US climate policy is unfolding under the Clean Air Act. Mobile source and construction permitting regulations are in place. The US Environmental Protection Agency (EPA) has developed draft final rules for the performance of new power plants. Most important, EPA and the states will soon determine the form and stringency of the regulations for existing power plants responsible for roughly 40 percent of the nation’s carbon dioxide emissions.
Achieving President Obama’s 2020 emissions goals will depend largely on how regulations for existing power plants are designed and implemented under the Clean Air Act. Recently, the president asked EPA to seek out a regulatory system that, “to the greatest extent possible,” incorporates market-based instruments, performance standards, and regulatory flexibility. This flexibility could be accomplished in a number of ways.
In a recent RFF discussion paper, we examine a group of flexible policies that could be available for achieving cost-effective emissions reductions through the electricity sector. We compare a tradable emissions rate performance standard with three variations on cap-and-trade policies. These various approaches would create an implicit price on emitting greenhouse gases and thereby create valuable assets. These approaches would distribute that asset value differently among electricity producers, consumers, and the government.
A tradable performance standard would distribute the asset value to fossil fuel generators. Alternatively, a cap-and-trade program might raise revenue through an auction and direct the value to the government. Although the federal government could not auction allowances under the Clean Air Act, states might do so. We also examine an auction where the revenue is directed to regulated local electric companies, which would channel the value to consumers. This approach is evident in California’s existing cap-and-trade program and existed in the Waxman-Markey proposal. We also consider a fourth approach that delivers only half the value to consumers through local distribution companies, and spends the other half on investments in energy efficiency. This approach is employed in the Regional Greenhouse Gas Initiative trading program.
Our research found that producers and consumers benefit most when the value is kept within the electricity sector. Distributing the value to fossil-fueled electricity producers or consumers or spending on energy efficiency has much smaller effects on average electricity prices than would a revenue-raising policy. At first glance, smaller price increases also seem beneficial as they offer political advantages, but higher prices actually create more incentive for consumers to lower their electricity use. Absent this incentive for energy efficiency, to realize further improvements in efficiency would require further policies such as the investment of allowance value in efficiency technology, or supplementary standards and regulations.
We also calculate the benefits of the policies—taking into account the value of reductions in carbon dioxide and sulfur dioxide—which stem in roughly equal proportion from these pollutants. The policies varied somewhat when comparing benefits and costs, but looking across policies, only one emerged as far worse than all the rest—that is, no policy. All the scenarios that regulate carbon dioxide emissions using flexible approaches appear dramatically more efficient than doing nothing. Overall, the net benefits of regulation are positive and large compared to our calculated no-policy baseline.
All four flexible policy approaches have their advantages, but various inconsistencies could still threaten their cost-effectiveness. It will be challenging to align the marginal abatement costs of these policies with regulatory measures that might be taken in other sectors, though pinning them to a common metric like the social cost of carbon could help align them. Our study also assumed that all states would choose to implement the same policy, even though real-world coordination between states on which policies to adapt may not be so uniform. Interactions between differing state markets could become problematic, and EPA may have to coordinate some policies to prevent this. However, states who commit to strategies that help them plan around these problems would be able to enjoy a larger share of the benefits from a market-based emissions plan.