Common Tragedies

Thoughts on Environmental Economics

What’s the point?

Posted by Rich Sweeney on December 10, 2007

As we move from debating if we should restrict carbon emissions to discussing how we should restrict carbon emissions, one of the more contentious battles is going to be over point of compliance. This is the question of at what point in the supply chain should you regulate carbon. Like much much of the climate policy debate in the US, the issue is currently being hashed out in California. Assembly Bill 32 requires the state to reduce aggregate GHG emissions to 1990 levels by 2020, and the California Public Utilities Commission (PUC) and California Energy Commission (CEC) have been holding meetings for the past year in order to prepare for compliance. These bodies are now knee deep in the debate over point-of-compliance, and the recent arguments of Dallas Burtraw, from RFF, and Richard Cowart, director of the Regulatory Assistance Project, provide a useful insight into issues at hand.****

*** In the interest of full disclosure, I should mention that I currently work for Dallas at RFF. Nevertheless the comments in this piece are entirely my own.

When it comes to point of regulation, I have always just assumed that economists favored a first-seller-approach. The purpose of capping carbon is to effectively make fossil fuels more scarce, by factoring the societal costs of emitting into the the price of the resource. Making this adjustment upstream alleviates red tape and has a clear and direct impact on prices, yet still allows the costs of compliance to flow through the rest of the supply chain. In the case of the California electricity market, the furthest up stream node on the table is the point of generation, which is the point of regulation favored by Dallas. The idea is that generators will have to buy permits for every ton of carbon they emit, making dirtier generation more expensive and providing an incentive to mitigate emissions.

On the other side of the debate is Rich Cowart, who advocates load-side compliance (this is the entity which brings electricity to your house). The idea is that the load serving entity (LSE) would have to purchase permits to offset the carbon emissions from its electricity suppliers. Assuming that in both scenarios 100% of permits are auctioned off and the proceeds are fed back to subsidize electricity costs, the effect on consumer prices would be identical. However, by forcing the LSE to work with carbon permits and pay the costs of emission themselves, Cowart argues that this will make the more conscious of the carbon costs, increase the incentives to invest in efficiency, and reduce end energy usage. His argument is essentially behavioral, and does have some appeal to the non-economist. He is in the same general vein of people who are pushing for “carbon labels” on products, and possibly even end user-compliance (like a green IRS or something).

However, the behavioral benefits of such a scheme are unclear (if anyone has seen any literature on this please let me know), and even if they were true, it is not obvious to me whether they would offset the corresponding behavioral costs of removing the compliance burden from the generators. As for efficiency, this could be achieved through other means, like decoupling.

Yet the costs of this approach, compared to first-seller, are potentially huge: it is the difference between using markets and using regulation. Severing the link between prices and scarcity puts an enormous informational burden on the load or end user. Every purchase will now require not only a price, but also an estimate of carbon content and permit costs. While in theory this can be handled with contracts and planning, the historical track record of such approaches has not been good. I spent almost two years in Eastern Europe studying the centrally planned economies, and one of the main factors contributing to their collapse was the fact that prices had no informational value.

Over the next few months, I’m sure we’re going to hear a lot more about point of compliance. During that time, when you’re out shopping at the mall or the grocery store, imagine if, in addition to the price you paid at the register, you also had to pay a carbon tax on all of the goods you bought. Sometimes you’d be super diligent about this looming burden, carefully considering and keeping track of the total costs. Other times you’d be rushed or stressed. Then, periodically, some agency would conduct a green audit of your possessions. Sometimes products might have been incorrectly or confusingly labeled, in which case you bear the actual carbon burden of your purchases. Even if your bookkeeping turned out to be correct, keeping these records and paying your carbon tax would be an enormous, time consuming burden. Wouldn’t it be much easier if you could just pay one price at the register, confident that it already incorporated the cost of carbon?

2 Responses to “What’s the point?”

  1. Susie said

    Hey Rich, let me see if I got this straight. In theory, consumer prices should be identical for both approaches. However, in practice, load-side compliance will lead to varied and inaccurate prices because of incomplete information?

  2. Rich Sweeney said

    Sorry I was unclear. In theory, assuming that load-side compliance proves equally as efficient as the market, prices would be the same. The only point I was trying to make here is that consumers would be equally well off if you gave them permits or if you auctioned the permits off and gave them the revenue. However, in reality, absent the informational value of prices, regulation will probably prove more costly and rigid than the market, leading to a suboptimal allocation of resources.

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