The Right Way to Cut Carbon Emissions

When President George W. Bush withdrew carbon dioxide from the list of air pollutants to be reduced by coal-burning power plants, he may have inadvertently done the right thing. For carbon is different from other pollutants, and America's system for reducing carbon emissions should be different too.

Carbon dioxide is a sneaky pollutant. It's invisible to our eyes and noses, and unlike its sister carbon monoxide, isn't directly toxic to humans. The danger from carbon dioxide lies solely, but nonetheless ominously, in its excess accumulation in the atmosphere. For carbon dioxide is a greenhouse gas -- like the panes of a greenhouse, it lets heat from the sun pass through, but traps heat that radiates back. Most scientists now agree that, unless we reduce carbon dioxide emissions substantially, average temperatures in the United States will rise five degrees to 10 degrees Fahrenheit within our children's lifetimes. This warming will produce more frequent -- and more intense -- storms, droughts, heat waves, floods and fires than we currently endure. Sea levels will rise and many habitats will be harmed. In time, the basic conditions that have sustained life on earth could be altered.

The trouble is that, unlike other pollutants, carbon dioxide isn't an impurity that can be easily removed or avoided. Rather, it's an inescapable byproduct of fossil fuel burning. Thus, to substantially reduce carbon dioxide emissions means to change the way we've made cars and electricity for over a century. That, obviously, is no mean task. So when we get around to doing it -- as sooner or later we must -- we'd better do it right. Otherwise -- as California's maladroit deregulation of electricity has shown -- the economic consequences could be severe.


Current policies to reduce carbon emissions -- tax credits, efficiency standards, research subsidies and the like -- are clearly inadequate, because they either rely on a voluntary action or are limited to specific sectors of the economy.

What's the right way to reduce carbon emissions? To answer this question we first need a set of guidelines. I propose five. The ideal carbon emission reduction system should be economy-wide, market-based, simple, gradual and equitable.

Why economy-wide? Current policies to reduce carbon emissions -- tax credits, efficiency standards, research subsidies and the like -- are clearly inadequate, because they either rely on voluntary action or are limited to specific sectors of the economy. Thus, the legislation from which George Bush excluded carbon applied only to electric utilities. It's conceivable that, sector by sector, appropriate regulatory schema could be devised that, taken together, could achieve a large reduction in carbon emissions. But the diversity of these schema would likely produce higher enforcement and compliance costs, longer delays in implementation, and many more loopholes than would a single scheme that applies seamlessly to the whole economy. The same considerations also argue for a system that is market-based rather than governmental, simple rather than complex and gradual rather than abrupt.

The need for equity in a carbon reduction system derives from the fact that the transition to a less carbon-intensive economy will of necessity impose costs on industry, consumers and workers. Adherence to the first four guidelines can minimize these costs, but some costs can't be avoided. For reasons of political acceptability, if nothing else, these unavoidable costs should be shared as equitably as possible.

Upstream vs. Downstream Permits

With these guidelines in mind, we can now consider the details of an optimal carbon emission reduction system. Let's assume, as most policymakers do, that the ideal system will include a cap-and-trade mechanism similar to that created by the Clean Air Act of 1990. That mechanism -- supported by George W. Bush's father -- established a gradually declining cap on total sulfur emissions by coal-burning power plants. Beneath that aggregate cap, individual plants were given tradable emission permits based on their historic emissions. Each plant could then reduce its sulfur emissions to the number of permits it received, reduce its emissions below that number and save or sell its unused permits, or buy permits to emit sulfur above that number. Compliance is checked by monitoring the plants' smokestacks.


In an upstream permit system, the companies that import carbon into the U.S. economy -- from underground or overseas -- would be required to won emission permits equivalent to the quantity of carbon they import.

The trouble with applying a similar system to carbon is the unimaginable difficulty of monitoring every smokestack and tailpipe in the United States Because carbon, unlike sulfur, is ubiquitous in our economy -- and because the carbon content of every barrel of oil, ton of coal or cubic foot of natural gas is a chemically fixed percentage -- it's much easier to keep track of carbon when it enters the economy than when it leaves. This argues for a system of upstream rather than downstream carbon permits.

In an upstream permit system, the companies that import carbon into the U.S. economy -- from underground or overseas -- would be required to own emission permits equivalent to the quantity of carbon they import. At the end of each year, they'd have to show permits equal to that quantity. This would be a matter of financial reporting rather than physical monitoring. And it would apply only to the 2,000 or so companies at the top of the carbon chain. No other companies -- and no consumers at all -- would have to hold permits or otherwise account for their carbon usage.

Such an upstream permit system could be compared to installing a spigot at the entry point of carbon into the U.S. economy. By gradually cranking the spigot down, the quantity of carbon emissions could be reduced slowly but steadily. All carbon entering the economy would be captured, and enforcement costs would be minimal.

Auctions vs. Giveaways

Under the Clean Air Act of 1990, virtually all sulfur emission permits were given at no cost to utilities. In effect, the right to pollute a common asset -- the atmosphere -- was handed to polluters for free.

The justification for this giveaway was that the windfall which accrued to utilities was small and would be passed through to ratepayers. (Utilities in those days were regulated monopolies.) The situation with regard to carbon today, however, is quite different.


The permit prices paid by fossil fuel importers would, of course, be passed on to downstream carbon users.

How Upstream Permits Would Work

An upstream permit system would be like a spigot at the point carbon enters the economy. Its chief virtues would be simplicity and effectiveness -- it would capture all the carbon entering the economy with minimal monitoring and enforcement.

The biggest difference is in the market value of carbon emission permits. When the permitted quantity of carbon emissions is reduced, this is equivalent to reducing the supply of fossil fuels. As American consumers know all too well by now, the result of reducing fossil fuel supplies is to increase their price. The faster supply is reduced, the bigger the price rise. The same law applies to reducing the supply of carbon emission permits.

According to various studies, the market value of U.S. carbon emission permits, once a cap-and-trade system kicks in, could be hundreds of billions of dollars per year. If carbon permits are given away free, those billions would be an unearned gift to fossil fuel companies. If, on the other hand, the carbon permits are auctioned, the revenues thus raised could cover some of the unavoidable costs of climate change. For example, coal miners could be paid to retire early, and consumers could be given rebates to offset higher energy prices.

The permit prices paid by fossil fuel importers would, of course, be passed on to downstream carbon users. These higher prices, though potentially burdensome, would send appropriate and non-discriminatory signals to everyone to reduce their use of fossil fuels. At the same time, they'd drive the introduction of carbon-free technologies.

The Sky Trust

One carbon emission reduction system that meets the guidelines set forth above has been advanced by Americans for Equitable Climate Solutions (www.aecs.org), a Washington-based nonprofit. Called the Sky Trust, it's an upstream cap-and-trade system that recycles the revenue from carbon permit auctions to consumers and other adversely affected parties. While the precise numbers proposed by AECS -- the initial emission cap, the rate at which the cap is lowered, and a first-year permit price ceiling of $25 per ton (to protect the economy against a sudden price jolt) -- can be much debated, the basic Sky Trust architecture should have wide appeal.

The Sky Trust is an upstream cap-and-trade system that auctions carbon permits and pays yearly dividends to all Americans.


Modeled after the Alaska Permanent Fund, the Sky Trust would pay equal dividends to all American using revenue from carbon permit auctions.

Modeled after the Alaska Permanent Fund (which pays all Alaskans equal yearly dividends from an investment fund built with state oil income), the Sky Trust would pay equal dividends to all Americans using revenue from carbon permit auctions. Though consumers would pay higher prices for fossil fuels, they'd get money back at the end of the year. Those who use lots of fossil fuel would pay more in higher prices than they get back, while those who are frugal would get back more than they pay in. This isn't only fair, it's precisely the incentive needed to change Americans' carbon consumption habits.

Notably, no new taxes would be involved. The higher prices paid by consumers would be set by markets, not politicians, and the extra money paid for carbon would go not to the U.S. Treasury, but back to consumers in the form of dividends.

The chief attractions of the Sky Trust are its simplicity, fairness and effectiveness -- plus the fact that it has nothing to do with the Kyoto Protocol. For these reasons, it could be the kind of plan George W. Bush eventually endorses. At the very least, it would show his critics that excluding carbon from traditional smokestack regulation wasn't such a bad idea after all.




This article originally appeared in the June 2001 issue of Environmental Protection, Vol. 12, No. 6, p. 22.

This article originally appeared in the 06/01/2001 issue of Environmental Protection.

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