Should State Cap and Trade Programs Be Preempted?

My general sense is that most environmentalists disfavor federal preemption of state climate change policy making.  States have led the way on progressive climate policy during the eight years of federal inaction under Bush, enacting renewable portfolio standards (29 states), greenhouse gas emissions caps (covering more than half the states), utility performance standards (four states), and auto emissions standards (California plus fifteen states set to follow California’s lead before Obama announced a stringent new national standard). Many believe states should be rewarded for their climate leadership with continued authority to regulate.  Perhaps more importantly, independent state authority is important to retain in the event that the federal government backs away from sufficiently stringent carbon policy or we see political leadership change in Congress or eventually the Executive branch.

But should states retain authority to enact or continue cap and trade programs in the event that Congress enacts a national cap and trade scheme?  State cap and trade programs could be meaningful in at least two instances:  if they cover more sources or impose a tighter cap than a comparable federal program.  Similarly, if federal legislation contains provisions that significantly undermine its effectiveness (a far too generous safety valve or generous borrowing provisions) a more stringent state cap and trade program could produce additional emissions reductions within the state.  But will they affect overall U.S. emissions reductions?  If a federal cap is in place, then a more stringent cap within a state will simply require in-state sources to meet the state cap without producing any net decrease in U.S. emissions.  Why?  Because the in-state sources will simply help the rest of the country meet the federal cap more easily, requiring fewer reductions by sources throughout the rest of the country.  Thus state cap and trade programs simply redistribute the allocation of emissions reductions and may increase the overall costs by limiting the freedom of a carbon market to distribute reductions efficiently.  This is the conclusion of an important paper by Megan McGuinness and A. Danny Ellerman of MIT.

But if states will simply incur a great proportion of costs by enacting their own cap and trade programs with no resulting benefit, why preempt them?  No rational state should enact a cap and trade scheme and in-state sources should be able to persuade elected officials not to regulate. So preemption shouldn’t be necessary.  But if Congress does preempt state cap and trade programs (as the Waxman-Markey bill currently does, see Cara’s post here) how much does it matter?

Reader Comments

6 Replies to “Should State Cap and Trade Programs Be Preempted?”

  1. Isn’t that assuming that the state cap doesn’t produce any technology forcing? If it does, then global mitigation costs go down.

  2. I think not but tell me if you disagree. The sources in the capped state would simply buy additional allowances if their abatement costs exceeded the allowance price and given that the federal cap will drive those prices, isn’t there just a redistribution? I think the answer to your question may be correct with respect to performance standards (say, limits on the importation of coal) but no with respect to cap and trade. But I’m interested if you think differently.

  3. Let’s unpack this a little. I think two assumptions are needed to make this question worth asking. The first assumption is that in fact it’s possible for sources outside of the state program to “pick up the slack” and use up those federal emissions permits. That might not be true if enough states decided to enact their own cap-and-trade programs, which they might be interlinked. (Consider the extreme case where every state does this — then the federal system becomes more or less irrelevant to determining the total level of emissions.) The second assumption is that technology-forcing is possible — which means that there are cost effective emission reduction technologies that the market wouldn’t discover without being forced to do so.

    Now, just to take a clearcut case, suppose California has a very low cap so state allowances are extremely expensive. The result of this is to come up with breakthrough technologies that are cheaper (per ton of carbon) than the market would otherwise have produced. (In other words, the new technologies are so good that they are actually below the national price for carbon.) In theory, the market should have come up with these anyway, but maybe that wouldn’t happen — maybe you really have to knock firms on their heads to get their attention. So in this case, the California program actually ends up lowering national compliance costs as the technology is adopted everywhere. To use some numbers, say that national allowances would otherwise trade for $50/CO2t, that California pushes the price to $90, and that the result is a breakthrough technology that eliminates carbon at a price of $40/ton. So the national compliance cost gets pushed down to $40.

    This takes a strong faith in technology forcing, but it might be possible to tell a story either about organizational pathologies within businesses or about various market failures in R & D that could make this plausible. But a state might find this economically worthwhile even in less extreme cases, if other countries have stricter controls than the U.S. the state might develop a marketable new technology. That is, the state comes up with a new technology that costs $55/ton, which it can market to the EU even though it won’t have any effect on U.S. emissions.

    However, at best this doesn’t affect the total amount of emissions anyway, just compliance costs. But there are other reasons, I think, to at least question whether there could be an impact on total emissions after all (which would make the technology-forcing issue secondary). First, if allowances are allocated to companies rather than auctioned, the state might be able to keep its firms from reselling their unused allowances assuming the federal program follows the S02 models and gives the allowance away for free. There’s a Second Circuit case involving the SO2 market that preempted a similar effort to block resale by New York, but every statute is different for preemption purposes (and we don’t know whether Congress would chose to allow this.) Second, and probably more importantly, if California or other states can push the technology enough to affect the relationship between costs and benefits in emission reductions, the federal cap is likely to get ratcheted downward one way or another in the future as a political response. Third, the federal cap may not be completely firm in any event– for instance, suppose EPA is given reserve allowances for use if the price spikes. Then California, by freeing up more allowances and lowering the price in the national market, makes it less likely that EPA will ever hit the trigger point and issue the additional allowances.

    Another reason that a state might want to have its own program is to improve on the design features of the federal program — for instance, allocate allowances differently or have difference compliance mechanisms. This could be a demonstration project for improving the federal system. It could also be significant if the state uses auctions and then does something innovative with the money.

    Thus, it seems to me that there are some possible reasons for states to develop their own cap-and-trade systems. But in my view, these advantages are a bit marginal — unless the state can take federal allowances off the market. If allowances are given free to in-state firms, the state might be able to prohibit their trade if it can beat the preemption argument. If there’s a auction, the state could auction its own allowances to firms and use the proceeds to buy up federal allowances.

    So I don’t think your first take on the issue is exactly wrong, but it seems to me that the situation is more complicated and that there might be some advantages to state (and possibly the nation) in having its own program.

  4. This is really helpful. I think the most important suggestion here is that states could force the retirement of federal allowances. If so they can have an effect on the overall federal cap, which to me would be the most likely technology forcing event. Otherwise I’m skeptical about technology forcing. I also like your suggestion about design features and experimentation (offsets come to mind). Thanks Dan!

  5. Following the conversation between Professors Farber and Carlson, I am left with some questions (perhaps reflecting a misunderstanding on my part). Isn’t it critical to the success of any pollution credit program that the environmental value of a given action not be double-counted? If that is true, then if the federal credits have been allocated by firm and not auctioned, how could a given emissions reduction be used both to comply with a state cap and to free up a federal credit for use elsewhere? Another question: If there is no preemption, couldn’t the federal program be designed to apply only in states that do not have more rigorous programs? In that case, couldn’t the emissions in the more rigorous state and any emission-related credits be eliminated from the federal credit system? If this occured, wouldn’t that eliminate the possibility that the more rigorous state would be taking on costs that would have been borne elsewhere?

  6. Professor Farber said:

    “…To use some numbers, say that national allowances would otherwise trade for $50/CO2t, that California pushes the price to $90, and that the result is a breakthrough technology that eliminates carbon at a price of $40/ton. So the national compliance cost gets pushed down to $40…”

    As an Engineer, I am seeing evidence of breakthrough technologies that are reducing the cost of greenhouse gas mitigation. We know there are other greenhouse gases besides carbon dioxide. Some of these other gases (such as methane, water vapor, and some volatile organic compounds) have a higher heat capacity than carbon dioxide and could potentially have a greater impact on atmospheric temperature and climate change.

    It may be possible to control and reduce these other greenhouse gases at a lower cost than carbon dioxide and acheive greater benefits in terms of climate change mitigation.

    One example is the relatively common technologies of vapor condensation and extraction that are employed in cooling towers, refrigeration cycles, air-cooled condensers, scrubbers, and electrostatic preciptators. These are proven technologies which can extract significant amounts of volatile organic compounds, water vapor, and other greenhouse gases from the atmosphere, but are not effective for carbon dioxide.

    The cost of climate change mitigation could be significantly reduced by focusing our efforts on those greenhouse gases that can be controlled with conventional technologies.

    The focus of our environmental laws has always been to control pollution at the source. We could apply this principle to carbon dioxide and control it at its source by capping production of fossil fuels, and then allow fossil fuels to freely trade at market prices.
    This is a much simpler and more effective approach than trying to cap and trade gaseous emissions after the fuel is burned, and it could achieve better results in terms of climate change mitigation.

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Ann Carlson

Ann Carlson is the Shirley Shapiro Professor of Environmental Law and the co-Faculty Director of the Emmett Institute on Climate Change and the Environment at UCLA School…

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