What Should We Make of China’s Announcement of a National CO2 Trading System?

On December 19, 2017, the government of China announced that it is commencing development of a nationwide CO2 trading system, that when launched will become the world’s largest carbon trading system, annually covering about 3.5 billion tons of CO2 emissions in China’s electric power sector.  That approaches twice the size of what is currently the world’s largest carbon trading system, the European Union Emissions Trading System, which accounts for about 2 billion tons per year, and is nearly nine times the size of the largest U.S. system, the California AB-32 cap-and-trade system, which covers about 400 million tons of annual emissions.

The ultimate purpose of the newly announced Chinese trading system is to help the country meets its emissions and renewable energy targets which are part of its Nationally Determined Contribution under the Paris Agreement, in particular, peaking its CO2 emissions by 2030, and achieving 20% of the country’s energy supply from renewables.  Note that coal currently accounts for 65% of China’s electricity generation.  Wind and solar capacity have been growing rapidly, but still account for only 4% and 1% of generation, respectively.

The Chinese carbon market will double the share of global CO2 emissions covered by worldwide carbon-pricing systems to almost 25 percent.  For this and other reasons, the December announcement was greeted with excited praise from climate activists (but simultaneously with disregard and skepticism from conservative opponents of climate action).  The most reasonable assessment, however, is between those two extremes, as I explain in this essay.  That said, the December announcement by China of its plan to develop and launch a nationwide CO2 trading system is an important landmark on the long road to addressing the threat of global climate change.

Some Brief History for Context

In 2011, China’s 12th Five-Year Plan (2011-2015) first included a statement about the government’s intention to develop – gradually – a nationwide carbon market.  Subsequently, in 2013 and 2014, seven pilot emissions trading programs were launched in the cities of Beijing, Chongqing, Shanghai, Shenzhen, and Tianjin, plus two provincial systems in Guangdong and Hubei.  In total, these covered some 3,000 sources, with total annual CO2 emissions of 1.4 billion tons.  The designs of the systems were intentionally varied, to facilitate learning, and allowance prices ranged from $3 to $10 per ton of CO2.

Then, in the lead-up to the Paris climate negotiations, on September 25, 2015, President Xi Jinping met at the White House with U.S. President Barack Obama, and announced that China would launch its nationwide CO2 trading system in 2017, presumably covering electricity, iron and steel, chemicals, cement, and paper production.

The announcement last month was the culmination of this brief history, as China seeks to move ahead with its “pledges” under the Paris Agreement, at the same time as the Trump administration in the United States intends to withdraw altogether from the Agreement (in November, 2020, the soonest that such withdrawal can take place under the rules of the Agreement).

What’s Known about the Chinese Carbon Trading System

China’s December announcement that it is commencing development of a nationwide CO2 trading system, beginning with the electric power sector only, provided few detailsApparently, the system is intended to eventually include electricity, building materials, iron and steel, non-ferrous metal processing, petroleum refining, chemicals, pulp and paper, and aviation, but will start with the electricity sector alone.  Like most operating systems in the world, it will regulate only CO2, not other greenhouse gases (GHGs), which in China’s case means potentially addressing more than 80% of its total GHG emissions.

The system will not be a cap-and-trade system per se (unlike the CO2 trading systems in Europe and California, for example), because there will not be an administratively set mass-based cap of some quantity of emissions.  Rather, the trading system will be rate-based, meaning that it will be in terms of emissions per unit of electricity output.  This is also called a tradable performance standard, whereby the government sets a performance standard (a benchmark emissions rate per unit of output), sources receive permits (allowances) based on their electricity output and their benchmark, and sources are allowed to trade.  Such tradable performance standards have been used previously in a variety of contexts, including the U.S. EPA leaded gasoline phasedown in the 1990s, U.S. Corporate Average Fuel Economy (CAFE) standards to regulate motor-vehicle fuel efficiency, the Obama Administration’s Renewable Fuel Standard, and California’s Low Carbon Fuel Standard.

One objective of using this approach is to insulate – or at least cushion – the (electricity) sector and the larger economy from “carbon market shock.”  By regulating the emissions rate (per unit of product output), rather than emissions per se, the rate-based approach may help mitigate the political worry about constraining economic growth, but does so by essentially rewarding (subsidizing) higher levels of output.  This relative inefficiency of China’s rate-based system, compared with a mass-based cap-and-trade approach is highlighted in a new paper by Lawrence Goulder (Stanford University) and Richard Morgenstern (Resources for the Future) and one by William Pizer (Duke University)and Xiliang Zhang (Tsinghua University).  (There is a parallel impact and concern – in cap-and-trade systems – with an output-based updating allocation, which can address competitiveness impacts but also introduces inefficiencies by subsidizing dirty production.  This mechanism – which affects only energy-intensive and trade-exposed industries – was proposed in the Waxman-Markey climate legislation and is employed in California’s system.)

The rate-based approach is intended to have a smaller impact on marginal production costs than the mass-based cap-and-trade approach, and thereby is likely to have a smaller impact on the price of products (whether electricity or manufactured goods).  This is the motivation for using this approach in an output-based updating allocation, as described above, and it carries with it the parallel disadvantage of insulating consumers from (some of) the social costs of their consumption decisions.  The problem is exacerbated in the case of China’s evolving system because the performance standards (emission benchmarks) are set not only by sector, but by various categories of electricity production within the sector.  As some categories are, in effect, subsidized by other categories, the cost-effectiveness of the overall system declines.  There is a lack of incentive for the carbon market to move energy consumption from coal to natural gas, for example, because of the multi-benchmark approach.

Finally, it appears that allowances will be allocated without charge, at least in the early stages of the program, which has been typical of emissions trading systems in other parts of the world, and may lessen political resistance while also sacrificing potential efficiency gains associated with auctioning allowances and recycling revenues.

What’s Unknown about the Chinese Carbon Trading System

Among the key design elements that are unknown as of now (at least to me) are the following:

(1)        What will the total allocation of allowances initially be and how will it change (presumably decrease) over time?  Apparently the overall “cap” will be set by adding up the expected emissions of compliance entities, based on their historical emissions.  Then, allocations will be reduced, presumably based on technology performance benchmarks.

(2)        When will trading commence?

(3)        What share of allowances will be distributed for free, and how many – if any – will be auctioned (and how will any auctions operate)?

(4)        What provisions will there be for monitoring and enforcement, and will there be fines or other penalties for non-compliance?

(5)        How will the system interact with other Chinese climate policies?  This is an important question, because so-called “complementary policies” that seek to regulate sources under the cap of a cap-and-trade system can lead to perverse outcomes, as in the European Union and California.

(6)        What is the time-path for expanding the scope of the system to include more sectors, and what sectors will be added?

(7)        When and how, if at all, will China seek to link its system with carbon-pricing and other climate policies in other parts of the world?

Given all of these open questions plus the limited sectoral scope of the announced system, it is reasonable to ask:  what should we make of all this?

How Significant was the Chinese Announcement?

The announcement, despite all the caveats, was a significant step along the road of climate change policy developments, because the Chinese system will eventually be very important, because of its magnitude and because of the importance of China in CO2 emissions and climate change policy.  However, the announcement was not a launch per se, but a statement about a forthcoming launch.

More broadly, the announcement and the eventual launch of the system will have significant effects on other governments around the world – regional, national, and sub-national.  Some will be encouraged to launch or maintain their own carbon trading systems, and to increase the ambition of their systems.  Why do I say this?

A frequently stated fear of adopting climate policies, including carbon pricing, is the competitiveness effects of those policies, due to emission, economic, and employment leakage.  This is more a political issue than a real economic one, but it is nevertheless important.  Since the greatest fear in this realm is that domestic factories will relocate to China, that concern will be greatly reduced – or at least it should be – when and if China has put in place a serious climate policy, whether through carbon markets or otherwise.

China is moving slowly and cautiously, which is wise.  Not long ago, they were considering launching a system that would initially cover 7,000 companies in several sectors, but the 2017 announcement is of a system that covers 1,700 companies in the electricity sector alone.  Of course, it is still important, given that the electricity sector (with its large coal and natural gas plants) accounts for fully a third of China’s CO2 emissions.

During the next two years, the Chinese government – apparently through its National Development and Reform Commission (NDRC), which will administer the trading system – will begin by developing systems for data reporting, registration, & trading – gathering and verifying plant-level emissions data.  This will facilitate the establishment of baselines for allocations of allowances.  Beyond this, a wide range of rules will need to be established.  Following some tests, the actual spot market may launch in 2020 (the same year the Paris Climate Agreement essentially replaces the Kyoto Protocol).

The Path Ahead

As inevitably seems to be the case, the best assessment of this new policy lies somewhere between the extremes.  The December announcement by China was neither as exciting as some of the applause from climate activists might suggest, nor was the announcement as meaningless as conservatives have claimed.

Rather, cautious optimism seems to be in order.  China is serious about climate change, and is thinking long-term.  The country appears to be methodically working to develop a meaningful carbon trading system.  What is important now is developing a robust system that can be effective, expanded in scope, and gradually made more stringent.  Among the greatest challenges will be achieving the cooperation of the provincial governments, not to mention the compliance of the regulated entities.

Development of the system has begun, with the real launch of trading likely to take place in 2020, which is a key year for Chinese climate policy for other reasons, as well.  In that year, China will release its next Five-Year Plan, and it will submit its updated Nationally Determined Contribution to the UNFCCC under the Paris Agreement.  What will the United States be doing that year?  Not much, just electing a President!

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Learning from Thirty Years of Experience with Cap-and-Trade Systems

“Those who do not remember the past are condemned to repeat it.”

The implication of this famous line (often misquoted as “those who do not learn history are doomed to repeat it”) from philosopher George Santayana’s 1905 book, The Life of Reason, Volume I – Reason in Common Sense, is that we are wise to learn from our mistakes.  This is undoubtedly true, as is the parallel recommendation that we are wise to learn from our successes.

Background

China is expected to launch later this year the world’s largest (CO2) emissions trading system; the European Union is in the process of extending and strengthening its CO2 cap-and-trade system; California has just extended and strengthened its CO2 cap-and-trade system; and earlier this week, nine New England and Middle Atlantic U.S. states announced their plan to extend and strengthen the Regional Greenhouse Gas Initiative.  With such developments in place and on the horizon, this is an important time to think carefully and critically about the history of cap-and-trade, and identify lessons that can be learned from three decades of prior experiences – both successes and failures.

That is precisely what Richard Schmalensee (Howard W. Johnson Professor of Economics and Management, Emeritus, at the Massachusetts Institute of Technology, and Dean Emeritus of the MIT Sloan School of Management) and I sought to do in an article which recently appeared in the Review of Environmental Economics and Policy (REEP) (“Lessons Learned from Three Decades of Experience with Cap and Trade,” Review of Environmental Economics and Policy, volume 11, issue 1, Winter 2017, pp. 59-79).  I encourage you to read the full article, which – in keeping with the style of the Review of Environmental Economics and Policy – is brief and broadly accessible.

In the hope that you may be stimulated to read the full article, in today’s blog essay I draw on the article to provide the historical context of our analysis, and to review some of our conclusions (for the actual analysis of individual cap-and-trade systems, and the justifications for our conclusions, you will need to see the article).

The Historical Context

Thirty years ago, many environmental advocates argued that government allocation of rights to emit pollution legitimized environmental degradation, while others questioned the feasibility of such an approach.  At the time, virtually all pollution regulations took a command-and-control approach, specifying the type of pollution-control equipment to be used or setting uniform limits on emission levels or rates.

Today, it is widely recognized – at least among students of economics – that because emission reduction costs can vary greatly, the aggregate abatement costs under command-and-control approaches can be much higher than under market-based approaches, which establish a price on emissions – either directly through taxes or indirectly through a market for tradable emissions rights established under a cap-and-trade policy.  Because market-based approaches tend to equate marginal abatement costs rather than emissions levels or rates across sources, they can achieve aggregate pollution-control targets at minimum cost.

In the REEP article, Dick Schmalensee and I examined the design and performance of seven of the most prominent emissions trading systems that have been implemented over the past 30 years in order to identify key lessons for future applications.  We focused on systems that have been important environmentally and/or economically, and whose performance has been well documented.  We excluded emission-reduction-credit (offset) systems, which offer credits for emissions reductions from some counterfactual baseline, because while emissions can generally be measured directly, emissions reductions are unobservable and often ill-defined.

The seven emissions trading systems we examined were:

  • the U.S. Environmental Protection Agency’s (EPA’s) phasedown of leaded gasoline in the 1980s;
  • the U.S. sulfur dioxide (SO2) allowance trading program under the Clean Air Act Amendments of 1990;
  • the Regional Clean Air Incentives Market (RECLAIM) in southern California;
  • the trading of nitrogen oxides (NOX) in the eastern United States;
  • the Regional Greenhouse Gas Initiative (RGGI) in the northeastern United States;
  • California’s cap-and-trade system under Assembly Bill 32; and
  • the European Union (EU) Emissions Trading System (ETS).

All of these programs except the first are textbook cap-and-trade systems.

In the article, we reviewed the design, performance, and lessons learned from each of the seven systems (and briefly discussed several other cap-and-trade systems).  In this blog essay, however, I turn immediately to our summary of key lessons.

Lessons from Thirty Years of Experience

Overall, we found that cap-and-trade systems, if well designed and appropriately implemented, can achieve their core objective of meeting targeted emissions reductions cost-effectively.  This is not something that was taken for granted in the past, and is still not accepted in some quarters.  That said, the devil is in the details, and design as well as the economic environment in which systems are implemented are very important.  Moreover, as with any policy instrument, there is no guarantee of success.  Based on the numerous specific lessons we identified in our analysis, several design and implementation features of cap-and-trade programs appear critical to their performance.

Key Features for System Design and Implementation

First, it is important not to require prior approval of trades.  In contrast to early U.S. experience with emissions offset systems, transactions costs can be low enough to permit considerable efficiency-enhancing trade if prior approval of trades is not required.

Second, it is clear from both theory and experience that a robust market requires a cap that is significantly below BAU emissions.

Third, to avoid unnecessary price volatility, it is important for final rules (including those for allowance allocation) to be established and accurate data supplied well before commencement of a system’s first compliance period.

Fourth, high levels of compliance in a downstream system can be achieved by ensuring there is accurate emissions monitoring combined with significant penalties for non-compliance.

Fifth, provisions for allowance banking have proven to very important for achieving maximum gains from trade, and the absence of banking provisions can lead to price spikes and collapses.

Sixth, price collars are important.  A changing economy can reduce emissions below a cap, rendering it non-binding, or a growing economy can increase emissions and drive allowance prices to excessive levels.  Price collars reduce price volatility by combining an auction price floor with an allowance reserve.  The resulting hybrid systems will generally have lower costs (as more stable prices facilitate investment planning) at the expense of less certain emissions reductions.

Finally, economy-wide systems are feasible, although downstream, sectoral programs have been more commonly employed.

Political Considerations that Affect Cap-and-Trade Design

Experiences with cap-and-trade also indicate the importance of political considerations for the design of cap-and-trade programs.

First, because of the potentially large distributional impacts involved, the allocation of allowances has inevitably been a major political issue.  Free allowance allocation has proven to help build political support. Under many circumstances, the equilibrium allowance distribution, and hence the aggregate abatement costs of a cap-and-trade system, are independent of the initial allowance allocation (Montgomery 1972; Hahn and Stavins 2012).  This means that the allowance allocation decision can be used to build political support and address equity issues without concern about impacts on overall cost-effectiveness.

Of course, free allowance allocation eliminates the opportunity to cut overall social costs by auctioning allowances and using the proceeds to cut distortionary taxes.  On the other hand, experience has shown that political pressures exist to use auction revenue not to cut such taxes, but to fund new or existing environmental programs.  Indeed, cap-and-trade allowance auctions can and have generated very significant revenue for governments.

Second, the possibility of emissions leakage and adverse competitiveness impacts has been a prominent political concern in the design of cap-and-trade systems.  Virtually any meaningful environmental policy will increase production costs and thus could raise these concerns, but this issue has been more prominent in the case of cap-and-trade instruments.  In practice, leakage from cap-and-trade systems can range from non-existent to potentially quite serious.  It is most likely to be significant for programs of limited geographic scope, particularly in the power sector because of interconnected electricity markets.  Attempts to reduce leakage and competitiveness threats through free allocation of allowances do not per se address the problem, but an output-based updating allocation can do so.

Third, although carbon pricing (through cap-and-trade or taxes) may be necessary to address climate change, it is surely not sufficient.  In some cases, abatement costs can be reduced through the use of complementary policies that address other market failures, but the types of “complementary policies” that have emerged from political processes have instead addressed emissions under the cap, thereby relocating rather than reducing emissions, driving up abatement costs, and suppressing allowance prices.

Identifying New Applications

Cap-and-trade systems are now being seriously considered for a wide range of environmental problems.  Past experience can offer some guidance as to when this approach is most likely to be successful.

First, the greater the differences in the cost of abating pollution across sources, the greater the likely cost savings from a market-based system – whether cap-and-trade or tax — relative to conventional regulation (Newell and Stavins 2003).  For example, it was clear early on that SO2 abatement cost heterogeneity was great, because of differences in ages of plants and their proximity to sources of low-sulfur coal (Carlson et al. 2000).

Second, the greater the degree of mixing of pollutants in the receiving airshed (or watershed), the more attractive a market-based system, because when there is a high degree of mixing, local hot spots are not a concern, and the focus can thus be on cost-effective achievement of aggregate emissions reductions.  Most cap-and-trade systems have been based on either the reality or the assumption of uniform mixing of pollutants. However, even without uniform mixing, well-designed cap-and-trade systems can be effective, as illustrated by the two-zone trading system under RECLAIM, at the cost of greater complexity.

Third and finally, since Weitzman’s (1974) seminal analysis of the effects of cost uncertainty on the relative efficiency of price versus quantity instruments, it has been well known that in the presence of cost uncertainty, the relative efficiency of these two types of instruments depends on the pattern of costs and benefits.  Subsequent literature has identified additional relevant considerations (Stavins 1996; Newell and Pizer 2003).  Perhaps more importantly, theory (Roberts and Spence 1976) and experience have shown that there are efficiency advantages of hybrid systems that combine price and quantity instruments in the presence of uncertainty.

Implications for Climate Change Policy

Two highly relevant lessons from thirty years of experience with cap-and-trade systems stand out.  First, cap-and-trade has proven itself to be environmentally effective and economically cost-effective relative to traditional command and control approaches. Moreover, less flexible systems would not have led to the technological change that appears to have been induced by market-based instruments (Schmalensee and Stavins 2013) or the induced process innovations that have resulted (Doucet and Strauss 1994).

Second, and equally important, the performance of cap-and-trade systems depends on how well they are designed.  In particular, it is important to reduce unnecessary price volatility, and hybrid designs can offer an attractive option if some variability of emissions can be tolerated, since substantial price volatility generally raises costs.

All of this suggests that cap-and-trade merits serious consideration when regions, nations, or sub-national jurisdictions are developing policies to reduce greenhouse gas (GHG) emissions.  And, indeed, this has happened.  However, because any meaningful climate policy will have significant impacts on economic activity in many sectors and regions, proposals for such policies have often triggered significant opposition.

In the United States, the failure of cap-and-trade climate policy in the Congress in 2010 was essentially collateral damage from a much larger political war that decimated the ranks of both moderate Republicans and moderate Democrats.  Nevertheless, political support for using cap-and-trade systems to reduce GHG emissions has emerged in many other parts of the world.  In fact, in the negotiations leading up to the Paris climate conference in 2015, many parties endorsed key roles for carbon markets, and broad agreement emerged concerning the value of linking those markets (codified in Article 6 of the Paris Agreement).

It is certainly possible that three decades of high receptivity to cap-and-trade in the United States, Europe, and other parts of the world will turn out to have been only a relatively brief departure from a long-term trend of reliance on command and control environmental regulation.  However, in light of the generally positive experience with cap-and-trade, there is reason for optimism that the tarnishing of cap-and-trade in US political debates will itself turn out to be a temporary departure from a long-term trend of increasing reliance on market-based environmental policy instruments.  Only time will tell.

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Trying to Remain Positive

With inauguration day in the United States just two weeks away, it is difficult to harbor optimism about what the Trump presidency will mean for this country and for the world in realms ranging from economic progress to national security to personal liberty (as I wrote in this space one month before the November election – This is Not a Time for Political Neutrality, October 9, 2016).  In the wake of the election, expectations are no better, including in the environmental realm (as I wrote shortly after the election – What Does the Trump Victory Mean for Climate Change Policy?, November 10, 2016).  And since then, the President-elect’s announced nominations for key positions in the administration have probably eliminated whatever optimism some progressives may have been harboring.

Remarkably, the least worrisome development in regard to anticipated climate change policy may be the nomination of Rex Tillerson to become U.S. Secretary of State.  Two months ago it would have been inconceivable to me that I would write this about the CEO of Exxon-Mobil taking over the State Department (and hence the international dimensions of U.S. climate change policy).  But, think about the other likely candidates.  And unlike many of the other top nominees, Mr. Tillerson is at least an adult, and – in the past (before the election) – he had led his company to reverse course and recognize the scientific reality of human-induced climate change (unlike the President-elect), support the use of a carbon tax when and if the U.S. puts in place a meaningful national climate policy, and characterize the Paris Climate Agreement as “an important step forward by world governments in addressing the serious risks of climate change.”

It’s fair to say that it is little more than damning with faint praise to characterize this pending appointment as “the least worrisome development in regard to climate change policy,” but the reality remains.  Everything is relative.  Of course, whether Mr. Tillerson will maintain and persevere with his previously stated views on climate change is open to question.  And if he does, can he succeed in influencing Oval Office policy when competing with Scott Pruitt, Trump’s pick to run EPA, not to mention Rick Perry, Trump’s bizarre choice to become Secretary of Energy?

In the face of all this (and much else), is it possible to offer any statement of optimism or at least hope?  The answer may be found in the reality that U.S. policy – in many issue areas – consists of much more than the policies of the Federal government.  In a variety of policy realms, the states play an exceptionally important role.  One might not normally think about this in the context of addressing a global commons problem, such as climate change, but these are not normal times.

And so I will try to rescue myself from my current mental state – at least temporarily – by focusing today on policy developments in the State of California.  To do this, I offer an op-ed I recently wrote with Professor Lawrence Goulder of Stanford University, which was published in the Sacramento Bee a week before the November election.  Good policy developments at the state level are, of course, even more important now than they were then.

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Sacramento Bee

October 30, 2016

New emissions targets make cap and trade the best low-cost, market-based approach

By Lawrence H. Goulder and Robert N. Stavins

This is a critical time for California’s climate policies. Recently, Gov. Jerry Brown achieved his hope of extending California’s action beyond 2020, the termination date of Assembly Bill 32. Whereas AB 32 called for reducing the state’s greenhouse gas emissions to 1990 levels by 2020, the newly signed Senate Bill 32 and AB 197 mandate an additional 40 percent reduction by 2030.

Unless these ambitious goals are pursued with the most cost-effective policy instruments, the costs could be unacceptably high. The governor’s targets make it especially important to use a low-cost, market-based approach: cap and trade.

Unfortunately, rather than increasing cap and trade’s role, recent proposals emphasize the use of less efficient, conventional policies. The environmental justice lobby supports this change, contending that emissions trading hurts low-income and minority communities by causing pollution to increase.

In fact, abandoning cap and trade would harm these communities by raising costs to businesses and thereby prices to consumers. With cap and trade, the sources able to reduce emissions least expensively take on more of the pollution-reduction effort. This lowers costs and prices.

When the environmental justice community worries about cap and trade, their concern is not about the greenhouse gas emissions that cause climate change: These gases spread evenly worldwide and have no discernible local impact. Rather, it’s about “co-pollutants,” such as nitrogen oxides, carbon monoxide and particulates, which often are emitted alongside greenhouse gases.

By reducing California’s greenhouse gas footprint, cap and trade lowers concentrations of these co-pollutants. Still, it’s possible – in theory – for co-pollutant emissions to increase in particular localities. The best defense against this possibility is to tighten existing laws that limit local air pollution. This would prohibit any trades that would violate such limits.

The environmental justice lobby’s concerns about local air pollution are justified: A new report by the U.S. Commission on Civil Rights acknowledges that low-income and minority communities face disproportionately high air pollution. The best response to this situation is to strengthen existing local pollution laws rather than abandon cap and trade.

Moreover, it is not clear that cap and trade shifts local air pollution toward low-income communities. One recent report from the University of Southern California identified emission increases and blamed them on cap and trade. But increased emissions have been due mainly to economic and population growth. And although emissions from some sources did increase, they decreased at 70 percent of facilities, according to mandatory reporting to the Air Resources Board.

The key question, however, is not how emission levels changed, but rather how cap and trade contributed to the change. Without cap and trade, it is likely that any increases in emissions would have been even greater.

Beyond the environmental impacts, it’s important to consider economic impacts on these communities. Reducing greenhouse gas emissions tends to raise costs of energy and transportation. Because low-income households devote greater shares of their income to energy and transportation than high-income households, virtually any climate policy places greater burdens on those households. Cap and trade minimizes these costs.

Further, cap and trade offers the government a powerful tool for compensating low-income communities for such economic burdens. Most emission allowances are auctioned and pursuant to SB 535, 25 percent of the proceeds go to projects that provide benefits to disadvantaged communities. This has already amounted to over $158 million.

Cap and trade serves the goal of environmental justice better than the alternatives, and it deserves a central place in the arsenal of weapons California uses to address climate change. Rather than step away from this progressive policy, the state should increase its reliance on this progressive, market-based approach.

Lawrence H. Goulder is a professor in environmental and resource economics at Stanford University and former chair of the AB 32 Economic and Allocation Advisory Committee to the California Air Resources Board. Contact him at goulder@stanford.edu.

Robert N. Stavins is a professor of business and government at the Harvard Kennedy School of Government, and contributed to assessment reports to the Intergovernmental Panel on Climate Change. Contact him at robert_stavins@harvard.edu.

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