Getting to the Right Carbon Price
Over the past two years, the idea of putting a price on carbon has gathered new and often unexpected support from across the political spectrum. In 2017 a group of former Republican leaders offered up a proposal for a national carbon tax. This January, top economists including all of the living former Federal Reserve Chairs pledged their support for such a plan on the Op-Ed page of the Wall Street Journal.
While Congress has remained polarized, carbon pricing proposals have recently emerged from lawmakers on both sides of the aisle. And oil companies such as Exxon and Shell now publicly support a carbon price.
Guest Dallas Burtraw, an advisor to carbon cap and trade programs in California and the Eastern U.S., discusses one of the most challenging and controversial aspects facing any effort to price carbon: getting the carbon price right. When done correctly, carbon pricing can speed greenhouse emissions reductions and fuel economic growth. Yet carbon cap and trade markets, which have been operating for over a decade in Europe and the US, have at times struggled with pricing, highlight the challenges likely to face future carbon pricing efforts.
Andy Stone: Welcome to the Energy Policy Now podcast from the Kleinman Center for Energy Policy at the University of Pennsylvania, I’m Andy Stone.
Over the past two years, the idea of putting a price on carbon as a means to reduce greenhouse gas emissions has gathered new and often unexpected support from across the political spectrum. In 2017, a group of former Republican leaders offered up a proposal for a national carbon tax. And this January, top economists including all the living former federal reserve chairs, pledged their support for such a plan on the op-ed page of The Wall Street Journal. While Congress has remained polarized, carbon pricing proposals have recently emerged from lawmakers on both sides of the aisle. And oil companies such as Exxon and Shell now publicly support a carbon price.
On today’s podcast, we’ll take a look at one of the most challenging and controversial aspects facing any effort to price carbon, and that’s getting the carbon price right. When done correctly, carbon pricing can speed emissions reductions in fuel economic growth, yet carbon cap and trade markets, which have been operating for over a decade in Europe and in parts of the U.S. have at times struggled with pricing, highlighting the challenges likely to face future carbon pricing initiatives. Today’s guest is an advisor to carbon cap and trade programs in California and the Northeast. Dallas Burtraw is chair of California’s Independent Emissions Market Advisory Committee, and a senior fellow with Resources for the Future. He’s also currently a visiting scholar here at the Kleinman Center. Dallas, welcome to the podcast.
Dallas Burtraw: Andy. Thanks. It’s great to be here.
Stone: So, you’ve played a role in developing some of the major carbon pricing systems in existence today from California to Europe. Tell us about your work on carbon markets and your history with some of the major cap and trade programs.
Burtraw: Well, I started my career at resources for the future just after the 1990 Clean Air Act Amendments had passed, which created the seminal cap and trade program for sulfur dioxide emissions, which has been dubbed the grand experiment. That program led to a precipitous reduction in acid rain. It was a very successful program and what outcomes were achieved at cost much lower than people had expected. That became sort of the template or model for negotiations around possible cap and trade applied to carbon dioxide emissions. And that’s what leads us today to thinking about the use of carbon pricing and cut in emissions markets.
Stone: So the major CO2 cap and trade programs we have to they all got their start within the last 10 or 15 years. What brought them about?
Burtraw: Well, after the Kyoto Protocol was signed, there was an international commitment to try to achieve reductions in greenhouse gases. And trading was on an international basis was the basis for doing so. The experience of the SO2 market, and a subsequent NOx trading program, led to thinking that the same type of tool can be applied to squeeze carbon dioxide emissions out of the economy and do so in a cost effective way.
Stone: Now, I just want to take a step here and just stop for a moment. And briefly discuss the difference between cap and trade and a carbon tax. It’s different methods of pricing carbon, before we go any further.
Burtraw: Yeah, there’s confusion about that. But there really doesn’t need to be. They both are about putting a price on carbon and sending that price signal to firms and to consumers so that they substitute away from carbon intensive activities. The difference is that a carbon tax will put fix a price and put that price per unit of emissions. But then you don’t know exactly the quantity of emissions you’re going to get.
And a cap and trade approach will put a emissions limit in place. And firms can trade which has the advantage that we expect firms that can reduce emissions at least cost to be the ones to do so and they can buy emission allowances from other firms. But then you don’t know exactly what the price is going to be. And this context for the discussion between a price instrument and a cap or quantity instrument as framed nearly a half a century of discussion in the economics literature.
Stone: So all the markets, the cap and trade markets have faced challenges related to the price of emissions allowances. Why can it be so hard to get the carbon price right?
Burtraw: Well, in the cap and trade markets, it’s not certain what that price is going to be in the first place. And what is at stake is the ambition that’s embedded in the number of emission allowances that are issued. What is going to be the emissions cap? And that will determine what the price in these programs is.
Stone: So let me just take that one step further, why is getting the carbon price so fundamentally important?
Burtraw: Well, if you take this from the perspective of the industry that’s going to be regulated and affected by the introduction of carbon pricing, they are deeply concerned that they might be put at a competitive disadvantage, especially compared to jurisdictions that may not be regulating carbon or may not be putting a price on carbon. And it serves no purpose to have economic activities and other associated emissions leave the jurisdiction that’s trying to regulate emissions, only to go into a different jurisdiction and an emerge there, maybe with production processes that are even less efficient, leading to an increase in emissions. That’s a possibility.
So industry has been very concerned that the carbon price not be set too high. The reality is, though, in every market, where we have tried to put a price on atmosphere resources, from sulfur dioxide to nitrogen oxides, to volatile organic compounds, and now just the several carbon dioxide markets we have, the dilemma is that the price has been lower than expected and often falling in real terms. So the real problem with respect to the implementation of these markets and to their influence and helping us address the climate change as the prices have turned out to be lower than expected.
Stone: So then you don’t get the climate impact, as you said that you’re going for?
Burtraw: That’s correct, you don’t get you don’t get the motivation for innovation and behavioral change that you hoped for, from a carbon price.
Stone: And you also said on the high side of the prices are too high that you feel that you might lose manufacturing, or that jurisdictions might lose manufacturing, they’d also lose obviously jobs that go along with that as well.
Burtraw: That’s right. And, you know, it’s not going to, no one’s going to be a popular politician through the loss of jobs, especially if you cannot, at the same time, you can say that emissions outcomes haven’t really been affected. So this is these are the challenges in trying to design these carbon markets.
Stone: So looking at the environmental aspect for just a moment, have carbon markets been, are shown themselves to be additive, meaning what portion of carbon dioxide emissions reductions can be attributed, in fact, to carbon markets, and not to other factors, other policies that states or countries may have?
Burtraw: Well, yes, for one thing, we know that even a small carbon price is going to have effects in terms of the variable operation of an industrial process or a firm. So, a modest carbon price is going to have modest behavioral effects and a large carbon price is going to have large behavioral effects. But even a small carbon price has important effects on the expectations of firms in terms of the kinds of investments they make. Because it’s a signal that we are committed to moving away from an economy that’s, you know, does not put any constraints on the use of carbon and entering a carbon constrained future. And that really changes the investment behavior of firms.
But if the price is too low, then you not only remove this incentive for investments, it all sounds, these other deleterious effects, that it undermines the confidence on the market in the first place. And you know, not everyone has been on board on the use of pricing of environmental externalities. And the traditional way to approach these problems is through regulation. And without putting these two approaches in juxtaposition or making the enemies of the other, there are many who are mistrustful of the use of pricing as a strategy to address environmental problems.
And when they see low prices, prices that are lower than expected and really falling over time in these markets, they will feel that the markets aren’t working. And it leads to a lack of confidence in those markets, and leads them to turn to other regulations increasingly to other regulations. And it creates a sort of vicious cycle, that when the prices are low and falling, we see the introduction of other regulations, and these other regulations tend to push down the price in the carbon market because they’re helping to achieve those very same emission reductions. And it’s a vicious cycle…
Stone: This could be state renewable portfolio standards that require certain number of wind or solar energy, for example?
Burtraw: That’s a perfect example or energy efficiency measures by local governments or, you know, fuel economy standards for cars. These are all really important measures that achieve real emissions reductions. We think less cost effectively then can a carbon price. So the question for some becomes do we do one or the other of these two approaches? My viewpoint is really quite different to come to recognize that these are companion approaches and one enables the other.
Stone: So, let me ask you this. What is the right carbon price? Should it be based on market drivers or should it be based on something such as the social cost of carbon?
Burtraw: Well, that’s a great question, Andy. And it’s a really hard one. And I will look at an audience sometimes and say, what is the right carbon price? Does anybody in this room know?
I like to joke that my son is now out of college, but between the time when he was in middle school, and when he left college, the accepted mainstream estimate of what the carbon price was more than tripled, and it has doubled again since then.
Stone: That’s the social cost?
Burtraw: The social cost of carbon. Social cost of carbon stands in for what we think is the damage, on average across the world, from the introduction of additional tonne of carbon emissions. And you tell economists, that’s a really important concept, because it’s a marginal cost. And we want to regulate such that marginal benefits of marginal cost equal each other. So that becomes like a signal, the level to which we want to regulate and impose costs on the economy.
But this price isn’t really knowable, we’re learning a lot about it. And we know it’s substantial. But I’m going to venture that the next time there’s a serious assessment at what the social cost is that it’s going to double or triple from our current estimates. It could go the other way. But I think most of the science literature is definitely pushing this estimate north. And so, we don’t really know what the carbon price is.
And, more importantly, it’s not really plausible to implement carbon pricing today, at a level that he equates the social cost of carbon when it’s up in that order of magnitude. And the reason is, because such an approach is not politically or economically sustainable. It politically, if one jurisdiction were to go this alone, that jurisdiction would be taking a huge steps forward. I mean, we look at what California is doing as one of the leading jurisdictions in the world or the EU, if you will, they still have prices that are way lower than even the current accepted and mainstream estimate of the social cost of carbon.
Stone: Is that what’s economically bearable in their eyes?
Burtraw: Yeah, that’s what’s politically bearable, and economically bearable, because of this problem of leakage, which we already addressed, which is that they put the price at a high level, there’s the risk that economic activity is going to flee from their jurisdiction and an emissions are going to leak out and occur anyway, in some other jurisdiction. So there is an important sequencing in my mind, sequencing of policies ,as we tried to build towards a global regime that will dress carbon in a comprehensive way, and increasingly introduced carbon pricing, I hope, in a comprehensive way.
Stone: Let me ask you specifically about the Northeast cap and trade market. That’s RGGI or the Regional Greenhouse Gas initiative that’s in, I believe, nine northeast states. When it was implemented about a decade ago, it had a price floor. That was an important part of the plan. Why is that?
Burtraw: Well, the Regional Greenhouse Gas Initiative is a modest program affecting only the power sector, with fairly low prices in the nine northeast states, but it has had an outsized influence on the global stage, and continues to do so as a model for a really well designed program and a program where the states are doing as much as they can when they’re trying to act alone. I mean, they are in a coalition of nine states. But they are still subject to an open electricity market where electricity generation from other states, such as Pennsylvania, can come into their markets and steal the generation from that otherwise should be occurring in the RGGI region, and potentially do so with a higher carbon content.
But nonetheless, the program has survived. And one of the reasons for that is that they looked at the experience in the EU, which the EU is the first jurisdiction to introduce carbon pricing in 2005. And what we observed at the beginning of the EU is that prices shot up when people were really in the very outset of the program, people were not sure what this was or how it was going to work, and then rapidly fell down to virtually zero, a zero price in that program. So, a lot of people had made investments expecting there to be some meaningful carbon price. And suddenly those investments didn’t look so good.
Stone: Why did it go down to zero?
Burtraw: Because there were too many allowances. And literally, I mean, it was a complicated start to the program. There were nearly 20 languages involved. Many of the jurisdictions that were involved had only paper processes at that point, it was not electronic. It was you know, people look at it as a trial phase of the program.
But nonetheless, we learned some important things from that trial phase of the program. And one of them was that the fact of the price could fall and if the price fell, then all your efforts to establish this program were came to no end. And, importantly, organizations that made investments to try to comply with the program maybe you know, from good citizenship point of view, those investments were rendered meaningless. I’ll tell you a little anecdote, I was out at a university in England around 2007, shortly after this price had the price had fallen to zero. And on the stage, this plant manager for the university was pointed his finger right in the face of the economists. And he was red in the face and spitting mad, saying some language we won’t put into this podcast.
Stone: This is a family program.
Burtraw: Yes. And he said, You made me look like a fool. I went to my university leadership, and told them to realign their capital budget in order to replace the boilers on our campus, several the boilers on the campus, because this price of pricing carbon was both the right thing to do and it was kind of how the economic importance for us as a university. And now the price has fallen to zero, and you made me look like a fool.
And I’ll tell you, I think any kind of public policy where people try to comply with the leadership that’s suggested by the front that framework, and then in the end to end up looking like a fool, one has to pause and think, what is the design of this program? And what are we actually accomplishing here?
Well, RGGI was in a position to do that, to learn from the experience in the EU. And so they said, well, one thing we don’t want is for after all this work involving nine states and ongoing negotiations, we put this in place, we don’t want the price to fall to zero, we don’t know what the price is going to be. And we don’t want to be that wrong. So, they introduced the price floor.
And that was possible, because they did another innovation, which has now had, you know, historic implications is that they introduced an auction. So previously in the sulphur dioxide trading program, and in the EU, emission allowances have been given away for free, so called grandfathering, they’ve been given away for free to the regulated firms. And this led to the, spun out a separate conversation about windfall profits, that firms were getting these allowances for free, but then turning around and wrapping them into product prices, because prices would go up reflecting the opportunity cost of using these allowances, you know, it’s like they wrap in the price of fuel.
Stone: They’re acting as if they’d paid for them.
Burtraw: Correct.
Stone: And that was reflected in that product.
Burtraw: They were charging customers in their product prices for something that they themselves had received for free. And this, there were many formal investigations in the EU establishing billions of euros in windfall profits at the early stages of the EU trading program that went to the electricity sector.
So RGGI looked at this and said, well, we don’t want to do that, we still will auction these emission allowances. And that’s really good, because there’s a lot of revenue, and we can use that revenue and reinvest that in program related purposes, like energy efficiency and other types of things. But once you think about, well, how do you design an auction? You know, if you if you look on eBay, for example, you’re going to see that there’s, you have the opportunity to put a minimum bid, minimum acceptable bid. And actually, throughout the auction literature, this, it’s widely recognized that putting a so-called reserve price or minimum acceptable price is a key feature of good auction design.
So RGGI looked at this and said, well, we’re going to put a minimum price in this program. And that turned out to be really important, because once again, as in every other atmosphere resource market, the prices fell, quickly fell. And in this case, they fell to the price floor and rode along that price floor for 11 consecutive auctions over a two year, longer than a two year period. If that price floor had not been in place, the RGGI price would have gone to zero, and that program, probably would have died a premature death. But instead it rode along that price floor until there a program review came and they were able to tighten the program and change their ambitions made a lot took a lot of things into consideration. And the price subsequently rose off that price floor.
And what’s really valuable about this RGGI model and why it’s had such outsized influence is first of all the introduction of an auction. I had people at the staff at the European Commission say to me incredulously, how did they do that? How was that possible? They didn’t think it was possible to auction allowances.
Stone: Politically possible?
Burtraw: Politically possible. But now the EU has done a 180. And they are now committed to 100% auction in the electricity sector, with few exceptions for some countries that get extra time in that transition. So they have totally bought this model that was tested in RGGI. And the second point is about the price floor. That design, auction with a price floor, was written almost verbatim from the RGGI regulations into the draft Waxman Markey legislation, if remember at the federal level, that never, that passed house represented a decade ago.
Stone: A decade ago.
Burtraw: And then also surfaced in the design of the California program and in Quebec. So now we have all the North American programs have an auction, important rule for auction, for most or for large share or all of the allowances with a price floor and each of those programs the price floor has been binding in at least one or two auctions, and then subsequently the price has risen off that price floor. So, these this auction design with a price work sort of gives these programs buoyancy during a storm. And then when the storm passes, there can be a program review. And regulators can revisit the design of the market and their ambition, they can then go forward with the program.
Stone: When you start out with a market as you’re talking about the European ETS and the price goes down right from the start. Does that mean that when the number of allowances were calculated prior to the beginning of the market, that essentially, emissions were much lower than people expected them to be? And thus there was less need for the allowances is that a fault of the people who design it that they get their estimates wrong?
Burtraw: Well, that’s really well framed. And directly to answer that question has to be yes, the reason the price is low as because there are more allowances than were, then are needed. And emissions are lower than what were expected. But the really interesting question is to ask why? Why do emissions fall at a rate that’s faster than where it could be anticipated at the time you design these programs?
And frankly, it’s because it’s for good reasons. I mean, it’s actually for hopeful reasons, in my mind. It’s because organizations and state and local governments and firms and churches and Boy Scout troops are all engaging in this challenge of how to address climate change, and doing innovative activities, that I would call companion activities to the introduction of a carbon price, as reflected everywhere where carbon prices have been introduced. The row has been plowed previously through a plethora of what we’ll call companion policies.
So sometimes economists come to this and think design carbon pricing and think, well, you put this price on and you get the price, right, and then you’re done. And that’s the most efficient possible outcome. And they’ll ask well, how is it theoretically possible that you could do something else? That would be a complimentary policy, a compliment to the carbon pricing? Would it make it would be more efficient or do anything better? And more often than not, the literature has said, nope, carbon pricing is as good as you can do.
But the reality is, you know, away from the chalkboard and in the real world, is that these companion policies came first. And in many of the jurisdictions where these conversations happen, carbon pricing is the complementary policy. And because, as we’ve already discussed, you can’t really at this point in time, put a carbon price at a level that’s going to do all the work for you, you’re going to have these companion policies continuing to play a really important role going forward. And what’s refreshing is the creativity that local jurisdictions come up with not always choosing the most cost-effective thing to do. I mean, we want to sort of resist the temptation to do everything that occurs to us. But subject to rigorous evaluation, what these jurisdictions are doing are making earnest efforts to try to achieve emission reductions and when they do so this has the effect of pushing down the allowance price
Stone: Sounds like it’s hard to actually factor that in when you’re designing a market because you don’t know what all those factors are going to be.
Burtraw: Yeah, yes, that’s right. People are infinitely creative. But one of the dilemmas that follows from this is the so-called waterbed effect. The waterbed effect, especially this metaphor has taken hold in Europe, is if you imagine a waterbed holding the allowable emissions that are going to be contained in the trading program. But if you push down on one part of the waterbed, another part of the waterbed just goes up.
Because admissions cap is an admissions floor. It is not just the maximum possible admissions, but it can be the absolute number of admissions that you’re going to have in place. So this causes sort of a conundrum because that means that if you have something like the Church of England, which has made a commitment to offset all of its emission reductions, the church for the best that we would think the best of intentions, it’s having no effect. So you’ve made impotent all the efforts of the schools and organizations and firms and local governments to try to reduce emissions, because the overall level of emissions are kept. And if they push down, emissions, just go up somewhere else. And this precipitated real criticism from the NGOs about, well, are these carbon markets working and even further…
Stone: So the Church of England was part of an overall system within the UK? Is that what you’re saying? And so they were lowering their emissions so other sectors of the economy said we don’t have to, and it was a wash. And they were taking it all on themselves, very good heartedly to do it. And somebody else was benefiting from it.
Burtraw: Yeah, I’m just using that as one example of which there are a thousand. Yeah, that’s the waterbed effect and NGOs and environmental activists have looked at this and said, you know, to put a strong point on it, they will they are started hinting towards the conclusion that this carbon pricing business, this is a fraud. You could imagine this being put in place as a way to protect business so that they don’t have to really do anything beyond the most trivial effort. And furthermore, anything more that we do isn’t going to really have an effect.
Well, of course, no one who’s dedicated their lives to try to address climate change and design these programs or worked on these programs. Nobody is approaching the problem like that. But it does give you pause in terms of like, how are these programs working? And that’s one of the really strong contributions of the RGGI program with this idea of a price floor, That at least in the vicinity of the price floor prices fall to that neighborhood, then there is this possibility of additionally, of the efforts of subsidiary jurisdictions or individual states within a trading program to achieve additional emission reductions.
Stone: Let me ask you one more thing about RGGI. So obviously, there’s been a price floor. But there still has obviously been a view that there’s more that needs to be done in RGGI and RGGI just recently rewrote or established their standards for the next decade through 2030. They’re more ambitious. But one thing they have implemented is something called an emissions containment reserve. It’s a very important development. Why?
Burtraw: Right, well, RGGI continues to be a laboratory of ideas and think having an outsized influence. In this case, what the emissions containment reserve is, if you can imagine in your mind’s eye, a price floor. And then the allowances, as a hard floor, no allowances will be sold into the program at a price below that price floor. What RGGI has done is said, well, we’re going to take 10% of the allowances and create a price step above the price floor. And we’re going to say that those allowances won’t sell for any price above this higher price step.
So you have effectively 90% of allowances that won’t sell for price below the price floor. But another 10% that won’t sell for any price, lower than this higher price, the price step. And you see then as the subsidiary actions by the states, etc. are measures that tend to reduce the demand for emissions allowances, all for encouraging reasons and push down the allowance price then hits this price step earlier than it would if we waited till it went all the way down to the floor. And it starts to share the benefits of these local governments and others, between the economy through a lower price and the environment through fewer emissions.
So it turns what a one time, you remember the outside we’ve set the reframe this as a choice between a price and a cap. What RGGI has done is envision this as a hybrid, in which there is an adaptable cap. And when prices fall, there are fewer emission allowances that come into the market. You know, if regulators design a program and notionally balance benefits and costs and say, this is what we can afford to do, this is what it’s going to cost us. And this is our environmental goal. And then it turns out to be much cheaper to achieve that goal. You’d think that they might try to buy additional emission reductions. And that’s what this new design…
Stone: This is taking those out of the market?
Burtraw: Yeah, that’s right. It’s taking them out of the market. And so RGGI has introduced this price step. And I think it’s gotten a lot of attention in the other North American programs. So they haven’t, it hasn’t been adopted there, per se. But all these programs from RGGI and in California and Quebec have other elements to start to look like a price responsive supply of emission allowances. For example, in California and in RGGI, there, in the eventuality the prices rise to be much higher than expected, some quantity of additional allowances will come into the market. That we that, you know, I think that’s unlikely in the California program currently with the way the prices tend to be low in these programs. But you can’t see the future for sure. And a good program design should anticipate what we can’t see today, that it might happen.
Stone: So the floor keeps the price from going too low in this new system. And RGGI limits the number of allowances in the market as a further step to keep the price up to a reasonable level.
Burtraw: That’s correct. That’s exactly what it does.
Stone: So fundamental question here. Does this remedy the waterbed effect that you talked about?
Burtraw: Right, well, it importantly contributes to a remedy to the waterbed effect. Because in the, when prices are in the vicinity of the price floor or this price step, then additional actions by the states or by local government work can have a meaningful effect on reducing emissions. But what I really want to kind of take that question and reframe it slightly differently in that, as an economist, we have come to this. We’ve tried to make a contribution to addressing the challenge of climate change through thinking about economic approaches. And I think the use of economic approaches is imperative.
Because everything we know tells us that really addressing climate problems, it requires great ambition, and it’s going to, it’s going to come at great cost. And it’s really important that we find ways to do so that are cost effective, as cost effective as possible, in order to achieve as much ambition as quickly as possible. But the mistake that we’ve made is to imagine economic approaches in place of other approaches that are also happening. And that’s what the waterbed effect does is essentially invalidates any other kind of effort that might be made. What’s really brilliant about the emissions contain reserve in the RGGI region is that in fact, it’s sort of designed to accommodate and even enable other actions by other actors within the regulated region.
So for example, in RGGI right now, almost every state has state specific policies that are unfolding renewable portfolio standards or clean energy standards in New York State, etc. and the state of Massachusetts actually has a state law that requires emission reductions at their regulated facilities on a recent court case, directed the state agencies to enact additional measures, those measures happening underneath the RGGI cap. So you might think that would lead to a perfect waterbed effect, enabling Maryland to emit more because Massachusetts is going to admit less. But that that problem is exactly what was anticipated by RGGI. And this price step, through the emissions containment reserve is meant to address it. And I take great encouragement from this because it’s now a rethinking of how carbon markets can work and how they can enable further action, rather than eroding the contribution of further action.
Stone: Now, some recent initiatives to implement a carbon tax in particular have failed. Washington state, which is generally progressive has had two carbon pricing ballot initiatives fail. And also talking about cap and trade, Ontario very recently backed out of the California cap and trade program. What’s going on?
Burtraw: Well, that’s right, you’ve picked on a couple bad pieces of news. But that’s not the only news that’s out there. I would point that to states have now lined up to join RGGI. New Jersey is actually rejoining RGGI after having previously left and Virginia, which will now be the largest state in the RGGI program will be joining in 2020. Virginia, in historically a coal state is going to be joining RGGI.
These jurisdictions are doing so because they recognize that it’s in their self interest to do so not it’s not only about a dressing climate change, I don’t think any jurisdiction in the world can do this for strictly altruistic reasons. Rather, they are in a position to see the future. And recognizing that efficient economies, clean economies, are the pathway toward where investments are going to occur, where we’re going to see technological innovation. And those states are getting out in front of that parade.
On the west coast. Very exciting news last week was the state of Oregon, introduced legislation that has support of the governor and was the result of a six month process involving both houses of the legislature that will adopt, well, that would make Oregon the second state in the world, the second jurisdiction in the world, to have economy wide and comprehensive carbon pricing. Oregon is doing it for Oregon’s purposes. Oregon First, if you will. But the one has to note that the design of that Oregon policy makes it very plausible that it could link with California. So there are some encouraging things happening also.
When one looks at Washington State and the two times that they were unable to enact through the through ballot measures carbon pricing, it gives me a reason to think about well, how do we make progress towards climate policy in general? And I think that the ballot approach or proposition is probably not the way to do it, at least with respect to putting a price right in front of people’s faces. I think you can ask people do you want our state or our jurisdiction to make a commitment, a serious commitment, to addressing climate change? That’s a meaningful question for people. But put a price right in front of their face and put it on the ballot is just odd.
There’s nothing there’s nowhere else that we do that. The only time in society where you see something like that is when you’re standing one time a week in front of the gas pump and you see these numbers roll by and nobody really used that as a, you know, favorable experience that leaves you with a weird impression there. You know, people want their political leaders to good decisions, people want to be involved in that conversation. Yes, let me help establish the priorities. Yes, let me help establish the level of commitment here. Now take care of business because I’ve got to get back to the soccer game. And that’s what I think our political leaders have to do.
Stone: But it’s it because this is such a politicized issue, that that’s why they felt they had to put it in front of voters?
Burtraw: I just think it was, you know, economists have sometimes not been not helpful. We have not been not helpful in that we tend to think, you know, on the chalkboard or in the classroom, we tend to think that putting a carbon price in place will incentivize all these behavioral changes throughout the economy and behavioral changes. And in order for that to occur, the carbon price has to be right in front of your face, just the way that gas prices right in front of your face.
But out in the political world. That’s just not really how decisions get made. And so it makes it, it’s too salient, if you will, it’s blowing it all out of proportion. I mean, yeah, a carbon price is an important as the next thing in terms of the effect that’s going to have on prices in the economy. But the next thing we don’t vote on, and we don’t put in front of people’s faces quite like that. So, I’m not undemocratic in any way, when I talk about this, I just think it’s blown all out of proportion.
Stone: And I think historically, to draw a parallel, or a sort of a parallel, I don’t think that many fossil fuel subsidies that are out there were ever put in front of voters, but they were implemented.
Burtraw: Well, I think that’s right, Andy, I mean, there’s it’s such a complicated problem that my preferred approach would be to see jurisdictions informed, having informed discussions and informed debates, either on the ballot or in the legislature about their commitments to addressing climate change, recognizing that it’s in their long term self-interest, to redesign their economies for the 21st century, and then delegate to the expert agencies to design the programs and the policies that are going to help them achieve that commitment, because that’s the way we address all sorts of other types of complicated social problems.
And so even legislating a specific tax is questionable in my mind, because you don’t know what the right price is. And that information that’s going to inform that is going to be emerging over time. Some of my colleagues have looked at ways that a tax could adapt to new information in order to help achieve a goal over time. And that’s quite analogous to the way RGGI has designed its cap and trade program. Such the price on that program sort of adapts and the quantity can constraint or adapts to new information over time.
But the best programs in the world and the best approach, the most democratic and the one approach with the best process, in my mind, is embodied in California, where there’s an expert agency that is reasonably transparent, and certainly tries to be transparent, and runs a series of policies that it tries to engineer and coordinate in order to achieve its firmly stated long run climate goals. So, it there, it’s not just an economic question, it becomes a political implementation question.
Stone: And take a jump from what you just said right now. And we’ve been talking a lot about the positive attributes of carbon pricing and what it’s brought to us. But you have written that carbon markets are a second-best solution. Why is that? And what are they second best to?
Burtraw: Well, what we use this term second-best, meaning that a policy is being implemented is not efficient on every margin in the economy, it’s not affecting behavior everywhere in the economy, at the exactly the efficient level. So, the term second-best, though it gets used in everyday speech all the time, it really has a pretty specific meaning in the economics literature. And in an economic model, a carbon price is the only policy that is potentially first-best. But I say that carbon pricing is second-best, because the real world departs from the models on the chalkboard.
For reasons we’ve already stated. Like it’s impossible to get the price at the level where it can be doing an efficient amount of work. And also because even the organization of institutions in our society doesn’t allow that price signal to get passed through and just the way we hoped that it would. There’s all sorts of market power, vertical market power in some industries. There’s all sorts of relationships between state and local government with developers on one side of the counter and regulators and the other side of the counter and, you know, a lot more concern about the interest of income property owners than new developers or whatever. Everywhere you look, there’s all sorts of ways that turns out the real world is a complicated place. So what we want to do is take the lessons that we can from economics and economic theory, and then find out ways to apply them to real policy setting.
Stone: You have also written about a concept you call sequencing. And I think you actually mentioned it earlier in this conversation. And that is essentially the idea that the markets, technology, interest groups, what have you, all need time to adapt to be able to aggressively address carbon emissions and climate. As you said, you can’t start out with a really high carbon price and expect everybody to jump on it. These things take time. Can you talk a little bit more about this idea of sequencing? And how that may lead to greater ambition? And I guess, higher carbon prices as well over time?
Burtraw: Yeah, well, we’ve thought about this formerly, actually. And the reason for thinking about it is that there is so much criticism from the economic side of the role of these companion policies and the fact that they’re inefficient. They are inefficient, in many cases. So what are they doing, and we discover that they do more than one thing, these policies are maybe addressing emission reductions in the present, but they may also really be important for the emission reduction that we can achieve in 2030. They may be delivering air quality co benefits, may be co benefits that are particularly important for disadvantaged communities, they may be putting administrative structures in place that allow us to enforce programs such as tradable emission allowance markets that previously didn’t exist, because that requires a whole data system.
And it’s important to evaluate the steps we take today, with the long run goal in mind. And the idea of policy sequencing is to try to carefully ask are the steps we are taking today, enabling us to take further steps tomorrow. I think that becomes a useful criteria, criterion, for evaluating policy rather than just sort of narrowly saying, Oh, is this the most efficient policy that we can think of on the chalkboard?
Stone: Let me ask you one final question. And thank you very much for all this insight to this point. Simple question, at least very simple to ask, are we going to see a national carbon price in the future in this country?
Burtraw: I’ll say yes. But you didn’t ask me when. And I may not be alive long enough to see it. I hope that’s not the case. But I do think that we will because I think we might be, this is climate policy is sort of like they sometimes describe the army, where nothing ever changes until everything changes at once.
And so it may be that we’re getting to a point a critical point where we’re going to see a carbon price, I don’t think, I’m not a fan of the approach that suggested by some that we tried to introduce a carbon price. And it’s a big political poker game in which we trade or horse trade, where we trade the carbon price to strike down the authority to regulate greenhouse gases under the Clean Air Act, for example, because as I said, already, I think these companion policies play such an important role in terms of enabling us to get to this point and enable us to go further.
But I do think we’ll see a carbon price and but also to be even more squishy for ya, Andy, we may see a carbon price that doesn’t look like a carbon price, that you don’t recognize those a carbon price and the way we usually talk about it. That is, you know, a carbon price actually has attributes. And we may see many of these attributes emerge in policy, even if you don’t see the final carbon price and add it onto things you buy at the grocery store. So, things like emissions intensity standards, introduce a price that can be around credits that can be traded in the production of vehicles, or renewable portfolio standards is another example of a effectively a price that is gets traded in it. It’s sort of an informal carbon price.
So, I’m being a little bit squishy here. But again, it comes back to this question of policy sequencing, I think we’ll see increasing element of formality in that carbon price. And to be honest with you, I think what you’re talking about is will we see a price that’s denominated in dollars per tonne of carbon and see that on a national basis passed through major portions of our economy, and I do think we’re going to see that.
Stone: Dallas, thanks for talking.
Burtraw: Thank you, Andy.
Stone: Today’s guest has been Dallas Burtraw a senior fellow with Resources for the Future. Learn more about carbon pricing and markets by checking out research on the Kleinman Center’s website. Our address is kleinmanenergy.upenn.edu. And for updates on new publications and events from the center, subscribe to our Twitter feed @kleinmanenergy. Thanks for listening to Energy Policy Now and have a great day.
Dallas Burtraw
