As I mentioned last week, my colleague Art Fraas and I have a new paper in which we compare EPA regulation of greenhouse gases under the Clean Air Act to most (though not all) economists' preferred alternative - a carbon price (either cap and trade or a carbon tax). When we wrote the paper, no concrete regulatory or carbon price options were on the table to compare with each other, so we instead offered pointers on what to look for in such proposals when they did emerge, grouped into 10 issues. Since we now do have a proposal from EPA, it's worth a quick look at those issues. What did EPA do, and how might it compare to an (admittedly hypothetical) carbon price?
1) General Cost-Effectiveness
EPA appears to have set its targets in an effort to level the burden across states, rather than setting targets that reflect a cost-effective level of control in each state. However, the proposal also allows the states to enter into multi-state agreements that could include emissions trading approaches that could yield more cost-effective outcomes. The general cost-effectiveness under the EPA proposal will ultimately rest with decisions in the individual states. Even if states implement wise policies and elect to cooperate, overall cost-effectiveness would still almost certainly be less than under an ideal economy-wide carbon price. But any carbon price legislation that could emerge from Congress is unlikely to be ideal - there will be many compromises and handouts.
2) Scope
The proposal is limited to electric generating units. EPA will likely proceed to regulate other sectors in the future, likely starting with oil and gas extraction. As we have stated before, regulation of carbon through this industry-by-industry rulemaking process will be a long and cumbersome process. An economy-wide carbon price would be simpler and would equalize costs across different sectors. But, of course, no such proposal appears politically viable today.
3) Stringency
The proposal appears to be directed to achieve a moderate level of stringency--a level consistent with President Obama's commitment that the US would achieve a 17% reduction in emissions from a 2005 baseline by 2020. It's unclear whether any carbon price would be more or less stringent.
4) Revenue
EPA almost certainly cannot directly impose a tax to raise revenue for the Federal government through its CAA authority. EPA recognizes in its preamble that some States already raise revenue through allowance auctions under their GHG mass-based emission budget programs. States could also generate revenue through a carbon tax, whether or not carbon is regulated by the CAA. However, EPA’s proposal is silent on the issue of whether it would consider a state carbon tax as part of a program designed to meet its guidelines. A federally legislated carbon tax (or auctioned allowances in a cap-and-trade system) would generate revenue. Few agree on what should be done with it, however.
5) Administrative Simplicity
As we explain in the paper, CAA regulation will likely be quite complex. The Act requires multiple rulemakings for different sectors and even industry-by-industry. EPA's proposal alone is very lengthy, and it is only guidelines for state plans, each of which will be very complex in its own right. Carrying out rulemaking for a single industry under Section 111(d) can take several years—longer if delayed by litigation. With limited resources, EPA must proceed sequentially, sector-by-sector. Congress in principle could move much faster - but of course it isn't right now. And cap-and-trade programs can be quite complex, though a carbon tax could in principle be quite simple, and fall on a relatively small number of entities.
6) Litigation and Legal Risk
EPA's proposal will be litigated once it's finalized next year, and faces real legal risks. A federally legislated carbon price probably would not (there are no obvious constitutional challenges).
7) Updating Environmental goals Over Time
Ideally, a climate policy can change over time in reaction to new information - whether about environmental risks or the actions of other countries. The proposal provides emissions targets that must be met by 2030. In the future, EPA could issue post-2030 targets, or even revise the proposed targets in response to new information (the policy could also be changed for political reasons, though that's true even with new legislation). In principle, a carbon price could be similarly flexible, perhaps by setting triggers in the legislation (carbon tax starts low, but goes up if China plays ball) or even by delegating stringency decisions to an agency or commission.
8) Capture and Political Compromise
The proposal represents a first step in what will be an extended process in reaching a final rule that survives legal challenge. Suffice it to say at this juncture that supporters of renewable energy (wind and solar) and utilities with heavy investment in natural gas and nuclear facilities have expressed strong support for the proposal, while the coal industry just as strongly opposes it. A well-designed carbon price might reduce political discord and opportunities for gaming the system by equalizing marginal costs across sectors. The political fortunes of cap-and-trade make that seem unlikely, however.
9) International Competitiveness
The electric power sector does not face any significant international competition. EPA projects only a small increase in electricity rates, so arguably the effects of an increase in electricity prices associated with the proposed rule will be small and unlikely to affect the competitive position of the industrial users of electricity.
10) International Signals
The proposal represents an initial step in limiting the GHG emissions from the electric utility sector. At this early juncture in the process, it is difficult to tell whether this proposed program will have any influence on international negotiations to limit GHGs. Several countries, including China, have welcomed the announced proposal. Predictably, greens have claimed that it will break the logjam that has faced international negotiations over recent years while some industry representatives remain sceptical that this unilateral action by the US will have any effect on future negotiations. Progress between now and the 2015 climate talks in Paris will likely show who is correct.
