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Issues in the Design of a Cap-and-Trade Program for Carbon Emissions 1 (November 2003)

handle is hein.congrec/cbo8847 and id is 1 raw text is: A series of issue summari.es from the Congressional Budget Office NOVEMBER 25, 2003 Issues in the Design of a Cap-and-Trade Program for Carbon Emissions If the United States acts to limit climate change, a key step may be reducing the use of fossil fuels (oil, natural gas, and coal) and thus decreasing the amount of carbon dioxide that human activities release into the atmosphere. Even policymakers who think such action is inevitable are far from agreeing about the timing or the size of cuts in carbon emissions because of uncertain science and complex eco- nomic considerations. However, there is a growing consen- sus that if cuts are to be made, economic incentives are a better method than direct government controls. Such con- trols might assign specific emission rates to individual fac- tories, vehicles, and other emitters or require the use ofpar- ticular equipment or production processes. By contrast, incentive-based approaches-such as taxes or the cap-and- trade program discussed below-would discourage emis- sions by raising their price. As a result, those approaches would generally be more cost-effective than direct controls. Under a cap-and-trade program, policymakers would set a limit (the cap) on total carbon emissions during some period-presumably at a level below what would otherwise occur-and require certain entities to hold rights, or allow- ances, to the emissions permitted under that cap. Each allowance would entitle the holder to emit some amount of carbon, such as a metric ton. After the allowances were initially distributed, entities would be free to buy and sell them (the trade part of the program). No effort to reduce carbon emissions would be free. Fossil fuels are key inputs in the U.S. economy, so restricting their use would reduce incomes. The appeal of a cap-and- trade program is that, if properly designed, it could moti- vate firms and households to cut emissions in ways that would minimize the cost of achieving the reductions. Be- cause entities could buy and sell allowances, those that could take advantage of the lowest-cost opportunities to re- duce emissions would make the deepest cuts. (They would then sell their excess allowances to entities for whom re- ducing emissions would cost more.) A cap-and-trade pro- gram could also be designed to include the sequestering of carbon-for example, by planting trees, which absorb carbon dioxide from the atmosphere. In that case, regulated entities could have the option of fulfilling part of their allowance requirement by paying other entities (such as farmers) to sequester carbon. Governments have successfully used cap-and-trade pro- grams to reduce emissions of other air pollutants, such as lead, nitrogen oxides, and sulfur dioxide (an ingredient of acid rain). In the case of sulfur dioxide, researchers estimate that the cap-and-trade program lowered the cost ofmeeting the emissions target by between 43 percent and 55 percent compared with the cost of requiring all regulated sources of sulfur dioxide to meet a uniform emission rate. Substan- tial cost savings would also be likely to occur under a cap- and-trade program for carbon dioxide. Various bills that would limit carbon emissions have been introduced in the 108th Congress. For example, the Cli- mate Stewardship Act of 2003 (S. 139) would cap carbon emissions from several sectors of the economy. The Clean Air Planning Act of 2003 (S. 843) and the Clean Smoke- stacks Act of 2003 (H.R. 2042) would cap carbon emis- sions (and other pollutants) from the electricity-generating sector. Choices about the design of a cap-and-trade program would determine whether reductions in carbon emissions occurred throughout the economy or only in certain sec- tors. Those choices would also affect the cost of achieving a given cut in emissions as well as the distribution of that cost among shareholders, workers, and consumers. Finally, those choices would determine whether the emissions cap would be met with certainty-but at an uncertain cost-or whether the cost would be capped but the actual level of reductions would remain uncertain.

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