With a new climate bill expected to be released any day now, there is likely to be a renewed interest in U.S. climate policy. While federal action on climate change has been in limbo, movement in California is still discernable (at least for the moment) as officials continue their consideration of the economic impacts of a cap on carbon today. A recent report from California’s Air and Resources Board (ARB) examined the impacts of California’s proposed cap-and-trade program created by Assembly Bill 32 (AB 32). While the general results of the study have been highlighted elsewhere (and a detailed breakdown of the underlying study and it’s comparability to earlier models of Waxman-Markey is the subject of a future post) an interesting issue has gone largely unnoticed.

Establishing a cap-and-trade program at the national level requires the examination of an important and varied set of issues. Two prominent examples concern U.S. competiveness impacts and the related issue of emissions leakage that might result under a given policy regime. Emissions leakage refers to the policy-induced emissions reductions in a country enacting a unilateral or near unilateral carbon pricing policy that are offset by an increase in emissions abroad. This increase in emissions is, in part, the result of firms shifting production to countries that have less stringent or non-existent environmental regulations, in particular carbon pricing policies. An earlier post highlighted some of the work being done by researchers at RFF and other organizations to consider the effectiveness of policies designed mitigate adverse leakage and competition impacts of a carbon pricing policy.

In considering unilateral policies, broadly speaking, one should be able conceive of California enacting a climate policy a lot like a single country (albeit smaller depending on your country of comparison) enacting a carbon pricing policy when other countries do not act. While for the most part this is the case, there is one distinct difference that was highlighted in a short report released by the Economic and Allocation Advisory Committee when examining an earlier draft of the ARB’s assessment of the impacts of AB 32 (see full document here).

When a country enacts a unilateral policy, there is the potential—and to some extent inevitable outcome—that a certain amount of emissions reductions will be offset by increases abroad. When a country enacts a unilateral policy there is no other legal jurisdiction with which the policy must interact. This, of course, ignores international law, which is fine because international law doesn’t, for example, govern fuel economy standards in the U.S. or other similar policies. However, when a state unilaterally enacts a carbon pricing policy, the requirements it sets for firms and households within the state must also interact with laws decided at the federal level. In the context of an emissions cap, this gives rise to what the authors refer to as reshuffling.

At its most basic level, reshuffling is a form of leakage. More specifically, reshuffling refers to policy-induced increases in emissions elsewhere in the U.S. arising from the interaction of two different but related regulatory requirements. One regulatory requirement that arises at the state-level and another that would arise at the federal level. In the case of California, the Low Carbon Fuel Standard (LCFS) is one component on the climate policy table that would be used to meet the state’s emission reduction targets established under AB 32. The potential for reshuffling would arise due to interaction of the LCFS and the EPA’s Renewable Fuel Standard. As the report by the EAAC highlights:

“…the Low Carbon Fuel Standard in California would require the consumption, in California, of fuels that the national Renewable Fuels Standard will itself require be consumed somewhere in the U.S. If both regulations remain in place, it is very plausible that the effect of the California regulation will be to divert some low-carbon fuel to California that otherwise would be consumed in other parts of the U.S. The implication of this diversionary effect (often referred to as reshuffling) is that a regulation that reduces local emissions achieves much smaller reductions at a broader level.”

Essentially there is the possibility that state-level requirements diminish the stringency of complying with another environmental regulation at the national level. It should be noted here that the issue of reshuffling in this context would not result in a net increase in emissions at the U.S. level; it would, however, result in part of the emission reductions undertaken in California to be offset by increases in emissions from other states.

It’s an interesting case in which the actions taken to internalize the costs of a negative externality, namely the emissions of CO₂ in California, generate a new externality in compliance. Since reducing emissions is costly and the effects of CO₂ are global in nature, costs imposed in meeting part of the emissions reductions under AB 32 would have the effect of lowering compliance costs for the Renewable Fuel Standard in the U.S. at large (not including CA). The size of emissions we are talking about here is not exactly clear, primarily since both standards have yet to come into full force. California has a reputation for more stringent environmental regulations than the U.S. at large (as AB 32 attests to), which would make it interesting to examine the prevalence of this sort of issue (e.g. reshuffling) that arises with differing levels of stringency and overlapping regulatory requirements.

Eric M. Moore is a research assistant with Resources for the Future.