The Failure of Cap and Trade in GHG Emissions Controls Gary D. Libecap UCSB, NBER, and Hoover Institution Environmentalism September 22-23, 2017 The College of Charleston

The Theory Ronald Coase, Nobel Prize 1991, and his famous paper, “The Problem of Social Cost,” 1960. Cap emissions in an area and assign tradable shares: Cap & Trade. Alternative to command and control regulation.

Theory Regulated firms relinquish emissions permits = to pollution. If more permits than needed, sell; if need more permits, buy. Compliance cost minimizing firms reduce emissions “in house” until their marginal abatement costs equal the prevailing permit price. Generates incentives for firms to reduce emissions in the most efficient manner.

Theory All firms arbitrage their abatement decisions against the costs of emissions credits. Low cost firms do relatively more abatement, high-cost firms buy permits. In equilibrium the emissions credit price becomes the marginal cost of abatement which is equilibrated across all regulated industries. Equate with marginal benefit of abatement. Efficient, welfare-enhancing outcome.

The Optimal Level of Abatement Dollars per unit of abatement Marginal damage curve Marginal Cost of Abatement Curve A* Abatement (tons)

Practice: SO2 Control Program Created under Title IV of CAAA 1990. Capped emissions . Phase I : 1995-1999: 263 plants affected east of Mississippi. Phase II : 2000-2010: all fossil plants>25 MW, 3,200. Most emissions from coal-fired electricity generation. Utilities to surrender 1 allowance for 1 ton of SO2 emitted

Practice: Acid Rain Control The SO2 and NOx interstate trading market Moved to equalize abatement costs. Low-cost abatement cost plants sold permits to high-cost. Emissions caps-- total emissions 1st year 25 % below 1980 levels; by 2000 40 % below. Goal to reduce nationwide utility emissions to 8.95 million tons annually achieved by 2007 Abatement costs may have been 3 X greater with regulation, $2.6 billion annually as compared to the actual program cost of $747 million. Achieved goal early.

SO2 Emissions Trends

SO2 Program Became basis for cap & trade GHG emissions controls. None have been as successful. By many measures, failures. Focus on equating marginal abatement costs of permit prices with marginal benefits, social cost of carbon.

European Union Emissions Trading Scheme (EU ETS)

Regional Greenhouse Gas Initiative 9 New England and MidAtlantic States

California’s AB-32 GHG Control

Other Cap & Trade Programs Nascent program in Quebec. Experimental ones in China.

Failure? In terms of equating marginal abatement costs/permit prices with marginal abatement benefits (social cost of carbon), no program has permit prices close or trending to SCC. What is lost? Reliance on market driven prices to find most efficient abatement mechanisms is absent. Most GHG abatement via command and control regulation. 20% of California’s GHG reduction from AB-32. 80% from regulation and related subsidies.

Failure of Cap & Trade Had the theory been followed, the permit markets would have driven pollution abatement. Little role for politicians and regulators, other than setting the cap. What has happened?

California’s AB 32 Politicians/advocates focus on revenues via auctioning permits. Permit permits are a tax that transfers wealth from consumers/shareholders to the government. The larger problem is that politicians use the money to subsidize competitors for the permits—renewable energy (wind, solar), electric vehicles, high-speed rail. Firms also can purchase “offsets” rather than buying permits. Regulators determine what projects qualify for selling offsets.

AB 32 Accordingly, command and control regulation plays a far greater role in air pollution control. Renewable energy portfolio standards. Low carbon fuel standards. Fuel economy standards. New energy efficiency standards. Offsets. “Standards” are regulations, mandated aside from Cap and Trade. To meet fuel efficiency standards, auto companies buy offsets from Tesla. These are mandated actions to reduce GHG emissions. Compete with permits and lowers permit prices because less demand. Higher permit prices would lead to market-driven abatement. Different from political/bureaucratic/interest group demands.

EU ETS As California, EU has aggressively subsidized green-energy alternatives from permit auction revenues. No reliance on firm choices based on market-based permit prices. Expansive offset use in China, India, Russia and the Ukraine. Offsets purchased from organizations there to cover GHG in the EU, rather than through the purchase of allowance permits. European Investment Bank offset purchases in developing countries. Additional abatement or what would have happened anyway? Corruption. Enforcement.

Cap and Trade in GHG Emission Controls 1960 Ronald Coase outlined less-costly, more efficient alternative to regulation via market exchange. Cap & Trade has potential for efficient emissions abatement. But plays a minimal role. Funding source. GHG abatement remains primarily command and control dominated by interest group politics for programs and subsidies. Funded in part by consumers and shareholders. Implemented programs—subsidies, standards-regulations, are likely to be far less effective than a market approach.