Global Climate Change: Market-Based Strategies to Reduce Greenhouse Gases

Order Code IB97057

CRS Issue Brief for Congress

Received through the CRS Web

Global Climate Change:

Market-Based Strategies

to Reduce Greenhouse Gases

Updated November 18, 2004

Larry Parker

Resources, Science, and Industry Division

Congressional Research Service ˜ The Library of Congress

CONTENTS

SUMMARY

MOST RECENT DEVELOPMENTS

BACKGROUND AND ANALYSIS

Status of Global Climate Change Issue and Response

Estimating Cost Impacts of Controls

Market-Based Mechanisms for Reducing Greenhouse Gases

Tradeable Permits (Allowances)

Tradeable Permits (Credits)

Carbon/CO2 Emissions Tax

International Market-Oriented Mechanisms

Issues

Cost-Effectiveness: Price versus Quantity

Comprehensiveness

Economic Impact

Equity

Legislation in the 108th Congress

Other Proposals

United States and International Activities

Administration Domestic Initiatives

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Global Climate Change:

Market-Based Strategies to Reduce Greenhouse Gases

SUMMARY

The possibility that human activities are

releasing gases, including carbon dioxide

(CO2), at rates that could affect global climate

has resulted in proposals for national programs to curtail emissions. An international

framework for specific reductions in greenhouse gases was negotiated at a meeting in

Kyoto in December 1997. Concern about

costs has encouraged consideration of CO2

reduction proposals that employ market-based

mechanisms. The passage in 1990 of a tradeable allowance system for sulfur dioxide

(SO2) control in the United States to reduce

acid rain provides a precedent for such mechanisms.

The two mechanisms receiving the most

attention are a tradeable permit program

(similar to the acid rain program) and carbon

taxes. Proposed CO2 reduction schemes

present large uncertainties in terms of the

perceived reduction needs and the potential

costs of achieving those reductions. Tradeable

permit programs would reduce CO2 emissions

to a specific level with the control cost handled efficiently, but not at a specific cost level.

Carbon taxes would effectively cap marginal

control costs at the specific tax level, but the

precise level of CO2 reduction achieved

would be less certain. Hence, a major policy

question is whether one is more concerned

about the possible cost of the program and

therefore willing to accept some uncertainty

about emission reduction in order to have

some limits on costs (i.e., carbon taxes) or

whether one is more concerned about achieving a specific emission reduction level with

costs handled efficiently, but not capped (i.e.,

tradeable permits).

Congressional Research Service

The specific effects of both a carbon tax

and tradeable permit program would depend

on the specific levy (carbon tax) or allocation

scheme (tradeable permit) chosen, the scope

of the program, the timing of the reductions,

and the recycling of any revenues.

In addition, many tradeable permit proposals include provisions allowing countries

to accumulate permits by reducing emissions

in other countries. Two such schemes, joint

implementation and the Clean Development

Mechanism (CDM), were approved at the

Kyoto conference in December 1997.

The climate change issue and CO2 control raise numerous equity issues. In one

sense, climate change is a concern about

intergenerational equity — the well-being of

the current generation versus generations to

come. On a global level, the issue also involves the North-South debate. At the domestic level, equity questions include the regional

distribution of costs under a tradeable permit

or carbon tax scheme. For example, an important impact of either a carbon tax based on the

carbon content of fossil fuels or a tradeable

permit program would be the pressure for fuel

shifts away from coal and toward gas. Regions such as fast-growing areas in need of

more energy and owners of “all electric”

homes, among others, would likely be disproportionately hit by a CO2 control scheme. In

addition, people may be affected differently

according to income class. These issues,

however, have not been sufficiently analyzed

at the current time to be sure of how various

sectors would be affected.

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MOST RECENT DEVELOPMENTS

On November 18, 2004, Russia handed its official Kyoto Protocol ratification papers

to the United Nations. With Russia’s action, the Kyoto Protocol will become a legally

binding treaty on February 16, 2005.

In the 108th Congress, six bills have been introduced to control greenhouse gas

emissions. S. 139, introduced by Senators McCain and Lieberman, would reduce and cap

emissions of greenhouse gases from electricity generation, transportation, industrial, and

commercial sectors. The reductions would be implemented in two phases with an emissions

cap in the year 2010 based on affected facilities’ 2000 emissions, and a further reduction cap

imposed in the year 2016 based on affected facilities’ 1990 emissions. The program would

be implemented through an expansive allowance trading program that includes cross-sector

trading and limited acquisition of allowances from foreign sources. The second bill, S. 366,

introduced by Senator Jeffords, is a modified version of the multi-pollutant bill reported out

by the Senate Environment and Public Works Committee in the 107th Congress. It would

reduce and cap emissions of carbon dioxide from electricity generation at their 1990 levels

by the year 2009. Similar to S. 139, the program would be implemented through an

allowance trading program. The third and fourth bills, S. 843, introduced by Senator Carper,

and H.R. 3093, introduced by Representative Bass are multi-pollutant control bills that

include carbon dioxide reductions. S. 843 and H.R. 3093 would cap carbon dioxide

emissions from powerplants at their 2006 levels by 2009 and further cap emissions at their

2001 levels by 2013. The fifth bill, H.R. 2042, introduced by Representative Waxman, is also

a multi-pollutant control bill and would cap carbon dioxide emissions from powerplants at

their 1990 levels by the year 2009. The sixth and most recent bill is H.R. 4067. Introduced

March 30, 2004, by Representative Gilchrest, it is modeled on S. 139 but includes only the

first phase of S. 139’s two-phase reduction program. Like S. 139, H.R. 4067 is a stand-alone

greenhouse gas reduction program.

In October 2003, the Senate debated and defeated an amended version of S. 139

(S.Amdt. 2028), the Climate Stewardship Act of 2003. S.Amdt. 2028 would have frozen

greenhouse gas emissions from major economic sectors at their 2000 levels, but was defeated

on a 43-55 vote. The sponsors of S. 139 have announced their intention to seek another vote

on the measure before the end of the 108th Congress.

BACKGROUND AND ANALYSIS

Certain gases emitted as a result of human activities may be affecting global climate.

Most concern centers on the possibility that CO2 (primarily from the burning of fossil fuels),

along with other gases, could increase global temperatures, with subsequent effects on

precipitation patterns and ocean levels that could affect agriculture, energy use, and other

human activities.

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Status of Global Climate Change Issue and Response

The initial issue of whether the potential for global climate change poses a threat that

justifies prompt action to curtail CO2 and other so-called greenhouse gases remains actively

debated — both domestically and internationally. (For a review of the technical dimensions

of this question, see CRS Issue Brief IB89005, Global Climate Change.) Some view the

risks as sufficiently grave and urgent to justify immediate action. Others are uncertain of the

risks but believe that selected policies to reduce emissions can be justified for other reasons

and would provide insurance if the risks were borne out; these other reasons include

improved energy efficiency, reduced reliance on imported oil, and increased revenues. Still

others caution that actions to reduce CO2 and other greenhouse gases could disrupt the

nation’s economy and should not be undertaken unless further scientific evidence of risks

becomes available.

Despite the uncertainties, however, scientists and policymakers have increasingly

adopted the view that human activities are releasing greenhouse gases at rates that could

affect global climate. As a result, initiatives are underway to address the issue, resulting in

proposals for national and international programs to curtail emissions.

An agreement on a United Nations Framework Convention on Climate Change

(UNFCCC) was on the agenda at the U.N. Conference on Economic Development in Rio de

Janeiro in June 1992. The United States was an early signatory to the agreement, which was

approved by the Senate October 7, 1992. In April 1993, President Clinton directed the

federal government to craft a plan that would stabilize U.S. greenhouse gas emissions at

1990 levels by the year 2000. However, in 2000, the United States did not meet its voluntary

commitment at Rio to stabilize greenhouse gas emissions at 1990 levels. Indeed, it is unclear

when U.S. carbon emissions may stabilize. The 2002 Climate Action Report by the current

Bush Administration estimates U.S. carbon emissions in the year 2010 will be 34% above

their 1990 levels. (For more on U.S. domestic climate change policy since Rio, see CRS

Report RL30024, Global Climate Change Policy: Cost, Competitiveness, and

Comprehensiveness.)

Meanwhile, the United States and other signatories to the Climate Change Convention

met in December 1997 in Kyoto, Japan, to conclude negotiations on a binding protocol for

specific provisions to reduce greenhouse gas emissions by developed countries, including the

United States. The final protocol agreed to at Kyoto requires the United States to reduce

emissions of six greenhouse gases (CO2, methane, nitrous oxide, hydrofluorocarbons,

perfluorocarbons, sulfur hexafluoride) by 7% on average from 1990 levels over the period

2008-2012. In contrast, undeveloped countries are not required to make reductions under the

Protocol. In November 1998, the parties met in Buenos Aires to develop work plans for

specific elements of the Kyoto Protocol, including the trading of emission reductions

between developed countries (joint implementation) and between developed and developing

countries (the Clean Development Mechanism). The parties decided that these work plans

should be completed by the year 2000. The November 1999 meeting in Bonn postponed

decisions about emissions trading until the November 2000 meeting at the Hague. The

meeting at The Hague failed to arrive at agreement on emissions trading, and scheduled

further negotiations for May 2001. However, in March 2001, the current Bush

Administration announced that it was formally abandoning the emission targets set under

Kyoto. (For more on the U.S. reduction requirement under Kyoto, see CRS Report 98-235

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ENR, Global Climate Change: U.S. Greenhouse Gas Emissions — Status, Trends, and

Projections.)

This decision by the Bush Administration has not deterred the international community.

In July 2001, the Sixth Conference of Parties to the Framework Convention on Climate

Change agreed to a draft decision on implementing the Kyoto Protocol. With respect to

flexible implementation mechanisms, the Parties agreed to exclude nuclear power as a

possible non-carbon alternative under the Clean Development Mechanism (CDM) and joint

implementation program. The Parties also reiterated that use of flexible mechanisms shall

be supplemental to domestic efforts. In November 2001, the Seventh Conference of Parties

to the Framework Convention on Climate Change concluded negotiations on implementation

of the Kyoto Protocol. With respect to flexible implementation mechanisms, the Parties

outlined the institutions that would oversee the flexible implementation mechanisms

contained in the Protocol. In October 2002, the Eighth Conference of Parties to the

Framework Convention on Climate Change met in New Delhi (October 23 - November 1).

The conference produced agreement on the procedures governing the Clean Development

Mechanism. In December 2003, the Ninth Conference of Parties met at Milan and produced

agreement on rules governing the use of sinks for joint implementation and CDM projects.

The United States was a non-participant to most of what took place at these post-March 2001

conferences.

The Kyoto Protocol entered a new phase on November 18, 2004, when Russia handed

its official Kyoto Protocol ratification papers to the United Nations. With Russia’s action,

the Kyoto Protocol will become a legally binding treaty on February 16, 2005. UN Secretary

General Kofi Annan described Russia’s accession to the treaty as a “historic step foward in

the world’s efforts to combat a truly global threat.”

Estimating Cost Impacts of Controls

Estimates of costs to reduce CO2 emissions vary greatly and focus attention on an

estimator’s basic beliefs about the problem and the future, rather than on simple, technical

differences in economic assumptions. (See CRS Report 98-738, Global Climate Change:

Three Policy Perspectives. It identifies three “lenses” through which people can view the

global climate change issues, and their influence on cost analysis.) These are summarized in

Table 1. None of these perspectives is inherently more “right” or “correct” than another;

rather, they overlap and to varying degrees complement and conflict with each other. People

hold to each of the lenses to some degree.

However, the differing perspectives lead to very different cost estimates. Figure 1 below

shows a scatter-plot by World Resources Institute (WRI) of the predicted impacts from 162

estimates from 16 different economic models on the U.S. economy from a CO2 abatement

program. Although the size of the proposed CO2 reduction and the time allowed to achieve

it (not explicitly modeled in the WRI report) are critical factors in determining the costs and

benefits of any reduction program, WRI found that underlying modeling assumptions not

related to policy decisions explained a significant amount of the difference in the estimates.

Consistent with a “technological” view of the problem, models that assumed technological

development of non-carbon substitutes for current fossil fuel use, along with increased

energy and product substitutions, had significantly less cost than models that assumed such

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advancements would not occur in a timely fashion. For example, a study by the American

Council for an Energy-Efficient Economy (ACEEE) argues that carbon emissions could fall

10% below 1990 levels by 2010 with a net economic savings of $58 billion along with

800,000 new jobs. Such savings are assumed to come from new technology and market

mechanisms to encourage cost-effective implementation strategies. Such a position

presumes that technologies are available now, or will be very shortly, that can achieve these

reductions cost-effectively.

Likewise, consistent with an “ecological” perspective, models that included the benefits

of air pollution damages and climate change damages averted by the CO2 reduction

estimated considerably less cost to the economy than models that did not include such

benefits. The WRI report suggests that the cost profile of a CO2 reduction program changes

substantially if one includes the benefits of air pollution and climate change effect averted

by controlling CO2. The Clinton Administration’s 1998 analysis of costs to comply with

Kyoto estimates benefits from controlling ancillary pollutants (SO2, NOx, and fine

particulates) at between $1.8 and $10.6 billion annually.

Consistent with an “economic” perspective, models that included policy approaches that

encouraged efficient economic responses to CO2 reductions, included joint implementation

schemes, and involved efficient recycling of any revenues from control strategies

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significantly reduced costs over model runs that did not include such policy options. Like

the technology perspective, economically efficient solutions assume that the program is

implemented in such a way to permit the economy sufficient time to absorb the new price

signals with minimal short-term constraints.

The uncertainty about the risk of climate change and the critical impact of assumptions

about the nature of the problem effectively preclude predictions of the ultimate costs of

reducing greenhouse gases. As a result, attention has focused on how to minimize costs by

selecting the most economically efficient strategies to reduce CO2 emissions. Traditionally,

air pollution control programs have relied on various “command and control” regulatory

approaches, including ambient quality and technology-based standards. But increasingly,

economic efficiency concerns have been directed toward supplementing regulatory control

with market-based mechanisms, including pollution taxes and tradeable permits.

The tradeable allowance system for SO2 control in the acid rain program enacted in

1990 represents a significant step in this evolution of economic mechanisms. Acceptance

of this system has led to calls for use of a similar system with other pollutants, including

CO2. Current bills proposing a tradeable permit-type system to begin controlling CO2

emissions are discussed in a later section.

Table 1. Influence of Climate Change Perspectives

on Policy Parameters

Seriousness of

problem

Risk in developing

mitigation program

Technology

Is agnostic on the merits

of the problem. The

focus is on developing

new technology that can

be justified from

multiple criteria,

including economic,

environmental and

social perspectives.

Believes any reduction

program should be

designed to maximize

opportunities for new

technology. Risk lies in

not developing technology

by the appropriate time.

Focus on research,

development, and

demonstration; and on

removing barriers to

commercialization of new

technology.

Viewed from the bottom

up. Tends to see

significant energy

inefficiencies in the

current economic system

that currently (or

projected) available

technologies can

eliminate at little or no

overall cost to the

economy.

Economic

Understands issue in

terms of quantifiable

cost-benefit analysis.

Generally assumes the

status quo is the

baseline from which

costs and benefits are

measured.

Unquantifiable

uncertainty tends to be

ignored.

Believes that economic

costs should be examined

against economic benefits

in determining any specific

reduction program. Risk

lies in imposing costs in

excess of benefits. Any

chosen reduction goal

should be implemented

through economic

measures such as tradeable

permits or emission taxes.

Viewed from the top

down. Tends to see a

gradual improvement in

energy efficiency in the

economy, but significant

costs (quantified in terms

of GDP loss) resulting

from global climate

change control programs.

Typical loss estimates

range from 1-2% of

GDP.

Approach

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Costs

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Approach

Ecological

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Seriousness of

problem

Risk in developing

mitigation program

Understands issues in

terms of their potential

threat to basic values,

including ecological

viability and the wellbeing of future

generations. Such

values reflect ecological

and ethical

considerations;

adherents see attempts

to convert them into

commodities to be

bought and sold as

trivializing the issue.

Rather than economic

costs and benefits or

technological opportunity,

effective protection of the

planet’s ecosystems should

be the primary criterion in

determining the specifics

of any reduction program.

Focus of program should

be on altering values and

broadening consumer

choices.

Costs

Views costs from an

ethical perspective in

terms of the ecological

values that global climate

change threatens.

Believes that values such

as intergenerational

equity should not be

considered commodities

to be bought and sold.

Costs are defined broadly

to include aesthetic and

environmental values that

economic analysis cannot

readily quantify and

monetize.

Market-Based Mechanisms for

Reducing Greenhouse Gases

Proposals to use market mechanisms to implement greenhouse gas emission reductions

have revolved around three approaches: tradeable permits (as “allowances” and as “credits”),

carbon taxes, and joint implementation. The protocol negotiated at Kyoto contains articles

on emissions trading and joint implementation. These provisions were strongly supported

by the Clinton Administration. In addition, some European countries have implemented or

are considering carbon taxes to bring about greenhouse gas reductions in their countries.

Tradeable Permits (Allowances)

A model for a tradeable permit approach is the SO2 allowance program to reduce acid

rain contained in Title IV of the 1990 Clean Air Act Amendments. The Title IV program is

based on two premises. First, a set amount of SO2 emitted by human activities can be

assimilated by the ecological system without undue harm. Thus the goal of the program is

to put a ceiling, or cap, on the total emissions of SO2 rather than limit ambient

concentrations. Second, a market in pollution rights between polluters is the most

cost-effective means of achieving a given reduction. This market in pollution rights (or

allowances, each of which is equal to one ton of SO2) is designed so that owners of

allowances can trade those allowances with other emitters who need them or retain (bank)

them for future use or sale. Initially, most allowances were allocated by the federal

government to utilities according to statutory formulas related to a given facility’s historic

fuel use and emissions; other allowances have been reserved by the government for periodic

auctions to ensure the liquidity of the market.

Conceptually, a CO2 tradeable permit program could work similarly. Some number of

CO2 allowances could be allocated, and a market in the allowances would permit emitters

to use, sell, buy, or bank them. However, significant differences exist between acid rain and

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possible global warming that may affect the appropriateness of a Title IV-type response to

CO2 control. For example, the acid rain program involves up to 3,000 new and existing

electric generating facilities that contribute two-thirds of the country’s SO2 and one-third of

its nitrogen oxide (NOx) emissions (the two primary precursors of acid rain). This

concentration of sources makes the logistics of allowance trading administratively

manageable and enforceable. However, CO2 emissions are not so concentrated. Although

over 95% of the CO2 generated comes from fossil fuel combustion, only about 33% comes

from electricity generation. Transportation accounts for about 33%, direct residential and

commercial use about 12%, and direct industrial use about 20%. Thus, small dispersed

sources in transportation, residential/commercial, and the industrial sectors are far more

important in controlling CO2 emissions than they are in controlling SO2 emissions. This

creates significant administrative and enforcement problems for a tradeable permit program

if it attempts to be comprehensive.

These concerns multiply as the global nature of the climate change issue is considered,

along with other potential greenhouse gases. Article 3 of the protocol negotiated at Kyoto

emphasizes that any international emissions trading should be supplemental to a country’s

domestic efforts, not a substitute for them.

Tradeable Permits (Credits)

As noted above, a tradeable allowance involves future emissions. An allowance is a

limited authorization to emit a ton of pollutant; allowances are allocated to an emitting

facility under an applicable emission limitation at the beginning of a year. The facility

decides whether to use, trade, or bank those allowances, depending on its emissions strategy.

Then, at the end of the year, the agency compares an emitting facility’s actual emissions with

its available allowances to determine compliance.

A different approach to creating a tradeable permit program is to use credits instead of

allowances. A credit is created when a facility actually emits a pollutant at less than its

allowable limit as defined in by the program. An example of this type of program is the

Environmental Protection Agency’s (EPA) “Emission Reduction Credit program” (ERC)

under the Clean Air Act. Under the ERC program, EPA requires that any credit created

under a state program implementing emissions trading be “surplus, enforceable (by the

state), permanent, and quantifiable.” Thus, a state must certify the creation of the credit,

unlike an allowance program, where allocation is dictated by a statutory or regulatory

formula. Any CO2 reduction credit program could build on EPA’s and states’ experience

with the current emission reduction credit program.

The primary advantage of a credit program over an allowance program is that it does

not discriminate against new sources. Allowance programs tend to allocate their allowances

based on some historic baseline year. Those sources included in the baseline get their

allowances free. Those future sources not included in the baseline have to pay either the

older, existing sources to obtain allowances or to buy allowances at auction. With a credit

program, sulfur credits can be created by any source, as the baseline is dictated by the

emissions cap and yearly production, not a historical year. The disadvantage of such a

system is that facility planning is very difficult as operators do not know precisely what their

permissible limit will be from year to year.

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Carbon/CO2 Emissions Tax

An alternative market-based mechanism to the tradeable permit system is carbon taxes

— generally conceived as a levy on natural gas, petroleum, and coal according to their

carbon content, in the approximate ratio of 0.6 to 0.8 to 1, respectively. In the view of most

economists, the most efficient approach to controlling CO2 emissions would be a carbon tax.

With the complexity of multiple pollutants and millions of emitters involved in controlling

CO2, the advantages of a tax are self-evident. Imposed on an input basis, administrative

burdens such as stack monitoring to determine compliance would be reduced. Also, a carbon

tax would have the broad effect across the economy that some feel is necessary to achieve

long-term reductions in emissions.

However, in other ways, a tax system merely changes the forum rather than the

substance of the policy debate. Because paying an emissions tax becomes an alternative to

controlling emissions, the debate over the amount of reductions necessarily becomes a debate

over the tax level imposed. Those wanting large reductions quickly would want a high tax

imposed over a short period of time. Those more concerned with the potential economic

burden of a carbon tax would want a low tax imposed at a later time with possible exceptions

for various events. Emissions taxes would remain basically an implementation strategy;

policy determinations such as tax levels would require political/regulatory decisions. In

addition, a tax system would raise revenues. Indeed, one argument for — or against — such

a system would be that it is a tax that would raise revenues. The disposition of these

revenues would significantly affect the economic and distributional impacts of the tax.

Other tax schemes to address global climate change are also possible. For example, the

European Community (EC) has discussed periodically a hybrid carbon tax/energy tax to

begin addressing CO2 emissions. Fifty percent of the tax would be imposed on energy

production (including nuclear power) except renewables; 50% of the tax would be based on

carbon emissions. Some European countries have modified their energy taxation to fit the

model discussed by the EC.

Currently, five European countries have carbon-based taxes. Finland imposed the first

CO2 tax in 1990 and modified it in 1994. The Finnish tax has two components: (1) a basic

tax component to meet fiscal needs and (2) a combined energy/CO2 tax component. For

coal, peat, and natural gas, there is no fiscal component. The Netherlands also introduced

a CO2 tax in 1990, modified in 1992 to fit the EC model; however, the tax does not vary

according to fuel type and energy use. It does include tax relief from the energy component

of the tax for energy-intensive industries. Sweden introduced a CO2 tax in 1991 on all fossil

fuels, unless they are used in electricity production. In 1993, the tax scheme was modified

to reduce its burden on industry. Denmark introduced a CO2 tax in 1992 that covers fuel oil,

gas, coal, and electricity (gasoline is taxed separately). Taxes paid by industry are

completely reimbursed to the sector. Norway introduced a CO2 tax in 1991 on oil and

natural gas and extended it to some coal and coke use in 1992. However, there are many

exemptions and the tax rate is not differentiated according to the carbon content of the fuels.

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International Market-Oriented Mechanisms

Joint Implementation (JI) and the Clean Development Mechanism (CDM) are attempts

to expand the availability of cost-effective CO2 reductions into the international sphere

through flexible, market-oriented mechanisms. Basically, these mechanisms allow a

developed country needing to make CO2 reductions to meet its obligations under an

international treaty to obtain reduction credits by financing emission reductions in another

country: either another developed country in the case of JI, or a developing country in the

case of CDM. During the 1990s, promoting flexible market-oriented mechanisms was a

keystone of U.S. climate change policy; they were subject to considerable debate at the

Conference of Parties (COP) meetings in Berlin. These discussions resulted in agreement to

implement JI in a pilot phase (renamed Activities Jointly Implemented — AJI).

After much negotiation, the protocol agreed to at Kyoto contains provisions on flexible

market-oriented mechanisms that generally followed the guidelines set up at Berlin. Article

6 provides for JI between developed countries with emission reduction requirements.

Because developing countries have no emission requirements to meet (unlike developed

countries), article 12 of the protocol set up a Clean Development Mechanism (CDM) to

promote sustainable development in them while providing emission reduction opportunities

for developed countries. Participation is voluntary; benefits must be real, measurable, and

long-term; reductions must be in addition to any normal activity. Operated under supervision

of the COP, reductions achieved between 2000 and 2008 may be used to offset commitments

in the 2008-2012 time period.

The advantage of flexible, market-oriented mechanisms for developed countries is that

they widen the options available to obtain necessary credits under any reduction program.

This translates into lower costs to those countries, compared with their own domestic

reduction activities. For the developed country, particularly where it does not have the

resources to control emissions or protect sequestration areas, reductions or protection would

occur more quickly than would otherwise be possible.

However, the disadvantages are also significant. A developed country may have to rely

on another sovereign government to ensure compliance with part of its international

commitment. Governments change, and policies change. If a new government chose to

remove or shut down a pollution control device, the developed country might have little

recourse but to look elsewhere for its necessary reduction. Particularly with sequestration

projects that involve marketable commodities, such as trees, enforcement could be quite

difficult. A tree’s value as cooking or heating firewood for natives could easily exceed its

value as a carbon sequester. In the long-run, the enthusiasm with which a developing country

may enforce agreements with respect to CDM projects is unclear.

Indeed, developing countries could have significant economic incentives to abrogate

CDM projects, particularly if they are viewed as constraining necessary development, or

locking up a natural resource that the country would like to exploit. This incentive is further

encouraged if the CDM project is perceived as a developed country’s project. The term

“economic imperialism” has already been applied to CDM projects by some opponents.

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Issues

Cost-Effectiveness: Price versus Quantity

Proposed CO2 reduction schemes present large uncertainties in terms of the perceived

reduction needs and the potential costs of achieving those reductions. In one sense,

preference for a carbon tax or tradeable permit system depends on how one views the

uncertainty of costs involved and benefits to be received. For those confident that achieving

a specific level of CO2 reduction will yield very significant benefits — enough so that even

the potentially very high end of the marginal cost curve does not bother them — then a

tradeable permit program may be most appropriate. CO2 emissions would be reduced to a

specific level, and in the case of a tradeable permit program, the cost involved would be

handled efficiently, but not controlled at a specific cost level. This efficiency occurs because

control efforts are concentrated at the lowest-cost emission sources through the trading of

permits.

However, if one is more uncertain about the benefits of a specific level of reduction —

particularly with the potential downside risk of substantial control cost to the economy —

then a carbon tax may be most appropriate. In this approach, the level of the tax effectively

caps the marginal control costs that affected activities would have to pay under the reduction

scheme, but the precise level of CO2 achieved is less certain. Emitters of CO2 would spend

money controlling CO2 emissions up to the level of the tax. However, since the marginal

cost of control among millions of emitters is not well known, the overall effect of a given tax

level on CO2 emission cannot be accurately forecasted. Hence, a major policy question is

whether one is more concerned about the possible economic cost of the program and

therefore willing to accept some uncertainty about the amount of reduction received (i.e.,

carbon taxes) or whether one is more concerned about achieving a specific emission

reduction level with costs handled efficiently, but not capped (i.e., tradeable permits).

A proposal was floated by the Clinton Administration for a tradeable permit program

with a ceiling on the price of permits. If permit prices rose above a certain level, the

government would have intervened to control costs by selling more permits at a specific

price. In essence, this would have given the permit program the character of a carbon tax by

controlling costs through a price “safety valve,” while allowing quantity to increase to any

level necessary to prevent price increases. Not surprisingly, environmental groups interested

in protecting the emission limitations of any global climate change program attacked the idea

as a “target-busting escape clause.” Industry groups suggested that such a tradeable permit

program amounts to a tax. For a discussion of other “safety valve” proposals, see CRS

Report RS21067, Global Climate Change: Controlling CO2 Emissions — Cost-limiting

Safety Valves.

Comprehensiveness

As suggested earlier, carbon emissions are ubiquitous. Much of the emissions come

from the direct combustion of fossil fuels from small, dispersed sources such as automobiles,

homes, and commercial establishments. For example, the 12% of U.S. emissions from the

residential/commercial sector come from such things as space heating/cooling (9.3%, oil and

natural gas), water heating (1.5%, mostly natural gas), and appliances (1.2%, mostly natural

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gas). If one adds to these dispersed sources the 33% of emissions that come from direct

combustion from automobiles (13.9%), trucks (11.2%), airplanes (4.5%), ships (1.8%),

pipelines (0.6%), and railroads (0.8%), the number of individual sources runs into the

millions; very small sources contribute almost half the emissions.

Assuming a carbon tax is assessed on an input basis (i.e., on the carbon content of the

fuel), then the number of sources is largely irrelevant — the sources would get the correct

price signal from the increased cost of their fuel. This is one of the primary strengths of the

carbon tax scheme — it can be very comprehensive and potentially induce the necessary

changes in individual as well as corporate behavior that could substantially reduce

dependence on carbon emitting energy sources. In this sense, a carbon tax is not just a

band-aid to reduce CO2 emissions, but a program to reduce carbon intensiveness in the

economy and in individual lifestyles.

For a tradeable permit program, the numbers of sources can represent a substantial

administrative and enforcement problem. One approach to making the situation more

manageable would be to limit the scope of the trading system to domestic implementation

strategies. As noted above, international emission trading is termed “supplemental” under

the consolidated negotiating text. Likewise, the scope could be limited further by focusing

the trading program on the electric utility sector. Another approach could be to limit the size

of the source included in the trading program. Others could “opt-in,” but their participation

would be voluntary. Thus, direct combustion of fossil fuels in the residential, commercial,

and industrial sectors (e.g., natural gas, home heating oil) would be indirectly encouraged by

the program and use of CO2 emitting electricity (particularly coal-fired electricity)

discouraged. The transportation sector would be little affected (unless it chose to be).

Economic Impact

Obviously, the economic impact of either a tradeable permit program or a carbon tax

depends on the level of reductions desired and the timing of those reductions. Most of the

studies on the economic impact of CO2 control programs have focused primarily on carbon

taxes. This is not surprising as carbon taxes are easier to model than a tradeable permit

program. However, the uncertainty involved in these analyses is quite large; further work

is necessary to reduce the current range of estimates.

Economic assumptions that influence cost estimates include (1) carbon emissions

growth assumptions in the absence of legislation, (2) responsiveness of the economy to the

carbon tax in terms of increased energy efficiency, and (3) type of model employed.

Uncertainty is compounded when attempts are made to estimate GDP effects of carbon taxes.

Very small differences in GDP estimation techniques can result in large differences in

projected impacts (particularly over the long term). Preliminary evidence indicates that the

adverse effects of a carbon tax can be reduced if the proceeds from that tax are “recycled”

either to offset certain existing taxes or fund investment incentives to encourage economic

growth (particularly through greater capital formation). Thus, the impact of a carbon tax on

the economy would depend to some degree on how the government disposed of generated

revenues. However, considerably more work is needed to define the economic consequences

of a specific proposal to recycle revenues before much confidence can be put into the results.

Of course, if one has a technological or ecological orientation, the assumptions resulting

from those orientations can outweigh the economic assumptions discussed here.

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The extent that economic analysis of carbon tax programs provides insight for a

tradeable permit program depends partially on the scope of the program, the options

included, and the monitoring and transaction costs. If the government chose to sell its

allowances at auction, rather than giving them away (as is typical), the government would

have revenue like a carbon tax to recycle or readdress perceived distortions in the current tax

code. In June 2000, the Congressional Budget Office released a study on the distributional

effects of carbon trading programs. It concludes that if the government gave away carbon

allowances to U.S. firms (as is typical for trading programs), the effects would be regressive

on households. If the allowances were sold at auction, the distributional effects would

depend on the ultimate disposition of the revenue received from the sale. However, the

carbon tax analysis does suggest that the price of a permit (and any revenues from the sale

thereof) would be difficult to estimate with any precision at the current time.

The specific effects of both a carbon tax and tradeable permit program would depend

on the specific levy (carbon tax) or allocation scheme (tradeable permit) chosen. Experience

with both tax code revisions and the allocation scheme under the acid rain title suggests that

regional, state, and sector-specific concerns could receive special treatment in these

decisions. In addition, for a carbon tax, the allocation of revenue received could also be

influenced by such concerns.

Equity

The climate change issue and CO2 control raise numerous equity issues. In one sense,

the concern about climate change is a concern about intergenerational equity — the

well-being of the current generation versus generations to come. On a global level, the issue

also involves the North-South debate. Some industrialized Northern countries suggest that

the lesser-developed Southern countries refrain from certain activities (such as clearing rain

forests) that Southern countries feel are important for their economic growth. Southern

countries often suggest that the Northern countries change their current “unsustainable”

growth practices and assist the South in sustainable development. Some supporters of

tradeable permits have suggested that internationalization of the permit program could allow

the wealthy countries to fund CO2-reducing activities (preserving forests, improving

efficiency, etc.) as a means of achieving cost-effective reductions and assisting developing

countries (i.e., CDM projects). However, as noted above, monitoring the long-term efficacy

of CDM projects raises administrative issues. Some carbon tax proponents have suggested

that a portion of collected revenue could be set aside for assisting developing countries.

Percentages to be set aside and more generally the political acceptability of such a proposal

are unclear.

Other equity questions include the regional distribution of costs under a tradeable

permit or carbon tax scheme. For example, an important impact of either a carbon tax based

on the carbon content of fossil fuels or a tradeable permit program would be the pressure for

fuel shifts away from coal and toward gas. Other regions, such as fast growing areas in need

of more energy and owners of “all electric” homes, among others, would likely be

disproportionately hit by a CO2 control scheme. In addition, people may be affected

differently according to income class. These issues have not been sufficiently analyzed at

the current time to draw firm conclusions.

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Legislation in the 108th Congress

In the 108th Congress, six bills have been introduced to control CO2 emissions. S. 139,

introduced by Senators McCain and Lieberman, would reduce and cap emissions of carbon

dioxide from electricity generation, transportation, industrial, and commercial sectors —

sectors that account for about 85% of U.S. greenhouse gas emissions. The reductions would

be implemented in two phases with an emissions cap in the year 2010 based on affected

facilities’ 2000 emissions, and a further reduction cap imposed in the year 2016 based on

affected facilities’ 1990 emissions. The program would be implemented through an

expansive allowance trading program that includes cross-sector trading and limited

acquisition of allowances from foreign sources. For a comparison of S. 139 with other

Senate bills to reduce greenhouse gases, see CRS Report RS21581, Climate Change: Senate

Proposals to Reduce Greenhouse Gas Emissions. For a summary and analysis of S. 139, see

CRS Report RS21637, Climate Change: Summary and Analysis of the “Climate Stewardship

Act” (S. 139/S.Amdt. 2028, and H.R. 4067).

The second bill, S. 366, introduced by Senator Jeffords, is a modified version of the

multi-pollutant bill (S. 556) reported out by the Senate Environment and Public Works

Committee in the 107th Congress. Placing emission caps on nitrogen oxides, sulfur dioxide,

and carbon dioxide, S. 366 would reduce and cap emissions of carbon dioxide from

electricity generation at their 1990 levels by the year 2009. Similar to S. 139, the program

would be implemented through an allowance trading program. In addition to these emission

caps, S. 366 would place facility-specific emission limitations on mercury.

The third and fourth bills, S. 843, introduced by Senator Carper, and H.R. 3093,

introduced by Representative Bass, are multi-pollutant control bills similar to S. 3135

introduced in the 107th Congress. Placing emission caps on nitrogen oxides, sulfur dioxide,

mercury, and carbon dioxide, S. 843 and H.R. 3093 would cap carbon dioxide emissions

from powerplants at their 2006 levels by 2009 and further cap emissions at their 2001 levels

by 2013. Similar to the other two control bills, S. 843 and H.R. 3093 would be implemented

through an allowance trading program.

The fifth bill, H.R. 2042, introduced by Representative Waxman, is a multi-pollutant

control bill similar to H.R. 1256 introduced in the 107th Congress. Placing emission caps on

nitrogen oxides, sulfur dioxide, mercury, and carbon dioxide, H.R. 2042 would cap carbon

dioxide emissions from powerplants at their 1990 levels by the year 2009. Implementation

strategies are to be determined by EPA with market mechanisms explicitly permitted (except

for mercury). For a further discussion of multi-pollutant legislation introduced in the 108th

Congress, see CRS Report RL31779, Air Quality: Multi-Pollutant Legislation in the 108th

Congress.

The sixth and most recent bill is H.R. 4067. Introduced March 30, 2004, by

Representative Gilchrest, it is modeled on S. 139 but includes only the first phase of S. 139’s

two-phase reduction program. Like S. 139, H.R. 4067 is a stand-alone greenhouse gas

reduction program.

In October 2003, an amended version of S. 139 (S.Amdt. 2028) was debated and

defeated on the Senate floor. The vote was 43-55.

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Other Proposals

United States and International Activities

In March 2001, the Bush Administration announced that the Kyoto Protocol was “dead”

as far as it was concerned. In rejecting the Kyoto Protocol as unfair to the United States,

EPA Administrator Whitman emphasized the Administration’s desire to work constructively

with the EC to develop technologies, market-based incentives, and other innovative

approaches to global climate change. However, the Administration has yet to announce or

outline any policy alternatives as a basis for international discussions.

Administration Domestic Initiatives

In late September 2000, presidential candidate George W. Bush proposed a national

energy plan that would include requiring utilities to reduce their carbon dioxide emission

over a “reasonable” time frame in a manner similar to the current market-based acid rain

reduction program. Few specifics, such as reduction targets or schedule, were included in

the plan. In March 2001, the Bush Administration reversed this position, stating that it

would not seek legislation to reduce CO2 emissions. In making the reversal, the

Administration cited a Department of Energy (DOE) study indicating that energy costs would

increase if controls were put on CO2 emissions.

In February 2002, the Administration initiated a new voluntary greenhouse gas program,

similar to ones introduced by the earlier Bush and Clinton Administrations. Developed in

response to the U.S. ratification of the 1992 United Nations Framework Convention on

Climate Change (UNFCCC), these previous plans projected U.S. compliance, or near

compliance, with the UNFCCC goal of stabilizing greenhouse gas emissions at their 1990

levels by the year 2000 through voluntary measures. The new proposal introduced by the

Bush Administration did not make that claim, only projecting a 100 million metric ton

reduction in emissions from what would occur otherwise in the year 2012. The plan focuses

on improving the carbon efficiency of the economy, reducing current emissions of 183 metric

tons per million dollars of GDP to 151 metric tons per million dollars of GDP in 2010. It

proposes several voluntary initiatives, along with increased spending and tax incentives, to

achieve this goal. However, the Administration projects that three-quarters of this reduction

would be achieved through current efforts underway, not by the new initiatives.

Based on the Administration’s estimates, the initiative will result in U.S. greenhouse

gas emissions being 28% above 1990 levels in the year 2010, a 4.5% reduction over a

business-as-usual baseline.

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