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What’s the Best Climate Policy?

September 25, 2019

In recent months, a flurry of climate proposals have been introduced in Congress. Among them are bills to tax carbon emissions, establish renewable portfolio standards (RPS) and institute technology-neutral clean energy standards. The leadership of the House Energy and Commerce Committee has committed to producing by the end of the year a comprehensive, economy-wide climate bill that leads to full decarbonization by midcentury.  Similarly, the House Select Committee on the Climate Crisis is scheduled to issue recommendations to the committees of jurisdiction for climate legislation.  These proposals may include a cap and trade program.

Naturally, this has led supporters of new policies to ratchet up a long simmering debate about which general approach – carbon taxes, cap and trade, or clean energy standards (CES) – is the best way to achieve climate goals.

This debate is unfortunately misguided and overly simplistic. The question of which approach is “the best” is less important than which policy can be enacted and meet multiple energy and climate goals in ways that are preferable to today’s modest set of policies. Answering this more nuanced question involves a complex exercise that looks beyond bumper sticker labels to design details because the merits of each policy approach depend critically on their design. Fortunately, all three of these approaches, if thoughtfully designed, could satisfy multiple policy goals and be important steps forward in addressing the climate challenge. Given the past difficulties of establishing ambitious climate policies at the national level and political uncertainties looking forward, the chances of success will be increased if policymakers are given more options not fewer.

Successful legislation will need to achieve multiple policy objectives. Obviously, it will need to be environmentally effective, which is to say it should lead to or be compatible with full decarbonization of the U.S. economy, including the electric, transport, industrial and building sectors. To be acceptable to the public, the policy will also need to be cost-effective when compared to current federal and state greenhouse gas policies. The impacts on consumer wealth and employment across a range of income levels, regions of the country and industry sectors will need to be sufficiently equitable to be accepted by policymakers. The policy should also be robust, that is, flexible enough to perform successfully in the face of unanticipated commodity price fluctuations, technology developments or other economic conditions. Policies that satisfy these objectives will also be durable over time, which is important since they are likely to be in place for several decades.

Fortunately, federal policy makers have a broad array of design tools available to them to craft successful legislation. These include:

  1. Production-Based Metrics – A production metric, such as tons emitted, electricity generated or emissions per unit of energy, creates incentives for firms to reduce emissions using both operational improvements (re-dispatch and plant efficiency) and investments (new low-carbon power plants and retirements). This reduces program costs.
  2. Pricing Mechanism – A transparent price applied to the production metric strengthens compliance incentives and provides compliance flexibility which will promote cost effectiveness.
  3. Technological Neutrality – Covering all emitting and non-emitting power generating technologies in a technologically-neutral manner promotes cost effectiveness by providing operational, investment and retirement incentives for all technologies in the energy system, rather than just a preferred subset of low-carbon technologies.
  4. Uniform Standards – Applying the same or consistent emission standards across all covered resources (new and existing plants, differing technologies etc.) and across states and regions, reduces emission leakage and supports cost-effectiveness.
  5. Broad Coverage and Harmonization – Broad coverage within and across sectors of the economy, including both existing and new capital equipment, encompasses a broader range of emission activities and avoids leakage to sectors not covered by the policy. This facilitates deeper emission reductions and leads to cost effective compliance.
  6. Tools to Manage Distributional Impacts – The distribution of economic gains and losses across income groups, states and industries will be shaped by policy tools including the allocation of emission credits, changes in tax rates, credits, rebates, exemptions, border carbon adjustments, subcategorization of emission standards, and the rate at which credits are issued and redeemed.
  7. Tools to Manage Emission and Cost Uncertainties – Policy tools are also available to manage emission reduction and cost uncertainties including banking, borrowing, alternative compliance payments and mechanisms to adjust tax levels.

The availability of these tools does not mean that carbon taxes, cap and trade policies and CES can all be designed to be perfect substitutes for one another. There are fundamental differences. Carbon pricing programs (carbon taxes and cap and trade) could be implemented on an economy wide basis, while CES are more reasonably limited to the electric sector alone, making carbon pricing potentially more effective and cost efficient. And carbon pricing, unlike CES, could also raise government revenues to reduce the federal budget deficit, promote distributional equity, support mitigation investments or for other public purposes.

At the same time, it is also the case that CES could be structured to be the basis for successful policy. CES share several important design elements with carbon pricing. The most important of these are production metrics, transparent market-based pricing and technological neutrality. While, all other things equal, a CES tends to be more costly than well-designed carbon pricing programs, technology neutrality makes them less costly than renewable portfolio standard (RPS) programs designed to achieve deep levels of decarbonization. And when compared to status quo policies, the economic literature on CES programs points to economic benefits roughly five to ten times program costs, demonstrating their substantial economic value.

Other design tools are also available to CES policymakers. Directly or indirectly linking CES to carbon pricing or emission programs in other sectors of the economy could improve overall cost-effectiveness, facilitate trading liquidity and promote price stability. And mechanisms to manage price risks such as credit banking, credit borrowing and alternative compliance payments, may be adapted for CES programs.

Given this, we would do well to reframe the “which is best?” debate, recognize that thoughtful design can be used to develop any of these general approaches into successful policy, and focus on crafting multiple options for policy makers.

Bruce A. Phillips is a Director and Co-Founder of The NorthBridge Group, a member of the Clean Air Task Force Board of Directors, and on the Advisory Board of the Yale Center for Business and Environment.

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