Recommendations to the U.S. Environmental Protection Agency: Why EPA Should Offer a Price-Based Standard for Carbon Pollution from Existing Power Plants

Good morning. Thank you for the opportunity to speak to you today about the design of a proposed rule to control greenhouse gases from existing power plants under Section 111(d) of the Clean Air Act. My name is Adele Morris, and I am a Fellow and the Policy Director for the Climate and Energy Economics Project at the Brookings Institution. My research focuses on the economic and environmental outcomes of climate and energy policies. My recommendations for the 111(d) rule are as follows.

I encourage you—in the rule—to offer states a menu of specific approaches that the agency believes would satisfy the law and the principles the President laid out in his memo to you in June 2013. Of course, states could deviate from this menu, but I believe concrete examples would help states develop their State Implementation Plans, or SIPs, more quickly. Specific examples would also allow states to assess the tradeoffs between different approaches given local contexts.

For example, you could offer three model SIPs:

• One model SIP could be a straightforward emissions performance standard that states could satisfy through flexible sector-wide compliance rules you could describe.
• Another model approach could accommodate the cap-and-trade system adopted by California in its implementation of AB32.
• Third, and this is my particular recommendation to you today, you could allow states to adopt a specific state-level excise tax or fee on the carbon content of fuels combusted by the power plants regulated under this rule. You’d provide a specified tax, per ton of carbon dioxide equivalent, that any state could adopt and thereby comply with your guidelines. You could specify a range of prices, or a price trajectory over time, or both, but as I’ll explain a price-based standard of some kind is very important.

You could use this menu to demonstrate the equivalence of these three actionable policy options with the analytical “toolbox” you’ve proposed. I believe the concrete illustration of those tools to show equivalence would be helpful.

As you know, economists have been advocating efficient price signals on carbon since we first heard the science of climatic disruption. Just as there is nearly universal agreement among scientists about human-induced climatic change, there is nearly universal agreement among economists that a price on carbon, such as through a carbon tax, is the most economically efficient policy to reduce GHG emissions. Sure sounds like a potential “best system of emission reduction” to me.

What would be the advantages of including a specific model excise tax SIP in the rule, along with the other options?

1. First, an excise tax approach is fully consistent with all of the principles the President laid out. It’s market-based, it’s flexible, it accommodates existing fuel mixes and the “remaining useful life” of equipment, and it doesn’t undermine reliability, while at the same time it provides an incentive to reduce use of fossil fuels in exact proportion to each fuel’s damage to the climate.
2. This is feasible and consistent with the law. If you can allow for a cap-and-trade approach as a “standard of performance,” you can allow an excise tax. You can show equivalence in expectation: for every price there’s a quantity and every quantity there’s a price.
3. An excise tax creates abatement incentives on the margin at every level of emissions, even beyond the point at which any particular technical performance standard is achieved. The policy always binds and always incentivizes abatement. An excise tax also helps drive a market for new technologies, which standards based on existing technologies may not do.
4. An excise tax, without any ancillary measures, creates incentives to abate through the entire supply chain for electricity. It incentivizes energy efficiency and a transition to lower-carbon fuels at the electricity generating unit, and it induces offsite actions to reduce or avoid emissions, including via end-use energy efficiency. Moreover, an excise tax incentivizes abatement through all means, including those about which neither EPA nor states have any information.
5. For some states, an excise tax would be the easiest, fastest, possible implementation. Some states already have excise taxes on fuels, including motor fuels and natural gas. They can do this. I encourage you to talk with state tax authorities, not just state environmental regulators, and learn about their excise tax policies and their experience with them. I know some states are already considering state carbon taxes, including Oregon and Massachusetts. If you want to accommodate those efforts, you should include a model excise tax SIP.
6. An excise tax would be easier for states to initiate and administer than other approaches, including a cap-and-trade system and tradable performance standards. States would not have to devise an initial allocation of allowances (including auctions), create a registry or market, monitor trades, or enforce a price floor. They don’t have to account for electricity generation, transmission, or consumption. They just monitor fossil fuel use and collect the money.
7. Excise taxes are easier for regulated firms, too, because they would not have to worry about allowance price volatility, fluctuating stringency, regulatory uncertainty, or macroeconomic gyrations that would affect allowance markets. The compliance price and its trajectory would be fixed, thus fostering the long term investments that you know are key to decarbonizing the economy.
8. Offering a particular tax rate or tax trajectory fosters transparent coordination of efforts across states. Multi-state coordination can help prevent inefficiently divergent incentives across states that can drive investment from more stringent states to less stringent states, and that undermines the environmental performance of the rule.

   And as you know, even if states harmonize across an identical emission standards, the same standard can have very different economic implications in different states depending on their baseline conditions. To minimize cross-state emissions leakage and competitiveness disparities, states should adopt similar price signals, and you can tell them in this rule what prices to coalesce around. Note, in an excise tax SIP approach, state policies don’t have to interact directly, like they would with a multi-state cap-and-trade program in which allowances trade cross state borders. In other words, harmonized excise taxes should be easier to implement than multi-state cap-and-trade programs, and they’d yield the same harmonizing benefits.

9. Importantly, states could use the revenue however they wish. The economic literature shows that the most cost effective climate policy would use revenue generated from a carbon tax or allowance auctions to lower other taxes that burden the economy, what we call a “tax swap.” States have some revenue instruments that are likely to be more distortionary than a carbon tax, so the possibility of an efficiency-enhancing tax swap at the state level raises the prospect of net social benefits of the SIP without even counting the environmental benefits. States could also use excise tax revenue to bolster precarious fiscal balances, pay down debt, fund under-capitalized pension or rainy day funds, fund other priorities, dividend the revenue to poor households, or any combination.
10. An excise tax explicitly bounds the marginal costs of the rule, and you can use the option to benchmark the rule’s costs directly to the range of estimates of the social cost of carbon (SCC) in the Administration’s guidance for federal rulemaking. Depending on the prices you specify, it may be helpful to allow states to ramp up their carbon tax over time to avoid premature scrapping of capital. By tying the carbon price to the Administration’s SCC guidance, you can directly demonstrate positive net benefits of the rule. In fact, you’ll probably have to do the implicit price calculation for an emissions performance standard anyway for the regulatory impact analysis, so you might as well put that price in the rule as an option for states.
11. If EPA puts an excise tax option in the rule, then the agency can signal that it expects to offer the same approach for future GHG rulemakings for industrial facilities. This immediately tells other emitters what to expect and helps them plan their long term investments efficiently. Thus, this information could drive abatement in those other sectors even before you start regulating them. Part of the problem we have now is that firms don’t know what investments in abatement will pay off. Here’s your opportunity to tell them and get those investment dollars off the sidelines.

    Even if few states choose to take up the excise tax SIP option, it’s important to put it in the rule…

12. For one thing, including the price-based standard in the rule offers strong diplomatic advantages. As a former negotiator, I can assure you that it is much easier to explain to other countries that we’ve adopted a specific price path on carbon — or that individual states have chosen something equivalent per official EPA analysis — across our electricity sector than it is to explain that our states will meet emissions standards of X tons per megawatt hour or whatever. Other countries keenly want to know the economic level of our ambition, and anything other than a price is hard for them to assess. Many officials from other countries that I talk to say that if the United States adopted a price on carbon it would significantly change the politics in their countries in favor of something similar. I strongly encourage you to work with the State Department to craft this rule in a way that gives the United States something to sell abroad. I encourage you talk to other countries to learn how they would view various approaches to this rule. After all, this rule is going to cover about a third of our GHG emissions. Barring unforeseen functionality in Congress, your rule will be the centerpiece of what the United States takes to the COP in 2015, so please think carefully how to optimize it for that purpose.
13. If all those advantages aren’t enough, how about the signal a carbon price in the rule would send to Congress? A number of carbon tax bills have been floated in Congress, and there has been talk of including a carbon tax in the context of broader fiscal reform. With your rule, the Administration can indicate to Congress what the President thinks would be an appropriate federal carbon tax approach. And if some members are intent on suspending EPA’s Clean Air Act authority for greenhouse gases, the Administration can signal in this rule what it would expect as an alternative. I think it would be a major lost political opportunity for the Administration not to use this rule to communicate its expectations for new authority.

Finally, many of the advantages I’ve laid out for offering an excise tax SIP would apply to the Federal Implementation Plan, or FIP, as well. The federal government already collects a number of fuel excise taxes, including a small tax on about 93 percent of U.S. coal production that funds care for victims of black lung disease. I believe it would be feasible for the feds to tax carbon in electricity fuels in states that do not submit an adequate SIP. I recommend you talk to the experts at the Office of Tax Policy at Treasury. There are precedents for the federal government collecting taxes on behalf of states and transferring revenues to state governments. Alternatively, the federal government could rebate FIP revenues directly to residents of states in which a FIP operates, or keep the revenues for the federal Treasury, in which case I think states would quickly see the advantage of imposing the tax themselves.

Thank you again for this opportunity to provide recommendations for the rule. I would be happy to discuss any of these ideas with you in more detail.