If a cap is not really a cap, what does that make an offset?
Even though the Biden administration has made it very clear that they do not want to even talk about a carbon tax or cap-and-trade program as part of their current climate strategy, debates over the role of these “market-based” policies keep emerging. The latest policy instrument in the news recently has been the carbon “offset.” Traditionally, offsets have been deployed as “alternative compliance mechanisms” for emissions caps. The idea is that firms that are regulated under caps can pay firms who are not capped – because they are in an unregulated industry, or are in another state or country – to reduce their carbon emissions instead. The theory is simple. If we want to reduce GHG emissions at lowest cost, why force costly reductions from capped company A when uncapped company B can do it for half the cost?
Generally, offsets are the environmental policy that environmentalists love to hate. Offsets seem to combine all of the negative stereotypes of market-based environmental policies in one package. Buying your way out of having to reduce your own pollution? Yep! Paying someone else to do stuff they maybe should have to do anyway? Sure! Allowing companies from [insert your location here] to pay to reduce pollution in [insert some other location here]? Bingo!
The newest wrinkle in the offset world is Climate Vault, a new company with a new (old) take on offsets. They will operate in the voluntary offset space. But instead of paying for some kind of carbon-reducing project, the main strategy of Climate Vault is to buy up, and then retire, the official allowances that form the “currency” of any cap-and-trade program. Under a classic cap-and-trade program, every ton of pollution from a regulated industry needs to acquire an official allowance, so reducing the number of allowances in circulation would reduce the amount of pollution from regulated industries.
By going straight for the official allowances, Climate Vault is avoiding a lot of the baggage normally associated with offsets. There are no arguments over whether trees will be cut down later, or if those clean energy projects in China would have been built anyway. In a setting with a “pure” emissions cap, retiring one allowance would force the equivalent reduction from a local, regulated source.
So then I must be a big fan of Climate Vault’s idea? Not exactly. Both proponents and critics of offsets, in any form, are stuck arguing over the wrong paradigm. They use language and arguments that imply that GHG caps like those in California or Europe are “pure” caps. But they are not. Not even close. No matter how many times we point out that California’s cap is not really a cap, many people continue to act like it is.
But I’ll say it again, the cap is not really a cap. The quantity of carbon allowances put in circulation by the Air Resources Board (and therefore the quantity of carbon emissions) is a function of the allowance price. It is similar in Europe, just way more complicated. When the price is too low, allowances are withheld from the market. When the price is too high, more allowances are made available. The 2017 law extending California’s cap-and-trade program committed the ARB to limit how high the allowance price would go, meaning that it is the price, not the quantity, of carbon that is truly “capped.”
It is instructive to instead think of GHG markets in California, and to a lesser extent Europe and RGGI in the US northeast, as kind of like progressive carbon taxes. They are taxes in the sense that emissions caps are enforced with a financial penalty for emitting carbon and not having an allowance. You could have a “cap” on street parking of five minutes, but when the fine for the violation is $4 an hour, then it’s essentially a fee. The taxes are progressive in the sense that the tax rate increases as the quantity of economy-wide carbon emissions increases. At low quantities of (aggregate) carbon emissions, the price (tax rate) is lower, at higher quantities, the price (tax rate) is higher. But “price collars” are in place to ensure that the tax rate is neither too low nor too high.
If one thinks of these markets as effectively dynamically adjusted carbon taxes, and I think we should, then what does that make an offset? Traditional offsets, like those for forest preservation, are essentially carbon “tax credits.” Instead of paying the carbon tax, you make a donation to a renewable energy project or to preserve a forest, and your tax bill goes down by the price of an allowance. Sounds crazy? Firms that buy into a renewable energy startup get income tax credits. Even buying a car can get you a $7,500 Federal Income tax credit. And don’t even get me started on residential rooftop solar.
Donations to the Nature Conservancy, which buys up and “vaults” natural lands, have been deductible from income taxes for years. To my knowledge, this didn’t spark much outrage as a tax dodge. More recently they started selling carbon offsets for similar activities, and now they are drawing fire over questions of additionality. These are voluntary offsets that do not even impact formal cap-and-trade programs. My point is not that we should ignore the question of additionality, but rather that it takes on a whole different meaning if we think of these programs as taxation, let alone as voluntary contributions.
The problem with Climate Vault’s business model becomes clear when one engages in the “cap is really a tax” thought exercise. Say someone gives money to Climate Vault, and CV turns around and buys California allowances with the money. Most likely, one of two things will happen. The California carbon price might be at its floor, in which case ClimateVault will purchase and retire an allowance that would have otherwise been withheld from the market by the ARB anyway. Or, the California carbon price might be at its ceiling, in which case Climate Vault will purchase and retire an allowance out of the ARB’s containment reserve which, you guessed it, would otherwise have been withheld from the market by the ARB. In other words, carbon emissions do not change and the money given to Climate Vault is converted into a donation to California’s carbon revenues. Thanks!
To be fair, I am oversimplifying the dynamics of price-collars in these markets. While California’s carbon market has often cleared at the price floor it doesn’t always. However, my work with Severin Borenstein, Frank Wolak and Matt Zaragoza-Watkins, suggests that over the long run, a system like California’s will settle in at either a floor or ceiling price. In this system, retiring permits does not do nothing. Removing allowances from circulation raises the odds that the carbon price will settle in at the price-ceiling, or higher “tax-rate,” rather than at the price floor. So there is an effect, but it is likely an effect on the price of carbon. I’m not sure about the appeal of the slogan “do your part to help raise marginal carbon tax rates.”
This brings us to an underappreciated point about offsets (the traditional kind), which is that they aren’t just about reducing emissions. We don’t justify the tax deductibility of charitable contributions because we think they could reduce the need for government spending (although they might). We do it because it provides an incentive to support “good” works. The idea behind offsets is that they could help fund worthwhile energy and ecosystem management projects, sometimes in developing countries, that are deserving of support in their own right. Providing some regulatory relief to the source of the funding gives an incentive to make those investments. The fact that they may not yield exactly the amount of true carbon reductions that they are nominally “offsetting” should be balanced against the other benefits those investments could produce. That is why the original offset program was called the clean development mechanism. A lot of its supporters were as interested in the development part as the clean part.
This is why I never fully understood the high level of moral outrage created by offsets, relative to say, the tax deductibility of donations to the nature conservancy, or the fact that the Low Carbon Fuel Standard program appears to be awarding massively more credits for residential EV charging than the data support. We are willing to accept mismeasurement or imperfections when it results in support for projects or technologies society deems worth supporting.
This is how we should think about the appeal (or lack thereof) of traditional offsets. Maybe those “other” benefits are worth it. Maybe these projects will stimulate learning-by-doing, or start communities on a sustainable development path, maybe not. Clearly some offset projects were not worthwhile. The better run oversight programs have hopefully learned to weed these out. It is worth having those debates. However, a debate that begins and ends with whether an offset violates the integrity of “the cap” is just wasting breath. The cap is not really a cap.
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Suggested citation: Bushnell, James. “When Did Environmentalists Stop Hugging Trees?” Energy Institute Blog, UC Berkeley, June 7, 2021, https://energyathaas.wordpress.com/2021/06/07/when-did-environmentalists-stop-hugging-trees/