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  An Introduction to Climate Change Legislation

Table of Contents | Foreword | Preface | Executive Summary | Overview | Contributors | Participants and Staff

Scope and Point of Regulation for Pricing Policies to Reduce Fossil Fuel CO2 Emissions

William A. Pizer


This issue brief examines the choice of what emissions to include—and where to regulate them—under a tax or tradable allowance policy to reduce fossil-fuel carbon dioxide (CO2) emissions. A companion brief (Issue Brief # 14) examines options for regulating non-CO2 greenhouse gases (GHGs) and non-fossil CO2 emissions. Several points emerge from this discussion:

A regulatory program that establishes a price on CO2 emissions—either through a tax or tradable permit system—will achieve the most reductions at the least cost when it covers as many emissions as possible under a single program with one price. Broader coverage also mitigates the tendency for emissions to shift to uncovered sources over time, raising the profile of any excluded emissions sources (that is, leakage).

IB 3
Scope and Point of Regulation for Pricing Policies to Reduce Fossil Fuel CO2 Emissions

  • The argument for a broad-based, single-price program is grounded in cost considerations. Other policies, however, are often proposed instead of, or in addition to, a pricing policy. These proposals are often motivated by a desire to pursue more popular technologies, to guarantee certain technology outcomes or emissions-reducing actions within a sector, and to shield some fossil-energy users from higher energy prices.

  • A program to price CO2 emissions that focused on large emission sources (for example, sources that emit over 10,000 metric tons of CO2 annually) could cover just over half of U.S. GHG emissions by regulating roughly 13,000 facilities. A program focused solely on the electricity sector would cover roughly one-third of U.S. emissions and involve 2,000–3,000 facilities.

  • An upstream tax or emissions-trading program could effectively cover almost all fossil-energy CO2 emissions by regulating approximately 3,000 entities, including refineries, natural gas pipelines or processors, coal mines, and importers.

  • While regulatory programs for other forms of pollution have traditionally focused on emitters, the unique nature of CO2 emissions makes it possible to regulate effectively at any point in the fossil-fuel supply chain. The vast majority of CO2 emissions result from the combustion of fossil fuels. Because these emissions do not depend on the combustion technology used or on other operating parameters, and because there is limited opportunity to reduce emissions other than by burning less fuel, downstream emissions can be calculated with relative ease and accuracy based on the quantity of fuel produced or processed and its carbon content. Thus, fuels can be regulated as a proxy for emissions at any point in the chain from production to processing to distribution and final consumption. Important adjustments must be made for imported and exported fossil resources and fuels, sequestered emissions (including carbon capture and storage), or uses of fossil fuels that do not result in emissions.

  • A concern frequently raised about upstream regulation of CO2 emissions is that fossil-fuel users will respond more strongly to direct incentives for reducing emissions than they will to higher fossil-fuel prices. There is a psychological appeal to this logic, but basic economic theory and business pressure to minimize cost argue against it.

  • While existing tradable permit programs have traditionally allocated free permits to regulated sources, there is no reason why CO2 permits cannot be allocated to other actors throughout the fossil-fuel supply chain that are directly or indirectly affected by regulation. Decisions about how to allocate permits or allowances need not be tied to decisions about which entities will be required to submit permits or allowances under a trading program.

  • For a given set of design choices concerning permit allocation and program coverage, the decision about where to regulate does not generally change the economic burden imposed on different actors in the fossil fuel supply chain. Important caveats may apply in situations where products are not competitively priced (as, for example, in regulated utility markets). In addition, point of regulation does affect which entities bear the administrative burden of demonstrating compliance under a tradable permits program (in a well-designed program, however, administrative costs should be relatively small).


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