Order Code IB97057
CRS Issue Brief for Congress
Received through the CRS Web
Global Climate Change:
Market-Based Strategies
to Reduce Greenhouse Gases
Updated September 25, 2001
Larry Parker
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

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CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
Status of Global Climate Change Issue and Response
Estimating Cost Impacts of Controls
Market-Based Mechanisms for Reducing Greenhouse Gases
Tradeable Permits (Allowances)
Tradeable Permits (Credits)
Carbon/CO2 Emissions Tax
Joint Implementation
Issues
Cost-Effectiveness: Price versus Quantity
Comprehensiveness
Economic Impact
Equity
Legislation in the 107th Congress
Other Proposals
United States and International Activities
Administration Domestic Initiatives

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Global Climate Change:
Market-Based Strategies to Reduce Greenhouse Gases
SUMMARY
The possibility that human activities are
The specific effects of both a carbon tax
releasing gases, including carbon dioxide
and tradeable permit program would depend
(CO2), at rates that could affect global climate
on the specific levy (carbon tax) or allocation
has resulted in proposals for national programs
scheme (tradeable permit) chosen, the scope of
to curtail emissions. An international frame-
the program, the timing of the reductions, and
work for specific reductions in greenhouse
the recycling of any revenues.
gases was negotiated at a meeting in Kyoto in
December 1997. Concern about costs has
In addition, many tradeable permit pro-
encouraged consideration of CO2 reduction
posals include provisions allowing countries to
proposals that employ market-based mecha-
accumulate permits by reducing emissions in
nisms. The passage in 1990 of a tradeable
other countries. This scheme, called joint
allowance system for sulfur dioxide (SO2)
implementation, was approved in principle at
control in the United States provides a prece-
the Kyoto conference in December, 1997.
dent for such mechanisms.
The climate change issue and CO2 con-
The two mechanisms receiving the most
trol raise numerous equity issues. In one
attention are a tradeable permit program
sense, climate change is a concern about
(similar to the acid rain program) and carbon
intergenerational equity — i.e., the well-being
taxes. Proposed CO2 reduction schemes
of the current generation versus generations to
present large uncertainties in terms of the
come. On a global level, the issue also in-
perceived reduction needs and the potential
volves the North-South debate. At the domes-
costs of achieving those reductions. Tradeable
tic level, equity questions include the regional
permit programs would reduce CO2 emissions
distribution of costs under a tradeable permit
to a specific level with the control cost handled
or carbon tax scheme. For example, an impor-
efficiently, but not at a specific cost level.
tant impact of either a carbon tax based on the
Carbon taxes would effectively cap marginal
carbon content of fossil fuels or a tradeable
control costs at the specific tax level, but the
permit program would be the pressure for fuel
precise level of CO2 achieved would be less
shifts away from coal and toward gas. Re-
certain. Hence, a major policy question is
gions such as fast-growing areas in need of
whether one is more concerned about the
more energy and owners of “all electric”
possible cost of the program and therefore
homes, among others, would likely be dispro-
willing to accept some uncertainty about
portionately hit by a CO2 control scheme. In
emission reduction in order to have some
addition, people may be affected differently
limits on costs (i.e., carbon taxes) or whether
according to income class. These issues,
one is more concerned about achieving a
however, have not been sufficiently analyzed
specific emission reduction level with costs
at the current time to be sure of how various
handled efficiently, but not capped (i.e., trade-
sectors would be affected.
able permits).
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
In July, the Sixth Conference of Parties to the Framework Convention on Climate
Change agreed to a draft decision on implementing the Kyoto Protocol. With respect to
flexible implementation mechanisms, the Parties agreed to exclude nuclear power as a
possible non-carbon alternative under the Clean Development Mechanism and joint
implementation program. The Parties also reiterated that use of flexible mechanisms shall
be supplemental to domestic efforts. The United States did not participate in these
deliberations.
In April, a third bill was introduced in the 107th Congress to reduce carbon dioxide
emissions from electric generating facilities. H.R. 1335, introduced by Representative Allen,
would reduce and cap carbon dioxide emissions at their 1990 levels by the year 2005.
In March 2001, two bills were introduced in the 107th Congress to reduce carbon
dioxide emissions from electric generating facilities to their 1990 levels. In contrast, the
Administration announced in March that the Kyoto Protocol was “dead” as far as it was
concerned. However, EPA Administrator Whitman emphasized that the Administration
hoped to work constructively with the EC to develop technologies and market-based
incentives to address global climate change.
BACKGROUND AND ANALYSIS
Certain gases emitted as a result of human activities may be affecting global climate.
Most concern centers on the possibility that CO2, along with other gases, could increase
global temperatures, with subsequent effects on precipitation patterns and ocean levels that
could affect agriculture, energy use, and other human activities.
Status of Global Climate Change Issue and Response
The initial issue of whether the potential for global climate change poses a threat that
justifies prompt action to curtail CO2 and other so-called greenhouse gases remains actively
debated—both domestically and internationally. (For a review of the technical dimensions
of this question, see CRS Issue Brief IB89005, Global Climate Change.) Some view the
risks as sufficiently grave and urgent to justify immediate action. Others are uncertain of the
risks but believe that selected policies to reduce emissions can be justified for other reasons
and would provide insurance if the risks were borne out; these other reasons include improved
energy efficiency, reduced reliance on imported oil, and increased revenues. Still others
caution that actions to reduce CO2 and other greenhouse gases could disrupt the nation’s
economy and should not be undertaken unless further scientific evidence of risks becomes
available.
Despite the uncertainties, however, scientists and policymakers have increasingly
adopted the view that human activities are releasing greenhouse gases at rates that could
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affect global climate. As a result, initiatives are underway to address the issue, resulting in
proposals for national and international programs to curtail emissions.
An agreement on a United Nations’ Framework Convention on Climate Change was on
the agenda at the U.N. Conference on Economic Development in Rio de Janeiro in June 1992.
The United States was an early signatory to the agreement, which was approved by the
Senate October 7, 1992. In April 1993, President Clinton directed the federal government
to craft a plan that would stabilize U.S. greenhouse gas emissions at 1990 levels by the year
2000 (see CRS Report 94-404, Climate Change Action Plans). However, in 1997 it is
projected that the United States will not meet its voluntary commitment at Rio to stabilize
greenhouse gas emissions at 1990 levels by the year 2000. Indeed, it is unclear when U.S.
carbon emissions may stabilize. A November 1997 report by the Energy Information
Administration estimates U.S. carbon emissions in the year 2020 will be 45% above their
1990 levels. (For more on U.S. domestic climate change policy since Rio, see CRS Report
RL30024, Global Climate Change Policy: From “No Regrets” to S.Res. 98.)
Meanwhile, the United States and other signatories to the Climate Change Convention
prepared to meet in December 1997 in Kyoto, Japan, in an effort to conclude negotiations on
a binding protocol for specific provisions to reduce greenhouse gas emissions. In October
1997, just before a meeting in Bonn, Germany, a preliminary for the Kyoto meeting, the
White House announced a new position on reducing greenhouse gases, calling for
stabilization at 1990 levels by the years 2008-2012. This position was modified in December
at Kyoto to be more flexible. The final protocol agreed to at Kyoto requires the United States
to reduce emissions of six greenhouse gases (CO2, methane, nitrous oxide,
hydrofluorocarbons, perfluorocarbons, sulfur hexafluoride) by 7% on average from 1990
levels over the period 2008-2012. In November 1998, the parties met in Buenos Aires to
develop work plans for specific elements of the Kyoto Protocol, including the trading of
emission reductions and the Clean Development Mechanism. The parties decided that these
work plans should be completed by the year 2000. The November 1999 meeting in Bonn
postponed decisions about emissions trading under the November 2000 meeting at the Hague.
The meeting at The Hague failed to arrive at agreement on emissions trading, and further
negotiations are scheduled for May 2001. In March, 2001, The current Bush administration
announced that it was formally abandoning the emission targets set under Kyoto. (For more
on the U.S. reduction requirement under Kyoto, see CRS Report 98-235 ENR, Global
Climate Change: Reducing Greenhouse Gases — How Much from What Baseline?)
This decision by the current Bush Administration has not deterred the international
community. In July 2001, the Sixth Conference of Parties to the Framework Convention on
Climate Change agreed to a draft decision on implementing the Kyoto Protocol. With respect
to flexible implementation mechanisms, the Parties agreed to exclude nuclear power as a
possible non-carbon alternative under the Clean Development Mechanism and joint
implementation program. The Parties also reiterated that use of flexible mechanisms shall be
supplemental to domestic efforts. The United States did not participate in these deliberations
Thus, despite continuing uncertainties about the risks of global climate change, proposals
for addressing it are going forward, and it is the content of those proposals rather than the
issue of whether the problem is exigent that is the focus of this brief.
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Estimating Cost Impacts of Controls
Estimates of costs to reduce CO2 emissions vary greatly, and focus attention on an
estimator’s basic beliefs about the problem and the future, rather than on simple, technical
differences, in economic assumptions. (See CRS Report 98-738, Global Climate Change:
Three Policy Perspectives. It identifies three “lenses” through which people can view the
global climate change issues, and their influence on cost analysis.) These are summarized in
Table 1. None of these perspectives is inherently more “right” or “correct” than another;
rather, they overlap and to varying degrees complement and conflict with each other. People
hold to each of the lenses to some degree.
However, the differing perspectives lead to very different cost estimates. Figure 1 below
shows a scatter-plot by World Resources Institute (WRI) of the predicted impacts from 162
estimates from 16 different economic models on the U.S. economy from a CO2 abatement
program. Although the size of the proposed CO2 reduction and the time allowed to achieve
it (not explicitly modeled in the WRI report) are critical factors in determining the costs and
benefits of any reduction program, WRI found underlying modeling assumptions not related
to policy decisions explained a significant amount of the difference in the estimates. For
example, consistent with a “technological” view of the problem, models that assumed
technological development of non-carbon substitutes for current fossil fuel use, along with
increased energy and product substitutions, had significantly less cost than models that
assumed such advancements would not occur in a timely fashion. For example, a recent study
by the American Council for an Energy-efficient Economy (ACEEE) argues that carbon
emissions could fall 10% below 1990 levels by 2010 with a net economic savings of $58
billion along with 800,000 new jobs. Such savings are assumed to come from new technology
and market mechanisms to encourage cost-effective implementation strategies. Such a
position presumes that technologies are available now, or will be very shortly, that can
achieve these reductions cost-effectively.
Likewise, consistent with an “ecological” perspective, models that included the benefits
of air pollution damages and climate change damages averted by the CO2 reduction estimated
considerably less costs to the economy than models that did not include such benefits. The
WRI report suggests that the cost profile of a CO2 reduction program changes substantially
if one includes the benefits of air pollution and climate change effect averted by controlling
CO2. The Administration’s 1998 analysis of costs to comply with Kyoto estimates benefits
from controlling ancillary pollutants (SO2, NOx, and fine particulates) at between $1.8 and
$10.6 billion annually.
Consistent with an “economic” perspective, models that included policy approaches that
encouraged efficient economic responses to CO2 reductions, that included joint
implementation schemes, and involved efficient recycling of any revenues from control
strategies, significantly reduced costs over models runs that did not include such policy
options. Like the technology perspective, economically efficient solutions assume that the
program is implemented in such a way to permit the economy sufficient time to absorb the
new price signals with minimal short-term constraints.
The uncertainty about the risk of climate change and the critical impact of assumptions
about the nature of the problem effectively preclude predictions of the ultimate costs of
reducing greenhouse gases. As a result, attention has focused on how to minimize costs by
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selecting the most economically efficient strategies to reduce CO2 emissions. Traditionally,
air pollution control programs have relied on various “command and control” regulatory
approaches, including ambient quality and technology-based standards. But increasingly,
economic efficiency concerns have been directed toward supplementing regulatory control
with market-based mechanisms, including pollution taxes and tradeable permits. (For more
on the pros and cons of economic mechanisms in pollution control, see CRS Report 89-360
ENR, Using Incentives for Environmental Protection: An Overview, and CRS Report 94-
213, Market-Based Environmental Management: Issues in Implementation.)
The tradeable allowance system for SO2 control in the acid rain program enacted in
1990 represents a significant step in this evolution of economic mechanisms. Acceptance of
this system has led to calls for use of a similar system with other pollutants, including CO2.
Three bills proposing a tradeable permit-type system to begin controlling CO2 emissions have
been introduced in the 107th Congress.
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Table 1: Influence of Climate Change Perspectives on Policy
Parameters
Seriousness of
Risk in developing
Approach
Problem
mitigation program
Costs
Technology
Is agnostic on the
Believes any reduction
Viewed from the bottom-
merits of the problem.
program should be
up. Tends to see
The focus is on
designed to maximize
significant energy
developing new
opportunities for new
inefficiencies in the
technology that can be
technology. Risk lies in
current economic system
justified from multiple
not developing technology
that currently (or
criteria, including
by the appropriate time.
projected) available
economic,
Focus on research,
technologies can
environmental and
development, and
eliminate at little or no
social perspectives.
demonstration; and on
overall cost to the
removing barriers to
economy.
commercialization of new
technology.
Economic
Understands issue in
Believes that economic
Viewed from the top-
terms of quantifiable
costs should be examined
down. Tends to see a
cost-benefit analysis.
against economic benefits
gradual improvement in
Generally assumes the
in determining any
energy efficiency in the
status quo is the
specific reduction
economy, but significant
baseline from which
program. Risk lies in
costs (quantified in terms
costs and benefits are
imposing costs in excess
of GDP loss) resulting
measured.
of benefits. Any chosen
from global climate
Unquantifiable
reduction goal should be
change control
uncertainty tends to be
implemented through
programs. Typical loss
ignored.
economic measures such
estimates range from 1-
as tradeable permits or
2% of GDP.
emission taxes.
Ecological
Understands issues in
Rather than economic
Views costs from an
terms of its potential
costs and benefits or
ethical perspective in
threat to basic values,
technological opportunity,
terms of the ecological
including ecological
effective protection of the
values that global
viability and the well-
planet’s ecosystems
climate change
being of future
should be the primary
threatens. Believes that
generations. Such
criterion in determining
values such as
values reflect ecological
the specifics of any
intergenerational equity
and ethical
reduction program. Focus
should not be considered
considerations;
of program should be on
commodities to be
adherents see attempts
altering values and
bought and sold. Costs
to convert them into
broadening consumer
are defined broadly to
commodities to be
choices.
include aesthetic and
bought and sold as
environmental values
trivializing the issue.
that economic analysis
cannot readily quantify
and monetize.
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Market-Based Mechanisms for Reducing Greenhouse
Gases
Proposals to use market mechanisms to implement greenhouse gas emission reductions
have revolved around three approaches: tradeable permits (as “allowances” and as “credits”),
carbon taxes, and joint implementation. The protocol negotiated at Kyoto contains articles
on emissions trading and joint implementation. These provisions were strongly supported by
the Clinton Administration. In addition, some European countries have implemented or are
considering carbon taxes to bring about greenhouse gas reductions in their countries.
Tradeable Permits (Allowances)
A model for a tradeable permit approach is the SO2 allowance program contained in
Title IV of the 1990 Clean Air Act Amendments. The Title IV program is based on two
premises. First, a set amount of SO2 emitted by human activities can be assimilated by the
ecological system without undue harm. Thus the goal of the program is to put a ceiling, or
cap, on the total emissions of SO2 rather than limit ambient concentrations. Second, a market
in pollution rights between polluters is the most cost-effective means of achieving a given
reduction. This market in pollution rights (or allowances, each of which is equal to one ton
of SO2) is designed so that owners of allowances can trade those allowances with other
emitters who need them or retain (bank) them for future use or sale. Initially, most
allowances were allocated by the federal government to utilities according to statutory
formulas related to a given facility’s historic fuel use and emissions; other allowances have
been reserved by the government for periodic auctions to ensure the liquidity of the market.
Conceptually, a CO2 tradeable permit program could work similarly. Some number of
CO2 allowances could be allocated, and a market in the allowances would permit emitters to
use, sell, buy, or bank them. However, significant differences exist between acid rain and
possible global warming that may affect the appropriateness of a Title IV-type response to
CO2 control. For example, the acid rain program may involve up to 3,000 new and existing
electric generating facilities that contribute two-thirds of the country’s SO2 and one-third of
its nitrogen oxide (NOx) emissions (the two primary precursors of acid rain). This
concentration of sources makes the logistics of allowance trading administratively manageable
and enforceable. However, CO2 emissions are not so concentrated. Although over 95% of
the CO2 generated comes from fossil fuel combustion, only about 33% comes from electricity
generation. Transportation accounts for about 33%, direct residential and commercial use
about 12%, and direct industrial use about 20%. Thus, small dispersed sources in
transportation, residential/ commercial, and the industrial sectors are far more important in
controlling CO2 emissions than they are in controlling SO2 emissions. This creates significant
administrative and enforcement problems for a tradeable permit program if it attempts to be
comprehensive.
These concerns multiply as the global nature of the climate change issue is considered,
along with other potential greenhouse gases. Article 3 of the protocol negotiated at Kyoto
emphasizes that any international emissions trading should be supplemental to a country’s
domestic efforts, not a substitute for them.
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Current SO2 allowance trading plans between individual utilities do not shed much light
on how well the existing allowance market will work over the long-term. Some individual
trades between utilities and EPA-sponsored auctions have been conducted, but the current
level of trading activity has not established the viability of the marketplace. For a market to
thrive, transactions must become sufficiently commonplace for an open, public market price
to be established with limited bilateral negotiation. Based on the results of the EPA auctions
conducted by the Chicago Board of Trade, allowance prices are considerably below that
anticipated when the legislation was enacted. However, the five-year experience of the
SO2-allowance market may be insufficient to give much guidance on how well a
CO2-allowance market might work.
Tradeable Permits (Credits)
As noted above, a tradeable allowance involves future emissions. An allowance is a
limited authorization to emit a ton of pollutant; allowances are allocated to an emitting facility
under an applicable emission limitation at the beginning of a year. The facility decides
whether to use, trade, or bank those allowances, depending on its emissions strategy. Then,
at the end of the year, the agency compares an emitting facility’s actual emissions with its
available allowances to determine compliance.
A different approach to creating a tradeable permit program is to use credits instead of
allowances. A credit is created when a facility actually emits a pollutant at less than its
allowable limit as defined in by the program. An example of this type of program is EPA’s
“Emission Reduction Credit program” (ERC) under the Clean Air Act. Under the ERC
program, EPA requires that any credit created under a state program implementing emissions
trading be “surplus, enforceable (by the state), permanent, and quantifiable.” Thus, a state
must certify the creation of the credit, unlike an allowance program, where allocation is
dictated by a statutory or regulatory formula. Any CO2 reduction credit program could build
on EPA’s and states’ experience with the current emission reduction credit program.
The primary advantage of a credit program over an allowance program is that it does not
discriminate against new sources. Allowance programs tend to allocate their allowances
based on some historic baseline year. Those sources included in the baseline get their
allowances free. Those future sources not included in the baseline have to pay either the
older, existing sources to obtain allowances or to buy allowances at auction. With a credit
program, sulfur credits can be created by any source, as the baseline is dictated by the
emissions cap and yearly production, not a historical year. The disadvantage of such a system
is that facility planning is very difficult as operators do not know precisely what their
permissible limit will be from year to year.
Carbon/CO2 Emissions Tax
An alternative market-based mechanism to the tradeable permit system is carbon taxes
— generally conceived as a levy on natural gas, petroleum, and coal according to their carbon
content, in the approximate ratio of 0.6 to 0.8 to 1, respectively. In the view of most
economists, the most efficient approach to controlling CO2 emissions would be a carbon tax.
With the complexity of multiple pollutants and millions of emitters involved in controlling
CO2, the advantages of a tax are self-evident. Imposed on an input basis, administrative
burdens such as stack monitoring to determine compliance would be reduced. Also, a carbon
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tax would have the broad effect across the economy that some feel is necessary to achieve
long-term reductions in emissions.
However, in other ways, a tax system merely changes the forum rather than the
substance of the policy debate. Because paying an emissions tax becomes an alternative to
controlling emissions, the debate over the amount of reductions necessarily becomes a debate
over the tax level imposed. Those wanting large reductions quickly would want a high tax
imposed over a short period of time. Those more concerned with the potential economic
burden of a carbon tax would want a low tax imposed at a later time with possible exceptions
for various events. Emissions taxes would remain basically an implementation strategy; policy
determinations such as tax levels would require political/regulatory decisions. In addition, a
tax system would raise revenues. Indeed, one argument for—or against—such a system
would be that it is a tax that would raise revenues. The disposition of these revenues would
significantly affect the economic and distributional impacts of the tax. (For further
information, see CRS Report 92-623 ENR, Carbon Taxes: Cost-Effective Environmental
Control or Just Another Tax?)
Other tax schemes to address global climate change are also possible. For example, the
European Community (EC) has discussed periodically a hybrid carbon tax/energy tax to begin
addressing CO2 emissions. Fifty percent of the tax would be imposed on energy production
(including nuclear power) except renewables; 50% of the tax would be based on carbon
emissions. Some European countries have modified their energy taxation to fit the model
discussed by the EC.
Currently, five European countries have carbon-based taxes. Finland imposed the first
CO2 tax in 1990 and modified it in 1994. The Finnish tax has two components: (1) a basic
tax component to meet fiscal needs and (2) a combined energy/CO2 tax component. For
coal, peat, and natural gas, there is no fiscal component. The Netherlands also introduced a
CO2 tax in 1990, modified in 1992 to fit the EC model. It does include tax relief from the
energy component of the tax for energy-intensive industries. Sweden introduced a CO2 tax
in 1991 on all fossil fuels, unless it is used in electricity production. In 1993, the tax scheme
was modified to reduce its burden on industry. Denmark introduced a CO2 tax in 1992 that
covers fuel oil, gas, coal, and electricity (gasoline is taxed separately). Taxes paid by industry
are completely reimbursed to the sector. Norway introduced a CO2 tax in 1991 on oil and
natural gas and extended it to some coal and coke use in 1992. However, there are many
exemptions and the tax rate is not differentiated according to the carbon content of the fuels.
Likewise, the Netherlands has a CO2 tax, but the taxes do not vary according to fuel type and
energy use.
Joint Implementation
Joint Implementation (JI) is an attempt to expand the availability of cost-effective CO2
reductions into the international sphere through a variety of different activities. Basically, a
developed country (where opportunities for reducing emissions are expensive) needing CO2
reductions to meet its obligations under any international treaty could obtain reduction credits
by financing emission reductions in another country, usually a developing country (where
more cost-effective reductions are available). As generally conceived, the developed country
financing the reductions and the developing country hosting the reduction project would split
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the achieved reductions between them in some previously agreed-upon manner. Joint
Implementation is a keystone of U.S. climate change policy; it was subject to considerable
debate at the Conference of Parties (COP) meetings in Berlin. These discussions resulted in
agreement to implement JI in a pilot phase. Projects must be compatible with and supportive
of national environmental and development priorities; accepted, approved, or endorsed
beforehand by the Parties’ governments; and have anticipated environmental benefits and
projected financing fully articulated beforehand. Credits generated cannot be used to meet
the Rio Treaty year 2000 target; credit for post-2000 targets was left to the meeting in Kyoto,
which included JI as one of its flexible implementation mechanisms.
The focus of the U.S. JI effort is the U.S. Initiative on Joint Implementation (USIJI).
Managed by a Secretariat cooperatively staffed by 8 federal agencies, the USIJI is a pilot JI
program initiated by the Administration as part of its “Climate Change Action Plan” in 1993.
Currently, there are about 26 projects in 11 countries that have received USIJI approval.
The USIJI encourages U.S. industry to use its resources and technology to reduce greenhouse
gas emissions and promote sustainable development. (Its web site is [http://www.ji.org].)
The advantage of JI for developed countries is that it widens the options available to
obtain necessary credits under any reduction program. This translates into lower costs to
those countries, compared with their own domestic reduction activities. For the developed
country, particularly where it does not have the resources to control emissions or protect
sequestration areas, reductions or protection would occur more quickly than would otherwise
be possible.
However, the disadvantages are also significant. A developed country may have to rely
on another sovereign government to ensure compliance with part of its international
commitment. Governments change, and policies change. If a new government chose to
remove or shut down a pollution control device, the developed country might have little
recourse but to look elsewhere for its necessary reduction. Particularly with sequestration
projects that involve marketable commodities, such as trees, enforcement could be quite
difficult. A tree’s value as cooking or heating firewood for natives could easily exceed its
value as a carbon sequester. In the long-run, the enthusiasm with which a developing country
may enforce agreements with respect to JI projects is unclear.
Indeed, developing countries could have significant economic incentives to abrogate JI
projects, particularly if they are viewed as constraining necessary development, or locking up
a natural resource that the country would like to exploit. This incentive is further encouraged
if the JI project is perceived as a developed country’s project. The term “economic
imperialism” has already be applied to JI projects by some opponents.
After much negotiation, the protocol agreed to at Kyoto contains provisions on joint
implementation that generally follow the guidelines set up at Berlin. Because developing
countries have no emission requirements to meet (unlike developed countries), the protocol
sets up a clean development mechanism to promote sustainable development in them while
providing emission reduction opportunities for developed countries. Participation is voluntary;
benefits must be real, measurable, and long-term; reductions must be in addition to any
normal activity. Operated under supervision of the COP, reductions achieved between 2000
and 2008 may be used to offset commitments in the 2008-2012 time period. In the July 2001
COP meeting, it was agreed that nuclear power was not an acceptable option under the CDM
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Issues
Cost-Effectiveness: Price versus Quantity
Proposed CO2 reduction schemes present large uncertainties in terms of the perceived
reduction needs and the potential costs of achieving those reductions. In one sense,
preference for a carbon tax or tradeable permit system depends on how one views the
uncertainty of costs involved and benefits to be received. For those confident that achieving
a specific level of CO2 reduction will yield very significant benefits—enough so that even the
potentially very high end of the marginal cost curve does not bother them — then a tradeable
permit program may be most appropriate. CO2 emissions would be reduced to a specific
level, and in the case of a tradeable permit program, the cost involved would be handled
efficiently, but not controlled at a specific cost level. This efficiency occurs because control
efforts are concentrated at the lowest cost emission sources through the trading of permits.
However, if one is more uncertain about the benefits of a specific level of reduction —
particularly with the potential downside risk of substantial control cost to the economy —
then a carbon tax may be most appropriate. In this approach, the level of the tax effectively
caps the marginal control costs that affected activities would have to pay under the reduction
scheme, but the precise level of CO2 achieved is less certain. Emitters of CO2 would spend
money controlling CO2 emissions up to the level of the tax. However, since the marginal cost
of control among millions of emitters is not well known, the overall effect of a given tax level
on CO2 emission cannot be accurately forecasted. Hence, a major policy question is whether
one is more concerned about the possible economic cost of the program and therefore willing
to accept some uncertainty about the amount of reduction received (i.e., carbon taxes) or
whether one is more concerned about achieving a specific emission reduction level with costs
handled efficiently, but not capped (i.e., tradeable permits).
A proposal was floated by the Clinton Administration for a tradeable permit program
with a ceiling on the price of permits. If permit prices rose above a certain price, the
government would have intervene to control costs by selling more permits at a specific price.
In essence, this would have given the permit program the character of a carbon tax by
controlling costs through a price “safety valve,” while allowing quantity to increase to any
level necessary to prevent price increases. Not surprisingly, environmental groups interested
in protecting the emission limitations of any global climate change program attacked the idea
as a “target-busting escape clause.” Industry groups suggested that such a tradeable permit
program amounts to a tax.
Comprehensiveness
As suggested earlier, carbon emissions are ubiquitous. Much of the emissions comes
from the direct combustion of fossil fuels from small, dispersed sources such as automobiles,
homes, and commercial establishments. For example, the 12% of emissions from the
residential/ commercial sector comes from such things as space heating/cooling (9.3 %, oil
and natural gas), water heating (1.5%, mostly natural gas), and appliances (1.2%, mostly
natural gas). If one adds to these dispersed sources the 33% of emissions that come from
direct combustion from automobiles (13.9%), trucks (11.2%), airplanes (4.5%), ships (1.8%),
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pipelines (0.6%), and railroads (0.8%), the number of individual sources runs into the
millions; very small sources contribute almost half the emissions.
Assuming a carbon tax is assessed on an input basis (i.e., on the carbon content of the
fuel), then the number of sources is largely irrelevant — the sources would get the correct
price signal from the increased cost of their fuel. This is one of the primary strengths of the
carbon tax scheme—it can be very comprehensive and potentially induce the necessary
changes in individual as well as corporate behavior that could substantially reduce dependence
on carbon emitting energy sources. In this sense, a carbon tax is not just a band-aid to reduce
CO2 emissions, but a program to reduce carbon intensiveness in the economy and in
individual lifestyles.
For a tradeable permit program, the numbers of sources can represent a substantial
administrative and enforcement problem. One approach to making the situation more
manageable would be to limit the scope of the trading system to domestic implementation
strategies. As noted above, international emission trading is termed “supplemental” under the
consolidated negotiating text. Likewise, the scope could be limited further by focusing the
trading program on the electric utility sector. Another approach could be to limit the size of
the source included in the trading program. Others could “opt-in,” but their participation
would be voluntary. Thus, direct combustion of fossil fuels in the residential, commercial, and
industrial sectors (e.g., natural gas, home heating oil) would be indirectly encouraged by the
program and use of CO2 emitting electricity (particularly coal-fired electricity) discouraged.
The transportation sector would be little affected (unless it chose to be).
Economic Impact
Obviously, the economic impact of either a tradeable permit program or a carbon tax
depends on the level of reductions desired and the timing of those reductions. Most of the
studies on the economic impact of CO2 control programs have focused primarily on carbon
taxes. This is not surprising as carbon taxes are easier to model than a tradeable permit
program. However, the uncertainty involved in these analyses is quite large; further work is
necessary to reduce the current range of estimates. (For further discussion, see CRS Report
92-623 ENR, Carbon Taxes: Cost-Effective Environmental Control or Just Another Tax?)
For example, estimates of the carbon tax necessary to stabilize U.S. CO2 emissions at
their 1990 level by the year 2000 range from under $30 a ton to over $100 a ton. Economic
assumptions that result in this range of estimates include: (1) carbon emissions growth
assumptions in the absence of legislation, (2) responsiveness of the economy to the carbon
tax in terms of increased energy efficiency, and (3) type of model employed. This uncertainty
is compounded when attempts are made to estimate GNP effects of carbon taxes. Very small
differences in GNP estimation techniques can result in large differences in projected impacts
(particularly over the long term). Preliminary evidence indicates that the adverse effects of
a carbon tax can be reduced if the proceeds from that tax are “recycled” either to offset
certain existing taxes or fund investment incentives to encourage economic growth
(particularly through greater capital formation). Thus, the impact of a carbon tax on the
economy would depend to some degree on how the government disposed of generated
revenues. However, considerably more work is needed to define the economic consequences
of a specific proposal to recycle revenues before much confidence can be put into the results.
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Of course, if one has an technological or ecological orientation, the assumptions resulting
from those orientations can draw the economic assumptions discussed here.
The extent that economic analysis of carbon tax programs provides insight for a
tradeable permit program depends partially on the scope of the program, the options included,
and the monitoring and transaction costs. If the government chose to sell its allowances at
auction, rather than given them away (as is typical), the government would have revenue like
a carbon tax to recycle or readdress perceived distortions in the current tax code. In June
2000, CBO released a study on the distributional effects of carbon trading programs. It
concludes that if the government gave away carbon allowances to U.S. firms (as is typical for
trading programs), the effects are regressive on households. If the allowances are sold at
auction, the distributional effects would depend on the ultimate disposition of the revenue
received from the sale. However, the carbon tax analysis does suggest that the price of a
permit (and any revenues from the sale thereof) would be difficult to estimate with any
precision at the current time.
The specific effects of both a carbon tax and tradeable permit program would depend
on the specific levy (carbon tax) or allocation scheme (tradeable permit) chosen. Experience
with both tax code revisions and the allocation scheme under the new acid rain title suggests
that regional, state, and sector-specific concerns could receive special treatment in these
decisions. In addition, for a carbon tax, the allocation of revenue received could also be
influenced by such concerns.
Equity
The climate change issue and CO2 control raise numerous equity issues. In one sense,
the concern about climate change is a concern about intergenerational equity—i.e., the
well-being of the current generation versus generations to come. On a global level, the issue
also involves the North-South debate. Some industrialized Northern countries suggest that
the lesser-developed Southern countries refrain from certain activities (such as clearing rain
forests) that Southern countries feel are important for their economic growth. Southern
countries often suggest that the Northern countries change their current unsustainable growth
practices and assist the South in sustainable development. Some supporters of tradeable
permits have suggested that internationalization of the permit program could allow the
wealthy countries to fund CO2-reducing activities (preserving forest, improving efficiency,
etc.) as a means of achieving cost-effective reductions and assisting developing countries (i.e.,
joint implementation). However, as noted above, monitoring the long-term efficacy of JI
projects raises administrative issues. Some carbon tax proponents have suggested that a
portion of collected revenue could be set aside for assisting developing countries.
Percentages to be set aside and more generally the political acceptability of such a proposal
are unclear.
Other equity questions include the regional distribution of costs under a tradeable permit
or carbon tax scheme. For example, an important impact of either a carbon tax based on the
carbon content of fossil fuels or a tradeable permit program would be the pressure for fuel
shifts away from coal and toward gas. (For a review of this impact, see CRS Report 91-883
ENR, Coal Market Impacts of CO2 Control Strategies as Embodied in H.R. 1086 and H.R.
2663.) Other regions, such as fast growing areas in need of more energy and owners of “all
electric” homes, among others, would likely be disproportionately hit by a CO2 control
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scheme. In addition, people may be affected differently according to income class. These
issues have not been sufficiently analyzed at the current time to draw firm conclusions.
Legislation in the 107th Congress
In the 107th Congress, three bills have been introduced to control CO2 emissions. S. 556,
introduced by Senator Jeffords, and H.R. 1256, introduced by Representative Waxman would
reduce and cap emissions of carbon dioxide from electric generating facilities beginning in
2007. For S. 556 and H.R. 1256, a cap of 1.914 billion tons would have affected all electric
generating facilities rated at 15 megawatts (Mw) or higher. The third bill, H.R. 1335,
introduced by Representative Allen, would also reduce and cap emissions of carbon dioxide
from electric generating facilities at 1.914 billion tons. However, unlike S. 556 and H.R.
1256, would affect generating facilities rate at 50 Mw or higher, and has a compliance
deadline of 2005. For all three bills, EPA is authorized to include market-oriented
mechanisms, such as emissions trading, to implement the reduction targets.
Other Proposals
United States and International Activities
In March 2001, the Bush Administration announced that the Kyoto Protocol was “dead”
as far as it was considered. In rejecting the Kyoto Protocol as unfair to the United States,
EPA Administrator Whitman emphasized the Administration’s desire to work constructively
with the EC to develop technologies, market-based incentives, and other innovative
approaches to global climate change. However, the Administration has yet to announce or
outline any policy alternatives as a basis for international discussions.
Administration Domestic Initiatives
In late September 2000, Presidential candidate George W. Bush proposed a national
energy plan that would include requiring utilities to reduce their carbon dioxide emission over
a “reasonable” time frame in a manner similar to the current market-based acid rain reduction
program. Few specifics, such as reduction targets or schedule, were included in the plan.
In March 2001, the Bush Administration reversed its campaign position, stating that it will
not seek legislation to reduce CO2 emissions. In making the reversal, the Administration
cited a DOE study indicating that energy costs would increased if controls were put on CO2
emissions.
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