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Environment Magazine September/October 2008


May-June 2009

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In Search of Effective and Viable Policies to Reduce Greenhouse Gases

The start of the Obama administration in 2009, following the return of Democratic party majorities in both houses of U.S. Congress in 2007, could mark a new chapter in the United States to reduce carbon dioxide (CO2) and other greenhouse gas (GHG) emissions. With GHG control policy already under way in a number of cities, states, and regional partnerships, the administration, Congress, and other stakeholders have entered a vigorous debate over a framework for strong federal action. However, growing interest and involvement does not necessarily imply all the various parties have moved closer to agreement. Even with increased political alignment among key stakeholders, generating support around a particular framework will be neither easy nor quick. Particularly at a time of significant preoccupation over serious economic problems, it seems inevitable that a great deal of compromise will be needed to accomplish such agreement. On the other hand, to improve the prospects for effective and sustainable action, policymakers should consider certain broad normative criteria, including a policy’s efficiency, adaptability, and fairness.

Constructing GHG Mitigation Policy

Since taking office in January 2009, President Obama and his administration have outlined a dynamic plan to reduce GHG emissions as part of a more comprehensive long-term strategy including limits on petroleum imports and economic stimulus through green investment.1 In its 2010 budget proposal, the Obama administration sketched out its approach to an economy-wide cap-and-trade system.2 This federal action comes on the heels of a number of prior congressional proposals,3 as well as state-level initiatives.4

Under a cap-and-trade system, a regulatory body limits total emissions and puts mechanisms in place that allocate allowances to all emitters and other entities covered by the system. Allowances are specified quantities of GHGs that the holder may emit. Companies in danger of surpassing their individual emissions limits can buy additional allowances from others that do not use all their allowances, creating a market for them. In other words, companies can change individual emissions caps through buying or selling emissions allowances. To maintain environmental integrity and confidence in the allowance market, regulators need an effective system for gauging a source’s emissions and comparing them to allowance holdings.

Cap-and-trade often focuses principally on CO2 from fossil fuel burning—the GHG that produces the most emissions. However, the system can include other GHGs and sources—for example, methane emissions from landfills and emissions released by deforestation. A “downstream” program, which measures and restricts actual emissions, would require emitters to possess sufficient allowances to match their emissions.5 An “upstream” program focuses on allowances tied to the production and sale of fossil fuels rather than emissions. In this case, allowances are based on the carbon content of fuels and implied emissions per unit of fuel use. Most of the congressional proposals under consideration combine these two approaches.

While cap-and-trade receives much attention in current debate, other approaches to harness economic incentives for reducing emissions exist. For instance, a tax on fossil fuels based on their carbon content, which directly corresponds to the amount of CO2 emitted per unit of fuel used, could be levied on either fuel production and imports or fuel purchases for consumption. The tax also could extend to other GHG emissions that can be monitored and measured based on their global warming potential relative to CO2.

Other kinds of regulatory policies include requirements for renewable-fuel use and stricter energy-efficiency standards for vehicles, buildings, and appliances, used either instead of or in conjunction with a cap-and-trade system or carbon tax. In considering different types of policies, one important question is which emissions to limit. For example, should a cap-and-trade system or carbon tax only include stationary sources like power plants, factories, and buildings, but exclude mobile sources like automobiles, buses, and trucks?

Addressing how to distribute the direct and indirect costs of GHG mitigation among those being regulated and across various parts of the larger economy is another piece of the policy puzzle. For example, should emissions allowances be allocated for free or auctioned? If an auction or a carbon-based energy tax is used, who will receive the revenues? If the government retains some revenues, how will it use them? How will the policy mitigate the burdens of higher energy costs that regulation will incur on lower income groups, and how will it help protect workers whose jobs are lost as the economy adjusts to new regulations? What kinds of tax benefits or direct subsidies might be used to offset GHG mitigation costs for different affected entities? What sectors should be supported by public research and development (R&D)? These questions touch in part on how policies are designed, but underlying them are more fundamental questions about the fairness in sharing costs.6

How to adjust limits on GHG emissions over time is another key component. Any policy framework for GHG mitigation must anticipate future changes in the coverage, approach, and stringency of GHG controls.

Incentives for innovation to meet new regulatory challenges also need to be considered when formulating GHG mitigation policy. New or improved technology to avoid (or store) GHG emissions will play a critical part in achieving deep long-term cuts in global emissions at costs acceptable to citizens and the policymakers who represent them.

Policy Considerations Based on Normative Criteria

Emerging from these considerations are four normative criteria for evaluating policy frameworks for GHG mitigation—cost-effectiveness, fairness, ability to provide incentives for innovation, and adaptability to change over time. These criteria are similar to those used in two prominent and respected reviews of policy options: the Intergovernmental Panel on Climate Change’s Fourth Assessment Report and the California Market Advisory Committee’s assessment of proposed state climate change policies.7

Cost-effective policies achieve the desired goal at the least cost to society as a whole. Cap-and-trade has attracted so much attention in part because of its more cost-effectiveness; the extent and means of mitigation are largely left up to individual sources, which tend to make more cost-effective choices.8

Cost-effectiveness is associated with broad, consistent coverage of emissions sources; a relatively low cost of implementing a regulation; and reasonably predictable rules and procedures to reduce the uncertainties associated with the regulation’s operation. Synergies with other goals, such as air quality, also enhance a policy’s cost-effectiveness.

Fairness, while obviously somewhat subjective, will prove especially relevant: GHG mitigation measures may disproportionately affect the livelihoods of certain households and workers. The distributional impacts of policies could be made fairer by the following actions:

•    designing policies that reflect broader societal judgments about fair burden sharing of compliance costs for different groups, such as a gasoline tax combined with lump-sum rebates scaled to household income;
•    alleviating economic adjustment costs associated with GHG mitigation policy through temporary compensations, such as returning a portion of carbon tax revenues to individual workers or communities whose economies are most adversely affected by reduced coal use and higher electricity costs; and
•    instituting a system that targets more of the compliance cost burden toward those who produce the most GHG emissions and obtain the greatest economic benefit from doing so, for example in the design of allowance allocation rules in cap-and-trade.9

Incentives for innovation are especially necessary to expand affordable longer-term GHG mitigation options. A policy package that ranks high on this criterion would offer significant economic rewards for introducing affordable new technologies that mitigate GHGs. Incentive-based policies, such as a cap-and-trade system or carbon-based fossil fuel tax, help drive innovation by creating greater demand for lower-emission technologies that reduce compliance costs. The government also can directly finance and carry out R&D, as it already does in the United States through national laboratories. Depending on the approach, innovation incentives may have greater or lesser alignment with cost-effectiveness. For example, prescriptive technology standards tend to hamper innovation. Targeted subsidies or other incentives to purchase new technology may spur rapid innovation through increased demand, but they also can impose higher costs and greater economic distortions than the other measures discussed here.

Adaptability of a policy framework could facilitate changing emissions targets or reconfiguring policies over time as knowledge and attitudes toward climate change risks and response options change. Policies that perform well on this criterion may incorporate flexibility in the timing of compliance to allow investment patterns to respond effectively to adjustment costs and technical innovations without undermining long-term environmental effectiveness; the ability to reset environmental goals periodically as new information becomes available without reconstructing the basic architecture of a policy; and the ability to relatively easily replace some policies and implementation details with others within the overall architecture without going back to square one.

Overlap and tension exist between what GHG mitigation policy can contain if it is to be acceptable to diverse constituencies and what it should contain to be effective and sustainable. While the four normative criteria identified above seem logically sound, participants in the policy debate must also be concerned with the political viability of the proposed solutions.

Lessons from Previous Government Initiatives

Three previous initiatives that had a capacity to reduce GHG emissions—even though mitigation was not their primary goal—can help inform ways to address the tension between normative and political criteria for GHG mitigation policy. These examples are the Clinton administration’s Partnership for a New Generation of Vehicles, a private-public partnership focused on technology improvements; the Clinton administration’s British Thermal Unit (BTU) energy tax proposal, which included tax rates on fuel based in part on their carbon content; and the Corporate Average Fuel Economy (CAFE) standards, which require automobile manufacturers to meet minimum fuel-efficiency regulations in vehicle fleets. By exploring the initial driving forces behind each initiative, as well as the politics surrounding each initiative’s adoption or rejection, several general lessons for future GHG policymaking emerge.10

As the partnership illustrates, government programs that encourage specific technological development have weak results without consistent and predictable support by public and private sector actors, marketable results, and appropriate agency coordination. Automakers participating in the partnership faced uncertainty on a number of fronts: first, the partnership’s budget came from a number of separate government agencies and thus lacked its own specific appropriation, and the size and inflexibility of the program made it difficult to reallocate funds to more promising technologies. Second, since participation was voluntary and budgets uncertain, the project might have ended at any time. Third, the involvement of numerous government agencies with the private sector in decisionmaking made the program inherently unwieldy and its progression unpredictable.11 Fourth, the Environmental Protection Agency promulgated more stringent emissions standards for conventional pollutants midway through the program, requiring much stronger emissions controls for the new vehicle designs than anticipated at the program’s start. Finally, government and business goals conflicted: the government wanted the program to yield fuel-efficiency research, while the automobile manufacturers wanted to create vehicles that would sell. While the three U.S. auto companies participating were able to develop concept vehicles, there was no pressure to develop marketable ones. The CAFE standards already in place were well below the program’s targets, and the automakers did not foresee a sufficient market for highly efficient vehicles to merit the full deployment of the technologies.

The BTU energy tax proposal illustrates how a single policy instrument cannot satisfactorily accomplish multiple, diverse goals. The BTU tax lacked a strong logical connection to any single problem or policy goal. Instead, it focused on limiting energy consumption with a variety of goals—debt reduction, energy conservation, energy security, and CO2 limitation. The potential for inconsistencies among these goals likely helped fuel skepticism that contributed to the proposal’s demise.

In contrast, CAFE standards were enacted for one reason—fuel savings in the wake of the 1973–1974 oil shock—and while now they are justified using a range of environmental and energy security criteria, initially they were not seen as having multiple goals. Since future climate policy will need to deliver on multiple goals within the overall objective of limiting GHG emissions, contrasting the CAFE standards and BTU energy tax highlights the need for coherent policies with multiple instruments.

A crisis can be a good opportunity to pass legislation that might otherwise fail in less politically charged times. Politicians and the public perceived the 1973–1974 oil shock as a serious problem, putting fuel efficiency in the national spotlight and supporting the initial adoption of the CAFE standards. Similarly, in late 2007, Congress passed legislation to raise the CAFE standards as oil prices rose sharply and concerns about dependence on foreign oil ran high. In a less charged political climate, auto manufacturers might have been able to successfully lobby against the introduction of higher standards. During a crisis, when discussion of drastic measures is common, moderate approaches may come to represent compromise positions.

It is often easier to pass legislation that calls for a technological solution (such as changing vehicle engineering) than a law that explicitly requires the average citizen to pay more money or change behavior. The impacts of CAFE standards on vehicle costs are hidden in the price of new vehicles, and more efficiency helps to lower driving costs. Moreover, because the vehicle fleet turns over slowly, higher vehicle costs do not affect all consumers at once the way a gas price hike would.

The greater the number and breadth of interests among the industries affected, the harder legislation can be to pass. CAFE standards primarily affect only the automobile industry, though they also lower demand for fuel. In contrast, the BTU tax would have affected a variety of energy-producing and energy-consuming industries such as oil, trucking, airlines, agriculture, and chemicals. The policy’s widespread reach put more muscle behind lobbying against the BTU tax.

Once initial legislative targets are in place, they can be difficult to change. CAFE standards for cars in the 1975 legislation were not raised until late 2007, despite several efforts to do so. The automobile industry successfully lobbied against raising the standards, but lack of subsequent crises also contributed to leaving standards unchanged. To help ensure timely changes over the longer term, mechanisms to periodically review and update technology-performance targets and instruments can be useful. While updating a policy does not guarantee success, it can help stimulate incentives for continuous improvement of technology-based standards.

Current Policy Proposals

While most proposals for national limits on GHG emissions have focused on cap-and-trade, it is important to consider the differences among proposals when evaluating the prospects for agreement on an effective national approach, beginning with various congressional cap-and-trade proposals.12 While not every proposal provides full details on how and where regulation would be applied, the basic approaches suggest a hybrid system with broad coverage of CO2 and some coverage of other GHGs, emissions caps on large downstream sources, and upstream controls on transportation fuels and natural gas. The upstream components of the approaches essentially would function like a carbon tax on fuels by requiring allowances for their sale, building the cost of allowances for the implied emissions into the fuel price.

While the various congressional proposals differ in their details, almost all the key proposals initially allot a large share  of allowances to existing sources for free based on specified criteria, such as shares for different sectors, with a gradual transition to auctioning most or all allowances. Funds raised from the auctions would be used for a mix of purposes, including assistance to low-income households, funding for energy-efficiency initiatives and new energy technology, and subsidies for adopting low-emissions technologies. Some proposals would combine cap-and-trade with regulations requiring stricter energy-efficiency standards and increased use of renewable energy.13

In sharp contrast to the general direction of the congressional approaches, the  Obama administration has indicated its intention to auction 100 percent of emissions allowances from the start “to ensure that the biggest polluters do not enjoy windfall profits.”14 A significant amount of money (US$150 billion over 10 years) would be devoted to clean energy investments, including efforts to establish the viability of large-scale capture and geological storage of CO2 emissions.
A number of large companies have joined the United States Climate Action Partnership, which explicitly endorses the imposition of a comprehensive national cap-and-trade program but stipulates a number of characteristics that such a system must have to function acceptably. Other companies and trade associations have not endorsed cap-and-trade specifically but have specified conditions that any national GHG control policy should have, including flexibility and measures to limit compliance costs. The box presents a few commonly held principles distilled from the business sector’s general position on national GHG regulation, although a considerable range of views exists on particular approaches.15
Finally, several key environmental organizations also have embraced the general approach of cap-and-trade.  However, the emphasis on a strong cap-and-trade
system (including opposition to cost-containment mechanisms in the system) is part of a broader regulatory framework that also includes such measures as new building codes for improved energy efficiency, continued increases in vehicle fuel-economy standards, and mandates for renewable-energy use in power production. Advocates of including these additional energy-efficiency and renewable-energy measures argue that they have significant cobenefits in terms of local pollution and energy security, in addition to their ability to lower GHG emissions. Environmental organizations also tend to strongly endorse direct government spending as part of the effort to reduce GHG emissions, including the recent emphasis on “green stimulus” initiatives, as well as the role for government in helping to finance new technology development.16

Composing Policy Packages: An Illustration

Three hypothetical, stylized GHG policy packages demonstrate the implications of the normative criteria and their potential political viability. The first stylized example is a comprehensive upstream carbon tax on all fossil-based energy. Producers initially pay the tax, but part of the costs would be passed forward to energy users in the form of higher primary energy or fossil fuel electricity prices. The rest of the policy’s costs would be borne by workers and shareholders in the fossil fuel sector. All revenue would be used for deficit reduction.

The second example is a hybrid cap-and-trade program that allocates free allowances to large fossil energy users (industrial and power plants) and upstream allowances, also allocated for free, to address fuels and direct residential and commercial use of natural gas.

A third hypothetical package would focus on tighter fuel-economy and other energy-efficiency standards for automobiles, appliances, buildings, and other end users. These standards would be combined with requirements, such as a minimum use of renewable-energy sources that do not specifically target the carbon-intensity of different sources. For example, Congress could mandate that utilities increase thermal efficiency of boilers and satisfy percentage requirements for use of renewable energy. The package would incorporate no incentive-based measures and no funding transfers.

Table 1 below summarizes a qualitative evaluation of these three options. The carbon tax and cap-and-trade packages have a high cost-effectiveness ranking. Regulatory standards, such as the third example above, are less cost-effective, in particular because they typically fail to target firms or consumers whose cost of reducing emissions is lower than others. With respect to fairness, free allocation of emissions allowances does not link the ultimate compliance cost burden of emitters either to their gains from emitting GHGs or their ability to absorb the costs. Use of carbon tax revenues for deficit reduction receives a relatively low score, since funding would not target adversely affected groups.17 The fairness of standards-based regulatory approaches in general depends on how they are designed. If stricter standards target companies or individuals better able to afford GHG mitigation investments, they will be perceived as fairer than market-based mechanisms that do not have such considerations.
Table 1. Qualitative scoring of carbon mitigation policy packages
As with cost-effectiveness, the cap-and-trade and carbon tax policy packages rank higher than the regulatory standards package in terms of providing incentives for innovation; technologically prescriptive energy-efficiency and renewables requirements limit the scope of innovation. None of the options increase direct funding for technology innovations or incentives to expand the use of low-carbon technology, and given the large number of proposals that call for such funding, omitting it could serve as a strike against the packages. Many participants in the debate doubt that relying only on mechanisms to create additional demand for new technologies will provide enough push for innovation.

A cap-and-trade program with free allowances is likely to be the most adaptable policy design among these examples. The aggregate allowance ceiling and share of free allowances (100 percent in the stylized package above) can be adjusted relatively easily, especially if they are not simply written into law but meeting statutory goals is left in part to the discretion of regulatory agencies. However, the economic and political investments required to obtain and then maintain an allowance allocation are likely to create resistance to changing this allocation. In principle, the carbon tax option also would be adaptable; however, tax rates must be set legislatively, and experience suggests that changing these rates through new legislation would not be easy. Technologically prescriptive regulatory standards and subsidies generally are not as adaptable as either of the other two options, because investments to comply with specific regulations may be stranded by subsequent changes, and beneficiaries tend to lobby for continued tax benefits. However, any given technology standard, such as appliance standards, may be relatively flexible in terms of updating or tightening regulatory requirements.

While judgments about political viability of a GHG policy package inherently involve personal judgments, the stylized package of regulatory standards discussed here could well receive a higher ranking on this criterion than the two incentive-based packages. Regulatory standards are a familiar option to U.S. policymakers, and consumers may view these standards favorably, as is the case with the CAFE program. Cap-and-trade programs also have a regulatory history in the United States, which is a likely reason numerous policy proposals widely support this approach. However, because of its upstream limits on fossil fuel supplies, the economy-wide cap-and-trade approach in the stylized example seems likely to receive less support in practice than a more narrowly targeted approach to control industrial and power sector emissions. The broader approach will create readily visible increases in energy prices paid by individual consumers. By similar reasoning, a carbon tax would have the least political viability given the public and Congress members’ general resistance to tax-based approaches limiting energy use. The proposed use of tax revenue in the stylized package for deficit reduction versus tax rebates also could detract from its political viability.

Potential dilemmas between strong performance on normative criteria and political viability can provide a starting point to improve these packages. For example, the carbon tax package can be altered to channel some revenue to incentives for technology development and adoption, such as government-sponsored R&D programs or subsidies for automobiles or high-efficiency appliances. Revenue could also be used to help displaced workers or low-income consumers by offsetting payroll or income taxes or targeted tax credits. Similarly, while increased use of auctioning for allowance allocation likely would reduce political support from firms covered under the trading system, consumers likely would find the approach more appealing, especially if some auction revenues are rebated to low-income households to counteract the impacts of higher energy costs. Some revenue that is generated through auctioning could also be allocated to technology research and demonstration programs, thus increasing innovation incentives. With technology standards, sectors that might be particularly vulnerable under this regulatory system could be given cost relief through tax breaks or special standards. The package could also be changed to subsidize the rapid development of alternative lower-carbon fuels, acknowledging that subsidies are often difficult to target and thus can have significant economic costs or engender adverse environmental side effects.

As Table 2 below shows, these various changes can improve ratings for fairness and innovation incentives. These changes also would increase the political viability of a carbon tax, since revenue is now used to increase the package’s appeal to groups most affected by the higher energy costs associated with such a tax. The impacts of these adjustments on political viability for the cap-and-trade option are less clear; Table 2 assumes that competing interests of firms and households balance out, holding this measure constant. For the regulatory standards option, changes can raise political viability while also increasing incentives for innovation. However, neither adaptability nor cost-effectiveness would increase because the updated standards-based policy contains as many, if not more, regulatory levers. Moreover, because the costs of compliance are less transparent under this regulatory approach, policymakers and the general public will have greater difficulty assessing the fairness of competing claims for financial incentives. For this reason, the impact on the fairness criterion is unclear and would be sensitive to financial incentives that target recipients bearing larger compliance burdens relative to their means.
Table 2. Qualitative scoring of carbon mitigation policy packages after modifications

Reconciling Normative and Political Considerations

It is notable that in both Tables 1 and 2, the regulatory standards package performs better on political viability than the more incentive-based carbon tax or cap-and-trade packages, even though the latter score higher on cost-effectiveness and innovation incentives.

Politicians have incentives to use targeted regulatory standards and seek advantages for various constituents and supporters through financial incentives. Targeted regulatory standards and financial incentives also mute direct impacts on energy prices and build on established regulatory approaches to which the public has already adapted.

Meanwhile, although cap-and-trade has garnered much rhetorical support, continued debate over various alternative proposals reveals the strong influence of differing views about economic impacts and burden sharing.18 An effective and successful policy framework needs to incorporate elements that diminish public opposition to direct energy price increases as a consequence of incentive-based measures, including cap-and-trade, and increase public opposition to special advantages provided to narrow constituencies without compelling justification.

Several suggestions to achieve such a balance can be drawn from this analysis. The proposed incentive-based GHG mitigation mechanisms will be most effective and politically viable if combined with transparent burden-sharing mechanisms that are limited in number, means-tested, and for the most part, limited in duration. Raising revenues with a carbon tax or auctioning emissions allowances provides funds for some time-limited adjustment assistance to workers and communities, such as coal mining regions most adversely affected by GHG policies. Broader political support can be built by “walling off” most of the revenues to be “recycled” to individuals and families, with some extra measures for mitigating the burdens of higher energy prices on lower-income households who spend a larger share of income on energy than higher-income households. Regular reviews of preferential regulatory treatment offered to select groups of stakeholders—for example to address the threat to international competitiveness—also may help reduce public opposition to more explicit energy price impacts of a cap-and-trade approach.

An optimal GHG mitigation package includes a carefully crafted policy for financing and carrying out GHG-reducing R&D and disseminating its results. Investing some policy-generated revenues in R&D makes a policy more acceptable and adaptable to future increases in stringency by creating more opportunities to lower GHG-mitigation costs.

The experience of the Partnership for a New Generation of Vehicles suggests several key elements for a strategic public sector R&D mechanism: relatively stable funding over time; periodic independent evaluation of the ability of alternative lines of R&D; competitive evaluation of R&D funding proposals instead of reliance on earmarking; and improved information sharing and coordination across agencies and the private sector to limit wasteful overlaps. This last point is especially important in order to take into account the positive response of private sector R&D and technology diffusion to incentive-based regulatory approaches. Public sector efforts should focus more on investments with the potential to yield significant advances in basic and applied technological knowledge that benefit society as a whole.19

Politically, however, incorporating a large number of earmarked revenue streams for use in advancing specific technologies in specific locations remains an attractive option. Highly prescriptive and centrally directed approaches to R&D funding allocation limit competition among alternatives and the ability to redirect funds toward more promising emerging options.

It is critical to transparently assess a policy’s cost-effectiveness, fairness, adaptability, and incentives for innovation, and limit built-in long-term commitments that would constrain improving a policy’s performance over time. Especially during the current economic crisis, political viability likely will require a blend of policy instruments that vary in cost-effectiveness, fairness, and incentives for innovation.

For example, the only practical way to include motor fuels in a cap-and-trade system is with upstream regulation, which would raise the price of fuels to consumers. Fuel price increases encourage low-carbon alternative fuels and motivate longer-term changes in vehicle preferences, driving patterns, and even land-use decisions that could reduce a significant share of total GHG emissions from transportation. Nevertheless, considering the political consequences of higher fuel prices, a contentious element in any potential GHG policy package is how or even whether to include the transportation sector.

Against this backdrop, it may prove necessary to consider an initial GHG control system with an incentive-based approach limited primarily to large stationary sources, provided provisions are made to incorporate vehicle and other emissions reasonably soon thereafter. Less coverage of total emissions in cap-and-trade would be less cost-effective and imply a different distribution of cost burdens than a more comprehensive cap-and-trade approach. On the other hand, vehicle fuel-economy standards already are scheduled to rise (along with elimination of the less demanding standard for light trucks and sport utility vehicles). In addition, over the medium to longer term, ongoing R&D may expand options for cost-effective GHG reductions in the transportation sector through changes in both vehicles and fuels. A portion of revenues generated by carbon taxes or auctioned allowances could be spent on mass-transport infrastructure, thereby expanding options for mobility beyond private vehicles. Focusing incentive-based GHG control initially on larger stationary sources would not preclude increasing taxes on petroleum-based transportation fuels to replenish depleted trust funds for transportation infrastructure, improve energy security, and help stimulate alternate fuels and vehicle technologies.

Before this kind of approach could be recommended, policymakers need to carefully weigh the tradeoffs among increased political viability, cost-effectiveness, and distribution of costs. In part, the political viability of this approach depends on the perceived affordability of lower-carbon options in transportation, as well as the availability of funding to finance burden sharing. Moreover, there would need to be a commitment and plan for transportation fuel emissions to be subsequently added to the control system.

Those who have long sought a more active role on the part of the United States in combating global warming welcome increased efforts to establish mandatory limits on GHG emissions. Despite current enthusiasm, however, the prospects for new legislation and subsequent regulation to control emissions will depend on finding an acceptable compromise among diverse interests at a time of great concern about the economy, global environment, and federal deficit. Balancing all these considerations in ongoing negotiations will demand policymakers weigh what policies are politically viable and what policies will be sustainable over the long term by virtue of cost-effectiveness, fairness, innovation incentives, and adaptability.

Nicholas Burger is an associate economist at RAND and was a lead author of the 2007 Fourth Assessment Report produced by the Intergovernmental Panel on Climate Change. His research focuses on environmental responses to economic incentives, especially in the areas of transportation and climate policy. He may be reached at Liisa Ecola is a project associate at RAND and a transportation planner whose work assesses congestion pricing and the intersection of transportation with climate policy. She may be reached at Thomas Light is an associate economist at RAND.  His research interests include environmental economics, transportation, energy, and environmental regulation. He may be contacted at Michael Toman is currently lead economist on climate change in the World Bank’s Development Economics Research Group. This article is based on research done while he was a senior economist at RAND. His research focuses on climate change mitigation, sustainable development, energy markets and security, and environmental policy design. He may be reached at


1. See The White House, Energy and the Environment, (accessed 11 March 2009). While this article focuses on different approaches for structuring national greenhouse gas (GHG) control policies, the energy security and economic stimulus components of President Barack Obama’s energy-and-environment program also are matters of debate.
2. See Office of Management and Budget (OMB), A New Era of Responsibility: Renewing America’s Promise (February 2009), 21, (accessed 11 March 2009).
3. These bills include the Clean Power Act, often referred to as the “4 Pollutant Bill” and introduced by Senator Jim Jeffords (R-VT) in the 107th Congress, to limit carbon dioxide (CO2) and other pollutants in the power sector; the Climate Stewardship Act, introduced by Senators John McCain (R-AZ) and Joe Lieberman (I-CT) in the 108th Congress and the first proposal to establish a national economy-wide cap-and-trade program for GHG emissions; the Global Warming Reduction Act, an amendment to the Clean Air Act introduced by Senator John Kerry (D-MA) in the 109th Congress to set up an economy-wide cap-and-trade system combined with regulatory standards for renewable-energy use and energy efficiency; and an amendment to the Climate and Economy Insurance Act, proposed by Senator Jeff Bingaman (D-NM), to add a cap on the price of emissions allowances. In the 110th Congress, the Boxer-Lieberman-Warner bill was the first proposal for mandatory economy-wide GHG limits through a cap-and-trade system to be voted out of committee and reach the Senate floor in June 2008, where a cloture vote to limit debate and move toward a vote was unsuccessful. While this list focuses on Senate bills primarily sponsored by Democrats because these bills strongly frame the current debate, Senate Republicans and representatives of both parties also offered a number of legislative proposals over this period. For a thorough online summary of various bills, see The Pew Center on Global Climate Change, Congressional Summaries and Analyses, (accessed 25 March 2009); and The Pew Center on Global Climate Change, Economy-Wide Cap-and-Trade Proposals in the 110th Congress, (accessed 25 March 2009).
4. For a compendium of information on state plans, see The Pew Center on Global Climate Change, U.S. States & Regions, (accessed 11 March 2009). For example, California passed and implemented Assembly Bill 32, an ambitious GHG-reduction program, that includes market-based incentives.
5. If large-scale investments in the physical capture and sequestration of GHG emissions materializes, then emissions counted under the cap will be the net of the quantities stored.
6. Throughout the article, “fairness” is related to the allocation of burdens or benefits. Another dimension of fairness this article does not address involves the procedures used to make and implement decisions.
7. Chapter 13 of the Intergovernmental Panel on Climate Change’s (IPCC) Fourth Assessment Report uses environmental-effectiveness, cost-effectiveness, distributional considerations, and institutional feasibility as its criteria. The Market Advisory Committee (MAC) report to the California Air Resources Board also uses four, somewhat different criteria: environmental integrity, cost-effectiveness, fairness, and simplicity. See IPCC, “Policies, Instruments, and Cooperative Arrangement,” in IPCC, Fourth Assessment Report, Working Group III: Mitigation of Climate Change (Cambridge, UK and New York, NY: Cambridge University Press, 2007), (accessed 11 March 2009); and MAC, Recommendations for Designing a Greenhouse Gas Cap-and-Trade System for California, 29 June 2007, (accessed 11 March 2009).
8. A carbon-based fossil fuel tax or a direct tax on GHG emissions also is cost-effective and can be seen as more efficient than cap-and-trade because it provides more flexibility for the economy to adjust the total mitigation effort downward if the cost of mitigation turns out to be higher than anticipated. The counterargument is that protecting against dangerous climate change requires strictly observed limits on emissions over time. For the pioneering analysis of these tradeoffs, see M. Weitzman, “Prices vs. Quantities,” Review of Economic Studies 41, no. 41 (1974): 477–91.
9. In addition, a transparent policy with clear rules for implementation based on credible assessments of potential impacts may increase confidence that a policy will work as advertised and that hidden cost-shifts do not unacceptably disadvantage some over others.
10. For details, see, N. Burger, L. Ecola, T. Light, and M. Toman, “Evaluating Options for U.S. Greenhouse Gas Mitigation Using Multiple Criteria,” Occasional Paper OP-252 (Arlington, VA: RAND Corporation, April 2009).
11. Ibid.
12. For examples, see note 3.
13. For examples, see note 3.
14. OMB, note 2, page 21.
15. For details, see, for example, United States Climate Action Partnership (USCAP), Summary Overview: USCAP Blueprint for Legislative Action, 15 January 2009, (accessed 11 March 2009); National Mining Association (NMA), NMA Position On Climate Change Policies, 31 July 2008, (accessed 11 March 2009); and Edison Electric Institute, Global Climate Change Principles, 8 February 2007, (accessed 11 March 2009).
16. Examples of these approaches include Natural Resources Defense Council (NRDC), Regulating Trading in the Carbon Market, January 2009, (accessed 11 March 2009); and Environmental Defense Fund, Four Elements of a Good Cap and Trade Bill, (accessed 11 March 2009).
17. This does not address the possibility that, in the face of the astronomical deficits currently facing the United States and the threat of future insolvency of Social Security, deficit reduction is fair with respect to the interests of younger and future generations.
18. For example, see R. Stavins, “A U.S. Cap and Trade System to Address Global Climate Change,” Discussion Paper 2007-13 (Washington, DC: The Brookings Institution, 2007), (accessed 11 March 2009).
19. Similar points apply to judging the broader and longer-term societal benefits of various green stimulus expenditures in economic recovery packages.

Greenhouse Gas Regulation: General Business Perspectives

Attitudes about the best policy instruments for greenhouse gas (GHG) mitigation vary within the business sector. Nonetheless, some general points of agreement about what constitutes a good policy include
•    limits on price volatility1 and the magnitude of allowance prices as GHG limitations are phased in through a variety of cost-containment mechanisms, including the ability to borrow allowances from future allocations; the use of various domestic and international offsets (for example, financing renewable-energy projects in developing countries); and the provision of supplementary allowances by the government to maintain their prices below certain thresholds as a “safety valve”;
•    rates of decline in national emissions over time that are consistent with the expansion of technological capacities for affordably reducing emissions and the provision of vigorous financial support from the public sector for the development and implementation of such options; and
•    allocation of most allowances for free to soften the cost of compliance for affected entities and their customers, with an auction gradually phased in. This point in particular reflects a sharp contrast with the Obama administration’s perspective that significant allowance transfers represent windfalls in many, if not most, cases.

1. Allowance price volatility in a cap-and-trade system has been a persistent concern since the unsettling experience in the European Union Emissions Trading System (EU ETS), which suffered a dramatic price collapse in 2006 after its first year of operation. A. Denny Ellerman of MIT and Barbara Buchner of France’s International Energy Agency present a careful analysis of this experience in which they conclude that poor estimates of baseline emissions and surprise on the part of market participants at the accumulation of unused allowances together played a large role in the collapse. While their analysis does not support the hypothesis that regulators simply provided too many allowances relative to expected business-as-usual emissions, it highlights the need for reliable disaggregated estimates of emissions prior to imposition of a cap-and-trade system with allocated allowances. See A. D. Ellerman and B. K. Buchner, “Over-Allocation or Abatement? A Preliminary Analysis of the EU ETS Based on the 2005–06 Emissions Data,” Environment and Resource Economics 41, no. 1 (2008): 267–87. For a detailed comparison of the EU ETS and the United States Climate Action Partnership (USCAP) proposal for U.S. climate change legislation, see The Pew Center on Global Climate Change, USCAP Blueprint for Legislative Action, EU Emissions Trading System Side-by-Side, 6 February 2009, (accessed 11 March 2009).

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