Thursday, September 15, 2011

Clean Energy Standard vs. Feebate vs. Carbon Tax vs. Cap and Trade

Alan J. Krupnick and Ian W.H. Parry of Resources for the Future have a nice short article on "Decarbonizing the Power Sector: Are Feebates Better than a Clean Energy Standard?" But if the policy goal is to reduce carbon emissions, there are at least four policies in play--all discussed in their article.

  • A clean energy standard. They write: "Under this approach, electricity producers would be required to meet a rising fraction of their generation using zero-carbon sources or sources with lower carbon intensity (defined as CO2 emissions per kilowatt-hour [kWh]) than that of coal generation." In July, the Congressional Budget Office put out a report on "The Effects of Renewable or Clean Electricity Standards:" :
  • A "feebate" system, "which involves fees for [electricity] generators with above-average emissions intensity and subsidies or rebates for those with below-average emissions intensity."
  • A cap-and-trade system, in which the government sets an overall cap on carbon emissions, and then allocates permits to emit this amount of carbon. These emission permits would have two important traits: 1) they would shrink over time, so a permit to emit amount of carbon in one year would gradually phase down to allow emitting only a certain percentage of that amount in future years; and 2) the permits could be bought and sold, so that those who could reduce emissions relatively cheaply would have an incentive to go ahead and do so, and to sell their excess permits to those who would find it more expensive to reduce emissions.
  • A carbon tax.  

I won't attempt to rank these options in any systematic way, but here are some of my thoughts about them.

1) A feebate system has some substantial advantages. Krupnick and Parry explain: "The feebate approach has several potential advantages over a CES [clean energy standard]. For starters, the incremental costs of reducing CO2 are automatically equated across different generators, promoting a cost-effective allocation of emissions reductions within the power sector at a given point in time. Another attraction of the feebate is that it automatically handles changes in the future costs of different generation technologies or fuel prices. If, for example, the future expansion of nuclear power is temporarily held up, firms would be permitted a higher emissions intensity (at the expense of paying more fees or receiving fewer rebates); under a strict CES they would be required to meet a given emissions intensity standard, regardless of costs. Conversely, if the competitiveness of wind power improves, firms are rewarded for exploiting this opportunity and further cutting their emissions under a feebate system; with a CES, they have no incentive to do better than the emissions intensity standard. By establishing a fixed price on CO2 emissions, moreover, a feebate facilitates comparison of policy stringency across countries. This price could be set in line with estimates of the (global) environmental damages from CO2 (currently about $21 per ton, according to a recent review across U.S. agencies and subsequent use in U.S. regulatory impact analyses [U.S. Interagency Working Group on Social Cost of Carbon 2010]) or prices prevailing in the European Union’s Emissions Trading."

2) Anti-tax sentiment is a political constraint. I suspect that the clean energy standard is popular because, at least to politicians, it appears to have no costs. Similarly, cap-and-trade may appear to impose no costs either. In contrast, a carbon tax clearly looks like a charge. A feebate proposal does require collecting revenue and passing it to other actors--but there is no actual revenue retained by the government, so it may not look like a tax

3) The clean energy standard and feebate approaches both focus only on electricity generation, and for that reason would have less effect on carbon emissions than a broader-based cap and trade or carbon tax approach. This may also be a political selling point, because drivers using gasoline and firms that are heavy users of coal or oil or natural gas would be less affected by an approach that focused only on electricity generation. However, the feebate idea might have broader applicability. I have in the past seen feebate proposals in the past that focuses on automobile fuel efficiency: that is, those driving cars with below some level of miles-per-gallon pay a fee, and those driving cars above that level of miles-per-gallon get a rebate.

4) A clean energy standard is a pure regulatory approach, specifying what is "clean" and what is not, and thus is likely to be less effective than a cap-and-trade or a carbon tax approach. Here's how the CBO makes this point in its report: "Even with a wide variety of compliance options, neither an RES [renewable electricity standard] nor a CES [clean electricity standard] would be as cost-effective in cutting CO2 emissions as a “cap-and-trade” program. Such a program would involve setting an overall cap on emissions and letting large sellers of emission-creating products (such as electricity generators, oil producers and importers, and natural gas processors) trade rights to those limited emissions. In that way, a cap-and-trade program would create a direct incentive to cut emissions; in contrast, an RES or CES would create a direct incentive to use more renewable or other types of clean electricity but would have only an indirect effect on emissions."

5) A carbon tax and auctioning of cap-and-trade permits would raise revenue that could be used to lower tax rates in other areas, in ways that could enhance efficiency--but it is difficult to guarantee that the revenues would be used in this way.

6) One great advantage of a carbon tax is that it reduces the incentives for political tinkering. A cap-and-trade proposal, for example, is likely to have extensive grandfathering of those who currently emit carbon, probably along with a parade of special rules and exemptions. Defining what is "clean energy" or even how the feebates would be structured are likely to be more highly political decisions.