Capping Carbon Emissions

If ice cream were free, we would eat an infinite amount of the creamy delight. If beer were free, we would buy loads of chips and guacamole and never go to work. And if putting CO2 into the air could be done without restraint, we would spew unlimited amounts out of our smokestacks and tailpipes. Unfortunately it is, and we are.

We'll either limit carbon, or carbon will severely limit our future. Carbon in our air must be limited by the only mechanism that can restore the market for energy: federal policy. Increasingly, not only activists but also major corporations and industrial producers like Duke Energy, BP, DuPont, Pacific Gas and Electric, and GE are calling for the certainty of a federal policy limiting carbon emissions, because the absence of clear policy is creating immense uncertainty for business planning.

Having to pay to dump CO2 into the atmosphere would actually help many American businesses make great progress in unexpected places. In Redmond, Washington, the Microsoft company would not normally be thought of as an energy company that would benefit from a carbon cap. But according to its vice president for special projects, Michael Rawding, a carbon cap would help Microsoft grow an entirely new line of business, one dedicated to saving energy. "Our company has a tremendous potential to integrate our software expertise in the new energy world. We can use our systems to control home or business energy usage. For instance, we are building a product to put whole banks of computers for businesses into sleeper mode when they are not in use. For every ten computers that go into sleeper mode when not in use, we save the equivalent of one car's CO2 a year. Bottom line—it's my personal belief that a carbon cap can help us grow our business. When companies have a cost on carbon, we'll have a better market for our product."37

But what should the restraint be, and upon whom? Two fundamental possibilities are available to us. One is simply to tax carbon. This offers a direct approach that ties emissions to a price, but it does not offer a mechanism to produce reductions in the most economically efficient way possible, and the possibility of passing a tax on carbon in Congress seems remote at best, especially after the failed effort to pass a Btu tax in the early 1990s. A tax also relies on altering prices, not directly capping emissions. A tax that was set too low could have the effect of failing to encourage a rapid shift to low-carbon fuels. Another strategy is to pursue a cap-and-trade system, limiting total emission levels and requiring polluters to bid for permits to release CO2. Each has advantages and disadvantages, and either would have a big impact.

The bottom line is this, however: Of all possible policies, a cap-and-auction system is the most feasible, most powerful, and most important arrow in our clean-energy quiver. It would set the framework within which the regulations, investments, and incentives outlined above would operate.

The cap-and-trade route where carbon permits are auctioned to emitters has two distinct virtues and one difficulty. Its prime virtue is that it sets a hard ceiling on CO2 emissions. We set a cap on total emissions, and we stick to it. It is a known number and is not subject to the winds of uncertainty.

Second, a cap-and-trade approach uses the market to encourage the most cost-effective solutions. There are many things we can do about carbon, but they vary wildly in cost. A cap-and-trade system would drive the economy toward the most cost-effective measures possible and away from the most expensive in quite elegant ways. It does so, for example, when emitters bid for pollution permits if they need them and trade them to other firms if they don't. Put another way, businesses can choose whether to reduce their own carbon emissions or buy the reductions of someone else who can do it at a lower price, which saves money for the economy as a whole or allows deeper reductions for the same cost. Plants that are more costly to retrofit will buy the credits and drive new money to cleaner-energy producers.

Through the auctioning of emission credits, such a system could also generate tens to hundreds of billions of dollars per year in revenue to help industry and workers make the transition to the new energy economy, to defray any regressive impacts from changing energy prices, and to invest in the commercialization of new technology. A safe exti-mate is that such a system could generate $75 billion each year to fund the clean energy transition.

It is critical to remember that even a cap-and-trade or cap-and-auction system, although principally regulatory, is also a program for driving new economic investment. The European emissions trading system, for example, created over $25 million in assets by placing a value on carbon. That leveraged three times that amount of value in equity investments and seven times that value in debt finance. All of this translates to $275 billion in new investment in industrial plants, energy-efficient equipment, and new technology deployment, as well as skilled installation, maintenance, and operations.38

It is in no small part these new capital flows driven by carbon finance that have helped the global market for renewable power generation, biofuels, and low-carbon technology jump from $28 billion in

2004 to $71 billion in 2006.39 Clearly, establishing a price for carbon can be a major source of new investment.

There are, of course, huge issues about the particulars of any such system, which will determine who bears the costs and who shares in the benefits. The first, and biggest, issue is where to set the cap. There is a growing scientific consensus that we need to stabilize our emissions (1990 levels are what's used in the Kyoto Protocol), and then set a trajectory toward steady reductions, resulting in a cut of 60-80 percent by 2050. Science tells us that we need to do at least that much to avoid doubling atmospheric CO2 and stop global warming.

This approach is embodied in the Safe Climate Act of 2007 (HR 1590). This bill would cut emissions by 2 percent a year starting in 2011, to stabilize at 1990 levels in 2020; after that date, it mandates reductions of 5 percent each year, to reach 80 percent below 1990 levels by 2050. This is similar to proposals introduced in the UK by Prime Minister Tony Blair and in California by Governor Schwarzenegger. Less ambitious targets have been introduced in the McCain-Lieberman Climate Stewardship and Innovation Act of2007 (S. 280), which shoots for 2000 levels by 2010, and the Climate and Economy Insurance Act of 2005, sponsored by Senator Jeff Bingaman of New Mexico, which sets a target based on the carbon intensity of the economy, rather than directly capping emissions.

Setting strong but achievable near-term targets for CO2 emissions is critical to building a market for carbon immediately. In addition, a long-term trajectory that continues reductions into the future is essential for stabilizing the buildup of greenhouse gases in the atmosphere over time. California passed landmark climate legislation in 2006 with Assembly Bill no. 32, which called for emissions to be returned to 1990 levels by 2020, with reductions to 80 percent below that level by 2050. In Arizona, Governor Napolitano has chosen a different target, calling for her state to return to 50 percent below 2000 levels by the year 2040. Other regions, from New Mexico to New England, are taking action, too. Whatever the long-term goal, the key is to get started with a meaningful goal for the near term as soon as possible.

Whichever cap we set, it must be firm, a ceiling, a legally enforceable limit. President Bush has offered to attempt to restrain the "carbon intensity" of our economy, so that the amount of CO2 created per dollar of gross domestic product does not rise. This is a course doomed to failure as a solution to limiting carbon. The earth's climatic system does not give a fig about our "energy intensity." It is affected by total emissions reductions, not ratios. In this race, only results count, not effort.

Some have argued for a "cap on the cap," to limit the possible total charges for permits. Such a "circuit breaker" or "safety valve" would provide comfort by limiting the costs to be incurred, but it also could undermine the enterprise by lessening the power of the cap to drive new investment into clean energy, setting a price too low to bring new clean technology into competition. This represents a real danger to creating the new markets and technologies. We already have a safety valve, in that if costs become too high, Congress can always change the cap.

Another critical concern is how credits are to be allocated. If the cost of carbon is high, that could hurt businesses. Such an adverse impact on particular sectors of the economy or regions of the country could be offset by grandfathering credits—allocating free credits to those who currently emit carbon. This would help cushion the blow, but if the allocation is too large, it could amount to a windfall for polluters. It is estimated that allocating only 10 percent of permits should be ample to make sure that businesses are not economically harmed.

If energy prices rise and nothing is done to offset the impact, a cap-and-trade system could also be regressive, hurting poor ratepayers disproportionately. However, if carbon credits were sold at auction to emitters, they would create an enormous revenue stream, ranging from tens to hundreds of billions of dollars a year, which could be used to create a pool of funds to support transition in impacted industries, assist workers, and restructure the tax code to expand existing income tax brackets, reducing the impact on low-income workers.

In a cap-and-trade system in which credits are auctioned and revenues are recycled into a more progressive tax code and support for clean-energy transition, the economic impact would be positive for all but the highest-income quintiles of the economy. Such an approach would not only clean up the atmosphere, but would also remove distortions in the economy and make the tax code more equitable. That "revenue recycling" back into the economy is critical for ensuring that a cap-and-trade system creates jobs and growth. While some studies of carbon caps in isolation show declining jobs and GDP, when the revenue is circulated back into the economy through investments in innovation, jobs and GDP rise. A UC Berkeley study of the impacts of California's Assembly Bill no. 32, for example, which reinvests revenue, shows the creation of 89,000 jobs and $74 billion, or 3.1 percent growth, in gross state product above the 2020 baseline.40 While a Tellus Institute analysis of the Climate Stewardship Act shows that with the right policies to recycle revenues and invest in new technology, it would save consumers $30 billion annually in 2020 and create 800,000 jobs and a $45 billion GDP gain by 2025.41

A final concern about a cap-and-trade system is that through trading, it could allow hot spots of emissions that could provide for increased local air pollution in parallel with carbon emissions. This raises environmental justice concerns for low-income and minority communities; the distributional impacts of a cap-and-trade system need to be closely monitored. However, this only serves to underscore that a cap-and-trade system cannot exist apart from an integrated strategy that includes appropriate regulations, including not only enforcement of local air quality laws, but also standards on oil savings, portfolio standards for renewables and efficiency, and carbon-based performance standards for advanced coal and biofuels. We need a mix of market-based tools, regulations, direct investment, and incentives. In short, we need to pull out all the stops to ensure that our economy, our communities, and our environment navigate this transition and build both a cleaner and a more prosperous future.

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