Smoke stacks and power lines at a generating plant outside Denver, Colorado

"A Sensible and Practical Way to Cut U.S. CO2 Emissions"

Election 2008 Commentary

Op-Ed, Harvard Kennedy School website

January 24, 2008

Author: Robert N. Stavins, Albert Pratt Professor of Business and Government; Member of the Board; Director, Harvard Project on International Climate Agreements

Belfer Center Programs or Projects: Environment and Natural Resources; Harvard Project on International Climate Agreements

There is growing impetus for a domestic U.S. climate policy that can provide meaningful reductions in emissions of CO2 and other greenhouse gases. It is important to identify the best policy instruments at the outset, because once a policy architecture is put in place, it can be very difficult to make a change. A poorly designed policy could impose unnecessarily high costs while providing little public benefit, and could detract from the development of a more effective, long-run policy.

A scientifically sound, economically rational, and politically feasible approach for the United States to reduce its contributions to the increase in atmospheric concentrations of greenhouse gases would be an up-stream, economy-wide CO2 cap-and-trade system. The system would implement a gradual trajectory of emissions reductions over time (with selective inclusion of non-CO2 greenhouse gases), and include mechanisms to reduce cost uncertainty, including provisions for banking and borrowing.

CO2 emissions would be cut from their 2008 level to 50 percent below their 1990 level by 2050, consistent with recommendations from the U.S. Climate Action Partnership, a broad-based coalition of private industry and environmental organizations. Costs would be significant but affordable, with impacts on GDP of less than one percent per year.

Initially, half the allowances should be allocated through auction and half through free distribution, with the share being auctioned gradually increasing to 100 percent after 25 years. This pattern is consistent with analysis of the share of allowances that would need to be distributed freely to compensate firms for equity losses.

In the short term, free allowance distribution should be targeted to entities that are burdened by the policy, including suppliers of primary fuels, electric power producers, and energy-intensive manufacturers. This may help establish consensus on a climate policy that achieves meaningful emission reductions. The auctioned allowances will generate revenue that can be used for public purposes, including compensation for program impacts on low-income consumers, public spending for related research and development, reduction of the Federal deficit, and reduction of distortionary taxes.

Offsets should be made available both for underground and biological carbon sequestration, to provide for both short-term cost-effectiveness and long-term incentives for technological change. The Federal cap-and-trade system should provide for linkage with emission reduction credit projects in other countries, harmonization over time with effective cap-and-trade systems in other nations, and appropriate linkage with other countries’ actions, in order to establish a level playing field among domestically produced and imported products.

While political leaders in the European Union, Canada, Australia, Japan, and the United States (Congress) move toward cap-and-trade systems as their preferred approach for achieving meaningful reductions in emissions of CO2 and other greenhouse gases, there is a lively debate among economists, many of whom have been critical of the cap-and-trade approach in the climate context and have endorsed the use of carbon taxes.

I am not opposed the notion of a carbon tax, having written about such approaches for more than twenty years. Indeed, both cap-and-trade and carbon taxes are good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences. I am opposed, however, to the confused and misleading straw-man arguments that have sometimes been used against cap-and-trade by carbon-tax proponents.

While there are tradeoffs between these two principal market-based instruments targeting CO2 emissions — a cap-and-trade system and a carbon tax — the best approach for the short to medium term in the United States is a cap-and-trade system.

The key merits of the cap-and-trade approach I have proposed are, first, the program can provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels. Second, it offers an easy means of compensating for the inevitably unequal burdens imposed by a climate policy. Third, it provides a straightforward means to harmonize with other countries’ climate policies. Fourth, it avoids the current political aversion in the United States to taxes. Fifth, it is unlikely to be degraded — in terms of its environmental performance and cost effectiveness — by political forces. And sixth, this approach has a history of successful adoption and implementation in this country over the past two decades.

There are some real differences between taxes and cap-and-trade that need to be recognized. First, environmental effectiveness: a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs. This is a fundamental tradeoff. Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism. On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade — this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and — depending upon design — the distributional consequences of the two approaches can be the same. But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table. But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful: reducing environmental achievement and driving up costs.

Getting serious about greenhouse gas emissions will not be cheap and it will not be easy. But if the current state-of-the-science predictions about the consequences of another few decades of inaction are correct, the time has arrived for a serious and sensible approach.

For more information about this publication please contact the Harvard Project on International Climate Agreements Coordinator at 617-496-8054.

Full text of this publication is available at:
http://www.ksg.harvard.edu/ksgnews/Features/opeds/012408_stavins.htm

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