Cap & Invest in Washington State

Shorter answer

A pure cap forces emissions reduction while a pure price (fee or tax) guarantees the price faced but not the emissions reduced.  A cap system meshes most closely with a path to meet specified emissions limits. It also is likely to be a much more cost-effective system for encouraging collective action to reduce emissions rather than a pay-or-reduce decision for each individual actor.   Carbon pricing can create a disadvantage for actors who have no real alternative, leading to greater economic disruption at the same market price as faced in a cap. A cap is best aligned to include trading and investments as complements to the system, and performs best with smart market management and foresight on setting an appropriate cap volume.  Additionally, a cap system with trading provides a stronger economic incentive to innovate because, rather than just avoiding a price, there is also an economic incentive to beat the cap and unlock a revenue market from selling excess allowances. And finally, linking with other jurisdictions if desired can create a more robust marketplace.

In practical terms, popular opinion tends to view regulating CO2 and making investments for tax rebates and renewable energy research much more favorably than a fee or tax on carbon.  We have seen this play out in Washington with two carbon tax or fee initiatives voted down by a comfortable margin in 2016 and 2018.

More detailed answer

While a cap can be designed to act more like a fee (with strict price floors and ceilings) and  a fee can be designed to act more like a cap (flexible pricing tied to the rate of emissions reductions), in general, a cap forces emission reductions, and fee or tax sets a  price with a less certain market reaction. A cap meshes well with setting specified limits on future emissions, and can be structured on a ramp course to meet those limits while providing certainty for cumulative carbon reductions in between.  It can also provide an opportunity to link with other jurisdictions directly to create a more robust marketplace.

Under a cap, the price depends more on the collective ability of regulated entities to meet the specified emissions limits. The program allows additional options beyond reducing one’s own emissions or paying the price in order to encourage the most cost effective outcome. If a large commercial building can more cheaply reduce emissions than an industrial manufacturer, the industrial manufacturer can pay for the extra emissions and both entities end up better off financially than if they had been required to each reduce an equal amount of emissions.  The net effect is more emissions reductions are achieved for the same market price.

As a tool to ensure reductions and ramp up ambition quickly as needed, a cap is a great fit.  By incorporating trading, the overall goal is collective effort to solve a collective problem, seeking the lowest possible cost of accomplishing cap compliance wherever in the economy is most cost-effective to do so.   This keeps economic disruption to a minimum while ensuring net emissions reduction goals are met.  

A tax or fee approach does not allow this same flexibility. Even if there’s no practical alternative, a fee or tax system creates a disadvantage to companies and people living within covered jurisdictions versus those that are not covered.  The greater the price, the greater the economic distress, so minimizing or offsetting the tax is necessary to mitigate its regressive impacts. This issue is often referred to as an “unlevel playing field.”

In practice, the best system is not a strict cap approach or a strict price approach, but rather a Cap with trading of allowances and investing of allowance-auction revenue along with some market management provisions, such as a floor and ceiling price on the carbon price set by the market.  The key addition is the “invest” component, because it provides funds for several important uses:

• Longer-term investments, like paying off capital equipment, that complement the market strength of shorter-term investments;  
• Investments in emission reductions that are the appropriate province of government, such as for activities not covered by the cap, as well as ones that seek co-benefits to GHG reductions such as traffic congestion relief, equity, or incentivizing entrepreneurial behavior like an “X prize” competition for an ambitious technology goal;

A cap system with trading also provides a stronger economic incentive to innovate.  Rather than simply avoiding a future price under a carbon fee with technology that only works for your specific site or process, monetizing excess allowances by “beating the cap” can provide revenue from accelerating emissions reductions.  Over the long run, the economic incentive is expected to generate more innovation for the same level of carbon price.

Certainly a cap is not without challenges. A cap requires the foresight to set a cap at an appropriate level, manage the impacts on sensitive populations and businesses, and to strike a net beneficial balance with offsets and banked allowances. 

However, on balance our research and education on carbon policies leads us to agree with the Pew Center on Climate Change’s perspective that: 

“Ultimately, cap-and-trade programs offer opportunities for the most cost-effective emissions reductions. Deciding on the most equitable method of initial allowance distribution, what trading rules should be, and other design features is challenging. Once established though, a well-designed cap-and-trade market is relatively easy to implement, can achieve emissions reductions goals in a cost-effective manner, and drives low-greenhouse gas innovation.”

Do you believe cap & invest is the best policy at the national level as well, or is your conclusion limited to the WA state level?

The same comparative issues explained above are applicable at the national and state levels. While a congressionally approved cap and trade system would offer certain advantages, a growing cluster of state’s adopting similar systems offers a credible alternative to advance national action.

The unlevel playing field issue still exists under a national program, as it relates to international competition.  This unfairness can be mitigated with “border adjustments,” which basically are tariffs paid by consumers on goods depending on their GHG emission footprint.  However, such systems are considered difficult to design and control.

How does popular support for a carbon tax change if coupled with a rebate/dividend of the proceeds?

When a fee or tax and dividend policy is compared to a policy to regulate CO2 as a pollutant, the dividend policy tends to trail: 

• In 2014, the Yale Climate Opinion Maps asked about a policy that would enact a “carbon tax if refunded to every American household.”  This received 44% support nationally and 44% as well within Washington. Regulating CO2 as a pollutant was received 30-35% more support. 
• The most recent Yale polling data, from April 2019, indicates more support for a fee & dividend policy than the 2014 data – 59% of all registered voters including 75% of Democrats, 58% of Independents, and 41% of Republicans.   However, fee and dividend lags support for requiring fossil fuels to pay a carbon tax (67% of all registered voters, including 85% of Democrats, 66% of Independents, and 46% of Republicans).   Regulating carbon dioxide as a pollutant remains an even more popular option among registered voters (74% of all registered voters, including 91% of Democrats, 71% of Independents, and 57% of Republicans).
• While not a fee & dividend approach, in Washington state we have actual, recent voting history on two carbon tax proposals:  I-732 which received 41% of the vote for it in 2016, and I-1631 which receive 43% of the vote in 2018.   The former was designed with the intent of being revenue-neutral (like a fee & dividend) but by reducing other taxes, while the latter was designed to provide new investment revenues.

Even more popular than taxes or regulations in public polling is support for tax rebates for energy-efficient vehicles or solar panels, and support for investing in and funding research for renewable energy. A cap & invest program can provide on all three of these popular ideas:  The cap regulates CO2, the auction including a price floor sends a price signal directly to large fossil fuel emitters while providing other compliance mechanisms to establish a collective system to reduce emissions, and the investments can support approaches like tax rebates and investments in renewable energy.