Cap and Trade is Easy; it’s the Tax that’s Hard

Loren Kaye

President of the California Foundation for Commerce and Education


Governor Brown cited the major deficiency of new climate change legislation at a press conference yesterday, citing cap and trade as the major piece of unfinished business.

He’s right. When the Governor signs the new climate change legislation rapidly nearing his desk, rather than clarifying public policy, California will be entering uncharted territory.

The hard-fought legislation does not simply extend the current regulatory regime for greenhouse gas (GHG) emissions. It replaces that regime with the only tools available to the Air Resources Board: command and control.

Left out of the mix is the “market mechanism” included in the original legislation governing state climate change policy, AB 32, which set a 2020 goal of reducing GHG emissions to no more than the amount released in 1990. The law authorizing the current cap-and-trade system will expire in 2020, at which point it must either be re-upped by the Legislature or stop operating.

In 2012 the Board implemented cap and trade, covering 85 percent of GHG emissions in California. The regulation places a cap on emissions from entities that emit at least 25,000 metric tons of GHGs per year, and allows them to buy and sell permits (aka “allowances”) as needed to meet their individual emission targets. As a result of this system, in combination with some command-and-control regulations and with help from a severe economic recession during the early implementation years, the Air Board reports that California is well on its way to meeting the AB 32 GHG reduction goal.

The California Chamber of Commerce was an original supporter of cap and trade, but is litigating the legality of the auction used to distribute many of the allowances under this system. Rather than freely allocating GHG allowances, as is typical for other cap-and-trade systems, the Board allocates to itself up to half of these allowances and then auctions them off to raise revenues for various state programs and subsidies. Since the auction is not necessary for a successful cap-and-trade program, but is in place to raise revenues for state programs, CalChamber argues the auction is an illegal tax, since AB 32 did not obtain the two-thirds legislative supermajority required by Proposition 13 for tax increases. The case is currently being considered by the 3rd District Court of Appeal.

Governor Brown acknowledges that a cap-and-trade approach is more effective and less disruptive on regulated industries – and would result in the same reductions in greenhouse gases.

But continuing the cap-and-trade program as operated today would require a two-thirds vote of the Legislature. The Governor is counting on affected businesses to motivate a legislative supermajority to re-up the existing approach that auctions allowances to raise revenues for state programs.

But that’s not the only way to re-create a market mechanism. The Legislature could pass a bill tomorrow with a simple majority vote to create a cap-and-trade program that doesn’t raise taxes. It would have all the benefits of a market-based approach – enforceable, cost-effective, innovative, minimizing leakage – but simply not include the superfluous tax increase.

So the issue isn’t whether cap and trade works to reduce emissions or is the most cost-effective approach. The issue is whether it can be joined to a revenue-raising scheme, which is the only reason to roll the issue over into 2017.

The Governor is right; using a cap-and-trade program and minimizing command-and-control regulations would achieve GHG emission reductions at the lowest overall cost to the California economy. It would also demonstrate to national leaders and to the rest of the world a cost-effective path to reduce global GHGs, which ultimately would have more effect on global climate than any California-only emission reductions.

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