Feb 6, 2017

Legal Strategies for Addressing Climate Change: A Comparative Analysis of Cap-and-Trade and Carbon Tax | Magnus Amudi

1.     Introduction
Today, major/global climate change conversations are no longer centered on the validity or otherwise of global warming as a major threat and challenge to the earth’s existence. The doubts that once welcomed this subject “are fading, appropriately, as rapidly as some ice sheets and glaciers are melting.”[1] 

The United States Department of State states that, “climate change poses multiple threats to U.S. and global security. It is likely to exacerbate economic and social inequality, and increase competition and conflict over agricultural, marine, and water resources. It can result in the massive displacement of people, including those whose livelihoods depend on these resources.”[2] The discussion today, both locally and internationally, focus on ways to abate the continued deterioration of our climate thereby enhancing our collective survival. The purpose of this paper is to discuss two major legal climate change strategies, comparing and contrasting both, and highlight their advantages and disadvantages The two strategies examined in this paper are Cap-and-Trade and Carbon Tax. “Climate change strategies” is used here to mean plans or methods employed to reduce the emissions of Greenhouse Gases (“GHGs”). The following are the critical GHGs found on earth’s atmosphere: Water vapor (H2O), Carbon dioxide (CO2), Methane (CH4), Nitrous oxide (N2O), Ozone (O3), Chlorofluorocarbons (CFCs).[3]

2.       Comparative Analysis of Cap-and-Trade and Carbon Tax as Legal Climate Change Strategies

2.1.  Cap-and-Trade
Cap and Trade are two words which when taken together represent a legal method of tackling the destructive effects of climate change by reducing the emissions of GHGs. “[A regulator] sets a [] ‘cap’ [] on emissions, which is lowered over time to reduce the amount of pollutants (e.g., CO2) released into the atmosphere. The ‘trade’ creates a market for carbon allowances, since the ‘total number of permits is limited by the cap, the permits take on financial value and can be traded on the open market,’[4] persuading companies to innovate in order to meet, or come in under, their allocated limit. The less they emit, the less they pay, so it is in their economic incentive to pollute less.”[5]

A very successful example of a cap-and-trade legal strategy is the Acid Rain Program (the “Program”). Established by Title IV of the 1990 Clean Air Act with U.S. Environmental Protection Agency (“EPA”) as its administrator. The major goal of the Program is to reduce Sulfur Dioxide (“SO2”) emissions to half of the level in 1980 by setting a cap on the total amount of SO2 that could be emitted by electric power plants across the country. It is believed that the Program have reduced annual SO2 emissions to one-half the amount emitted in 1980.[6]

How it works(ed)? As a typical cap-and-trade program, the Program did not set individual emission caps for each powerplant, rather, an overall cap is set each year with each powerplant allocated a certain number of allowances based on the predetermined cap. An allowance is a right to pollute, to the extend ‘allowed.’ When not fully exhausted or used, by reducing emissions below the allowed level, an allowance holder may sell (trade) or save (bank) the allowance for future use. To be complaint, powerplants that are unable to reduce their emissions below the allowed level must purchase allowances. The trading aspect therefore creates an incentive for emission reduction. The overall allowances are adjusted and lowered over time to ensure continued reduction in emissions and achievement of the program’s goal. How are emissions monitored? Every powerplant under the Program is required to deploy a Continuous Emissions Monitoring (CEM) which continuously measure the emissions of SO2, reporting emissions to the EPA. Under cap-and-trade strategy, some of the major policy issues are what to regulate and the scope (which GHGs and emissions sources to include and where in the fossil fuel supply chain the point of regulation will occur), method of allowance distribution (free distribution, auction or a synergy of both?), and flexibility and cost controls (bankability, safety valve, offsets e.t.c.).

2.2.  Carbon Tax
By contrast, a carbon tax is a tax levied on the carbon content of fuels.[7] “It is intended to make users of fossil fuels pay for climate damage their fuel use imposes by releasing [GHGs, chiefly] carbon dioxide into the atmosphere, and also to motivate switches to cleaner energy.”[8] Like the traditional command and control regime, carbon tax tries to internalize the social cost of the utilization of dirty fuels. Emissions of GHGs, specifically CO2 is proportionate to the carbon content of the fossil fuel burned for the generation of energy, making the implementation of a tax regime on the carbon content of the fossil fuel ease.[9] Due to this certainty, a carbon tax could be implemented at the point of the entry of the dirty fuels into the market (Upstream), passed along through the wholesale users (downstream) to the final consumer of products in rates. An example of a successful carbon tax program is that of Sweden. Sweden has used a carbon tax to reduce greenhouse gas emissions since 1991. “The Swedish Ministry of Environment estimated that carbon tax has cut emissions by an additional 20 percent (as opposed to solely relying on regulations), enabling the country to achieve its 2012 target under the Kyoto Protocol.”[10]

Why Carbon tax? It is direct and it can be used to generate revenues for the government, which applies it for a more economic purpose. “It could be revenue-neutral: all revenues could be rebated directly to every citizen (tax-and-dividend) or could be used to reduce existing taxes (tax-and-shift). Alternatively, revenues could be invested in development and deployment of new clean-energy technologies (tax-and-invest) and/or in energy efficiency programs (tax-and-caulk).”[11]

3.     Comparative Analysis (Highlighting the Strengths and Weaknesses of Both Strategies
Cap-and-trade and carbon trade as discussed are both market-based legal strategies used to address adverse impacts of climate change. However, they will be compared and contrasted under the following subheadings:
3.1.  Innovation-Both cap-and-trade similarly encourage innovation in the way industries or large entities generate/consume energy. To take advantage of the trading part of cap-and-trade, a polluter would require to reduce emissions and either save or trade allowances. In carbon tax, polluters are forced to look for alternatives sources for their energy needs to avoid paying carbon taxes. Thereby driving innovation or forcing the development and deployment of new technologies.
3.2.  Revenue Generation-Both strategies are possible revenue generators. Cap-and-trade can also generate revenue for government if the initial allowances are auctioned rather than freely distributed. However, carbon tax is a certain way to generate revenues.

3.3.  Certainty/Uncertainty-Both strategies share similarities and difference regarding certainty/uncertainty. While cap-and-trade firmly conveys the amount of emissions to be allowed (the ‘cap’), carbon tax does not. Conversely, carbon tax guarantees the amount of revenue to be received from the regulation, but cap-and-trade does not.

3.4.  Monitoring/Report Requirements-Both strategies require close monitoring, reporting and verification of reports to be successful. Without the regulators close monitoring of the program, issues of fraud and misrepresentations may defeat the exercise.

3.5.  Independence/Dependence-One of the not so popular characteristics of these two strategies are their independence/dependence on the intervention of the regulators. For cap-and-trade, as soon as the initial allocation of the allowances are made, emission regulation becomes market controlled, thus requiring little or no governmental intervention. However, for a carbon tax, the regulator will continuously monitor the operation of the program to ensure that the tax has not been a burden to businesses or become too little to matter, as such, requiring adjustments.

3.6.  Economic Justice/Equity-Both strategies raise the price of energy (both electricity and gas) bringing additional adverse economic impact on low-income consumers. Nonetheless, these impacts can be mitigated by utilizing the collected revenue (where allocation was auction in cap-and-trade) in a way that ameliorates its impacts on low-income households. Similarly, if not adequately implemented and regulated, cap-and-trade may create emission hotspots, especially within the low-income communities. Even if the reduction in GHGs are widespread, that of co-pollutants remain a conundrum as they impact on local environment.

3.7.  Regulatory Framework-Both strategies would require a legal framework and/or enabling legislation to be implemented. It is thought that while cap-and-trade may require an entirely new implementation framework, carbon tax may piggyback on existing tax frameworks.

3.8.    Flexibility-Cap-and-trade is the most flexible of both. While polluter may choose to either reduce their emissions by investing in better technologies, some may easily buy allowances to continue usual operations. However, carbon tax offers no such flexibility. Indeed, even if polluters desired to switch from fossil fuel EGU to cleaner burning fuels, such as natural gas, such moves require major investments and a major overhaul.

4.       Conclusion
In view of the above comparative analysis, I am of the view that the cap-and-trade strategies offers much more than the carbon tax does. For one, one of the strongest points in favour of carbon tax is its revenue certainty, if cap-and-trade adopts the auction method for the distribution of initial allowances, it would be carbon tax in addition to trade. Finally, another cap on the feather of cap-and-trade is its tremendous success in United States (the Program) and in the European Union.

[1] Perry E. Wallace, Climate Change, Corporate Strategy, and Corporate Law Duties, American University Washington College of Law Digital Commons @ American University Washington College of Law, 2009
[2] United States Department of State, Addressing Climate Change: A Top U.S. Priority, http://www.state.gov/r/pa/pl/223165.htm
[3] Wikipedia, https://en.wikipedia.org/wiki/Greenhouse_gas#Greenhouse_gases
[4] Eleanor Revelle, Cap-and-Trade Versus Carbon Tax: Two Approaches to Curbing Greenhouse Gas Emissions, retrieved from: http://lwv.org/content/cap-and-trade-versus-carbon-tax-two-approaches-curbing-greenhouse-gas-emissions
[5] Environmental Defence Fund, How Cap and Trade Works, Retrieved fromhttps://www.edf.org/climate/how-cap-and-trade-works (December 17, 2016).
[6] U.S. Environmental Protection Agency, Acid Rain Program Basic Information. Available at: http://www.epa.gov/airmarkets/progsregs/arp/basic.html
[8] Carbon Tax Centre, Pricing Carbon Efficiently and Equitably,https://www.carbontax.org/whats-a-carbon-tax/ Retrieved December 17 2016.
[9] Id.
[11] Eleanor Revelle, Cap-and-Trade Versus Carbon Tax: Two Approaches to Curbing Greenhouse Gas Emissions, retrieved from: http://lwv.org/content/cap-and-trade-versus-carbon-tax-two-approaches-curbing-greenhouse-gas-emissions

Magnus Amudi
Corporate, Energy and Environmental Law Practitioner

Ed’s Note – This article was first published here.

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