Pricing carbon is vital to US climate goals and politically unlikely but there is another way, analysts say

Imposing a federal price on carbon to drive decarbonization is both urgent and unlikely, but there may be a workaround, according to some economists and policymakers.

One approach to pricing carbon is a direct tax. The other is a market-based cap and trade system in which tradeable allowances for emissions above or below a pre-set cap can be bought and sold. Most economists say either can work. Neither approach has been politically viable for carbon at the national level. But many are beginning to see another approach.

The federal government could start with the “suite of policies” California used to reach its first emissions reduction goals four years early, California Air Resources Board (CARB) Deputy Executive Officer Rajinder Sahota said. California has a price on carbon now, but its success was built on a “clear regulatory framework of clean energy policies, programs, incentives and strong enforcement.”

There are still multiple legislative efforts in Congress to create a federal carbon price, some with bipartisan interest, Sen. Sheldon Whitehouse (D-R.I.) told a Federal Energy Regulatory Commission Sept. 30, 2020, conference. And elimination of the clean energy mandate from the infrastructure bill makes proposed methane and carbon pollution fees in federal legislation “even more critical,” he told Utility Dive Oct. 18.

Sen. Whitehouse’s urgency about a price signal for carbon is appropriate, advocates for carbon pricing agreed. But they also agreed with CARB’s Sahota that imposing a price is a process and where it is not politically viable, mandates and standards created by policy and regulations can lay the groundwork.

Politics, regulations and economics

Limited carbon pricing is now reducing emissions in California and in the 11-state Regional Greenhouse Gas Initiative (RGGI). But past and current U.S. federal legislation to price carbon has not advanced.

The leading Senate vehicle now is the Save Our Future Act (S. 2085), introduced by Sen. Whitehouse June 16 and co-sponsored by nine Democrats, which remains in committee. It would impose a “fee” on carbon and other pollutants to be reinvested in the clean energy transition.

The House’s Energy Innovation and Carbon Dividend Act (H.R. 2307), introduced by Rep. Ted Deutch, D-Fla., on April 2 has attracted 88 Democrat co-sponsors but also remains in committee. It would impose a “fee” of $15/metric ton (tonne) on carbon and other pollutants. The fees would be reinvested or returned to taxpayers, through a trust fund and would increase $10/year until carbon reduction targets still to be specified are met.

With little movement on this legislation, pricing carbon remains a challenge in Congress.

“A carbon tax is now more firmly established as not viable than ever,” said Samuel Thernstrom, CEO of the Energy Innovation Reform Project (EIRP). “The logic was that a market mechanism would get Republican support, but that was misguided because Republicans oppose raising taxes and raising the cost of energy.”

Sen. Joe Manchin, D-W.Va., and other senators reject a carbon tax and “many members of Congress will be unwilling to add to current economic uncertainties,” Thernstrom added.

The bipartisan Clean Energy Future through Innovation Act (H.R. 4153) is more politically viable because it does not impose a carbon price, Thernstrom said. Introduced by Reps. David B. McKinley, R-W.Va., and Kurt Schrader, D-Ore., it has one Democrat co-sponsor, but also remains in committee. Instead of pricing carbon, it provides financial support to drive innovation and creates a technology-neutral clean energy mandate that targets an 80% reduction in carbon dioxide emissions from electricity generators by 2050 relative to the date of enactment.

“Climate change is the greatest environmental and energy challenge of our time, and our government is failing to meet it,” McKinley and Schrader wrote of their proposal last year. “While many would prefer a broad tax on emissions, we do not believe it can get through Congress.” Their bill is a more pragmatic combination of “innovation and reformed regulations,” they added.

Central banks from most industrial nations recommend a carbon price to limit the potential $23 trillion cost of the climate crisis, Sen. Whitehouse told the 2020 FERC conference. Republican and centrist think tanks agree carbon fees can generate economically productive revenues, he said in urging the commission to allow “regional grids in sovereign states to pursue carbon pricing.”

Carbon pricing is “an important market-based tool in state efforts to reduce greenhouse gas emissions,” FERC’s April 15 ruling on carbon pricing in wholesale markets acknowledged. But the commission will not “indicate a preference for carbon pricing over any other state policy” because it is “is a matter exclusively within that state’s jurisdiction.”

The economic benefits of pricing carbon come from “driving substitution among energy sources” by providing a financial incentive to use “lower-carbon technologies,” Severin Borenstein, a governor on the California Independent System Operator Board and professor of economics and policy with the Energy Institute at the University of California, Berkeley’s, Haas Business School, wrote in 2019.

The Obama administration-calculated social cost of carbon, set as part of a cost-benefit analysis that could some day lead to a carbon price, is now estimated at $50/tonne by the original methodology, Borenstein said.

It would raise the cost of coal-generated electricity by about $0.05/ kWh, which prices it “out of the generation market,” he concluded from his references. And the $0.02/kWh higher cost of natural gas-generated electricity from that $50/tonne price would “boost the competitiveness of renewables and near-zero carbon generation” and limit “the shuttering of existing nuclear,” he added.

Economists support carbon pricing, “but they don’t live in the real world,” EIRP’s Thernstrom responded. “There are countless ways the economic and political structure is not built on what economists recommend.”

The problem is that “either approach to pricing carbon makes some things more expensive,” said former Regulatory Assistance Project Senior Advisor Jim Lazar, an economist and author of Electricity Regulation in the US: A Guide. “It makes everything not carbon more competitive, but it makes everything carbon more expensive.”

But revenues from a carbon price can help pay for complimentary policy measures like renewables mandates and building and transportation electrification incentives that drive markets, Lazar acknowledged.

“Without a robust meaningful carbon price, policy tools are not going to come close to the Biden 50% by 2030 emissions reduction goal,” Carbon Tax Center Director Charles Komanoff’s calculations have concluded.

Pricing in use

Programs in California, the RGGI states and Canada show that policy tools can be key steps toward a price on carbon when it is not politically viable, some policymakers and analysts said.

Recent federal negotiations over climate and infrastructure measures show “the national politics against a carbon price are brutal,” said Danny Cullenward, vice chair of CARB’s Independent Emissions Market Advisory Committee (IEMAC) and policy director at CarbonPlan. Visibly impacting consumers’ gasoline prices and big companies’ energy prices “gives both reasons to push back through electoral hostility and lobbying,” he said.

Canada, California and RGGI “pursued carbon pricing because politics allowed for it, but recognized it was not necessarily the primary instrument,” Cullenward added.

But policies supporting innovation can lead to new technologies that a later push from the market’s carbon price can help deploy at scale, and most current programs use a version of that approach, Cullenward and others said.

To achieve the “maximum technologically feasible and cost-effective” emissions reductions ordered in 2006’s Assembly Bill (AB) 32, California “never relied on just carbon pricing,” CARB’s Sahota said. “Cap-and-trade was an entirely new concept and did not take effect until 2012,” she added. It still has a price of only about $25/tonne, showing that other factors are contributing to California’s clean energy progress, she added.

The initial AB 32 scoping plan included a suite of programs, mandates and incentives to address the “low-hanging fruit” of emissions reductions from land use, electricity generation and transportation, Sahota said. The Biden administration is already acting on vehicle, methane and other emissions, and could act on other standards, she added.

Another potential federal policy action to prepare the way for a price on carbon could be a low carbon fuel standard, Sahota said. By allowing oil and gas companies to earn credits for producing cleaner fuels, California’s fuel standard has helped prepare them to benefit from a carbon price “instead of being pushed out of the market.”

RGGI is 11 states instead of one, and more varied market forces are ramping up its carbon price more slowly than California’s, but with a similarly broad set of supporting policies, University of Virginia Professor of Public Policy William Shobe said.

Though RGGI has multiple aspects, its power system-focused market essentially caps emissions and auctions tradable allowances to emit carbon that allow emitters to continue conducting business at a cost, he said. RGGI’s auction sets the price for allowances after policymakers set the cap, and both the 18% average annual allowance price growth and the tightening cap shows the system is working, he added.

Today’s average $10/tonne price for RGGI allowances “is high enough to influence dispatch and future generation decisions, though not high enough to reach net zero emissions in 2050,” Shobe acknowledged. But emissions are trending down, and allowance prices are rising because emitters see participating states’ support for clean energy and efficiency policies as signaling a higher future carbon price, Shobe said.

Partisanship still makes immediate near-term federal carbon pricing unlikely, but markets don’t do it all, Shobe said, agreeing with Sahota and others about the value of other clean energy policies.

The administration could accelerate support for research and development to drive innovation in storage, green hydrogen, geothermal, and advanced nuclear technologies, and encourage states to form RGGI-like coalitions “to start pricing carbon in transportation fuels,” Shobe added.

Canada’s 2018 federal Greenhouse Gas Pollution Pricing Act requires each province and territory to price carbon. Various cap-and-trade, tax and hybrid systems have been designed and implemented, the government’s carbon price website reported. 

British Columbia (BC) led Canada with its 2008 cap-and-trade system that imposed a $10/tonne price, according to BC’s carbon price website. The law establishing the system also imposed an annual $5/tonne price increase until the province’s policy objectives were achieved.

Its revenue neutral design, achieved by offsetting certain income tax provisions, limited costs to consumers, British Columbia Utilities Commission Chair and CEO David Morton said. In addition, BC’s largely hydropower and wind-generated electricity incurred little burden from the carbon price. As a result, BC’s carbon price has had limited impacts on customers and has met little resistance.

BC’s price on carbon remains politically-accepted, but it is now high enough to have a noticeable impact on the price of the natural gas many rely on for heating, leading to questions “about its effectiveness,” Morton said. Canada’s other carbon programs are not advanced enough to have definitive results and redesigns are being considered, according to a June 14 Canadian Institute for Climate Choices report.

Though the annual BC price increase was not applied every year, it is now $45/tonne and the federal government’s 2030 target for all provinces is $170/tonne, Morton cautioned. “It is not clear whether the carbon tax will remain revenue neutral or how that will be received by customers.”

The power of policy

Many economists agree about the need for a U.S. carbon price. They also recognize the present moment’s political reality and see the potential of other policies as a foundation for future action.

Strengthening federal energy efficiency, building, and transportation standards, and providing financial incentives for supporting utility programs drive decarbonization, even in the absence of a carbon price, a paper published in the December 2020 edition of Public Utilities Fortnightly observed.

By 2040, customer actions in adopting clean distributed energy resources and energy efficiency solutions can eliminate twice the emissions as decarbonizing only the energy supply, a Sept. 7 Opower and Brattle Group study found. Energy efficiency, distributed solar, electric vehicles, load flexibility through smart thermostats, and time-varying rates could provide “nearly 60% of the annual GHG reductions achieved from all sectors from 2005 to 2021,” it added.  

California has shown that policies driving appliance, building, transportation and fuel efficiency can reduce emissions, said Brattle Group Principal and co-author of both papers Ahmad Faruqui. Policymakers, regulators and political leaders should not “wait for a carbon tax like waiting for Godot,” when stronger “standards, codes, and incentives are the art of the possible.”

There are many reasons why actual policymaking departs from economists’ textbook prescriptions, said Resources for the Future Darius Gaskins Senior Fellow Dallas Burtraw. But a modest price on carbon is like “no other policy or regulation” in conveying policymakers’ “long-term commitment to decarbonization” and signaling to investors across the economy “to align their actions with decarbonization.”

A federal carbon price “is an imperative” eventually, Burtraw said. But the road to California’s carbon cap-and-trade system and RGGI began with “performance standards and regulations,” like the low carbon fuel standard, renewables and zero emissions vehicle mandates, and “pricing mechanisms through things like environmental compliance and planning standards.”

The California and RGGI programs have been successful and the suite of policies other than carbon pricing they used for support were essential to that success, Burtraw said. “Attributing a majority of the emission reductions to standards and policy regulations does not mean carbon pricing has not succeeded. Carbon pricing is a journey, not an endpoint.”

Bipartisan climate action is unlikely anytime soon, CARB’s Cullenward added. But a flexible approach based on multiple policies for getting to zero carbon “is not materially different from the economist’s dream about how to use carbon pricing.”