Incorporating the Best of Cantwell-Collins into KGL: Don't Forget the Missing Instrument

by David Driesen

March 24, 2010

Last week, Senators Kerry, Graham, and Lieberman (KGL) reportedly released an 8-page outline for a bill mitigating climate disruption that they are crafting in order to try to break the deadlock that has heretofore blocked legislation in the Senate. ClimateWire reported that the KGL bill would incorporate ideas from the bill introduced by Senators Maria Cantwell (D. Wash.) and Susan Collins (R. Maine), the Carbon Limits and Energy for America’s Renewal (CLEAR) Act. That incorporation might be a good thing, because CLEAR contains several great ideas.

Last year, Amy Sinden and I characterized the idea of Dirty Input Limits (DILs), limits on inputs causing pollution rather than pollution itself, as the “missing instrument” in environmental law. We used the idea of creating a tradable permit market from limits on fossil fuel production and imports as an illustration of the potential of this instrument, which has been used in successful regulatory efforts to head off stratospheric ozone depletion and practically eliminate lead pollution, but has hitherto gone unnoticed as an environmental policy instrument. CLEAR in fact creates a DIL for fossil fuels, just as we recommended.

The main advantages of this approach come from its relative simplicity and its likely effect on innovation. We have far fewer fossil fuel producers and importers than fossil fuel users. By regulating upstream, CLEAR may reduce the number of entities that EPA needs to monitor. Also, by sending a strong signal that the government will demand reductions in fossil fuel use, this approach will likely jump-start innovation.

CLEAR also follows the example set by the Regional Greenhouse Gas Initiative by providing for auctioning of all of the allowances instead of giving them away for free. This is widely recognized among policy experts as a desirable reform, because it helps avoid windfall profits, maximizes incentives for reductions, and generates revenue. CLEAR contemplates using 75% of the revenue to provide “dividends” to consumers, who will experience higher energy prices, and 25% to fund additional cleanup. Moreover, auctions can provide a means of escaping a danger that has received insufficient attention: massive delays and slippage in establishing an operational trading program that could occur because of prolonged rulemaking and litigation over EPA decisions about allowance distribution. (See my previous post and David M. Driesen, Capping Carbon, 40 Envtl. L. 1 (2010) (forthcoming)). Substitution of market-based allocation for administrative allowance giveaways constitutes a step forward.

CLEAR contains another idea generating great interest, that of price collars, limits on the maximum and minimum prices for allowances. This is a more problematic idea, but price collars might serve a useful political purpose. One of the main advantages of a cap-and-trade approach over taxes is certainty about the amount of emission reductions generated. This idea compromises that advantage in order to assure industry that the costs will remain manageable. The danger, of course, is that temporary volatility in prices could then derail a vital program. While the bill would be simpler and more effective without this, if this idea creates sufficient political support to secure passage and the price collar is designed so as not to threaten the program’s overall achievements substantially, this might be a good thing.

Senators Kerry, Graham, and Lieberman should incorporate the idea of focusing on fossil fuel inputs and auctioning off allowances into the bill they are crafting. They need to, however, make it consistent with the strict caps envisioned in Waxman-Markey, probably through supplemental programs outside the fossil fuel sector and strict limits on the amount of DIL permits auctioned off to the fossil fuel providers. They also need to curtail or limit the role of offsets, which threaten to undermine the simplicity and reliability the CLEAR approach obtains by focusing on inputs instead of emissions. Senators Cantwell and Collins deserve credit for a bipartisan effort to introduce DILS and full auctioning into the debate. Let’s hope the missing instrument does not go back into hiding.

Implementing an appropriate price collar is an extremely hard exercise. It is certainly an interesting tool for price or cost containment. However, depending on the precise mechanisms that regulate the price collar, the price volatility might remain an issue. We addressed exactly this aspect in the paper "Cap-and-Trade Properties Under Different Scheme Designs" available at http://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=605723 Comments are very welcome. Luca London School of Economics
— Luca Taschini
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Also from David Driesen

David M. Driesen is a University Professor at Syracuse University College of Law, and an Adjunct Associate Professor at the State University of New York College of Environmental Science and Forestry. He holds a J.D. from Yale Law School. He is a member of the editorial board of the Carbon and Climate Law Review, published in Berlin and Environmental Law, published in Oxford.

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