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Introduction
EPA's proposed rule sets state-by-state carbon intensity targets for the production of electricity. States are expected to adopt some form of economic incentive regulatory system to achieve these targets, but there has been a great deal of confusion about how, exactly, such a system should work. Several states have asked EPA how to translate these "rate-based" intensity targets into equivalent “mass-based” targets that could form the basis of a cap-and-trade or similar system; EPA recently responded to these questions with a supplementary notice.
This comment will argue that it would be a serious mistake for states to convert intensity goals to mass-based goals. Economic theory suggests that the costs of achieving emissions reduction using a mass-based control system will be an order of magnitude more expensive than achieving the same reduction with a rate-based system, when the costs of rent-seeking (which a rate-based system can better resist) are taken into account. Moreover, states that adopt a mass-based system place themselves at a severe competitive disadvantage, not only with respect to other states, but also with respect to foreign jurisdictions that adopt a rate-based target or no target at all. Finally, a mass-based system of emissions control would have regressive distributional effects that can easily be avoided with a rate-based system of control.
Historically, emissions trading has been most successful when designed to achieve an intensity goal. For example, between 1982 and 1987 EPA used an emissions trading system to phase out the use of tetraethyl lead as an octane booster in gasoline. Other countries followed, and the United Nations Environment Program recently estimated that the global benefit of removing lead from gasoline now amounts to at $2.4 trillion per year. A key factor leading to the success of this effort was EPA’s deliberate use of an intensity target, rather than a mass-based target.
The economic literature on emissions trading contains confusing and contradictory discussions about the relationship between constraints on the intensive margin (intensity constraints) and constraints on the extensive margin (mass-based constraints). This comment, which will be most accessible to economists, is intended to provide a structure for thinking about these options and their advantages and disadvantages.
This comment will not address many other important questions raised by EPA’s proposal: e.g., climate science, the estimation of the Social Cost of Carbon, EPA’s legal authority for the proposed rule, or the calculation of state-by-state targets. Regardless of the disposition of this particular rulemaking, any attempt to regulate carbon emissions – particularly at the state level – will require that policy makers understand the dynamics of emissions trading and the implications of working under a constraint on the intensive or extensive margin.