Energy & Environment

A Cap-and-Trade Program That Works

Northeastern states have developed an efficient way to reduce greenhouse gases. So why won't the feds follow suit?
by | December 2010
 

Built in 1922, the Town Hall of Athol reflects the prosperity and pride that characterized this mill town in Western Massachusetts a century ago. Its high bell tower and three-story town meeting room, complete with a proscenium stage, is testament to a time when Yankee engineering and cheap hydropower turned small New England towns into industrial powerhouses.

That world is largely gone now, but Athol’s residents are still proud of their Town Hall. High school seniors hold their prom there, and city employees are proud to point out that the building’s quiet grandeur reflects that it is also a memorial hall, designed to honor the men and women who fought and died for their community.

Yet after 80 years of constant use, Athol’s Town Hall had become an uncomfortable place for the people who spent the most time there: the 29 town employees. “The town clerk’s office was so cold that we put plastic up inside the window,” says David Ames, Athol’s town manager. “The wind coming through the window blew it off.” In the foothills of Western Massachusetts, this was clearly a problem. But when Ames priced replacing the original single-pane, triple-hung windows on the 40,000-square-foot building, the cost -- about $100,000 -- seemed prohibitive for a town of 11,299 residents.

“There was always something more pressing,” says Ames, “an ambulance, say, or a police cruiser.” So employees brought in space heaters in the winter, and elementary school children shivered through Christmas carols during the annual sing-along. But earlier this year, all that changed when Athol received a $98,000 grant from the state Department of Energy Resources for new Energy Star-certified windows, funded by a novel source -- the sale of carbon dioxide.

In Washington, D.C., the idea of reducing greenhouse gases with a cap-and-trade system is a controversial one. Liberals insist it would jump-start the green economy; conservatives say it would cripple the struggling economy. But in Massachusetts -- and most of the nine other Northeastern and mid-Atlantic states that make up the Regional Greenhouse Gas Initiative (RGGI, pronounced “reggie”) -- this debate is moot. Two years ago, RGGI imposed a cap-and-trade regime on large power plants in Delaware, Maryland, New England, New Jersey and New York. Nine auctions and $729 million later, the verdict is in: Cap and trade works. RGGI’s auctions have run smoothly, avoiding the price volatility and lack of transparency that characterized California’s experiments with energy trading a decade ago or the early problems that plagued the European Union’s Emission Trading Scheme.

“When we originally started doing this, back earlier in the decade,” says David Littell, commissioner of Maine’s Department of Environmental Protection and chair of RGGI’s board of directors, “there were a lot of people who emphasized how it would wreck our economy and push jobs overseas.” That clearly has not been the case. On the contrary, RGGI states have used auction proceeds to create hundreds, if not thousands, of green jobs closer to home. A study in New York state found that every dollar devoted to green energy generated another six dollars in economic activity.

But something strange happened on the way to a national cap-and-trade system: At the very moment when a state-created regional program has demonstrated that the method can work, policymakers in Washington are turning against it. What started as a conservative idea has become an expletive for many in the Republican Party. According to an analysis conducted by the liberal Center for American Progress, 86 of the 100 freshmen Republicans elected to Congress in November are opposed to any climate change legislation that would increase government revenue. At a post-election press conference, even President Barack Obama conceded that cap and trade was effectively dead. That leaves the states participating in RGGI -- as well as the states participating in other regional climate change initiatives, such as the Western Climate Initiative and the Midwestern Greenhouse Gas Reduction Accord -- facing a difficult question: Should states build what the federal government will not?

Pigovian Tax, Clean Air Act and RGGI

To understand the appeal of cap-and-trade approaches to pollution reduction, it’s important to understand how economists think about environmental problems. To economists, pollution is a negative externality -- a cost incurred by people who did not agree to it by a transaction that was not properly priced. On a large scale, negative externalities can lead to market failure. That’s precisely how most environmental economists view global warming: a transaction (burning fossil fuels) that produces a negative externality (rising temperatures) that affects everyone, including people who did not consent to it. To correct such a negative externality, economists typically recommend what is called a Pigovian tax, where the value of the tax is equal to the value of the negative externality. A tax on carbon would be an example. Set correctly, such a tax would make the market more efficient, allowing cleaner alternative fuels to compete more successfully in the marketplace.

But taxes -- even Pigovian taxes -- have drawbacks. In 1960, University of Chicago economist Ronald Coase -- worried that the Pigovian tax amounted to heavy-handed government intervention -- wrote a classic paper that suggested a different way to think about addressing negative externalities. Coase showed how, when property rights were clear and transaction costs were low, it was possible in theory for the parties to organize payments to each other in a way that maximized efficiency but required only minimal government intervention. Coase’s insight won him a Nobel Prize, and inspired subsequent work that established the formal economic foundation for the idea of a market in pollution. It remained a fairly academic idea until 1990 when President George H. W. Bush implemented a cap-and-trade system to tackle the challenge of acid rain.

Acid rain was caused largely by Midwestern power plants burning high-sulfur coal. To reduce sulfur dioxide and nitrogen oxide emissions, environmentalists and elected officials in the states most affected by the problem wanted to require power plants to install “scrubbers.” (The Pigovian tax solution -- tax high-sulfur coal -- was politically unworkable.) Gray preferred a different approach. Policymakers would set an overall goal for reductions, but individual utilities would have considerable flexibility in meeting it. Utilities that could reduce emissions cheaply would be allowed to sell emissions credits to plants that couldn’t, achieving the same level of reduction but at a far lower price. In 1990, Congress made this approach the centerpiece of its Clean Air Act reauthorization. It was a smashing success.

“We saw emission reductions being made at much lower costs than most people originally expected,” says Nathaniel Keohane, chief economist at the Environmental Defense Fund. This was, he adds, largely because of the flexibility that cap and trade gave utilities in meeting the targets.

Back in 1991, the Environmental Defense Fund was the only major national environmental group to enthusiastically support a cap-and-trade approach to acid rain. And Keohane still backs the method. “If you were going to draw up a list of all-time great Republican ideas, marketplace-oriented environmental policies would be one of them,” he says. “It would have to be at the top of the list.” It was also a politically appealing idea, one that played well with suburban swing voters, particularly in Northeastern states. So it was hardly surprising that as climate change replaced acid rain as the major issue of environmental concern, politicians would begin to look at instituting a cap-and-trade regime.

In 2003, George Pataki, the Republican governor of New York, took the first step. He sent the governors of 11 Northeastern states letters proposing the creation of a system that capped emissions from the region’s largest utility plants. Two years later, on Dec. 20, 2005, the Republican governors of Connecticut, New Hampshire, New York and Vermont, and the Democratic governors of Delaware, Maine and New Jersey signed a memorandum of understanding that laid the foundation for RGGI. (Massachusetts, after initially participating in the process and then dropping out toward the end of Gov. Mitt Romney’s administration, rejoined the process after Deval Patrick succeeded Romney as governor. Maryland and Rhode Island also joined the organizing group.)

The governors -- both Republican and Democratic -- were frustrated “with the lack of forward federal action,” Littell says. So they took the lead. Each state committed itself to seeking statutory or regulatory approval for a program aimed at stabilizing and then reducing carbon dioxide emissions from fossil fuel-fired power plants with a capacity equal to or greater than 25 megawatts. Instead of simply giving allowances directly to utilities, as most earlier cap-and-trade systems had done, states decided to sell carbon dioxide allowances through a regional market, making cap-and-trade a revenue generator. The emissions cap was set 4 percent higher than the average annual emission for the period from 2000-2005. Starting in 2015, it would begin to decline by 2.5 percent a year over the course of four years, leading to a 10 percent reduction by the year 2019. Auctions would be held quarterly, using a trading platform that RGGI would create; credits would be bankable so that utilities or traders could secure credits now against future reductions.

There was another important design feature. Participating states agreed to direct the auction proceeds back into the green economy. Twenty-five percent of allowances were set aside for programs that promoted energy efficiency, furthered renewable or non-carbon energy technologies, supported the development of carbon-emissions abatement technology and mitigated ratepayer price increases. Participating states quickly pledged to devote almost 100 percent of auction proceeds to such programs. Connecticut, Maine, Rhode Island and Vermont went further by writing the requirement into law.

RGGI started modestly. “A lot of states had or were developing their climate action plans,” says Massachusetts Commissioner of Environmental Protection Laurie Burt. For most states, RGGI represented just one element of a portfolio approach. As a result, says Burt, RGGI largely eschewed publicity and focused instead on developing a trading platform and ensuring that trades went smoothly. All the while, though, the RGGI states expected the federal government to come forward with a plan of its own.

As the national economy slowed, carbon dioxide emissions slowed, diminishing the value of state carbon dioxide allowances. Yet even so, over the course of two years, RGGI auctions have raised nearly $750 million for the 10 states now participating.

The importance of that part of the program “wasn’t initially appreciated, but given the depths of the recession, it is certainly strongly appreciated now,” says Littell. For hard-pressed states, that source of money has been hard to resist. Even climate change skeptics such as New Jersey Gov. Chris Christie have found the funds raised by RGGI auctions useful. He’s quietly diverted $65 million from New Jersey’s RGGI account to the general budget. And to many conservatives, that is part of the problem.

The Resistence to Cap and Trade

Ryan Hecker, a 30-year-old Harvard Law School graduate who lives in Houston, is one of the pistons in the Tea Party movement. Early last year, as the movement was taking shape, Hecker got the idea of creating a bottoms-up, grassroots version of former House Speaker Newt Gingrich’s Contract with America. In September, he created a website (www.thecontract.org) and invited people to submit their ideas for issues such a contract would cover. He received more than a thousand proposals. Through surveys and grass-roots meetings, he narrowed them down to 10 issues and then asked responders to cast votes ranking them by order of importance. Over the course of nearly four months, some 453,000 people cast their vote. On April 15, Hecker announced his results. The second most popular item was: “Reject Cap and Trade.” It attracted 72 percent support, 10 percentage points less than “Protect the Constitution.”

Hecker says he wasn’t surprised by the negative reaction to cap and trade. “It’s the idea that with the kind of economic problems we have today, we were focused on something that might not work and that would heavily influence consumer behavior through taxes,” he says. To Hecker and those who voted on his online survey, cap-and-traders are looking for a quick solution that involves trying to change consumer behavior by forcing them to pay a higher cost in a regulated market. “They are just passing the buck to the consumer through this kind of solution.”

Government, Hecker argues, should be promoting solutions that lead to cheaper energy. “Why isn’t there a natural gas car?” he asks, rhetorically. “It’s not the consumers fault that other alternative energy sources aren’t doing well in the marketplace. They are not doing well because of a lot of the lobbyist stuff that is going on.”

Skepticism of this sort had stalled cap-and-trade legislation in the U.S. Senate even before last month’s election. After November’s vote, most observers believe that the prospective of legislative action on cap and trade in the 112th Congress is now nil. There is, however, likely to be a push by the new House Republican majority to prevent the U.S. Environmental Protection Agency from moving ahead with plans to regulate carbon dioxide as a harmful pollutant. That leaves state efforts such as RGGI standing alone as virtually the sole governmental attempt to address climate change. It also raises an uncomfortable question: When a global solution is needed, what can a handful of states really do?

Conceptually the case for pessimism seems strong. But in a state like Massachusetts, it’s hard not to be impressed by the enthusiasm for collaboration and experimentation evident in many cities and towns. In addition to its new windows, Athol recently became one of the commonwealth’s 35 designated “green communities” by enacting stringent new zoning commissions and committing to reduce its energy consumption by 20 percent over five years. Thanks to RGGI, stimulus money and ratepayer changes, Massachusetts is also expanding the reach of its energy efficiency programs from between 10,000 and 15,000 homes a year to between 50,000 and 100,000 homes a year.

“Cap and trade is only one area of collaboration” among the RGGI states, says Burt. Thirty states now have climate action plans, and what those “are really doing is a portfolio approach,” says Burt. Indeed, the RGGI states, along with Pennsylvania and Washington, D.C., are now looking at transportation sector initiatives, such as California-style fuel efficiency and auto emissions standards, and promoting smart growth.

RGGI has also fostered striking collaboration within states, between departments of environmental protection and energy resources, which have historically been at odds. In Massachusetts, it was the Department of Energy Resources that administered Athol’s grant. That department has also worked with Burt’s agency to create such innovative tools as MassEnergyInsight, which allows cities and towns to go online and document exactly how much energy local government is consuming.

Although RGGI members still figure the feds will step in and take action, they are continuing to move forward without it. “It may take longer than we anticipated,” says Littell. “It would be too much to say we are hopeful for cap and trade, but we are hopeful that a renewable energy bill might have some support after the election.”

Massachusetts Commissioner of Energy Resources Philip Giudice remains optimistic that the U.S. Congress will see the light on cap and trade. “The underlying societal need hasn’t diminished,” he says. “The question is still when -- not if.”

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