Climate Cap and Trade and Pollution Hot Spots: an Economics Perspective

• Jurisdiction: United States,Federal
• Citation: Vol. 39 No. 4
• Publication year: 2023
• topic: Environmental Law,Energy & Natural Resources

Climate Cap and Trade and Pollution Hot Spots: An Economics Perspective

Jeff Todd

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CLIMATE CAP AND TRADE AND POLLUTION HOT SPOTS: AN ECONOMICS PERSPECTIVE

Jeff Todd^*

Abstract

Although cap and trade is overwhelmingly preferred by economists for reducing greenhouse gases and spurring the adoption of renewables and other zero-carbon alternatives, some scholars and advocates worry that it allows firms to concentrate operations in poor and minority neighborhoods, thus leading to hot spots of harmful co-pollutants. Commentators differ on the danger of hot spots and the necessity of adjusting cap-and-trade programs to avoid them, however. This Article therefore surveys ex post economic studies of cap-and-trade programs to show that they do not lead to hot spots but may actually cool them—perhaps even better than command-and-control regulation. Accordingly, cap and trade unencumbered by unnecessary restrictions should be part of the policy mix for a just energy transition.

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CONTENTS

Introduction...............................................................................1005

I. Cap and Trade Is Cost-Effective at Reducing GHGs and Increasing Carbon-Free Alternatives...........................1008

II. Mixed Opinions on Pollution Hot Spots and Cap and Trade ................................................................................................1014

III. Economic Analyses: Cap-and-Trade Programs Do Not Result in Hot Spots............................................................1021

A. California's Climate Cap-and-Trade Program...............1022
B. Studies of Other Cap-and-Trade Programs....................1026

Conclusion: a Just Energy Transition with Cap and Trade ................................................................................................1030

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Introduction

Federal and state lawmakers have a range of options to guide the transition away from fossil fuels and toward carbon-free alternatives like renewables.¹ States target carbon supply through command-and-control approaches like efficiency standards, which include renewable portfolio standards (RPS).² By contrast, tax deductions and credits target the demand for carbon by incentivizing consumers to purchase electric vehicles (EVs) or install residential solar panels.³ By putting a price on greenhouse gases (GHGs), carbon taxes and cap-and-trade schemes target both the supply and the demand.⁴ GHGs are an unpriced externality, so a carbon tax forces firms and their customers to internalize the externality by paying a more accurate price.⁵ When emissions permits are auctioned or sold, cap-and-trade programs achieve the same effect,⁶ plus the permits create property rights for a

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vibrant carbon market.⁷ Climate cap-and-trade programs are more efficient than mandates or subsidies because they allow heterogeneous participants to make decisions based on their individual information and capabilities, such as whether or how to produce less carbon or switch to renewable energy sources.⁸

It is therefore no surprise that carbon pricing, whether via taxes or auctioned cap and trade, is overwhelmingly preferred by economists.⁹ Many environmental justice scholars and advocates, however, oppose cap and trade because of concerns over hot spots: they worry that firms will buy or trade for permits to concentrate their activities at the dirtiest plants, thus perpetuating, or even exacerbating, the release of harmful co-pollutants in disadvantaged communities.¹⁰ Some commentators have therefore proposed modifying cap and trade in ways that lessen the likelihood of hot spots but sacrifice efficiency.¹¹ The necessity of

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these modifications is called into question, however, by those who argue that cap and trade does not lead to hot spots.¹²

In light of the potential for cap and trade to reduce GHG emissions while spurring innovation in, and the adoption of, renewable energy, policymakers should understand the extent to which concerns over pollution hot spots are warranted before rejecting cap and trade as an option or saddling it with restrictions that make it less effective.¹³ Given the economic questions raised by a just energy transition,¹⁴ and responding to commentators who have lamented the dearth of attention in the legal literature to the distributional consequences of environmental laws,¹⁵ this Article surveys ex post economic studies of cap-and-trade programs to determine whether they have in fact resulted in hot spots.¹⁶ Contrary to popular perception, the survey reveals that cap and trade does not lead to hot spots—with some studies finding that it lowers pollution in minority and low-income communities better than command-and-control regulation.¹⁷

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Accordingly, concern over hot spots should not drive policymakers to forego cap-and-trade programs or to design them in ways that unnecessarily limit their cost-effectiveness for combatting climate change.

Part I describes why cap and trade is more cost-effective than efficiency standards and subsidies for reducing GHG emissions and spurring the adoption of renewables and zero-carbon products. Part II turns to the potential for cap and trade to exacerbate pollution hot spots and describes scholars' mixed opinions about this danger and how to design cap-and-trade programs to avoid it. To bring some clarity to the debate, Part III surveys economic studies on the distributional impacts of cap-and-trade programs to argue that they do not lead to hot spots; to the contrary, they reduce pollution in disadvantaged communities—and may do so more than in well-off areas and better than command-and-control regulation. The Article ends with a brief conclusion.

I. Cap and Trade Is Cost-Effective at Reducing GHGs and Increasing Carbon-Free Alternatives

The United States cannot immediately switch to zero-carbon electricity and vehicles—not only are existing infrastructure and vehicles powered overwhelmingly by fossil fuels but the infrastructure for a decarbonized economy is decades away.¹⁸ Lawmakers can intervene to accelerate the transition, however, with one approach being climate cap-and-trade programs. For sources of carbon and other GHGs, like power plants and industrial facilities,¹⁹ lawmakers can set a series of ever-more-stringent caps on emissions and then issue

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permits, with each permit allowing a certain amount of carbon emissions.²⁰ Although the government could grandfather or give away these permits, an auction system (or at least a combination of grandfathered and auctioned permits) will serve the dual purpose of pricing carbon and raising revenue so that market participants internalize the costs of emissions while governments can lower other distortionary taxes and fund rebates to low-income households to offset the higher costs of carbon-intensive products.²¹ Cap-and-trade systems include a market that allows firms that can abate emissions more effectively to sell permits to firms that cannot.²² As permits become fewer and more expensive, firms will develop and invest in new technologies, wind down carbon-intensive activities, and switch to carbon-free sources like renewable energy.²³

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Lawmakers can and have intervened in other ways, but only carbon taxes are as cost-effective as cap and trade.²⁴ For example, Carolyn Fischer and Richard Newell evaluated six different policy approaches to climate change and found that emissions pricing, whether via taxes or cap and trade, "is the most efficient single policy for reducing emissions, since it simultaneously gives incentives for fossil energy producers to reduce emissions intensity, for consumers to conserve, and for renewable energy producers to expand production and to invest in knowledge to reduce their costs."²⁵ They ranked RPS, renewable production subsidies, and research-and-development subsides as fourth, fifth, and sixth best, respectively.²⁶ Similarly, Karen Palmer and Dallas Burtraw found that abatement costs to achieve carbon emissions reductions under cap and trade were about 50% lower than with RPS and about 75% lower than with renewable energy production tax credits.²⁷ In a survey of cap-and-trade programs, including several for climate change, Richard Schmalensee and Robert Stavins concluded that these are "environmentally effective and economically cost effective relative to traditional command-and-control approaches"

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and that "less flexible systems would not have led to the technological change that appears to have been induced by market-based instruments or the induced process innovations that have resulted."²⁸

Other regulatory approaches are not as efficient as cap and trade. For example, technology mandates and performance standards work well when regulators have perfect information and regulated firms are homogenous²⁹ or if lawmakers desire a modest emissions cap.³⁰ This is not the situation with climate change, however. One "fundamental problem" is the "mismatch between capabilities and responsibilities": regulators have "too little information" to accomplish their objectives cost-effectively, while the plant managers with the best information have no incentive to accept responsibility voluntarily or to transmit unbiased cost information.³¹ Moreover, market participants are heterogeneous, with differing operations, emissions, and costs in seeking to respond to one-size-fits-all standards.³² A further complication is uncertainty over technological progress: some promising technologies have worked while others have not, so mandates may require low-carbon options based on insufficient information on whether they will be successful.³³ Mandates and performance standards therefore lead to higher compliance costs per unit of abatement.³⁴ By contrast, cap-and-trade schemes "provide firms with flexibility in achieving emissions reductions and tend to

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equalize marginal abatement costs across firms."³⁵ Emissions rights end up in...