This month, Representative Sean Casten (IL-6) released the Tradable Emissions Standard Act, a bill that combines aspects of traditional performance standards with market-based carbon pricing features. The proposal comes at a critical time. While certain Republican party members have shown an interest in working on climate policy, including carbon pricing, some Democrats have moved away from explicit pricing proposals. Earlier this year, Democratic members of the House Select Committee on the Climate Crisis released a report detailing how the U.S. can achieve net-zero CO2 by 2050 that mostly relied on sector-by-sector regulations and subsidies. It did include a short section on carbon pricing as a policy option, but one that would need to meet specific conditions, including meeting the emission targets spelled out in the report.
Rep. Casten’s bill represents something of a policy middle ground between emissions standards and carbon pricing, while maintaining high ambitions for climate action. The bill aims to eliminate greenhouse gas emissions from the electric and industrial thermal energy sectors by 2040, which combined produced roughly 2.7 billion metric tons of CO2e, about 40 percent of U.S. greenhouse gas emissions in 2018. The policy design aims to ensure those goals are met, while using the coverage and efficiency advantages of a carbon price.
The bill works by setting a declining carbon intensity standard (metric tons of CO2e/megawatt hour or million British thermal units) that would cut covered emissions by 40 percent in 2030, ultimately reaching zero by 2040. Instead of requiring each generator to meet the standard independently, the EPA issues a declining number of allowances each year to power and thermal generators, and set up a marketplace where allowances can be traded among generators. Generators that exceed that standard must obtain additional allowances from generators that outperform the standard or invest in technologies that reduce their carbon intensity. For example, let’s say the performance standard is set at .5 metric tons of CO2/MWh, roughly the current carbon intensity of our electricity grid. A coal plant that emits roughly 1 mtCO2/Mwh would immediately receive .5 metric tons of CO2 allowances for each MWh of delivered electricity, but would need to buy allowances equal to the remaining .5 metric tons of CO2. Theoretically, it could buy these allowances from zero-carbon power sources, such as a solar generator, who has 0.5 metric tons of CO2 worth of allowances to sell. Much like a carbon price, the market determines the clearing cost of CO2 emissions, thereby determining the allowance price.
Rep. Casten’s plan also employs a similar design to a feebate. A key feature is that fees paid by generators with carbon intensities above the standard are used to pay the rebates for generators below the standard. Thus, the total cost of the fees paid by dirty generators equals the value of the rebates paid to clean generators, which makes the scheme revenue-neutral. The role of the federal government is limited to setting the performance standard and providing appropriate oversight to ensure that the standards are being met. At the same time, market forces figure out how to optimally price and deploy technology, driving capital towards the most-cost effective carbon reduction approaches. Rep. Casten claims that because the wealth transfer occurs between generators, consumer electricity rates will not be impacted. However, a 2015 study by Brookings evaluated the effects of a tradable performance standard that functions similarly to Rep. Casten’s bill, and did find that electricity prices did rise 5 percent over a baseline no-policy scenario by 2030. While these results could simply be a result of modeling inputs, the impact of Rep. Casten’s plan on electricity rates has important implications for its cost-efficiency and its political viability, considering it does not raise revenue to compensate consumers if in fact electricity rates do go up.
Although carbon taxation offers a more cost-effective approach than tradable performance standards because it raises revenue that can be used to reduce distortionary taxes or provide welfare increasing dividends, Casten’s proposal’s flexibility to allow generators to trade credits increases its cost-effectiveness over traditional performance standards. A 2011 study by Resources for the Future compared the overall costs of both a tradable and inflexible performance standard, finding generators’ ability to trade credits reduced overall compliance costs of performance standards by two-thirds.
The bill also incentivizes the construction of clean energy generators in the short-term. As the performance standard tightens over time, so to do the rebates given to clean energy generators. The number of allowances a zero-carbon generator has to sell, therefore the value of a unit of zero-carbon electricity is higher when the standard is set at 0.5 MT of CO2/MWh, than when it’s at 0.1 MT of CO2/MWh. To address this, the bill allows existing generators to enter into contracts with new clean energy generators for a minimum of 10 years that allows them to lock-in the current value of a credit. This provides a significant incentive for new clean generators to get built as soon as possible to maximize the value of the clean generation they provide. Putting steel in the ground and deploying low-carbon technologies as soon as possible is not only necessary for timely decarbonization, but would help scale these technologies, which in turn would reduce their costs and the overall costs of the policy itself.
Rep. Casten’s bill is a novel and well-thought piece of legislation, and its approach has many price-like properties. Its standards over pure CO2 pricing approach does sacrifice a bit of efficiency, but enabling generators to trade emission allowances provides a degree of flexibility that is lost in traditional performance standards, and in effect, allows for a market-derived carbon price. Although it does not have the coverage benefits of an economy-wide carbon price, it does extend into the thermal heat sector, equating marginal abatement costs across thermal heat and electricity generators, driving low-cost CO2 reductions in both sectors. Additionally, similar to a carbon price, its output-based allowance system is technology-neutral and rewards every approach that emits less CO2 per MWh. Still, the revenue-neutral aspect of this policy could either help or hurt its viability, since revenue raised by a carbon price can be used for dividends or reducing existing distortionary taxes, which helps to win political support for the policy.
Some critics of carbon pricing worry that political pressure forces carbon prices to be set too low, or do not guarantee deep emission reductions. Others in the climate policy community continue to tout the coverage, efficiency gains, and administrative ease of an economy-wide pricing approach over standards. Resolving this tension between pricing and standards to achieve effective, and durable climate policies is an important task and Rep. Casten’s new bill gives all of us food for thought.