Climate Change Policy: Overview of Options to Reduce GHG Emissions Liz Brosius, KEC Director

1. Climate Change Policy: Overview of Options to Reduce GHG Emissions Liz Brosius, KEC Director KEC GHG Policy Committee, April 9, 2008

2. Where we are today • 2007 U.N. IPCC report states that there is a “very high confidence” that human activities are causing a net warming of the planet. • Human activities = combustion of fossil fuels and the subsequent release of carbon dioxide into the atmosphere

3. Where we are today • Policymakers at every level of government are considering options for stabilizing and then reducing GHG emissions • Leading economic analysts have studied this problem for decades and conclude that market-based policies are the most cost-effective way to reduce GHG emissions

4. Where we are today • The world has finite resources and many competing uses for them • Tackling global warming, even with optimally efficient policies, will be expensive • Wise climate change policy should aim to get the most reduction of GHGs for every dollar spent

5. Policies to reduce GHGs • Economy-wide GHG tax (most efficient, least cost) • Economy-wide hybrid cap-and tax (permit auction, safety valve) • Cap-and-trade with permit banking, borrowing, and auction • Cap-and-trade with permit giveaway • Command-and-control mandates and standards (least efficient, highest cost)

6. Scope of problem • Global warming is a problem requiring an international, collective solution • GHG emissions cause equal harm no matter where they are emitted. • Will require establishment of international regulatory framework and institutions

7. Scope of policy options • In the U.S., a national-level approach is appropriate focus for policymakers • starting point for international policy • U.S. responsible for 21% of global emissions • Provides uniformity, level playing field • does not unduly disadvantage certain states or regions • avoids redundancy and lack of uniformity of state-by-state or regional approach

8. Scope of policy options • Regional initiatives: MGA, RGGI, WGI • State-level “climate action plans” or GHG emissions goals • largely focused around non-market mandates, standards • GHG emitters may avoid doing business in those states, regions, effectively bypassing regulation • most costly way to reduce emissions

9. Policy options to reduce GHGs • Market-based initiatives - carbon tax or cap-and-trade - set a price on emissions so that costs to society and environment are included in market prices • sends clear signals to producers and consumers • facilitates flexibility in policy setting and also in how firms and consumers respond

10. Policy options to reduce GHGs • Non-market (command-and-control) policies mandate particular solutions and technologies or set minimum standards • less flexible: “one-size-fits-all” approach • promote specific solution, often without regard for costs and benefits • less opportunity for innovation and individualized decisions

11. Carbon tax • Tax on each ton of CO2emitted (downstream) or each ton contained in fossil fuels (upstream). • Provides direct incentive to • reduce consumption, • substitute lower-carbon alternatives (where available), and • spur innovation • Establishes upper limit on cost of reducing emissions during given time period.

12. Carbon tax • Easily adjusted to accelerate emissions reductions (by raising tax) or vice versa • Relatively inexpensive to administer • use existing tax infrastructure • Produces less predictable annual emissions reductions than inflexible cap • less predictable does not mean less reduction

13. Carbon tax • Politically unpopular • cost to consumers is obvious • Generates revenue that can be used to • reduce other taxes (revenue neutral) • assist low-income households • fund energy science research • Best option for international consistency considerations (CBO)

14. Cap-and-trade • Sets limit (cap) on quantity of total emissions during some period • issues permits equaling that cap • entities would be free to trade permits. • Setting initial level can be problematical • CBO estimates could cost 30% more than tax in lost benefits • Permit prices may vary drastically • Permit allocation is highly political • Produces incentives to cheat, “game” the system

15. Cap-and-trade • Sets predictable annual reductions • More costly to administer than tax • requires new administrative infrastructure to track allowance holdings and transfers • upstream cap would not require emissions monitoring • Politically popular • cost to consumer is not obvious • Lowest ranked option for international consistency considerations (CBO)

16. Hybrid cap-and-trade • Combines advantages of tax with cap-and-trade • One option: cap-and-trade combined with base carbon tax and safety-valve permits at penalty price • auction initial permits with base (floor) price as lower limit • sell unlimited quantities of allowances at safety valve (ceiling) price (e.g., 50% higher than base)

17. Hybrid cap-and-trade • Auctioning permits: less political or subject to favoritism • may result in more equitable distribution • More efficient than cap-and-trade, less efficient than tax • Same administrative considerations as cap-and-trade

18. Hybrid cap-and-trade • More politically popular than tax • Like tax, generates revenue • reduce other taxes (revenue neutral) • assist low-income households • fund energy science research • Mid-ranked option for international consistency considerations (CBO)

19. Mandates and standards • Non-market / command-and-control policies include subsidies, tax credits, minimum standards • Politically popular • quantifiable goals and targets • costs often hidden • benefits targeted industries, sectors

20. Mandates and standards • Most expensive approach • even when cost effective they are 10 times more expensive than market-based methods • Favor specific solutions • instead of encouraging lowest-cost reductions • can create counter-productive side effects

21. Conclusions • Given the scope of problem and huge costs and challenges of solutions, important to chose policies that provide greatest reduction for each dollar spent • Honest policy debate acknowledges that all approaches to reducing GHG emissions will force consumers to pay more for goods and services that require combustion of fossil fuel

22. Conclusions • Enactment of U.S. GHG policies that are national in scope is not only efficient, but it would clearly signal U.S. commitment to a common purpose. • Positions U.S. to take a leadership role in forging an international effort to fight this global problem.

23. Further reading Greenhouse Gas Emissions: Policy and Economics, A Report Prepared for the Kansas Energy Council, by Trisha Shrum, August 2007 Policy Options for Reducing CO2 Emissions, Congressional Budget Office (CBO) Report, February 2008 A Question of Balance: Weighing the Options on Global Warming Policies, William Nordhaus, Yale University Press (pre-publication version available: http://nordhaus.econ.yale.edu/Balance_2nd_proofs.pdf).