Is ‘Cap-and-Trade’ Good for California?

The California Air Resources Board is mulling a mix of regulations, fees and market-like mechanisms to impose on California, to comply with the state’s Global Warming Solutions Act. That 2006 law requires California to cut greenhouse gas emissions back to 1990 levels within 12 years, but it gives the board some latitude in determining how to achieve the goal. Two proposals are now being considered.

One of the board’s expected tools is a “cap-and-trade” system, successfully used in Northeast states to reduce acid rain generated by utilities. Under such a system, the state would establish a limit on emissions, which it did in December, then assign allowances to emit a certain amount to each facility. This system would impose costs on companies that emit greenhouse gases. These costs would encourage them either to reduce emissions or buy allowances from other companies that can reduce them at less expense. The future price of allowances would be determined by the supply and demand for credits, both to be set by regulators. The price of credits will also be affected by how regulators allocate emission credits—either by assigning them or by auctioning them. All of these steps are subject to political manipulation.

In politics, it is impossible to get policy mechanisms exactly right. This is why major shifts require policy makers to provide serious deliberation and scrutiny in order to achieve thoughtful, common-sense solutions. That is exactly what is needed to address the ongoing and increasingly complex debate about global warming, emissions reduction and overall environmental protection.

The passage of AB 32, the Global Warming Solutions Act (AB 32) has garnered the attention of environmental activists, regulators and affected industry leaders. AB 32’s goals have now been set: a 25 percent reduction in Greenhouse Gas emissions (that is, our 1990 emissions level) by 2020 and a reduction of 80 percent of those 1990 levels by 2050.

The question of how to reach those goals is now in the hands of CARB, whose cap-and-trade system will set an annual limit on GHG emissions and then allow for a market-like trading of emissions credits. The claimed advantages of cap-and-trade schemes, like the ones favored in principle by Sens. Barack Obama, Hillary Clinton and John McCain, are emissions predictability and the benefits inherent in a market-based trading system.

The second proposal is a straight tax on carbon emissions. Proponents of the carbon tax tout its clarity, resistance to market manipulation and predictable impact on energy prices. Neither proposal is administratively simple, safe from abuse, nor even technically accurate in measuring emissions. Both proposals directly harm consumers, a fact that engenders less discussion.

As that nightmare recedes from memory, Californians should recall that the system’s inadequacies were not market-based but rather the biases of regulators. Manipulation was enabled by the government agencies charged with designing and monitoring the restructuring process. They failed to account for possible predatory activities and worse. Many of the mechanisms put in place encouraged misbehavior. It is impossible for policy makers to predict every consequence of their proposals. If money can be made manipulating government-created faux-markets like cap-and-trade – and it can – someone will find a way to do it.

When so much money is at stake, how can regulators hope to account for every possible market manipulation? How can trading schemes track the actual emissions from millions of disparate sources and through the entire production process? Who gets “charged” for the carbon dioxide released baking the bread of a worker’s sandwich? What army of new accountants keeps track?

A look at Europe confirms that cap-and-trade plans can be subject to abuse by participants and government alike. Europe has not achieved promised reductions, and their emissions have actually increased under cap and trade rather than decreasing as designed.

Carbon cap-and-trade policy will place a drag on California’s economy and will strangle our ability to grow as a state. This will ultimately worsen our current budget deficit as economic activity continues to stagnate.

Whatever the merits a more transparent and revenue-neutral carbon tax may provide, there is not enough public support to warrant serious consideration. Such a tax is likely subject to the same misbehavior as cap-and-trade plans. Of course, the concept of tax revenue neutrality sounds good—but has never happened.

Comprehensive public policy must allow time for study, trial and error and experimentation, and must account for human nature as well as human ingenuity. Free-market competition and innovation can identify better solutions. This process, however, will come at a cost of occasional volatility in the price and availability of energy in California.

Cap-and-trade schemes come with known high costs, plus those we cannot yet predict. A rational policy would include a short-term strategy mindful of consumer impacts while looking at a long-term solution that achieves evolving goals. With the aid of technology and entrepreneurship, along with deliberative policymaking, we can take significant steps toward reducing greenhouse gas emissions.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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