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Friday, January 22, 2010

Climate Change: Design Approaches for a Greenhouse Gas Reduction Program

Larry Parker
Specialist in Energy and Environmental Policy

Three events provide impetus for revisiting the cost issue with respect to designing a greenhouse gas reduction program. The first is the election of a new President publicly committed to substantial reductions in greenhouse gases over the next several decades. The second was passage of H.R. 2454 by the House that would mandate a 83% reduction in the country's greenhouse gas emissions from 2005 by 2050. The reduction would be primarily achieved through a market based, cap-and-trade program, beginning in 2012. The third is the Copenhagen Accord that may begin the process of incorporating developing countries in a global climate change framework by committing them to implement "mitigation actions," along with monitoring, reporting, and verification procedures "in accordance with guidelines adopted by the Conference of the Parties." Facets of the cost issue that have raised concern include absolute costs to the economy, distribution of costs across industries, competitive impact domestically and internationally, incentives for new technology, and uncertainty about possible costs. 

Market-based mechanisms address the cost issue by introducing flexibility into the implementation process. The cornerstone of that flexibility is permitting sources to decide for themselves their appropriate implementation strategy within the parameters of market signals and other incentives. That signal can be as simple as a carbon tax or comprehensive credit auction that tells the emitter the value of any reduction in greenhouse gases, to a credit marketplace that is constrained by a ceiling price (safety valve) and includes incentives for new technology. As illustrated here, the combinations of market mechanisms are numerous, allowing decision makers to tailor the program to address specific concerns. 

In general, market-based mechanisms to reduce greenhouse gas emissions, the most important being carbon dioxide (CO2), focus on specifying either the acceptable emissions level (quantity) or the compliance costs (price), and allowing the marketplace to determine the economically efficient solution for the other variable. For example, a tradeable permit program sets the amount of emissions allowable under the program (i.e., the number of permits available limits or caps allowable emissions), while allowing the marketplace to determine what each permit will be worth. Likewise, a carbon tax sets the maximum unit cost (per ton of CO2 equivalent) that one should pay for reducing emissions, while the marketplace determines how much actually gets reduced. 

In one sense, preference for a carbon tax or a tradeable permit system depends on how one views the uncertainty of costs involved and benefits to be received. The options discussed here represent a continuum between alternatives focused on the price side of the equation (e.g., carbon taxes) through hybrid schemes (e.g., safety valves) to alternatives focused on the quantity side (e.g., banking and borrowing). They are tools to assist in the assessment of potential greenhouse gas reduction approaches, leaving any policy decision on balancing the price-quantity issue to the ultimate decision makers. 

Date of Report: January 12, 2010
Number of Pages: 28
Order Number: RL33799
Price: $29.95

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