Order Code IB97057
CRS Issue Brief for Congress
Received through the CRS Web
Global Climate Change:
Market-Based Strategies
to Reduce Greenhouse Gases
Updated May 2, 2002
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
and tradeable permit program would depend on
releasing gases, including carbon dioxide (CO2),
the specific levy (carbon tax) or allocation
at rates that could affect global climate has re-
scheme (tradeable permit) chosen, the scope of
sulted in proposals for national programs to
the program, the timing of the reductions, and the
curtail emissions. An international framework for
recycling of any revenues.
specific reductions in greenhouse gases was
negotiated at a meeting in Kyoto in December
In addition, many tradeable permit propos-
1997. Concern about costs has encouraged
als include provisions allowing countries to accu-
consideration of CO2 reduction proposals that
mulate permits by reducing emissions in other
employ market-based mechanisms. The passage
countries. This scheme, called joint implementa-
in 1990 of a tradeable allowance system for
tion, was approved in principle at the Kyoto
sulfur dioxide (SO2) control in the United States
conference in December, 1997.
provides a precedent for such mechanisms.
The climate change issue and CO2 control
The two mechanisms receiving the most
raise numerous equity issues. In one sense,
attention are a tradeable permit program (similar
climate change is a concern about
to the acid rain program) and carbon taxes.
intergenerational equity — i.e., the well-being of
Proposed CO2 reduction schemes present large
the current generation versus generations to
uncertainties in terms of the perceived reduction
come. On a global level, the issue also involves
needs and the potential costs of achieving those
the North-South debate. At the domestic level,
reductions. Tradeable permit programs would
equity questions include the regional distribution
reduce CO2 emissions to a specific level with the
of costs under a tradeable permit or carbon tax
control cost handled efficiently, but not at a
scheme. For example, an important impact of
specific cost level. Carbon taxes would effec-
either a carbon tax based on the carbon content
tively cap marginal control costs at the specific
of fossil fuels or a tradeable permit program
tax level, but the precise level of CO2 achieved
would be the pressure for fuel shifts away from
would be less certain. Hence, a major policy
coal and toward gas. Regions such as
question is whether one is more concerned about
fast-growing areas in need of more energy and
the possible cost of the program and therefore
owners of “all electric” homes, among others,
willing to accept some uncertainty about emission
would likely be disproportionately hit by a CO2
reduction in order to have some limits on costs
control scheme. In addition, people may be
(i.e., carbon taxes) or whether one is more
affected differently according to income class.
concerned about achieving a specific emission
These issues, however, have not been sufficiently
reduction level with costs handled efficiently, but
analyzed at the current time to be sure of how
not capped (i.e., tradeable permits).
various sectors would be affected.
The specific effects of both a carbon tax
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
In February, 2002, the Bush Administration initiated a new voluntary greenhouse gas
reduction program. Rather than attempting to meet a specific reduction target, the proposal
focuses on improving the carbon efficiency of the economy.
In November 2001, the Seventh Conference of Parties to the Framework Convention
on Climate Change concluded negotiations on implementation of the Kyoto Protocol. With
respect to flexible implementation mechanisms, the Parties outlined the institutions that
would oversee the flexible implementation mechanisms contained in the Protocol. However,
the Conference put off deciding on the consequences of non-compliance until a later date.
In July, the Sixth Conference of Parties to the Framework Convention on Climate
Change agreed to a draft decision on implementing the Kyoto Prot ocol. 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
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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 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 2000, the United States did not meet its
voluntary commitment at Rio to stabilize greenhouse gas emissions at 1990 levels. Indeed, it is
unclear when U.S. carbon emissions may stabilize. A November 2001 draft Climate Action
Report by the Administration estimates U.S. carbon emissions in the year 2010 will be 34% above
their 1990 levels. (For more on U.S. domestic climate change policy since Rio, see CRS Report
RL30024, Global Climate Change Policy: Cost, Competitiveness, and Comprehensiveness.)
Meanwhile, the United States and other signatories to the Climate Change Convention met
in December 1997 in Kyoto, Japan, to conclude negotiations on a binding protocol for specific
provisions to reduce greenhouse gas emissions. 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 until 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: U.S. Greenhouse Gas Emissions —
Status, Trends, and Projections)
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-
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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 November 2001, the Seventh
Conference of Parties to the Framework Convention on Climate Change concluded negotiations
on implementation of the Kyoto Protocol. With respect to flexible implementation mechanisms,
the Parties outlined the institutions that would oversee the flexible implementation mechanisms
contained in the Protocol. However, the Conference put off deciding on the consequences of non-
compliance until a later date. The United States was a non-participant to most of what took place
at this conference.
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.
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
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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
Clinton 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.
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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 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.
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
that currently (or
criteria, including
technology by the
projected) available
economic,
appropriate time. Focus on
technologies can
environmental and
research, development,
eliminate at little or no
social perspectives.
and demonstration; and
overall cost to the
on 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 specific
energy efficiency in the
status quo is the
reduction program. Risk
economy, but significant
baseline from which
lies in imposing costs in
costs (quantified in terms
costs and benefits are
excess of benefits. Any
of GDP loss) resulting
measured.
chosen reduction goal
from global climate
Unquantifiable
should be implemented
change control programs.
uncertainty tends to be
through economic
Typical loss estimates
ignored.
measures such as
range from 1-2% of GDP.
tradeable permits or
emission taxes.
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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
that currently (or
criteria, including
technology by the
projected) available
economic,
appropriate time. Focus on
technologies can
environmental and
research, development,
eliminate at little or no
social perspectives.
and demonstration; and
overall cost to the
on removing barriers to
economy.
commercialization of new
technology.
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 climate
viability and the well-
planet’s ecosystems
change threatens.
being of future
should be the primary
Believes that values such
generations. Such
criterion in determining the
as intergenerational
values reflect ecological
specifics of any reduction
equity should not be
and ethical
program. Focus of
considered commodities
considerations;
program should be on
to be bought and sold.
adherents see attempts
altering values and
Costs are defined
to convert them into
broadening consumer
broadly to include
commodities to be
choices.
aesthetic and
bought and sold as
environmental values
trivializing the issue.
that economic analysis
cannot readily quantify
and monetize.
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.
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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.
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 six-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
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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 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
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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 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.
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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-6 meeting, it was agreed that
nuclear power was not an acceptable option under the CDM
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
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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%), 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
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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. 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
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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 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.
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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.
In February, 2002, the Administration initiated a new voluntary greenhouse gas program,
similar to ones introduced by the earlier Bush and Clinton Administrations. Developed in response
to the U.S. ratification of the 1992 UNFCCC, these previous plans projected U.S. compliance,
or near compliance, with the UNFCCC goal of stabilizing greenhouse gas emissions at their 1990
levels by the year 2000 through voluntary measures. The new proposal introduced by the Bush
Administration does not make that claim, only projecting a 100 million metric ton reduction in
emissions from what would occur otherwise in the year 2012. Instead, the plan focuses on
improving the carbon efficiency of the economy, reducing current emissions of 183 metric tons per
million dollars of GDP to 151 metric tons per million dollars of GDP in 2010. It proposes several
voluntary initiatives, along with increased spending and tax incentives, to achieve this goal.
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However, the Administration projects that three-quarters of this reduction would be achieved
through current efforts underway, not by the new initiatives.
Based on the Administration’s estimates, the initiative will result in U.S. greenhouse gas
emissions being 28% above 1990 levels in the year 2010, a 4.5% reduction over a business-as-
usual baseline.
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