dallas burtraw is an economist and senior fellow at Resources for the Future in Washington. amelia keyes is a researcher at RFF.
Published April 27, 2018
Economics prescribes that policies to address environmental harm should target the source of that harm. In this case, it’s also common sense. Climate change is the undisputed global environmental problem, and its solution, it would seem, will require global action with the greatest commitments coming from the greatest emitters.
Though considerable diplomatic effort to mobilize global cooperation paid off in the UN Framework Convention on Climate Change’s Paris Agreement in 2016, it’s no secret that the world’s largest economy is now missing. The Trump administration has opted to side with climate change skeptics, walking back regulations and a variety of initiatives designed to help keep the United States on track with its Paris commitments.
But that’s not the end of the story. A host of U.S. states and cities have reacted to the federal reversal by ramping up their own programs to limit greenhouse emissions, as well as by organizing a coalition of similarly inclined local governments, universities, churches and businesses, defiantly declaring “We Are Still In.” The big question, then, is what these efforts can achieve in the face of federal inaction.
Step One: Price Carbon
Placing a price on carbon emissions is the most attention-grabbing state climate initiative. Ten states are already doing so, using “cap-andtrade” markets to fix total emissions and encourage the greatest emissions reductions where they can be accomplished at least cost.
Nine states comprise the Regional Greenhouse Gas Initiative, which, beginning in 2009, set a limit on carbon emissions from the power industry in the Northeast and mid-Atlantic states. One more state, and likely a second, will join soon.
The initiative was launched by Republican Governor Pataki of New York in 2005. At one time, 10 states were involved, but Governor Chris Christie – in an effort to make himself a more palatable presidential candidate in the Republican primaries — withdrew New Jersey in 2012. Just this January, the state’s newly elected Democratic governor began the reenlistment process, which will bring RGGI membership back to 10.
The other state poised to participate is Virginia. Former Governor Terry McAuliffe directed the state’s environmental agency to develop a “trade-ready” regulation a year ago, which is expected to be finalized in 2018 with a link to RGGI. While it’s not precisely joining RGGI, the difference is more apparent than real. As in the other RGGI states, Virginia would create a “budget” of emissions allowances that could be freely traded and used for emissions compliance anywhere in RGGI.
The tenth state referred to above is California, whose cap-and-trade program was launched by Republican governor Arnold Schwarzenegger in 2006 and implemented in 2013. This program stands out because it applies economy-wide rather than to just the electricity sector, covering about 85 percent of all greenhouse gas emissions. The California program is linked to Quebec and Ontario through the Western Climate Initiative, meaning that allowances owned by emitters in any one of the three can be used for compliance across those jurisdictions.
Currently the emissions allowance price determined by trading in the RGGI market hovers around a modest $5 per short ton (i.e., 2,000 pounds) of CO₂. The more comprehensive California program has set emissions limits low enough to generate a considerably higher price on the allowance market, currently about $15 per metric ton (2,204 pounds; go figure).
An important observation about these carbon- pricing states, alluded to earlier, is the role of bipartisanship in defending the trading programs against the vicissitudes of politics. Since the inception of the RGGI and California programs, every state except for Delaware and New Jersey has stayed the course under both Democratic and Republican governors.
Other states may yet join or initiate a parallel program with the same ends in mind. Oregon, for its part, is currently designing a variant on California-style cap and trade. Meanwhile, several states have contemplated a carbon tax that, unlike cap and trade, sets the price of carbon directly. In Washington, a statewide initiative to introduce a carbon tax failed in November 2016, but Governor Jay Inslee has indicated he will try again in 2018.
Carbon pricing takes other forms as well. For example, in Minnesota, state electricity regulators will apply a “shadow price” of $43 per ton of carbon emissions by 2020 (three times more than California’s carbon price and seven times more than RGGI), which will be used to guide planning for new power-generation infrastructure. Regulators in Colorado have also decided to integrate a measure of the cost of carbon emissions to society into utility industry planning.
New York and Illinois offer subsidies, based in part on the social cost of carbon emissions (the modeled cost of emitting one more ton of CO₂), to keep zero-emissions nuclear power plants in service. And the New York Independent System Operator, the organization that operates the electricity grid in the state, is conducting a formal process to set a price for carbon comparable to the shadow price in Minnesota that would be collected from emitters and returned to electricity customers in some form that did not increase demand. This process in New York is being watched closely by electricity system operators throughout the Eastern and Midwestern states.
Does it Work?
There’s evidence that carbon pricing has, indeed, worked to cut emissions — and to pare them at lower cost than direct regulation of utility technology and fuels. However, putting a number on the emissions reductions that can be attributed to carbon pricing is difficult. It requires, for one thing, distinguishing the effects of carbon pricing from unrelated national economic trends that have reduced emissions in the last decade. Emissions fell along with the demand for electricity during the Great Recession, and they have remained almost flat ever since. In this same period, the substantial expansion in natural gas supply through fracking (and the associated decline in its price) has been the major factor in reducing the market share of coal in electricity generation.
At the national level, coal-fired generation plummeted from nearly 50 percent of total electricity generation in 2008 to 30 percent in 2016 — remarkable numbers in an industry with hundreds of billions of dollars in coal plants still depreciating on their books. Meanwhile, natural gas’s share of total generation increased from 21 to 34 percent.
What matters here from the climate change perspective, of course, is that coal-fired plants emit twice as much carbon per kilowatt-hour generated as new natural-gas-fired “combined cycle” plants. So the market-induced shift away from coal has reduced emissions in the electricity sector independent of new regulation and cap and trade.
Renewable energy has also expanded greatly as the costs of wind and solar facilities have fallen, increasing their combined share of electricity generation from 3 percent to 9 percent between 2008 and 2016. Complicating the interpretation a bit, the federal production and investment tax credits — both part of the Federal effort to reduce climate emissions – have amplified the financial competitiveness of renewables across all states. Complicating the interpretation further, the need for new sources of electricity driven by the retirement of aging nuclear plants has spurred demand for natural gas — which, though more carbon-sparing than coal, emits more than zero-emissions nuclear power.
These national trends were even more pronounced in the carbon-pricing states. In RGGI states, coal fell from 22 percent to 6 percent of electricity generation from 2008 to 2016, while natural gas increased from 31 to 42 percent and renewables increased from 4 to 7 percent.
California, for its part, has historically imported about a quarter of its electricity from a dozen other Western states, a large share of which was coal-generated. Because state law requires accounting for out-of-state emissions associated with imported power in meeting renewable fuels mandates, California’s climate efforts have been turbocharged by the overall reduction in coal-fired generation (from 30 to 22 percent) in the Mountain and Pacific regions in the 2008-16 period.
California has accelerated this trend by barring new long-term contracts with coal generators from out of state, which has helped undermine the financial prospects for coal throughout the West. Renewables play a particularly important role in California, increasing from 12 to 28 percent of generation from 2008 to 2016. The RGGI states and California have also retired three nuclear reactors; six more are planned. Nuclear retirements in California led to a transitory increase in emissions that has since been erased.
Against this backdrop, carbon pricing should yield additional emissions reductions, amplifying the national trends toward reduced carbon emissions in the electricity sector. To date, though, the emissions limits imposed by cap and trade have been modest, at $15 a ton. However, one way the trading programs have made a significant difference is through a second, indirect channel: creating revenue used for investment in renewable energy and energy efficiency.
Most allowances in cap-and-trade programs are initially distributed through auctions (of rights to emit carbon dioxide), which generate hundreds of millions of dollars annually in the RGGI states and billions in California. RGGI invests most of the proceeds in climate programs. Decisions about how to use auction revenue are left to each state, with the understanding that at least one-quarter will be spent on strategic energy goals or will be rebated to ratepayers. In fact, about 95 percent of the revenues have been spent with these ends in mind, with about 57 percent going to increase energy efficiency. Brian Murray and Peter Maniloff have estimated that, all told, about half of the total emissions reductions achieved by the RGGI states over the course of the initiative are attributable to carbon pricing and associated program spending, with the rest resulting from unrelated national trends.
In California, auction revenues are also dedicated to climate programs, with a significant share refunded to utility customers. Policy-driven emissions reductions in California stem from a fully developed portfolio of regulations that probably bite harder than cap and trade at $15 a ton.
Every five years, the California Air Resources Board produces a Climate Scoping Plan with a roadmap describing how the state will achieve its legally binding emissions-reduction goals. The first and second Scoping Plans, which describe efforts to drive emissions back to 1990 levels by 2020, identify regulations sufficient to achieve over 80 percent of that emissions-reduction target. The target of obtaining one-third of electricity from renewables by 2020 has been already met; the next step is to get to 50 percent by 2030. In addition, California has a low-carbon fuel standard requiring that the carbon content of fuel used for transportation be reduced by 10 percent by 2020. This could be achieved by using ethanol, natural gas or batteries, or by improvements in life-cycle emissions in the petroleum industry.
Of the remaining share of emissions reductions by 2020 as identified in the 2017 Scoping Plan, less than 20 percent is credited to cap and trade. The trading program should be acknowledged, though, for improving the cost-effectiveness of the total policy portfolio. Moreover, in the next decade carbon pricing is expected to have increased bite, as California dramatically tightens the target to 40 percent below 2020 (and 1990) emissions. The state’s most recent Scoping Plan (2017) identifies regulatory standards and measures that achieve only 60 percent of the necessary emissions reductions, leaving cap and trade the job of closing the remaining gap.
Economists have noted that the emissions reductions achieved in California through direct regulation have for the most part been substantially more expensive per ton than the market price of emission allowances determined by trading. Indeed, the third Scoping Plan identifies regulatory measures in place that cost over $100 per ton — six times as much as emitters pay for allowances in the marketplace.
Defenders of the regulation-heavy California approach offer two justifications. First, while direct regulation may be more expensive, a greater portion of the costs are borne by producers and are less likely to be reflected in product prices. Smaller changes in the final price of goods and services improve the program’s political sustainability and protect the state against competition from neighboring states and other countries that do not regulate carbon. When other jurisdictions begin to price carbon, it should be possible for California to increase the influence of carbon pricing in its portfolio of emissions policies.
Second, some advocates of the California approach argue that direct regulation today will minimize the cost of the transition to much tougher emissions regimes down the road. Alone, a $15-a-ton carbon price is insufficient to spur the sort of high-risk innovation and investment needed to get from here to there at an adequate pace. Nonetheless, Mary Nichols, the state’s top air quality regulator (who, incidentally, was appointed by a Republican governor), told the legislature in January that it may soon be time to ramp up the impact of allowance prices by tightening the cap on emissions.
The Regulatory Approach
As noted already, states have adopted and preserved a variety of traditional regulatory approaches even after carbon pricing was put in place. It is the prerogative of states as well as cities to develop policies that guide land use, industrial permitting, infrastructure planning and economic development. Climate concerns have filtered into this planning, not only for purposes of reducing emissions but also for adapting to climate change.
All told, existing regulatory policies have a greater impact on the economy and emissions than carbon pricing. Half of all states provide incentives for the use of renewable energy in the power sector, and some 30 states have energy efficiency programs. A substantial number of states have incentives for the use of hybrid and battery electric vehicles. For example, in addition to the policies already mentioned, California has a vehicle standard that requires the proliferation of battery-electric, fuel cell and plug-in hybrid propulsion systems, with a goal of reaching 1.5 million zeroemission vehicles on the road by 2025.
In his State of the State address in January, California Governor Jerry Brown pledged to put in place a quarter-million charging stations by 2025, relying in part on proceeds from the trading allowance auction to pay for them. And he set the goal of 5 million electric vehicles by 2030. Other states offer rebates and tax credits, reduced vehicle registration fees and support for charging infrastructure, often aiming to reach specific targets for the market penetration of hybrid and battery electric vehicles.
One of the most important state regulatory programs concerns vehicle emissions standards. A truly unique aspect of the Clean Air Act amendments in 1970 — and one of the most important levers the states have to drive broader change on environmental issues — is the special status it granted to California to manage its especially severe vehicle-related air-quality issues. California cars must meet federal standards, but the state also has the option to apply for waivers from the EPA allowing it to impose more stringent standards. This option has been exercised about 100 times.
Other states are not permitted to develop their own standards. But they can adopt the California standards in lieu of the federal ones, and 15 states have signed on. This relationship has spawned what UCLA law professor Ann Carlson describes as “iterative federalism”: California adopts a clean vehicle standard; other states adopt the California standard; the federal government finally adopts the California standard. Rinse and repeat.
Most recently, the California standard became the model for the Obama-era federal vehicle standards, which are now under review by the Trump administration. If the Trump EPA revises the federal standard, and if they also decide to challenge California’s rights to waivers, it will set the stage for a potentially dramatic court challenge.
The states advancing more aggressive climate-mitigation policies have already been active in the courts, supporting the Obama-era EPA’s Clean Power Plan, which, based on climate change’s potential to harm human health, imposed greenhouse gas emission targets on the electricity industry. The Trump administration has pledged to repeal it.
The states are fighting back on several fronts. They are working to prevent the EPA from reversing new energy efficiency standards for truck engines as well as reversing new regulations aimed at reducing emissions of methane (a potent greenhouse gas) from new oil and gas operations. Less visibly, but importantly, while Congress and the White House have largely ceased to provide information or analysis on climate change issues, states are filling the void.
Does it Pay To Be a First Mover?
In part, states are responding to voters’ wishes to go green — to help contain climate change through leading by example. However, this is not necessarily the most important reason for parting company with Washington: many states see economic and public health benefits from implementing climate policy, independent of what others do.
Notably, policies that reduce carbon emissions by lowering fossil fuel use also reduce the emission of local pollutants well understood to increase morbidity and mortality. Indeed, several independent studies, along with the Obama-era EPA’s original regulatory impact analysis of the Clean Power Plan, found the societal benefits of reducing conventional air pollutants may even exceed the value from slowing climate change. (It’s noteworthy that the Trump EPA’s defense of its proposal to jettison the Clean Power Plan turns on dramatically lower estimates of both sources of benefits.)
Containment of greenhouse emissions by reducing the use of fossil fuels, increasing the use of renewables and, more generally, promoting energy efficiency across the economy is sure to harm some industries. But others will benefit. Indeed, states that are not rich in fossil fuels, but do have abundant wind and sunshine, are particularly well positioned to do well by doing good. In these states, the net benefits of policies that contain emissions are positive even if the environmental benefits are ignored.
While Congress and the White House have largely ceased to provide information or analysis on climate change issues, states are filling the void.
For example, the Analysis Group, a consulting firm, estimates that the increased economic activity resulting from the spending of auction revenues in the RGGI states generated $1.3 billion in benefits in the 2012-14 period by encouraging the growth of new industries such as solar and wind, along with a lot of jobs. The Department of Energy estimates that in 2016 the U.S. solar and wind industries employed some 475,000 workers, over half of the electric-power-generation workforce. California alone employed over 157,000 solar and wind workers in that year.
It’s important to add one qualifier here. All too often, such studies count the benefits of added jobs even when the only way to recruit workers is to bid them away from other jobs. But it isn’t always clear that a $15 an hour job installing solar panels on rooftops in August is all that much better than a $12 an hour job behind the deli counter at a supermarket.
States that are not rich in fossil fuels, but do have abundant wind and sunshine, are particularly well positioned to do well by doing good.
What is clear is that California and other leading states are also incubators of innovation positioned to capitalize on the energy transformation that will necessarily be part of deep decarbonization. The first movers no doubt incur disproportionate costs in the near term because the benefits of slowing carbon emissions are shared by the entire world. But there’s good reason to believe that time is on their side.
Consider, too, that while the primary focus of climate change policy is to slow emissions that are warming the atmosphere, adaptation to climate change matters, too. State and local governments must concern themselves with the local impact of increased storm damage, rising sea levels and more pronounced cycles of flooding and drought. Measures designed to reduce harm from extreme weather have gained widespread attention even in conservative states, which has allowed consideration of mitigation to slip in through the back door.
Of course, climate change is a global problem that cannot be solved by a handful of states acting on their own. And the likely emissions reductions in RGGI states and California won’t be adequate to meet the U.S. pledge in Paris. However, state actions could catalyze broader actions down the road. The states are essentially providing a laboratory in which to experiment with a range of climate-related policies, both regulation- and market-based.
RGGI and California have served as a testbed for a national carbon emissions cap-and-trade market, fine-tuning approaches ranging from allowance auctions to price floors. Many of these successes have been adopted in trading programs outside the United States. For example, Quebec and Ontario have embraced California’s program design, and, though a much older program, the European Union’s Emissions Trading System followed the North American programs in changing the distribution of allowance to an auction system.
By the same token, state-level experiences can lay the groundwork for broader action. The Paris Agreement was made possible by the participation of the world’s largest emitters — the United States and China. The United States was able to make a credible pledge in part due to the expected emissions reductions from the now-contested Clean Power Plan. And it is no stretch to argue that leadership from the states shaped the economic and political climate in which the conversation about creating the Clean Power Plan was possible. Looking back further, state regulations — notably renewable energy mandates for utilities and energy efficiency requirements – helped form the technical basis of “adequately demonstrated” approaches that the Obama administration relied on as a legal justification for the Clean Power Plan.
If it were not for the actions of the states, the conversation at the national and international levels would be very different. And the payoffs, once Washington again steps up to lead on climate change policy, are likely to be felt around the world.