Would Californians be Better Off with a Fuel Tax instead of Cap-and-Trade?

Steinberg’s surprising proposal for California climate regulation

Climate regulation drama!  Sen. Darrell Steinberg is floating a proposal that would change California law to take transportation fuels out of the cap-and-trade program, and to enact a new fuels tax instead.  As background, distributors of those fuels are slated to join the cap-and-trade program in 2015, meaning they would need allowances to cover their greenhouse gas emissions starting in January of that year, through 2020.

I have no idea what the politics of the proposal are.  It seems to be stumbling out of the gate a bit, with some business groups and environmentalists opposed.  (See an early LA Times story with those reactions here.)  Steinberg’s party is at best divided, with Sen. Pavley, who authored AB 32, publicly opposing the move.  As a tax, the legislation would need a 2/3 majority of the Legislature — a hurdle AB 32 itself didn’t pass.

But on the substance, would Californians be better off with a fuel tax instead of cap-and-trade?  My first blush answer is No, and certainly not at this stage.  Here’s why.

Generally speaking, a tax provides more cost certainty to emitters and (sometimes) fewer administrative implementation burdens than a cap-and-trade system.  Cap and trade, by contrast, provides more certainty about the emissions reductions it would achieve (via a cap), but less certainty about cost.  Given AB 32’s mandate that California return to a known level of emissions by 2020, a hard cap is attractive from a regulatory perspective, despite its challenges.  It also provides more flexibility to regulated entities than would more presciptive, traditional environmental regulations requiring reductions.  A cap-and-trade program seems like a reasonable fit for reaching AB 32’s mandates and achieving GHG reductions.

But even if you believe that a fuels tax would have been better from the get-go for California, there’s a path-dependency to these questions.  We are now years into development and deployment of a cap-and-trade program that is working as designed, and well.  The administrative burdens of its development are largely sunk costs.  We have linked with another jurisdiction, Quebec, to join markets.  Allowance prices are stable, not far above the floor but also not so low as to suggest that companies aren’t buying them or taking the program seriously.  Companies know the program and know what to expect.  And, importantly, the market was designed with an expectation about how many entities would participate, and how many allowances they would demand.  Fuel distributors will be a large segment of the market starting in 2015. Taking fuels out of the cap now would inject considerable uncertainty into the market.  It would also affect its liquidity by reducing the demand, which economists say makes prices more manipulable and less predictable. At this point, I don’t see much gain from disrupting what’s working well or dividing up large emitters into those who pay taxes, versus those under the cap.

It appears that one of the primary motivations for the proposal is to allow the state to return tax dollars to some of those who would be hit hardest by any rise in fuel prices that may result from a tax or from cap and trade.  The LA Times writes:

About half the money would be put back into the pockets of low- and  moderate-income people in the form of a tax credit, similar to the earned income  tax credit for the federal income tax. The rest would fund transit projects to give commuters an incentive not to  drive their cars, as well as some environmental projects.

Even here, however, the fuels tax doesn’t seem to me to hold much of an advantage.  As I testified to the Senate Budget Committee last week, the State has a fair amount of flexibility about how to spend its auction revenue.  It likely couldn’t create a tax credit, or at least not without altering existing statutory law, but it can certainly use the revenue to benefit low- and moderate-income people, and to fund transit projects.  In fact, California has already committed to using at least 25% of auction revenue in ways that benefit disadvantaged communities (a floor, not a ceiling), and Governor Brown’s budget proposal invests heavily in transit with these monies.  So, again, I don’t see much gain here.

I’ll write more about spending auction revenue in a bit, drawing from my testimony at last week’s hearing.

, , , , , ,

Reader Comments

4 Replies to “Would Californians be Better Off with a Fuel Tax instead of Cap-and-Trade?”

  1. Hi Cara,

    I agree that there are significant and important institutional commitments to the cap-and-trade market. That definitely counsels caution when thinking about any structural changes, just as you suggest.

    On the other hand, I don’t think it’s fair to say the carbon market is working as designed. For example, the state legislature explicitly required ARB to minimize leakage and produce real emissions reductions; yet ARB has decided to permit significant resource shuffling, which produces leakage, i.e., the false appearance of emissions reductions. Market traders tell me that the expectation of resource shuffling is already baked into the low market price.

    This matters because (1) it’s not clear the market is working as designed, and (2) with leakage expectations dampening prices, the market functions a lot like a tax at the price floor — just without the transparency of a tax system.

    Neither a market with a weak resource shuffling rule nor a simple tax prevents leakage, so the environmental outcomes are comparable. In addition, pulling transportation fuels out of the market should act to depress prices, since the transportation sector would be a net buyer of carbon credits. So the market price impacts should be minimal, too — at least in the short term.

    Again, it’s incredibly important to value the effort that has gone into the system that’s in place, both in terms of the government resources and private stakeholders’ expectations. Personally, I wish that more effort went into designing strong market rules. But whatever one’s views on the merits of taxes vs. carbon markets, it’s high time to start talking about the role of transparency and predictability in climate policy design.


    Danny Cullenward

  2. Hi Cara,

    As part of CCL (Citizens Climate Lobby), I contacted Steinberg’s office and discussed the carbon tax with him. CCL is going to partner with Steinberg in making it a truly effective price on carbon, a model for US, and even international “environmental tax reform” policies. CCL commissioned an economic, demographic and pollution study of a California carbon tax, which results came out on Friday, posted here:


    I understand that the cap and trade is functioning. But it’s not enough for my kids or Steinberg’s kids, or for what we want for your kids. And this is why Steinberg is doing the carbon tax.
    His aide explained their reasoning, and I was thrilled to hear him say it without him knowing anything about me.

    1. Reaching 1990 levels by 2020 is simply insufficient to save the climate. Period.
    a. See the emissions graph on p2 of our CA carbon tax study. We will get to 1990 levels in 2020 with no tax, but after that emissions will increase again with our population increases.
    2. The way to achieve 25%, 50%, etc. reductions is by long term investing in renewables capacity. As Robert Rubin said at the CERES meeting at the UN: Investors aren’t rational, they use gut feeling, intuition. And intuition is based on extrapolating the present into the future. Cap and trade gives unpredictable prices—and thus an unpredictable future in our intuition. A gradually increasing carbon tax gives a very certain future: fossil fuels will stop being competitive in a decade or two. Period.

    How much global investment is needed to build the renewables to get down to 50% of 1990 emissions? It’s about $20 trillion. That’s 20 years’ worth of our current annual investment in oil exploration. When we send a subtle message (i.e. a gradually increasing carbon tax), that trillion dollars a year will quickly shift to renewables where they’re assured of an 8% or more return for 20-30 years. Investors won’t shift investments now because the future is too frighteningly uncertain, and the intuitive brain, which runs investors, says “Stay the course” when the future is foggy and uncertain.

    In conclusion, a gradually increasing carbon tax works in a world run by human brains. Cap & trade would work in a world run by naive robots with economics degrees. Reducing sulfur emissions with cap and trade worked because it required short term investments, which are rational, compared to long-term, which are intuitive.

    I apologize if I sound arrogant and over-certain. You can check out the numbers though–CERES has most of them.

    Best regards,

    Peter Fiekowsky
    Citizens Climate Lobby Team Oil and 100-year plan leader.
    2014: The Year of Climate Action
    +1-650-941-6871 (o) 650-776-6871 (m)
    952 S. Springer Rd. Los Altos CA USA 94024

  3. I agree with Danny Cullenward, but would go even farther. On what basis is the California cap and trade regulation being deemed a success? Resource shuffling is already apparent. Most experts (including me) are forecasting a significant CO2 allowance supply surplus. This means that CO2 allowance prices well remain well below the marginal cost of achieving real reductions for the foreseeable future. In turn, this also means that it is near inevitable that within 36 to 48 months the CA carbon market regulators will have to come up with a plan to “restructure” the CA cap & trade market. Any CA regulated source owner who has done the basic arithmetic is certain of only one thing–the CA cap & trade market will have to be restructured. That means the future market value for banked vintage 2011-2015 allowances will crash, or be artificially inflated–no in-between–depending on how the regulators go about restructuring. In other words: massive investor uncertainty–today, not in some future, for the investors who have done the arithmetic. Entities that over-comply with short-term CO2 limits in the hope that their banked allowances will be worth more in the future are taking very large risks, given the inevitability of the already predictable required restructuring. The CA carbon market regulators can mitigate this risk, today, one of two ways: (1) abandon cap and trade and replace it with a more disciplined alternative (where options worth considering may include but should not be restricted to the proposed carbon tax), or (2) amend the existing cap and trade regulation to define, with certainty, exactly what measurs the regulator will employ to address a significant banked allowance surplus in the (highly likely) event a surplus becomes systemic and obvious.

  4. Another attempt to tax human beings for the weather. Stupid people who must think that WE are stupid. Well, Steinberg, we are NOT. Just say NO to this idiocy.

    As for Horowitz, spewing this crap all over California and elsewhere, go to China and give taxing the weather a shot there. Americans are tapped out.

    This liberal Progressive nonsense must be brought to an end. The arrogance and hubris of these people is truly abhorrent.


Comments are closed.

About Cara

Cara Horowitz is the co-executive director of the Emmett Institute on Climate Change and the Environment at UCLA School of Law. The Emmett Institute was founded as the f…

READ more

About Cara

Cara Horowitz is the co-executive director of the Emmett Institute on Climate Change and the Environment at UCLA School of Law. The Emmett Institute was founded as the f…

READ more