Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

Global Climate Change: Controlling CO2

Emissions—Cost-Limiting Safety Valves

-name re-acte-Specialist in Energy and Environmental Policy

December 22, 2004

Congressional Research Service

7-....

www.crs.gov

RS21067

CRS Report for Congress

Prepared for Members and Committees of Congress

Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

Summary

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

needs and the potential costs of achieving those reductions. Several cost-limiting “safety valves”

have been proposed to bound costs of any CO2 control program, including (1) a straight carbon

tax, (2) a contingent reduction scheme, (3) unlimited permit purchases, and (4) cost-based excess

emissions penalties. Employing a safety valve shifts much of the emission reduction debate from

compliance targets to the specifications of the safety valve, in particular, the level of the tax or fee

involved. This report will be updated if events warrant.

Congressional Research Service

Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

Contents

The Dilemma: Price versus Quantity ...........................................................................................1

Safety Valves ..............................................................................................................................3

Discussion ..................................................................................................................................4

Tables

Table 1. Key Considerations of Safety Valves..............................................................................4

Contacts

Author Contact Information ........................................................................................................5

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Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

T

he fundamental policy assumption that has changed between the U.S. ratification of the

1992 Framework Convention on Climate Change (FCCC) and the current Bush

Administration’s decision to abandon the Kyoto Protocol process concerns costs.1 The

ratification of the FCCC was based at least partially on the premise that significant reductions

could be achieved at little or no cost. This assumption helped to reduce concern some had

(including those of the former Bush Administration) that the treaty could have deleterious effects

on U.S. competitiveness—a significant consideration because developing countries are treated

differently from developed countries under the FCCC. Further ameliorating this concern,

compliance with the treaty was voluntary. While the United States could “aim” to reduce its

emissions in line with the FCCC’s goal, if the effort indeed involved substantial costs, the United

States could fail to reach the goal (as has happened) without incurring any penalty under the

treaty.

This flexibility would have been eliminated under the Kyoto Protocol with its mandatory

reduction requirements. The possibility of failure to comply with a binding commitment

intensifies one’s perspective on potential costs: How confident can one be in the claim that carbon

reductions can be achieved at little or no cost?2 Compliance cost estimates ranging from $5.5

billion to $200 billion annually cause some to pause.3 The current Bush Administration was

sufficiently concerned about potential CO2 control costs to reverse a campaign pledge to seek

CO2 emissions reductions from power plants, in addition to its decision to abandon the Kyoto

Protocol process. 4

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

needs and the potential costs of achieving those reductions. In an attempt to prevent any CO2

control program from incurring unacceptable costs, several cost-limiting “safety valves” have

been proposed to bound costs. These safety valves are designed to work with market-based CO2

reduction schemes, similar to the tradeable permit strategy used by the acid rain program,5 and

would effectively limit the unit (per ton of emissions) control costs sources would pay. This

report examines four such safety valves: (1) a straight carbon tax, (2) a contingent reduction

scheme, (3) unlimited permit purchases, (4) cost-based excess emissions penalties.

The Dilemma: Price versus Quantity

In general, market-based mechanisms to reduce CO2 emissions focus on specifying either the

acceptable emissions level (quantity), or compliance costs (price), and allowing the marketplace

to determine the economically efficient solution for the other variable. For example, a tradeable

permit program sets the amount of emissions allowable under the program (i.e., the number of

1

For a review of U.S. global climate change policy, see CRS Report RL30024, U.S. Global Climate Change Policy:

Evolving Views on Cost, Competitiveness, and Comprehensiveness, by (name redacted) and (name redacted).

2

For a further discussion of the foundations for such divergent cost estimates, see CRS Report 98-738, Global Climate

Change: Three Policy Perspectives, by (name redacted) and (name redacted).

3

CRS Report RL30024, U.S. Global Climate Change Policy: Evolving Views on Cost, Competitiveness, and

Comprehensiveness, by (name redacted) and (name redacted), p. 16.

4

President George W. Bush, Letter to Senators Hagel, Helms, Craig, and Roberts, Office of the Press Secretary, March

13, 2001.

5

For more on market-based strategies to reduce greenhouse gases, see CRS Issue Brief IB97057, Global Climate

Change: Market-Based Strategies to Reduce Greenhouse Gases, by (name redacted).

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Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

permits available caps allowable emissions), while permitting the marketplace to determine what

each permit will be worth. Likewise, a carbon tax sets the maximum unit (per ton of CO2) cost

that one should pay for reducing emissions, while the marketplace determines how much actually

gets reduced. In one sense, preference for a carbon tax or a 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 significant

benefits—enough so that even the potentially very high end of the marginal cost curve does not

bother them—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, though not controlled at a specific cost level. This efficiency occurs

because through the trading of permits, emission reduction efforts concentrate at sources at which

controls can be achieved at least cost.

However, if one feels more certain of the potential downside risk of substantial control costs to

the economy than of the benefits of a specific level of reduction, then a carbon tax may be most

appropriate. In this approach, the level of the tax effectively caps the marginal cost of control that

affected activities would pay under the reductions 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 emissions reductions for a given tax level on CO2 emissions cannot be

accurately forecast.

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 one is more concerned about achieving a specific

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

A model for a tradeable permit approach is the sulfur dioxide (SO2) allowance program contained

in Title IV of the 1990 Clean Air Act Amendments. Also called the acid rain control program, the

tradeable permit system 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 licenses between polluters is the most cost-effective

means of achieving a given reduction. This market in pollution licenses (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 market liquidity.

There are no existing U.S. models of an emissions tax, although five European countries have

carbon-based taxes.6

6

Finland, the Netherlands, Sweden, Denmark, and Norway. See CRS Issue Brief IB97057, Global Climate Change:

Market-Based Strategies to Reduce Greenhouse Gases, by (name redacted).

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Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

Safety Valves

As a stalemate has continued on strategies to control CO2 emissions, particularly because of costs

fears, attention increasingly focuses on the cost-limiting benefit of a carbon tax, either as the

primary strategy or as a component blending a carbon tax with the reduction certainty of the

tradeable permit system. The object is to create a safety valve to avert unacceptable control costs,

particularly in the short term. These safety valves limit unit (per ton) costs of reducing emissions.

Four ideas are identified below:

•

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. 7 However, proposals have been made to impose the tax downstream

of the production process. Several European countries have carbon taxes in

varying degrees and forms.

•

Unlimited permits at set price: generally conceived as part of an auction system

where permits are allocated to affected sectors by auction with an unlimited

number available at a specific price. The most recent proposal is by the National

Commission on Energy Policy, which recommends an initial limiting price of

$7/ton that would increase by 5% annually.8 Other variations include the

Resources for the Future/Skytrust proposal, which would increase the limiting

price ($25/ton) by 7% above inflation annually, and the Brookings proposal,

which would set up a short-term market based on a $10/ton price, and a longterm market based on market rates.9

•

Contingent reduction: generally conceived as a declining emission cap system

where the rate of decline over time is determined by the market price of permits.

If permit prices remain under set threshold prices, the next reduction in the

emission cap is implemented. If not, the cap is held at the current level until

prices decline. 10 Discussions have centered on a 2% annual declining cap subject

to a $5 a permit CO2 cost cap.

•

Excess emissions penalty: generally involves a fee on emissions exceeding

available permits based on control costs or other economic criteria, rather than

criminal or civil considerations. For example, Oregon’s CO2 standard for new

energy facilities includes a fee of 57 cents per short ton on CO2 emissions in

excess of the standard (increase to 85 cents proposed).11

7

(name redacted),

Carbon Taxes: Cost-Effective Environmental Control or Just Another Tax? CRS Report 92-623 ENR,

August 4, 1992.

8

The National Commission on Energy Policy, Ending the Energy Stalemate: A Bipartisan Strategy to Meet America’s

Energy Challenges, December 2004, p. 21.

9

Raymond Kopp, Richard Morgenstern, William Pizer, and Michael Toman, A Proposal for Credible Early Action in

U.S. Climate Policy, available at http://www.weathervane.rff.org/features/feature060/pb66.htm; Americans for

Equitable Climate Solutions, Sky Trust Initiative: Economy-Wide Proposal to Reduce U.S. Carbon Emissions, available

at http://www.aecs-inc.org/skytrust.htm; and Warwick J. McKibbin, Moving Beyond Kyoto, Policy Brief #66, October

2000, available at http://www.brook.edu/comm/policybriefs/pb066/pb66.htm.

10

See Clean Power Group website: http://www.eea-inc.com/cleanpower/index.html.

11

State of Oregon, OAR, Chapter 345, Division 24.

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Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

Discussion

Table 1 summarizes the key considerations of each of the proposals identified above. As

indicated, each safety valve effectively controls cost, but at the price of some uncertainty about

the amount of emissions reduced.

Table 1. Key Considerations of Safety Valves

Cost-Emission

Reduction Balance

Implementation

Enforcement

Other

Carbon Tax

A cost-focused

strategy with

reductions achieved

dependent on the tax

imposed.

Strategy can be

implemented either

upstream or

downstream. Can also

be implemented

across different

economic sectors.

Strategy is selfenforcing.

Strategy would

generate sizeable

revenues that could

be recycled or used

for other priorities.

Unlimited

Permits at a

set price

A transitional strategy

from cost-focused to

reduction-focused.

Emission reductions

dependent on the

price set for excess

emissions permits.

Strategy places focus

on the excess

emissions permit’s

initial price, and the

schedule of any prices

increases or excess

emissions permit

phase-out over time.

Besides requiring the

usual monitoring/

tracking mechanisms

of a tradeable permit

system, strategy

requires a system to

separately track

allocations of excess

emission permits.

A low price for excess

emission permits

could have the effect

of flooding the permit

trading market,

discouraging any

trading.

Contingent

Reductions

An interactive strategy

where costs

determine reductions

and reductions

determine costs

through a market

mechanism. Emission

reductions dependent

on a freely functioning

permit market.

Strategy requires

agreement on

emission reduction

schedules, appropriate

permits prices to

trigger those

schedules, and the

specific price

determination

mechanism (spot vs.

long-term prices).

Besides requiring the

usual monitoring/

tracking mechanisms

of a tradeable permit

system, strategy

requires major

oversight of permit

market operations.

Potential market

manipulation to avoid

increased reduction

requirements is a

serious issue.

Excess

emissions

penalty

An incremental

strategy where

reductions achieved

are dependent on the

penalty imposed.

Strategy places focus

on initial penalty and

any scheduled

increases in that

penalty over time.

Requires the usual

monitoring/ tracking

mechanisms of a

tradeable permit

system only.

Strategy is most

similar to existing

tradeable permit

system.

If one uses the existing Title IV acid rain control program as a baseline, the excess emissions

penalty option is the most similar, while the carbon tax option is the most different. The excess

emissions penalty option would work in essentially the same fashion as the acid rain program,

with the primary difference being the penalty for having insufficient permits at the end of the

year. Under Title IV, the penalty is intended to be punitive—to punish the offender for breaking

the law. Thus, the offender pays a fine three times the estimated cost of control in addition to

forfeiting a future permit. The overriding assumption is that the offender could have reduced his

emissions sufficiently, but refused to do so. Under the excess emissions penalty option, there is

uncertainty as to whether an offender could have reduced his emissions sufficiently at the

estimated price, and that reductions at a cost greater than that price are either socially

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Global Climate Change: Controlling CO2 Emissions—Cost-Limiting Safety Valves

unacceptable or economically unjustifiable. Hence, the penalty is assessed on the basis of a

socially acceptable or economically justifiable price so that the offender pays a cost for his

unlawful activity and is encouraged to comply with the law, but is not punished beyond what

society has deemed reasonable. Arriving at such an acceptable penalty could be contentious.

The carbon tax is the most radical compared with the Title IV program because it dispenses with

the permit system approach to emissions control. All the pressure under a carbon tax scheme is on

the timing, pace, and level of the tax, as there is no stigma for not controlling pollution. The

strength of this approach is that it is self-enforcing, and considerable revenues will be generated

that could be recycled to polluters or used for other priorities. However, U.S. environmental

policy has generally opposed any approach suggesting a polluter’s right to pollute, which the

carbon tax approach does grant.

Depending on how the unlimited permit approach is implemented, it can look and act a lot like a

carbon tax. If the initial allocation of permits is by auction and unlimited permits are available at

a low price, the auction price will equal the unlimited permit price, resulting in a carbon tax equal

to the excess emissions permit price. Thus, without limits on the quantity of permits allowed, the

unlimited permits approach is merely a carbon tax by another name, at least in the short term. In

addition, the unlimited permits system requires the tracking mechanisms of a tradeable permit

system if it is ever to evolve into a permit system. As with a carbon tax, setting the unlimited

permit price could be contentious.

The contingent reduction approach attempts to turn both the price and the quantity of reductions

into variables solved by the trading market. This requires agreements on both the profiles of

emissions reductions and threshold price triggers. It also puts enormous pressure on the trading

permit market to produce an accurate price to make the whole system work. Although in some

ways the most innovative, the contingent approach also could be the most difficult in terms of

arriving at acceptable parameters for the reductions and triggers.

In short, employing a safety valve shifts much of the emission reduction debate from compliance

targets to the specifications of the safety valve. The safety valve becomes the controlling

mechanism of the permit tradeable system, or the sole mechanism in the case of a carbon tax.

Whether this shift would contribute to an acceptable result is not clear.

Author Contact Information

(name redacted)

Specialist in Energy and Environmental Policy

#redacted#@crs.loc.gov, 7-....

Congressional Research Service

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