CA's Global Warming Solutions Act

Officials Reach Deal to Cut California Emissions:

California’s political leaders announced an agreement on Wednesday that imposes the most sweeping controls on carbon dioxide emissions in the nation, putting the state at the forefront of a broad campaign to curb the man-made causes of climate change despite resistance in Washington.

The deal between the Democratic-controlled Legislature and the Republican governor, Arnold Schwarzenegger, calls for a 25 percent reduction in carbon dioxide emissions by 2020, and could establish controls on the largest industrial sectors, including utilities, oil refineries and cement plants. The state has already placed strict limits on automobile emissions, although that move is being challenged in federal court.

The Bush administration has rejected the idea of similar national controls on carbon dioxide emissions, and efforts to get Congressional approval for such firm caps on emissions have repeatedly been defeated.

There are two big economic issues.

The first is the concern that business firms will leave high regulatory cost California and relocate their factories in "pollution havens" elsewhere, much like the effect of state air and water quality regulations before they were federalized in the 1970s:

The first major controls are scheduled to begin in 2012, with the aim of reducing the emissions to their level in 1990. The legislation allows for incentives to businesses to help reach the goals, but opponents warn that the state may be sacrificing its economic interests for a quixotic goal.

“If our manufacturers leave, whether for North Carolina or China, and they take their greenhouse gases with them, we might not have solved the problem but exacerbated it instead,” said Allan Zaremberg, the president of the state’s Chamber of Commerce.

North Carolina is a pollution haven? Don't we have a legislative commission looking at state-level climate change options?

The second issue is the design of the policy. Details in the NYTimes are sketchy, but it sounds like the policy involves tradeable emissions credits, the darling of environmental economists (emphasis added):

Peter Darbee, the chairman and chief executive of Pacific Gas and Electric, broke with his industry as PG&E became the first and possibly only major utility in the state to support the legislation, called the Global Warming Solutions Act.

“The issue of climate change is important and needs to be dealt with,” Mr. Darbee said. “We need a pragmatic and practical result. Since the bill has a market-based program, it will work efficiently and effectively for businesses.”

In short, if it costs you a lot to reduce your CO2 then you can buy permits on the open market at a cost below your abatement cost. If it doesn't cost you a lot to reduce your CO2 then you can sell your permits. Both types of firms, high and low cost abaters, are better off than in a command and control system. Both types of firms are also better off with trading than with a carbon tax.

Comments

[Liam]

"Both types of firms are also better off with trading than with a carbon tax."

Really? Surely this depends on where the money from the tax goes? If it went to each firm equally (or rather, in the same proportion as the caps/quotas were allocated), then as I see they would both be ambivelent (assuming the tax is set at the market price level). But if the money is spread in a different way (which is presumably quite likely), then this doesn't hold, and one will be better off while the other is worse off. How can it be that they are both better off under a tax than a trading scheme, i.e. where does the extra value come from?

The only difference I see is that a tax sets a price wheras a market sets a quantity. But when the cap is fairly arbritary does this matter?

Let me know where I'm going wrong...

[John]

Liam,

My assumption is that the tax revenue goes into the general fund (the double dividend that could offset distorting taxes) and is not returned to firms.

Comparing a carbon tax with tradeable permits, with a tax the firm pays on all of its emissions. With tradeable emissions permits, the firm only pays on the emissions that must be reduced (whether they do it with permits or abatement). They don't pay on the emissions that continue to produce and their total abatement cost lower.

In the most basic analysis.

John

[Tim Haab]

Drats, scooped again.

I've got to start waking up earlier to beat John to these stories.

Liam, you're right on track. In theory, the tax and the trading scheme are both economically efficient provided the tax is set at what will eventually be the carbon credit price and the credit quantity is set at the 'socially optimal level.' Distributional issues with the tax (who gets the money) tends to make economists favor the cap and trade programs instead. With cap and trade, the firms decide who gets what part of the revenues. At best, the tax could be devised so that the distribution is equivalent to the distribution established by the market based cap and trade program.

[Tim Haab]

D'OH!

[Liam]

John, thanks very much for your response, I think I see what you mean.

If you consider the tax money is removed completely from the firms then they are better off under the market system - i.e. both types of firm are better off, but everyoen else is worse off.

The advantage of a tax is, as you say, that it could go towards offsetting some distortive tax that the firms pay, and hence in this case could make both types of firm better off AND everyone else better off (as compared to a credit/market system).

Liam

[Liam]

Sorry Tim, didn't read your post before I posted! I see what your saying - although presumably the government still plays a distributional role with caps and trade by deciding how much to cap each firm?

Liam

[John Whitehead]

Liam,

In terms of efficiency (the social optimum, etc), if the tax and the permit price are at the same level (equating the marginal abatement cost of all firms) then we don't prefer either policy. No ifs, ands, or buts.

The tax revenue is a distributional issue (this is something that economists sometimes try to stay agnostic about). Firms lose because they pay the tax but someone else gains. What do we (economists) care?

More complex schemes can be devised to lower corporate taxes, income taxes, etc, with other distributional consequences and, perhaps, further efficiency gains since corporate and income taxes distort good behavior (working).

John

[John Whitehead]

Tim,

I've been up since 5:40 with the 2 year old. You really have to add another member to your family if you want to read the papers before I do (at least on days like today).

John

[Dan Cole]

Any details about monitoring requirements? While emissions trading is the darling of economists and politicians, they often fail to bear in mind that the success of the SO2 trading regime under the CAA hinged on the existence of continuous emissions monitoring systems, without which the government would not have been able (within an acceptable range of error) to determine whether sources were complying with quota limits. Without a robust monitoring and enforcement program, neither emissions trading nor emissions taxes can be expected to actually reduce pollution levels.

[John Whitehead]

More details on GWSA are provided in my next post.

[J.S.]

John- you say that if the tax or permits are set at the same level- equating all marginal costs of firms- than economists don't care which policy we take. This isn't correct because of uncertainty. The Weitzman results show clearly that in the prescence of uncertainty there are HUGE differences in efficiency depending on the slope of the curves and whether you choose permits or taxes. Since uncertainty with CO2 abatement is a given this is a big deal that needs to be looked into.

J.S.

[John Whitehead]

J.S.,

You're right, of course. I should have added the same addendum that I added a few comments above:

In the most basic analysis.

John

[Robert Metcalfe]

In terms of the pollution haven hypothesis, isn’t the evidence of dirty industries migrating from a high regulated area to a lower regulated area quite ambiguous? Some industries do not migrate because they simply can’t (e.g. electricity production), or there are high transport costs (e.g. cement), and that environmental regulation costs are typically low anyway.

Furthermore, in the UK, most dirty industries are partly exempt from environmental regulation, but not sure on the US regulations. Given that manufactured and human capital are more important in firms’ decision-making, I can’t quite see a mass exodus of firms from CA.

[Daryl Brown]

I think that there is no way the lions are going to be the seehawks on sunday

[Technika]

I think we can do anything smart and effective with that problem, the civilisatio is to expanded.