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Looking for Environmental Certainty in All the Wrong Places

What will be the fate of California’s cap and trade system for GHG? This is an issue that has been flying under the radar nationally, given the hullabaloo about carbon taxes in Washington State, the potential addition of Ontario to the California cap and trade system, and, umm, other stuff.

The California Air Resources Board last Monday unveiled three potential plans for addressing the state’s new climate goals that were set in CA Senate Bill SB 32. In addition to “plan A” which involves tightening the carbon cap down to 2030 target levels, there is an alternative that scraps the cap and instead identifies an expanded set of “specified” reductions, and also an alternative that replaces the cap with a carbon tax.

While in a vacuum, many economists support a carbon tax, it is for a different set of reasons than the ones causing its popularity in west-coast policy circles today.   The carbon tax is starting to be seen less as a mechanism to induce innovative ways to reduce emissions, and more as a means to fund specific abatement programs.

The ARB’s alternative plans are a response to the growing disillusion with California’s cap and trade program. This disillusion stems in part from frustration that it’s not producing the revenues once projected, and in part from some anecdotal evidence that it may not be delivering reductions in local pollutants in disadvantaged communities. Policy makers are now scrambling for policies that they believe can deliver what they consider to be more reliable benefits.

In fact none of the alternative climate policies gives us any guarantees over the emissions of either GHG or local pollutants.   Choices between policy instruments amount to trading off more uncertainty in meeting some goals in exchange for more assurance in meeting others.  For example, to pretend that we can estimate a specific tax level that will hit anything close to a reliable carbon reduction amount is to deny everything we know about what we don’t know.

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California ARB Reference Scenario Emissions and reductions called for under SB 32.

My previous work with Severin Borenstein, Frank Wolak, and Matt Zaragoza-Watkins (BBWZ)  documented just how much volatility there is in “business as usual” GHG emissions. The top figure on the left shows how much abatement we would need from the baseline (ARB’s reference scenario). The lower figure (from BBWZ) shows one forecast of the range of BAU emissions (these are emissions under the cap so not exactly the same thing).  The comparison shows just how volatile the ARB’s baseline can be.   That’s even before accounting for the uncertainty in planned reductions, some of which are speculative at best.

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Forecast Variability of Business as Usual Emissions through 2020 (from Borenstein, et al, 2016).

The only way to truly have some kind of confidence of hitting a specific carbon reduction target with a tax is to be willing to continually adjust that tax based upon updated valuation of how close or far we are from the carbon target. Such a floating carbon tax would re-introduce the same uncertainty over the cost (and revenue generation) of our policy that has drawn so much complaint about the cap and trade program.

Concern about uncertainty has led to an embrace of plans that focus more on so-called specified measures. These measures appear to specifically identify the sources of the reductions that we will achieve. However to view these policies as giving any more certainty than a carbon tax is to again ignore the vast gaps between our goals and what we know about how to achieve them.

Many of the reductions identified in the California Air Resources Board’s recent alternative scoping plan (the route that scraps cap-and-trade) are better labeled as aspirations than programs.  For instance, there is a goal of reducing GHG emissions at refineries by 30% but no specific policy or technological solutions identified as to how exactly to achieve such a goal. There is also no current sense of how much such reductions may cost. There are similar goals associated with emissions from freight traffic, passenger travel, rooftop solar, and short lived climate pollutants (SLCP). None of these have any degree of certitude or confidence about them. If these reductions don’t materialize as hoped for, or cost much more than anticipated, there would be no cap to back-fill the shortfall.

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How much abatement can we count on? These are ARB scenarios assuming different effectiveness of specified programs

Both carbon taxes and cap and trade suffer from an image problem. These policies are intentionally designed for a world in which we don’t know exactly what is going to happen. If energy efficiency programs don’t yield enough savings, then we try something else. This adjustment happens automatically under a cap.  Yet the policy process seems to demand that specific sources of reductions be identified ex ante. Unfortunately such lists of policies can create only the illusion of certainty. Developing a potentially attractive list of sectors to draw GHG reductions from doesn’t address the large uncertainty about how to actually achieve those reductions.

In reality, an approach that relies upon rigidly enforced specific measures creates more uncertainty than either of the other approaches. We generally frame the choice between taxes and caps as one of choosing between more certainty over pollution levels on the one hand or more confidence about the costs on the other.   A plan that would rigidly adhere to a set of specific reduction policies, about which we have very little confidence over the costs or the actual resulting abatement, represents the worst of both worlds. We would have very little sense of how much actual carbon (or local pollutants) we will be producing in 2030 while also committing to a set of policies that could turn out to be quite costly, ineffective, or both.  Isn’t it better to have a firm commitment to an abatement strategy (be it a cap or a tax) without knowing exactly where those reductions will come from, than a firm commitment to try one specific approach without knowing whether it will actually work?

So, how should we balance the goals of carbon reductions and costs to industry and consumers? Well using the tools we already have is a pretty good place to start.  We have a cap on GHG emissions. It has its flaws but is one of the most effective GHG reduction mechanisms in the world (a somewhat low bar these days).  It also has cost containment mechanisms, a restraint on the upper and lower limits of allowance price, that while also imperfect, has helped to support GHG prices even in the face of lower than expected emissions.

Of course, some have argued that a rigid GHG cap for just California makes little sense, given that it would in isolation provide few climate benefits. This camp would support a carbon tax because of the innovation and abatement activity it would inspire, rather than as a means to achieve any set number. However, that is not the direction California committed to earlier this year when it passed SB 32. If we truly want more control over revenues and abatement, working within the existing cap-and-trade structure is much more likely to provide it than blowing it up and starting from scratch.

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