Saturday, January 17, 2015 2:03:31 AM
The Political History of Cap and Trade
.. good .. hope you find these interesting ..
How an unlikely mix of environmentalists and free-market conservatives hammered out the strategy known as cap-and-trade
By Richard Conniff
Smithsonian Magazine | Subscribe
August 2009
John B. Henry was hiking in Maine's Acadia National Park one August in the 1980s when he first heard his friend C. Boyden Gray talk about cleaning up the environment by letting people buy and sell the right to pollute. Gray, a tall, lanky heir to a tobacco fortune, was then working as a lawyer in the Reagan White House, where environmental ideas were only slightly more popular than godless Communism. "I thought he was smoking dope," recalls Henry, a Washington, D.C. entrepreneur. But if the system Gray had in mind now looks like a politically acceptable way to slow climate change—an approach being hotly debated in Congress—you could say that it got its start on the global stage on that hike up Acadia's Cadillac Mountain.
From This Story
Photo Gallery .. http://www.smithsonianmag.com/air/the-political-history-of-cap-and-trade-34711212/?all
People now call that system "cap-and-trade." But back then the term of art was "emissions trading," though some people called it "morally bankrupt" or even "a license to kill." For a strange alliance of free-market Republicans and renegade environmentalists, it represented a novel approach to cleaning up the world—by working with human nature instead of against it.
Despite powerful resistance, these allies got the system adopted as national law in 1990, to control the power-plant pollutants that cause acid rain. With the help of federal bureaucrats willing to violate the cardinal rule of bureaucracy—by surrendering regulatory power to the marketplace—emissions trading would become one of the most spectacular success stories in the history of the green movement. Congress is now considering whether to expand the system to cover the carbon dioxide emissions implicated in climate change—a move that would touch the lives of almost every American. So it's worth looking back at how such a radical idea first got translated into action, and what made it work.
The problem in the 1980s was that American power plants were sending up vast clouds of sulfur dioxide, which was falling back to earth in the form of acid rain, damaging lakes, forests and buildings across eastern Canada and the United States. The squabble about how to fix this problem had dragged on for years. Most environmentalists were pushing a "command-and-control" approach, with federal officials requiring utilities to install scrubbers capable of removing the sulfur dioxide from power-plant exhausts. The utility companies countered that the cost of such an approach would send them back to the Dark Ages. By the end of the Reagan administration, Congress had put forward and slapped down 70 different acid rain bills, and frustration ran so deep that Canada's prime minister bleakly joked about declaring war on the United States.
At about the same time, the Environmental Defense Fund (EDF) had begun to question its own approach to cleaning up pollution, summed up in its unofficial motto: "Sue the bastards." During the early years of command-and-control environmental regulation, EDF had also noticed something fundamental about human nature, which is that people hate being told what to do. So a few iconoclasts in the group had started to flirt with marketplace solutions: give people a chance to turn a profit by being smarter than the next person, they reasoned, and they would achieve things that no command-and-control bureaucrat would ever suggest.
The theory had been brewing for decades, beginning with early 20th-century British economist Arthur Cecil Pigou. He argued that transactions can have effects that don't show up in the price of a product. A careless manufacturer spewing noxious chemicals into the air, for instance, did not have to pay when the paint peeled off houses downwind—and neither did the consumer of the resulting product. Pigou proposed making the manufacturer and customer foot the bill for these unacknowledged costs—"internalizing the externalities," in the cryptic language of the dismal science. But nobody much liked Pigou's means of doing it, by having regulators impose taxes and fees. In 1968, while studying pollution control in the Great Lakes, University of Toronto economist John Dales hit on a way for the costs to be paid with minimal government intervention, by using tradable permits or allowances.
The basic premise of cap-and-trade is that government doesn't tell polluters how to clean up their act. Instead, it simply imposes a cap on emissions. Each company starts the year with a certain number of tons allowed—a so-called right to pollute. The company decides how to use its allowance; it might restrict output, or switch to a cleaner fuel, or buy a scrubber to cut emissions. If it doesn't use up its allowance, it might then sell what it no longer needs. Then again, it might have to buy extra allowances on the open market. Each year, the cap ratchets down, and the shrinking pool of allowances gets costlier. As in a game of musical chairs, polluters must scramble to match allowances to emissions.
Getting all this to work in the real world required a leap of faith. The opportunity came with the 1988 election of George H.W. Bush. EDF president Fred Krupp phoned Bush's new White House counsel—Boyden Gray—and suggested that the best way for Bush to make good on his pledge to become the "environmental president" was to fix the acid rain problem, and the best way to do that was by using the new tool of emissions trading. Gray liked the marketplace approach, and even before the Reagan administration expired, he put EDF staffers to work drafting legislation to make it happen. The immediate aim was to break the impasse over acid rain. But global warming had also registered as front-page news for the first time that sweltering summer of 1988; according to Krupp, EDF and the Bush White House both felt from the start that emissions trading would ultimately be the best way to address this much larger challenge.
It would be an odd alliance. Gray was a conservative multimillionaire who drove a battered Chevy modified to burn methanol. Dan Dudek, the lead strategist for EDF, was a former academic Krupp once described as either "just plain loony, or the most powerful visionary ever to apply for a job at an environmental group." But the two hit it off—a good thing, given that almost everyone else was against them.
Many Environmental Protection Agency (EPA) staffers mistrusted the new methods; they had had little success with some small-scale experiments in emissions trading, and they worried that proponents were less interested in cleaning up pollution than in doing it cheaply. Congressional subcommittee members looked skeptical when witnesses at hearings tried to explain how there could be a market for something as worthless as emissions. Nervous utility executives worried that buying allowances meant putting their confidence in a piece of paper printed by the government. At the same time, they figured that allowances might trade at $500 to $1,000 a ton, with the program costing them somewhere between $5 billion and $25 billion a year.
Environmentalists, too, were skeptical. Some saw emissions trading as a scheme for polluters to buy their way out of fixing the problem. Joe Goffman, then an EDF lawyer, recalls other environmental advocates seething when EDF argued that emissions trading was just a better solution. Other members of a group called the Clean Air Coalition tried to censure EDF for what Krupp calls "the twofold sin of having talked to the Republican White House and having advanced this heretical idea."
Misunderstandings over how emissions trading could work extended to the White House itself. When the Bush administration first proposed its wording for the legislation, the EDF and EPA staffers who had been working on the bill were shocked to see that the White House had not included a cap. Instead of limiting the amount of emissions, the bill limited only the rate of emissions, and only in the dirtiest power plants. It was "a real stomach-falling-to-the-floor moment," says Nancy Kete, who was then managing the acid rain program for the EPA. She says she realized that "we had been talking past each other for months."
EDF argued that a hard cap on emissions was the only way trading could work in the real world. It wasn't just about doing what was right for the environment; it was basic marketplace economics. Only if the cap got smaller and smaller would it turn allowances into a precious commodity, and not just paper printed by the government. No cap meant no deal, said EDF.
John Sununu, the White House chief of staff, was furious. He said the cap "was going to shut the economy down," Boyden Gray recalls. But the in-house debate "went very, very fast. We didn't have time to fool around with it." President Bush not only accepted the cap, he overruled his advisers' recommendation of an eight million-ton cut in annual acid rain emissions in favor of the ten million-ton cut advocated by environmentalists. According to William Reilly, then EPA administrator, Bush wanted to soothe Canada's bruised feelings. But others say the White House was full of sports fans, and in basketball you aren't a player unless you score in double digits. Ten million tons just sounded better.
Near the end of the intramural debate over the policy, one critical change took place. The EPA's previous experiments with emissions trading had faltered because they relied on a complicated system of permits and credits requiring frequent regulatory intervention. Sometime in the spring of 1989, a career EPA policy maker named Brian McLean proposed letting the market operate on its own. Get rid of all that bureaucratic apparatus, he suggested. Just measure emissions rigorously, with a device mounted on the back end of every power plant, and then make sure emissions numbers match up with allowances at the end of the year. It would be simple and provide unprecedented accountability. But it would also "radically disempower the regulators," says EDF's Joe Goffman, "and for McLean to come up with that idea and become a champion for it was heroic." Emissions trading became law as part of the Clean Air Act of 1990.
Oddly, the business community was the last holdout against the marketplace approach. Boyden Gray's hiking partner John Henry became a broker of emissions allowances and spent 18 months struggling to get utility executives to make the first purchase. Initially it was like a church dance, another broker observed at the time, "with the boys on one side and the girls on another. Sooner or later, somebody's going to walk into the middle." But the utility types kept fretting about the risk. Finally, Henry phoned Gray at the White House and wondered aloud if it might be possible to order the Tennessee Valley Authority (TVA), a federally owned electricity provider, to start buying allowances to compensate for emissions from its coal-fired power plants. In May 1992, the TVA did the first deal at $250 a ton, and the market took off.
Whether cap-and-trade would curb acid rain remained in doubt until 1995, when the cap took effect. Nationwide, acid rain emissions fell by three million tons that year, well ahead of the schedule required by law. Cap-and-trade—a term that first appeared in print that year—quickly went "from being a pariah among policy makers," as an MIT analysis put it, "to being a star—everybody's favorite way to deal with pollution problems."
Almost 20 years since the signing of the Clean Air Act of 1990, the cap-and-trade system continues to let polluters figure out the least expensive way to reduce their acid rain emissions. As a result, the law costs utilities just $3 billion annually, not $25 billion, according to a recent study in the Journal of Environmental Management; by cutting acid rain in half, it also generates an estimated $122 billion a year in benefits from avoided death and illness, healthier lakes and forests, and improved visibility on the Eastern Seaboard. (Better relations with Canada? Priceless.)
No one knows whether the United States can apply the system as successfully to the much larger problem of global warming emissions, or at what cost to the economy. Following the American example with acid rain, Europe now relies on cap-and-trade to help about 10,000 large industrial plants find the most economical way of reducing their global warming emissions. If Congress approves such a system in this country—the House had approved the legislation as we went to press—it could set emissions limits on every fossil-fuel power plant and every manufacturer in the nation. Consumers might also pay more to heat and cool their homes and drive their cars—all with the goal of reducing global warming emissions by 17 percent below 2005 levels over the next ten years.
But advocates argue that cap-and-trade still beats command-and-control regulation. "There's not a person in a business anywhere," says Dan Esty, an environmental policy professor at Yale University, "who gets up in the morning and says, ‘Gee, I want to race into the office to follow some regulation.' On the other hand, if you say, ‘There's an upside potential here, you're going to make money,' people do get up early and do drive hard around the possibility of finding themselves winners on this."
Richard Conniff is a 2009 Loeb Award winner for business journalism.
http://www.smithsonianmag.com/air/the-political-history-of-cap-and-trade-34711212/?all
.. this one is different .. note it is an extended version of this one .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation .. which also has some links ..
Market mechanisms for regulation: Cap-and-trade and Obamacare
Jeffrey Frankel 27 February 2014
Market-based mechanisms such as cap-and-trade can tackle externality problems more efficiently than command-and-control regulations. However, politicians in the US and Europe have retreated from cap-and-trade in recent years. This column draws a parallel between Republicans’ abandonment of market-based environmental regulation and their recent disavowal of mandatory health insurance. The author argues that in practice, the alternative to market-based regulation is not an absence of regulation, but rather the return of inefficient mandates and subsidies.
Markets can fail. But market mechanisms are often the best way for governments to address such failures. This has been demonstrated in areas from air pollution, to traffic congestion, to spectrum allocation, to cigarette consumption.
Markets for emission allowances – in which those firms that can cheaply cut pollution trade with those that cannot – achieve desired environmental goals at relatively low economic costs. As of a decade ago, that long-standing economic proposition had become widely recognised and put into action. Yet the political tide on both sides of the Atlantic has been against ‘cap-and-trade’ over the last five years.
In the US, the highly successful trading system for allowances in emissions of SO2 (sulphur dioxide) has all but died since 2012. In the EU as well, the Emissions Trading System was in effect overtaken by other kinds of regulation in 2013.
Cap-and-trade as a Republican policy
In the US, cap-and-trade was originally considered a Republican idea. Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation. Most environmental organisations were opposed to the novel approach; many of them thought it immoral for corporations to be able to pay for the right to pollute. The pioneering use of the cap-and-trade approach to phase out lead from gasoline in the 1980s was a policy of Ronald Reagan’s administration. Its successful use to reduce SO2 emissions from power plants in the 1990s was a policy of George H W Bush’s administration. The proposal to use cap-and-trade to reduce SO2 and other emissions further was a policy of George W Bush’s administration ten years ago under, first, the Clear Skies Act proposed in 2002, and then the Clean Air Interstate Rule of 2005 (see Schmalensee and Stavins 2013, pp.103-113).
The problem is not that cap-and-trade is a theoretical proposal from ivory-tower economists that cannot survive application in the real world. On the contrary, its performance in action surpassed expectations. The mechanism in the 1980s allowed lead to be phased out more rapidly than predicted and at an estimate savings of $250 million per year compared to the old-fashioned approach that did not permit trade (Stavins 2003). SO2 emissions were curbed at a much lower cost than even the proponents of cap-and-trade had predicted before 1995, let alone what the cost would have been under the old command-and-control approach. As expected, the electric power sector chose to close down those plants where it would have been most expensive to achieve pollution cuts. The flexibility of the cap-and-trade system also allowed the industry to take advantage of unexpected developments such as new scrubber technology and newly accessible low-sulphur coal, to a much greater extent than would have been possible without the market mechanism. (Among those explaining why costs came in so low are Ellerman et al. 2000).
The Republican candidate for president in 2008, Senator John McCain, had sponsored US legislative proposals to use cap-and-trade to address emissions of carbon dioxide and other greenhouse gases responsible for global warming. He had co-sponsored the Climate Stewardship Act with Senator Joe Lieberman in 2003 – it was defeated in the Senate by 55 votes to 43. They tried again as recently as 2007, but got no further. McCain continued to advocate a cap-and-trade approach to climate change during the 2008 presidential campaign.
The retreat from cap-and-trade
Republican politicians have now forgotten that this approach was ever their policy. To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric. The American Clean-Energy and Security Act, sponsored by Congressmen Ed Markey and Henry Waxman, was passed by the House of Representatives that year, but not the Senate. The Republican rhetoric successfully stigmatised cap-and-trade. Schmalensee and Stavins (2013) sum it up: ‘It is ironic that conservatives chose to demonize their own market-based creation.’
This stance left in its place alternative approaches that are less market-friendly (Stavins 2011) – especially after court cases pointed out that the 1970 Clean Air Act and its 1990 Amendments were still the law of the land (originally signed into law by Republican Presidents Richard Nixon and George H W Bush, respectively, with large bipartisan congressional majorities both times).
The non-market alternatives – such as ‘command-and-control’ regulation requiring that particular energy sources or particular technologies be used – are less efficient. Nonetheless they are once again the dominant regime. The number of SO2 allowances specified by the cap-and-trade regime has not been adjusted since 2000. As a result, emissions since 2006 have been steadily declining below the ceiling. The cap is no longer binding. People aren’t willing to pay for something if they already have more of it than they need. So the price of emission allowances has fallen steeply, essentially hitting zero since 2012, which indicates that it no longer affects behaviour in the electric power sector (Schmalensee and Stavins 2013, p.106-07 and p. 114).
In Europe, the peak of cap-and-trade came ten years ago. The EU adopted the Emissions Trading System (ETS) in 2003, as a cost-effective way to achieve the commitments it had made under the Kyoto Protocol on Global Climate Change. It rapidly became the world’s biggest market in the trading of carbon allowances. But the ETS has in recent years been pushed aside by older ‘command-and-control’ approaches, in which the government dictates who should use which technologies, in what amounts, to reduce which emissions.
European directives say that 20% of energy must come from renewables by 2020. Renewable energy has been promoted by mandates and subsidies. These policies, along with excessive allocations, have collapsed the price of emissions permits in the ETS, because demand for the permits now falls short of any binding constraint. The price of carbon fell below 3 euros a tonne in April 2013, rendering the market almost irrelevant. It remains very low (5 euros a tonne). This in turn contributes to the burning of coal – the worst energy source, from the viewpoint of global warming or local pollution – which would not have happened if the central policy to address these problems were still a mechanism to put a price on carbon.
On top of that, the EU methods of encouraging renewables have proven ruinously expensive. This has been giving pause to European officials as they decide how to extend the 2020 framework to goals for 2030. The European Council will discuss this at a meeting scheduled for March 2014. The EU should abandon its numerical targets for renewables and go back to relying on the ETS, with whatever limits on permit quantities are necessary to keep the price up. This route can achieve greater progress at reducing Greenhouse Gas emissions at lower cost to the European economies.
There is nothing inevitable or irreversible about the recent trend away from cap-and-trade. Indeed in some parts of the world, such as China, governments seem to be moving in the direction of emissions trading as an efficient way to address global climate change (OECD 2013).
Even in the US, where it began, there are still grounds for hope. The Environmental Protection Agency is currently developing federal guidelines for state programmes to reduce CO2 emissions from power plants under the Clean Air Act [Section 111(d)]. As a good model for putting a price on carbon, the EPA should consider the cap and trade schemes that have been developed by the northeastern Regional Greenhouse Gas Initiative (RGGI), California, and some Canadian provinces. The RGGI began trading permits among large power plants in 2008 and continues to operate among nine northeastern states. California recently started an important new emissions trading system, though the Golden State is another example where policies to set standards for particular fuels or particular modes of power generation are in danger of undermining the emissions trading plan [“Assembly Bill 32”].
Parallels with Obamacare
One can draw an interesting analogy between the evolution of American political attitudes toward market mechanisms in the area of federal environmental regulation and Republican hostility to the Affordable Care Act, also known as Obamacare. The lynchpin of the programme is the attempt to make sure that all Americans have health insurance, via the individual mandate. But Obamacare is a market mechanism in that health insurers and health care providers remain private and compete against each other. As has been pointed out countless times, this was originally a conservative approach, designed to work via the marketplace: The alternative is to have the government either:
* directly provide the health insurance (a ‘single payer’ system, as in Canada; or under US Medicare for that matter); or
* directly provide the health care itself (‘socialised medicine’, as in the UK; or the US Veterans Administration hospitals).
The new approach was proposed in conservative think tanks such as the Heritage Foundation. It was enacted in Massachusetts by Republican Governor Mitt Romney. By the time President Obama adopted it, however, it had become anathema to Republicans, most of whom forgot that it had ever been their policy.
One can trace through the parallels between air and health care. The market failure in the case of the environment is that pollution is what economists call an externality – in an unregulated market, those who pollute don’t bear the cost. The market failure in the case of health care is what economists call ‘adverse selection’ – insurers may not provide insurance, especially to patients with pre-existing conditions, if they have reason to fear that the healthy customers have already taken themselves out of the risk pool.
Government attempts to address the market failure can themselves fail. In the case of the environment, command-and-control regulation is inefficient, discourages innovation, and can have unintended consequences. For example, CAFÉ standards (Corporate Average Fuel Economy) were partly responsible for the rise of the SUV. When ‘New Source Review’ requires that American power companies adopt the most stringent available control technology if they build a new power plant, they respond by keeping dirty old plants running as long as possible (Stavins 2006). In the case of health care, a national health service monopoly can forestall innovation and provide inadequate care with long waits. In general, the best government interventions are designed to target the failure precisely – using cap-and-trade to put a price on air pollution or using the individual mandate to curtail adverse selection in health insurance – and otherwise let market forces do the rest more efficiently than bureaucrats can.
American conservatives often talk as if the alternative they would prefer is no regulation at all. But few in fact would want to go back to the unbreathable pre-1970 air of Los Angeles, London or Tokyo. Even those few who might want to should recognise that most of their fellow citizens feel differently. Political reality shows that the alternative in practice is an inefficient rent-seeking system in which solar power, corn-based ethanol, and fossil fuels all get subsidies or mandates. Analogously, few conservatives in fact will say that they want hospital emergency rooms to turn away critically ill patients who lack health insurance. Even for those who might want this, reality shows that the alternative in practice is hospitals that give emergency care to those who lack insurance, whether because of personal irresponsibility or for reasons beyond their control, and then pass the charges on to the rest of us.
A third example is the Earned-Income Tax Credit (EITC). It was originally considered a conservative idea; an implementation of Milton Friedman’s proposed negative income tax, it was championed by Ronald Reagan as a pro-work market-friendly way of addressing income inequality. President Obama proposed expanding the EITC in his State of the Union address last month. But conservatives, again forgetting that it was their own creation, have opposed expansion of the EITC as verboten redistribution. So proposals to increase the minimum wage get more political traction as a way to address income inequality, even though that approach is more interventionist and less efficient.
Editor’s note: This is an extended version of an op-ed published at Project Syndicate .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation . Comments may be posted there.
References .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation
See also:
So, Europe's ETS works after all?
http://investorshub.advfn.com/boards/read_msg.aspx?message_id=89918761 .. and a bit from a reply to that one ..
An ETS works by setting a cap on emissions and requiring emitters to hold a permit for each tonne of CO2 that they emit. The level of the cap determines the number of permits available.
If emitters don’t already hold a permit, they must either cut back on their emissions or buy a permit from another emitter, who must then cut back.
This means that a cost is imposed on emissions, equal to the price of buying or selling a permit.
But importantly it’s not actually the price that causes the overall cuts in emissions. The cap determines the level of emissions, and the required cuts in emissions cause the price.
That is, permits have a value because they allow you to avoid making cuts in emissions.
How does this differ from a carbon tax?
A carbon tax is sort of the opposite. A cost is added to all emissions, equal to the level of the tax, and this causes people to cut back.
There is no cap on emissions in a tax-based system. People are free to emit as much or as little as they like, but if they do emit, they must pay the tax.
Unlike an ETS, under a carbon tax it is the price that determines the level of emissions.
http://investorshub.advfn.com/boards/read_msg.aspx?message_id=90054503
.. good .. hope you find these interesting ..
How an unlikely mix of environmentalists and free-market conservatives hammered out the strategy known as cap-and-trade
By Richard Conniff
Smithsonian Magazine | Subscribe
August 2009
John B. Henry was hiking in Maine's Acadia National Park one August in the 1980s when he first heard his friend C. Boyden Gray talk about cleaning up the environment by letting people buy and sell the right to pollute. Gray, a tall, lanky heir to a tobacco fortune, was then working as a lawyer in the Reagan White House, where environmental ideas were only slightly more popular than godless Communism. "I thought he was smoking dope," recalls Henry, a Washington, D.C. entrepreneur. But if the system Gray had in mind now looks like a politically acceptable way to slow climate change—an approach being hotly debated in Congress—you could say that it got its start on the global stage on that hike up Acadia's Cadillac Mountain.
From This Story
Photo Gallery .. http://www.smithsonianmag.com/air/the-political-history-of-cap-and-trade-34711212/?all
People now call that system "cap-and-trade." But back then the term of art was "emissions trading," though some people called it "morally bankrupt" or even "a license to kill." For a strange alliance of free-market Republicans and renegade environmentalists, it represented a novel approach to cleaning up the world—by working with human nature instead of against it.
Despite powerful resistance, these allies got the system adopted as national law in 1990, to control the power-plant pollutants that cause acid rain. With the help of federal bureaucrats willing to violate the cardinal rule of bureaucracy—by surrendering regulatory power to the marketplace—emissions trading would become one of the most spectacular success stories in the history of the green movement. Congress is now considering whether to expand the system to cover the carbon dioxide emissions implicated in climate change—a move that would touch the lives of almost every American. So it's worth looking back at how such a radical idea first got translated into action, and what made it work.
The problem in the 1980s was that American power plants were sending up vast clouds of sulfur dioxide, which was falling back to earth in the form of acid rain, damaging lakes, forests and buildings across eastern Canada and the United States. The squabble about how to fix this problem had dragged on for years. Most environmentalists were pushing a "command-and-control" approach, with federal officials requiring utilities to install scrubbers capable of removing the sulfur dioxide from power-plant exhausts. The utility companies countered that the cost of such an approach would send them back to the Dark Ages. By the end of the Reagan administration, Congress had put forward and slapped down 70 different acid rain bills, and frustration ran so deep that Canada's prime minister bleakly joked about declaring war on the United States.
At about the same time, the Environmental Defense Fund (EDF) had begun to question its own approach to cleaning up pollution, summed up in its unofficial motto: "Sue the bastards." During the early years of command-and-control environmental regulation, EDF had also noticed something fundamental about human nature, which is that people hate being told what to do. So a few iconoclasts in the group had started to flirt with marketplace solutions: give people a chance to turn a profit by being smarter than the next person, they reasoned, and they would achieve things that no command-and-control bureaucrat would ever suggest.
The theory had been brewing for decades, beginning with early 20th-century British economist Arthur Cecil Pigou. He argued that transactions can have effects that don't show up in the price of a product. A careless manufacturer spewing noxious chemicals into the air, for instance, did not have to pay when the paint peeled off houses downwind—and neither did the consumer of the resulting product. Pigou proposed making the manufacturer and customer foot the bill for these unacknowledged costs—"internalizing the externalities," in the cryptic language of the dismal science. But nobody much liked Pigou's means of doing it, by having regulators impose taxes and fees. In 1968, while studying pollution control in the Great Lakes, University of Toronto economist John Dales hit on a way for the costs to be paid with minimal government intervention, by using tradable permits or allowances.
The basic premise of cap-and-trade is that government doesn't tell polluters how to clean up their act. Instead, it simply imposes a cap on emissions. Each company starts the year with a certain number of tons allowed—a so-called right to pollute. The company decides how to use its allowance; it might restrict output, or switch to a cleaner fuel, or buy a scrubber to cut emissions. If it doesn't use up its allowance, it might then sell what it no longer needs. Then again, it might have to buy extra allowances on the open market. Each year, the cap ratchets down, and the shrinking pool of allowances gets costlier. As in a game of musical chairs, polluters must scramble to match allowances to emissions.
Getting all this to work in the real world required a leap of faith. The opportunity came with the 1988 election of George H.W. Bush. EDF president Fred Krupp phoned Bush's new White House counsel—Boyden Gray—and suggested that the best way for Bush to make good on his pledge to become the "environmental president" was to fix the acid rain problem, and the best way to do that was by using the new tool of emissions trading. Gray liked the marketplace approach, and even before the Reagan administration expired, he put EDF staffers to work drafting legislation to make it happen. The immediate aim was to break the impasse over acid rain. But global warming had also registered as front-page news for the first time that sweltering summer of 1988; according to Krupp, EDF and the Bush White House both felt from the start that emissions trading would ultimately be the best way to address this much larger challenge.
It would be an odd alliance. Gray was a conservative multimillionaire who drove a battered Chevy modified to burn methanol. Dan Dudek, the lead strategist for EDF, was a former academic Krupp once described as either "just plain loony, or the most powerful visionary ever to apply for a job at an environmental group." But the two hit it off—a good thing, given that almost everyone else was against them.
Many Environmental Protection Agency (EPA) staffers mistrusted the new methods; they had had little success with some small-scale experiments in emissions trading, and they worried that proponents were less interested in cleaning up pollution than in doing it cheaply. Congressional subcommittee members looked skeptical when witnesses at hearings tried to explain how there could be a market for something as worthless as emissions. Nervous utility executives worried that buying allowances meant putting their confidence in a piece of paper printed by the government. At the same time, they figured that allowances might trade at $500 to $1,000 a ton, with the program costing them somewhere between $5 billion and $25 billion a year.
Environmentalists, too, were skeptical. Some saw emissions trading as a scheme for polluters to buy their way out of fixing the problem. Joe Goffman, then an EDF lawyer, recalls other environmental advocates seething when EDF argued that emissions trading was just a better solution. Other members of a group called the Clean Air Coalition tried to censure EDF for what Krupp calls "the twofold sin of having talked to the Republican White House and having advanced this heretical idea."
Misunderstandings over how emissions trading could work extended to the White House itself. When the Bush administration first proposed its wording for the legislation, the EDF and EPA staffers who had been working on the bill were shocked to see that the White House had not included a cap. Instead of limiting the amount of emissions, the bill limited only the rate of emissions, and only in the dirtiest power plants. It was "a real stomach-falling-to-the-floor moment," says Nancy Kete, who was then managing the acid rain program for the EPA. She says she realized that "we had been talking past each other for months."
EDF argued that a hard cap on emissions was the only way trading could work in the real world. It wasn't just about doing what was right for the environment; it was basic marketplace economics. Only if the cap got smaller and smaller would it turn allowances into a precious commodity, and not just paper printed by the government. No cap meant no deal, said EDF.
John Sununu, the White House chief of staff, was furious. He said the cap "was going to shut the economy down," Boyden Gray recalls. But the in-house debate "went very, very fast. We didn't have time to fool around with it." President Bush not only accepted the cap, he overruled his advisers' recommendation of an eight million-ton cut in annual acid rain emissions in favor of the ten million-ton cut advocated by environmentalists. According to William Reilly, then EPA administrator, Bush wanted to soothe Canada's bruised feelings. But others say the White House was full of sports fans, and in basketball you aren't a player unless you score in double digits. Ten million tons just sounded better.
Near the end of the intramural debate over the policy, one critical change took place. The EPA's previous experiments with emissions trading had faltered because they relied on a complicated system of permits and credits requiring frequent regulatory intervention. Sometime in the spring of 1989, a career EPA policy maker named Brian McLean proposed letting the market operate on its own. Get rid of all that bureaucratic apparatus, he suggested. Just measure emissions rigorously, with a device mounted on the back end of every power plant, and then make sure emissions numbers match up with allowances at the end of the year. It would be simple and provide unprecedented accountability. But it would also "radically disempower the regulators," says EDF's Joe Goffman, "and for McLean to come up with that idea and become a champion for it was heroic." Emissions trading became law as part of the Clean Air Act of 1990.
Oddly, the business community was the last holdout against the marketplace approach. Boyden Gray's hiking partner John Henry became a broker of emissions allowances and spent 18 months struggling to get utility executives to make the first purchase. Initially it was like a church dance, another broker observed at the time, "with the boys on one side and the girls on another. Sooner or later, somebody's going to walk into the middle." But the utility types kept fretting about the risk. Finally, Henry phoned Gray at the White House and wondered aloud if it might be possible to order the Tennessee Valley Authority (TVA), a federally owned electricity provider, to start buying allowances to compensate for emissions from its coal-fired power plants. In May 1992, the TVA did the first deal at $250 a ton, and the market took off.
Whether cap-and-trade would curb acid rain remained in doubt until 1995, when the cap took effect. Nationwide, acid rain emissions fell by three million tons that year, well ahead of the schedule required by law. Cap-and-trade—a term that first appeared in print that year—quickly went "from being a pariah among policy makers," as an MIT analysis put it, "to being a star—everybody's favorite way to deal with pollution problems."
Almost 20 years since the signing of the Clean Air Act of 1990, the cap-and-trade system continues to let polluters figure out the least expensive way to reduce their acid rain emissions. As a result, the law costs utilities just $3 billion annually, not $25 billion, according to a recent study in the Journal of Environmental Management; by cutting acid rain in half, it also generates an estimated $122 billion a year in benefits from avoided death and illness, healthier lakes and forests, and improved visibility on the Eastern Seaboard. (Better relations with Canada? Priceless.)
No one knows whether the United States can apply the system as successfully to the much larger problem of global warming emissions, or at what cost to the economy. Following the American example with acid rain, Europe now relies on cap-and-trade to help about 10,000 large industrial plants find the most economical way of reducing their global warming emissions. If Congress approves such a system in this country—the House had approved the legislation as we went to press—it could set emissions limits on every fossil-fuel power plant and every manufacturer in the nation. Consumers might also pay more to heat and cool their homes and drive their cars—all with the goal of reducing global warming emissions by 17 percent below 2005 levels over the next ten years.
But advocates argue that cap-and-trade still beats command-and-control regulation. "There's not a person in a business anywhere," says Dan Esty, an environmental policy professor at Yale University, "who gets up in the morning and says, ‘Gee, I want to race into the office to follow some regulation.' On the other hand, if you say, ‘There's an upside potential here, you're going to make money,' people do get up early and do drive hard around the possibility of finding themselves winners on this."
Richard Conniff is a 2009 Loeb Award winner for business journalism.
http://www.smithsonianmag.com/air/the-political-history-of-cap-and-trade-34711212/?all
.. this one is different .. note it is an extended version of this one .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation .. which also has some links ..
Market mechanisms for regulation: Cap-and-trade and Obamacare
Jeffrey Frankel 27 February 2014
Market-based mechanisms such as cap-and-trade can tackle externality problems more efficiently than command-and-control regulations. However, politicians in the US and Europe have retreated from cap-and-trade in recent years. This column draws a parallel between Republicans’ abandonment of market-based environmental regulation and their recent disavowal of mandatory health insurance. The author argues that in practice, the alternative to market-based regulation is not an absence of regulation, but rather the return of inefficient mandates and subsidies.
Markets can fail. But market mechanisms are often the best way for governments to address such failures. This has been demonstrated in areas from air pollution, to traffic congestion, to spectrum allocation, to cigarette consumption.
Markets for emission allowances – in which those firms that can cheaply cut pollution trade with those that cannot – achieve desired environmental goals at relatively low economic costs. As of a decade ago, that long-standing economic proposition had become widely recognised and put into action. Yet the political tide on both sides of the Atlantic has been against ‘cap-and-trade’ over the last five years.
In the US, the highly successful trading system for allowances in emissions of SO2 (sulphur dioxide) has all but died since 2012. In the EU as well, the Emissions Trading System was in effect overtaken by other kinds of regulation in 2013.
Cap-and-trade as a Republican policy
In the US, cap-and-trade was originally considered a Republican idea. Market-friendly regulation was pushed by those who thought of themselves as pro-market, rather than by those who thought of themselves as pro-regulation. Most environmental organisations were opposed to the novel approach; many of them thought it immoral for corporations to be able to pay for the right to pollute. The pioneering use of the cap-and-trade approach to phase out lead from gasoline in the 1980s was a policy of Ronald Reagan’s administration. Its successful use to reduce SO2 emissions from power plants in the 1990s was a policy of George H W Bush’s administration. The proposal to use cap-and-trade to reduce SO2 and other emissions further was a policy of George W Bush’s administration ten years ago under, first, the Clear Skies Act proposed in 2002, and then the Clean Air Interstate Rule of 2005 (see Schmalensee and Stavins 2013, pp.103-113).
The problem is not that cap-and-trade is a theoretical proposal from ivory-tower economists that cannot survive application in the real world. On the contrary, its performance in action surpassed expectations. The mechanism in the 1980s allowed lead to be phased out more rapidly than predicted and at an estimate savings of $250 million per year compared to the old-fashioned approach that did not permit trade (Stavins 2003). SO2 emissions were curbed at a much lower cost than even the proponents of cap-and-trade had predicted before 1995, let alone what the cost would have been under the old command-and-control approach. As expected, the electric power sector chose to close down those plants where it would have been most expensive to achieve pollution cuts. The flexibility of the cap-and-trade system also allowed the industry to take advantage of unexpected developments such as new scrubber technology and newly accessible low-sulphur coal, to a much greater extent than would have been possible without the market mechanism. (Among those explaining why costs came in so low are Ellerman et al. 2000).
The Republican candidate for president in 2008, Senator John McCain, had sponsored US legislative proposals to use cap-and-trade to address emissions of carbon dioxide and other greenhouse gases responsible for global warming. He had co-sponsored the Climate Stewardship Act with Senator Joe Lieberman in 2003 – it was defeated in the Senate by 55 votes to 43. They tried again as recently as 2007, but got no further. McCain continued to advocate a cap-and-trade approach to climate change during the 2008 presidential campaign.
The retreat from cap-and-trade
Republican politicians have now forgotten that this approach was ever their policy. To defeat the last major climate bill in 2009, they worked themselves into a frenzy of anti-regulation rhetoric. The American Clean-Energy and Security Act, sponsored by Congressmen Ed Markey and Henry Waxman, was passed by the House of Representatives that year, but not the Senate. The Republican rhetoric successfully stigmatised cap-and-trade. Schmalensee and Stavins (2013) sum it up: ‘It is ironic that conservatives chose to demonize their own market-based creation.’
This stance left in its place alternative approaches that are less market-friendly (Stavins 2011) – especially after court cases pointed out that the 1970 Clean Air Act and its 1990 Amendments were still the law of the land (originally signed into law by Republican Presidents Richard Nixon and George H W Bush, respectively, with large bipartisan congressional majorities both times).
The non-market alternatives – such as ‘command-and-control’ regulation requiring that particular energy sources or particular technologies be used – are less efficient. Nonetheless they are once again the dominant regime. The number of SO2 allowances specified by the cap-and-trade regime has not been adjusted since 2000. As a result, emissions since 2006 have been steadily declining below the ceiling. The cap is no longer binding. People aren’t willing to pay for something if they already have more of it than they need. So the price of emission allowances has fallen steeply, essentially hitting zero since 2012, which indicates that it no longer affects behaviour in the electric power sector (Schmalensee and Stavins 2013, p.106-07 and p. 114).
In Europe, the peak of cap-and-trade came ten years ago. The EU adopted the Emissions Trading System (ETS) in 2003, as a cost-effective way to achieve the commitments it had made under the Kyoto Protocol on Global Climate Change. It rapidly became the world’s biggest market in the trading of carbon allowances. But the ETS has in recent years been pushed aside by older ‘command-and-control’ approaches, in which the government dictates who should use which technologies, in what amounts, to reduce which emissions.
European directives say that 20% of energy must come from renewables by 2020. Renewable energy has been promoted by mandates and subsidies. These policies, along with excessive allocations, have collapsed the price of emissions permits in the ETS, because demand for the permits now falls short of any binding constraint. The price of carbon fell below 3 euros a tonne in April 2013, rendering the market almost irrelevant. It remains very low (5 euros a tonne). This in turn contributes to the burning of coal – the worst energy source, from the viewpoint of global warming or local pollution – which would not have happened if the central policy to address these problems were still a mechanism to put a price on carbon.
On top of that, the EU methods of encouraging renewables have proven ruinously expensive. This has been giving pause to European officials as they decide how to extend the 2020 framework to goals for 2030. The European Council will discuss this at a meeting scheduled for March 2014. The EU should abandon its numerical targets for renewables and go back to relying on the ETS, with whatever limits on permit quantities are necessary to keep the price up. This route can achieve greater progress at reducing Greenhouse Gas emissions at lower cost to the European economies.
There is nothing inevitable or irreversible about the recent trend away from cap-and-trade. Indeed in some parts of the world, such as China, governments seem to be moving in the direction of emissions trading as an efficient way to address global climate change (OECD 2013).
Even in the US, where it began, there are still grounds for hope. The Environmental Protection Agency is currently developing federal guidelines for state programmes to reduce CO2 emissions from power plants under the Clean Air Act [Section 111(d)]. As a good model for putting a price on carbon, the EPA should consider the cap and trade schemes that have been developed by the northeastern Regional Greenhouse Gas Initiative (RGGI), California, and some Canadian provinces. The RGGI began trading permits among large power plants in 2008 and continues to operate among nine northeastern states. California recently started an important new emissions trading system, though the Golden State is another example where policies to set standards for particular fuels or particular modes of power generation are in danger of undermining the emissions trading plan [“Assembly Bill 32”].
Parallels with Obamacare
One can draw an interesting analogy between the evolution of American political attitudes toward market mechanisms in the area of federal environmental regulation and Republican hostility to the Affordable Care Act, also known as Obamacare. The lynchpin of the programme is the attempt to make sure that all Americans have health insurance, via the individual mandate. But Obamacare is a market mechanism in that health insurers and health care providers remain private and compete against each other. As has been pointed out countless times, this was originally a conservative approach, designed to work via the marketplace: The alternative is to have the government either:
* directly provide the health insurance (a ‘single payer’ system, as in Canada; or under US Medicare for that matter); or
* directly provide the health care itself (‘socialised medicine’, as in the UK; or the US Veterans Administration hospitals).
The new approach was proposed in conservative think tanks such as the Heritage Foundation. It was enacted in Massachusetts by Republican Governor Mitt Romney. By the time President Obama adopted it, however, it had become anathema to Republicans, most of whom forgot that it had ever been their policy.
One can trace through the parallels between air and health care. The market failure in the case of the environment is that pollution is what economists call an externality – in an unregulated market, those who pollute don’t bear the cost. The market failure in the case of health care is what economists call ‘adverse selection’ – insurers may not provide insurance, especially to patients with pre-existing conditions, if they have reason to fear that the healthy customers have already taken themselves out of the risk pool.
Government attempts to address the market failure can themselves fail. In the case of the environment, command-and-control regulation is inefficient, discourages innovation, and can have unintended consequences. For example, CAFÉ standards (Corporate Average Fuel Economy) were partly responsible for the rise of the SUV. When ‘New Source Review’ requires that American power companies adopt the most stringent available control technology if they build a new power plant, they respond by keeping dirty old plants running as long as possible (Stavins 2006). In the case of health care, a national health service monopoly can forestall innovation and provide inadequate care with long waits. In general, the best government interventions are designed to target the failure precisely – using cap-and-trade to put a price on air pollution or using the individual mandate to curtail adverse selection in health insurance – and otherwise let market forces do the rest more efficiently than bureaucrats can.
American conservatives often talk as if the alternative they would prefer is no regulation at all. But few in fact would want to go back to the unbreathable pre-1970 air of Los Angeles, London or Tokyo. Even those few who might want to should recognise that most of their fellow citizens feel differently. Political reality shows that the alternative in practice is an inefficient rent-seeking system in which solar power, corn-based ethanol, and fossil fuels all get subsidies or mandates. Analogously, few conservatives in fact will say that they want hospital emergency rooms to turn away critically ill patients who lack health insurance. Even for those who might want this, reality shows that the alternative in practice is hospitals that give emergency care to those who lack insurance, whether because of personal irresponsibility or for reasons beyond their control, and then pass the charges on to the rest of us.
A third example is the Earned-Income Tax Credit (EITC). It was originally considered a conservative idea; an implementation of Milton Friedman’s proposed negative income tax, it was championed by Ronald Reagan as a pro-work market-friendly way of addressing income inequality. President Obama proposed expanding the EITC in his State of the Union address last month. But conservatives, again forgetting that it was their own creation, have opposed expansion of the EITC as verboten redistribution. So proposals to increase the minimum wage get more political traction as a way to address income inequality, even though that approach is more interventionist and less efficient.
Editor’s note: This is an extended version of an op-ed published at Project Syndicate .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation . Comments may be posted there.
References .. https://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation
See also:
So, Europe's ETS works after all?
http://investorshub.advfn.com/boards/read_msg.aspx?message_id=89918761 .. and a bit from a reply to that one ..
An ETS works by setting a cap on emissions and requiring emitters to hold a permit for each tonne of CO2 that they emit. The level of the cap determines the number of permits available.
If emitters don’t already hold a permit, they must either cut back on their emissions or buy a permit from another emitter, who must then cut back.
This means that a cost is imposed on emissions, equal to the price of buying or selling a permit.
But importantly it’s not actually the price that causes the overall cuts in emissions. The cap determines the level of emissions, and the required cuts in emissions cause the price.
That is, permits have a value because they allow you to avoid making cuts in emissions.
How does this differ from a carbon tax?
A carbon tax is sort of the opposite. A cost is added to all emissions, equal to the level of the tax, and this causes people to cut back.
There is no cap on emissions in a tax-based system. People are free to emit as much or as little as they like, but if they do emit, they must pay the tax.
Unlike an ETS, under a carbon tax it is the price that determines the level of emissions.
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