnational economies have started implementing carbon pricing systems unilaterally, from the bottom up. Therefore, the potential linking of individual cap-and-trade programs to capture efficiency gains and other benefits is of keen interest. This paper introduces a two-tiered framework to guide policymakers, with an interest in North American policy outcomes. One tier discusses program elements that need to be aligned before trading of allowances across programs can occur. The second identifies benefits of incremental alignment of program elements even prior to trading between programs—which we call “linking by degrees.” We apply this framework to California’s cap-and-trade program and the Regional Greenhouse Gas Initiative. These programs are already linking through cooperation and sharing of information. Many aspects of the program designs are ready for the exchange of allowances within a common market; however, the difference in allowance prices remains an issue to be considered before formal linking could occur.

Abstract: Carbon markets are substantial and they are expanding. There are many lessons from experiences over the past eight years: fewer free allowances, better management of market-sensitive information, and a recognition that trading systems require adjustments that have consequences for market participants and market confidence. Moreover, the emerging international architecture features separate emissions trading systems serving distinct jurisdictions. These programs are complemented by a variety of other types of policies alongside the carbon markets. This sits in sharp contrast to the integrated global trading architecture envisioned 15 years ago by the designers of the Kyoto Protocol and raises a suite of new questions. In this new architecture, jurisdictions with emissions trading have to decide how, whether, and when to link with one another, and policymakers overseeing carbon markets must confront how to measure the comparability of efforts among markets and relative to a variety of other policy approaches.

Abstract: In 2009, President Obama pledged that, by 2020, the United States would achieve reductions in greenhouse gas emissions of 17 percent from 2005 levels. With the failure of Congress to adopt comprehensive climate legislation in 2010, the feasibility of the pledge was put in doubt. However, we find the United States is near to reaching this goal; currently, the country is on course to achieve reductions of 16.3 percent from 2005 levels in 2020. Three factors contribute to this outcome: greenhouse gas regulations under the Clean Air Act, secular trends including changes in relative fuel prices and energy efficiency, and subnational efforts. Nonetheless, global emissions likely will be greater than if comprehensive climate legislation had passed because of the absence of offsets, and at this point the United States is expected to fail to meet its financing commitments under the Copenhagen Accord for 2020.

Abstract: Economic approaches are expected to achieve environmental goals at less cost than traditional regulations, but they have yet to find widespread application. One reason is the way these tools interact with existing institutions. The federalist nature of governmental authority assigns to subnational governments much of the implementation of environmental policy and primary authority for planning the infrastructure that affects environmental outcomes. The federalist structure also interacts with the choice of economic instruments; a national emissions cap erodes the additionality of actions by subnational governments. Even the flagship application of sulfur dioxide emissions trading has been outperformed by the venerable Clean Air Act, and greenhouse gas emissions in the United States are on course to be less than they would have been if Congress had frozen emissions with a cap in 2009. The widespread application of economic tools requires a stronger political theory of how they interact with governing institutions.

Abstract: Climate policymaking faces twin challenges of carbon leakage and public sector revenue requirements. A large literature advocates the use of carbon dioxide (CO2) pricing and recycling the revenues to lower distorting taxes as a way to minimize costs. In this paper, we explore the implications of labor tax interactions for the cost-effectiveness of border adjustments and other measures to cope with leakage. We find that, for plausible values of labor supply elasticities, the cost savings from revenue recycling are significant—from 15 to 25 percent. The cost savings from anti-leakage measures are generally smaller, but also significant, particularly for small coalitions or more binding reduction targets. Tax interactions further enhance the cost savings from border adjustments, but make other measures like rebates or exemptions less attractive.

Abstract: Price collars have frequently been advocated to restrict the price of emissions permits. Consequently, collars were incorporated in the three bills languishing in Congress as well as in California's AB-32; Europeans are now considering price collars for EU ETS. In advocating collars, most analysts have assumed (1) collars will be implemented by government purchases and sales from bufferstocks, just like bands on foreign exchange rates or commodity prices; and (2) firms must surrender permits whenever they pollute. In fact, however, no actual emissions trading scheme has conformed to these assumptions. In the current paper, we maintain the second assumption (continual compliance) and show that while a price collar supported by a suffciently large bufferstock can restrict permit prices, a price collar supported instead by auctions with reserve prices cannot. In a companion paper (Hasegawa and Salant, 2012), we show that neither method works once account is taken of delayed compliance.

Abstract: Two decades have passed since the Clean Air Act Amendments of 1990 launched a grand experiment in market-based environmental policy: the SO2 cap-and-trade system. That system performed well but created four striking ironies. First, by creating this system to reduce SO2 emissions to curb acid rain, the government did the right thing for the wrong reason. Second, a substantial source of this system’s cost-effectiveness was an unanticipated consequence of earlier railroad deregulation. Third, it is ironic that cap-and-trade has come to be demonized by conservative politicians in recent years, since this market-based, cost-effective policy innovation was initially championed and implemented by Republican administrations. Fourth, court decisions and subsequent regulatory responses have led to the collapse of the SO2 market, demonstrating that what the government gives, the government can take away.

Abstract: Previous analyses assumed that firms must surrender permits as they pollute. If so, then the price of permits may remain constant over measurable intervals if the government injects additional permits at a ceiling price or may even collapse if more permits are injected through an auction. However, no cap-and-trade program actually requires continual compliance. The three federal bills and California's AB-32, for example, instead require that firms surrender permits only periodically to cover their cumulative emissions since the last compliance period. Anticipated injections of additional permits during the compliance period should have different effects than under continual compliance. We develop a methodology for analyzing the effects of such permit injections. Using it, we explain why the sales provisions of one federal bill might generate a speculative attack in the permit market and why one provision of AB-32 may undermine the very existence of an equilibrium.

Abstract: The outcome of the December 2011 United Nations climate negotiations in Durban, South Africa, provides an important new opportunity to move toward an international climate policy architecture that is capable of delivering broad international participation and significant global CO2 emissions reductions at reasonable cost. We evaluate one important component of potential climate policy architecture for the post-Durban era: links among independent tradable permit systems for greenhouse gases. Because linkage reduces the cost of achieving given targets, there is tremendous pressure to link existing and planned cap-and-trade systems, and in fact, a number of links already or will soon exist. We draw on recent political and economic experience with linkage to evaluate potential roles that linkage may play in post-Durban international climate policy, both in a near-term, de facto architecture of indirect links between regional, national, and sub-national cap-and-trade systems, and in longer-term, more comprehensive bottom-up architecture of direct links. Although linkage will certainly help to reduce long-term abatement costs, it may also serve as an effective mechanism for building institutional and political structure to support a future climate agreement.

Abstract: California will enact an economy wide cap-and-trade program on CO2. Estimates of the value of tradable emissions allowances in the first year range from roughly $2.6 to $7.8 billion, when electricity and industry are covered under the program. Those sectors receive most of their allowances for free; electricity sector allowance value is directed to the benefit of ratepayers. In the first year a fraction of allowances, mostly with future year vintage, will be sold through an auction with a value of roughly $0.6 to $1.8 billion. That revenue will be returned to the California economy through appropriation by the legislature. Allowance auction revenue will grow five-fold in 2015 when transportation and natural gas are included. To whom does this revenue belong? This is the key unresolved issue in the design of the California program.

Abstract: California will implement a cap-and-trade program to limit emissions of carbon dioxide covering industry and electricity sector emissions in 2013, expanding to cover transportation and natural gas in 2015. Although cap-and-trade would increase annual electricity costs for the average customer by $30 to nearly $100, the allowance value created under the program can offset all of these costs and even reduce electricity bills. California’s Air Resources Board has directed electricity regulators to ensure this allowance value is used for the benefit of electricity ratepayers. This paper surveys four options: (1) reducing electricity bills; (2) sending equivalent revenue directly to households in proportion to costs; or (3) as equal payments per customer account; and (4) making investments to improve the electricity system and help reduce emissions. Under special consideration is this question: Who will receive the allowance value associated with the electricity sector? We explore the implications of three specific proposals.

Abstract: Implementation of new environmental regulations in the electricity industry has triggered concerns about system reliability. We find these regulations are unlikely to create the shock to the system as some worry. They lead to little change in generation capacity. The large costs associated with investments in pollution control technologies are partially offset by a decrease in the cost burden associated with tradable emissions allowances. The combined effects contribute to a 1 percent increase in retail electricity prices and a decrease in producer profits of about $3–$5 billion in 2020. Though it varies across scenarios and regions, over the simulation horizon, consumers pay approximately 70 percent of total costs. In 2020, for example, total annual costs are between $6.6 billion and $7.1 billion. The investment in pollution controls leads to substantial reductions in emissions of mercury and sulfur dioxide.

Abstract: The introduction of the U.S. SO2 allowance-trading program to address the threat of acid rain as part of the Clean Air Act Amendments of 1990 is a landmark event in the history of environmental regulation. The program was a great success by almost all measures. This paper, which draws upon a research workshop and a policy roundtable held at Harvard in May 2011, investigates critically the design, enactment, implementation, performance, and implications of this path-breaking application of economic thinking to environmental regulation. Ironically, cap and trade seems especially well suited to addressing the problem of climate change, in that emitted greenhouse gases are evenly distributed throughout the world’s atmosphere. Recent hostility toward cap and trade in debates about U.S. climate legislation may reflect the broader political environment of the climate debate more than the substantive merits of marketbased regulation.