When a National Cap-and-Trade Policy with a Carve-out Provision May Be Preferable to a National C[O.sub.2] Tax.

AuthorAccordino, Megan H.
  1. INTRODUCTION

    Greenhouse gas (GHG) emissions are widely regarded as a textbook case of a global externality warranting coordinated global action (Oates, 2001). However, what appears to be emerging from international negotiations is a weaker agreement whereby countries set their own targets for emission reduction (Diringer, 2013). One impediment to a stronger global commitment is the lack of national consensus within some large industrialized countries including the United States and Canada (Rabe et al., 2005; Bulkeley, 2010). In such countries (and elsewhere too), lower levels of government are undertaking various measures to reduce GHG emissions (Rabe, 2008). The range of policy measures includes carbon dioxide (C[O.sub.2]) taxes (e.g., the province of British Columbia in Canada and the city of Boulder, Colorado in the U.S.), tradable emission permits, henceforth referred to as cap-and-trade, (e.g., the state of California and the Regional Greenhouse Gas Initiative by states in the north-eastern U.S.), emission intensity standards (e.g., the province of Alberta in Canada and the state of California in the U.S.) and renewable energy policies (e.g., state-level Renewable Portfolio Standards, feed-in-tariffs, and various forms of subsidies).

    While economic theory suggests that emission pricing, either directly through a C[O.sub.2] tax or indirectly through a cap-and-trade program, is the cost-effective approach, renewable energy policies appear the more popular approach for state-level action. Justifications for renewable energy include the local economic benefits of "home-grown" energy resources for long-term economic development and the benefits of reducing (or even simply aiming) to reduce GHG emissions (Rabe, 2008). Bushnell et al. (2008) argue that in a market comprised of many states which are not subject to a unified climate policy and which do not have state-level C[O.sub.2] reduction programs, if one state decides to reduce its own emissions, then this goal may be achieved by simply reshuffling pollution within the market such that the state with the policy consumes "cleaner" products while the rest of the market consumes the "dirtier" products. For instance, electricity is susceptible to reshuffling because wholesale purchases of electricity are financial arrangements which are not tied to the physical exchange of electrons. Thus, if "clean" products already have a significant market share, the policy can be satisfied with no change in production or emissions. Indeed, in many electricity markets in the U.S., sizeable zero-carbon electricity generating capacity in the form of nuclear and hydroelectric power exists which may prevent policies targeting C[O.sub.2] emissions from being effective in many states.

    The goal of this paper is to formally model the interaction of policies at multiple levels of jurisdiction, specifically at the federal and state level, in order to identify the effect on pollution and the relative costs and benefits of C[O.sub.2] taxes vis-a-vis cap-and-trade at the federal level when combined with overlapping state-level climate policies (specifically, C[O.sub.2] taxes (1) or renewable portfolio standards (RPS)). (2) This research is motivated by the premise that in countries where national opinion on climate change is divided, in the near to medium-term, any national agreement, should it be achieved, would likely be viewed by some states as insufficiently stringent and such states would likely pursue overlapping state-level policies. While an emission tax and a cap-and-trade program are ex ante equivalent (Jaffe et al., 2003), we show that when states enact additional emission control policies, the two national policies could yield different results. In any case, the cost of a given reduction in national emissions is always lower under a unified national emissions policy than under differentiated and/or overlapping policies by multiple jurisdictions.

    Several authors have analyzed the effect of combining state and federal emissions reduction policies (Bushnell et al., 2008; McGuinness and Ellerman, 2008; Burtraw and Shobe, 2009; Goulder and Stavins, 2011a,b; Williams, 2012). One common conclusion in these studies is that under a national cap-and-trade regime, additional state policies have little to no effect on national emissions as any additional emission reduction at the state or local-level, beyond that which would have resulted under the national policy alone, only allows emissions from the rest of the nation to rise back to the level of the national cap. However, by developing innovative policies and infrastructure, state and local regulators could help lower the cost of achieving national emission goals (Burtraw and Shobe, 2009). Another set of papers analyzes the effect of renewable energy policies operating under the European Union (EU) Emissions Trading System (ETS). See Fischer and Preonas (2010) for a summary of this literature. These articles conclude that overlapping national renewable energy policies raise the cost of national cap-and-trade policies without affecting national emissions and may benefit the dirtiest fuels.

    The offsetting increase in consumption outside the state under a national cap could, however, be avoided by either "carving-out", i.e. exempting states from the national policy provided they set a stricter state policy, or through price-based regulations, e.g. a C[O.sub.2] tax (Goulder and Stavins, 2011a). (3) Contrary to Goulder and Stavins (2011a), we show that a price-based regulation, specifically a C[O.sub.2] tax, does not necessarily prevent a completely offsetting increase in emissions elsewhere when states adopt an additional C[O.sub.2] tax on top of the national C[O.sub.2] tax. Consequently, we also show that, for small states (relative to their market, see Section 2.3 for definition) that are subject to a national C[O.sub.2] tax, a state-level renewable energy policy is able to further reduce national emissions while a state-level emissions policy cannot. However, if a carve-out provision is added to a national cap-and-trade program, allowing states to exempt themselves from the national policy provided they set a tighter cap, and a state decides to set a tighter cap, emissions must decline regardless of the size of the state as the sum of permitted national and state emissions is now lower. Furthermore, because any reshuffling (4) or leakage (5) of emissions within the market caused by a tighter state cap would increase the national emissions permit price (in order to keep emissions outside the state constant), a cap-and-trade policy with a carve-out provision limits reshuffling and leakage within the market and reduces the cost of achieving a given reduction in emissions with a state policy relative to the cost under a national C[O.sub.2] tax coupled with an additional state C[O.sub.2] tax. However, a tighter state cap under a national cap-and-trade policy with a carve-out raises electricity costs for consumers outside the market relative to the costs before the tighter state cap was implemented and relative to those under equivalent national and state C[O.sub.2] taxes, which may impede support for state carve-outs from the national regime.

    Our findings result from the following key features of our model: (i) the commodity (or commodities) under consideration can be produced with inputs (say, energy) from different sources or using different technologies resulting in different emissions per unit of output and at least one such input or process results in a zero emission product. In our example, the commodity is electricity derived from coal, natural gas, nuclear, hydro and renewable resources, the latter three being considered zero emission resources; (ii) the commodity is traded at negligible transportation cost within a specified geographic region that spans multiple policy jurisdictions. In our example, it refers to the free flow of electricity within a regional interconnected grid; (iii) under any state-level climate policy, retailers are accountable for emissions attributable to final in-state sales regardless of where emissions actually arise in the supply chain, which may be outside the policy jurisdiction. In our example, this implies that even though electricity consumption is emission-free, regulated state retailers are accountable for C[O.sub.2] emitted during generation of the electricity imported into the state.

    Relaxing the above assumptions affects our findings as follows. Without a zero-carbon resource, pure reshuffling of output would not be sufficient to avoid the state C[O.sub.2] tax and thus a state C[O.sub.2] tax would be effective even for small states. As the cost of reshuffling increases, the ability of state-level policies to affect national emissions increases for any given state size. Thus the higher the transportation costs (or any other costs associated with shuffling the distribution of the final good), the more effective state-level policies will be at reducing national emissions. The implications of state policies directed at targets other than the emissions attributable to final in-state sales, say, extraction of primary fossils fuels, are discussed in Section 3.5.

    While our mathematical and numerical illustrations are for a single commodity, specifically electricity, the simplified model allows for more general conclusions about emission policies spanning multiple economic activities. As the scope of the policy at either the state-level, the national-level or both widens to include emissions from multiple sectors, so does the scope for reshuffling and leakage, causing the efficacy of state-level emissions policies to depend on how the size of the state changes relative to the broader market(s) across which resources can be reshuffled. The comparisons of the various state and national policy combinations are, however, unaffected. Given the global effects of C[O.sub.2] emissions, our...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT