The Design and Implementation of U.S. Climate Policy

May 13-14, 2010
Don Fullerton of the University of Illinois and NBER and Catherine Wolfram of the University of California, Berkeley and NBER, Organizers

Lawrence H. Goulder, Stanford University and NBER, and Robert Stavins, Harvard University and NBER

Interactions of State and Federal Climate Change Policies (NBER Working Paper 16123)

In the near future, federal action addressing climate change is likely to emerge either through new legislation or via the U.S. EPA's recently granted authority under the Clean Air Act. The prospect of federal action raises important questions regarding the interconnections between federal efforts and ongoing state-level climate policy developments. To what extent will federal efforts overlap with state policies? In the presence of federal policies, to what extent will state efforts be cost-effective? How does the co-existence of state- and federal-level policies affect the ability of state efforts to achieve emissions reductions? Goulder and Stavins address these questions. They find that in scenarios corresponding to current and planned climate policies, the co-existence of state and federal policies leads to significant difficulties (although in other cases, co-existing state and federal climate policies can be mutually effective or reinforcing). The problematic interactions arise when the federal policy involves restrictions on aggregate emissions quantities (as with a federal cap-and-trade program with no safety valve) or constraints relating to performance (as with fuel-economy standards or renewable fuel standards). In these circumstances, the emission reductions accomplished by a subset of U.S. states reduces pressure on the constraints posed by the federal policy, thereby freeing facilities or manufacturers to increase emissions in other states. Serious "emissions leakage" thus occurs. In contrast, when the federal policy fixes prices for emissions (as under carbon taxes or under a cap and-trade program with a binding "safety valve"), more aggressive climate policy in subset of states does not produce the state-federal interactions that lead to offsetting emissions increases elsewhere. The potential for problematic interactions does not necessarily vitiate the case for some state-level policies. The authors articulate and evaluate a number of arguments that have been made to support state-level climate policy in the presence of federal policies, despite the potential for leakage.

Frank A. Wolak, Stanford University and NBER
Regulating a Global Carbon Market

Wolak characterizes the major challenges facing a regulatory process for a global carbon market and points out the tradeoffs that policymakers face in addressing these challenges. He first outlines the three basic roles of a regulatory process. Then he summarizes how the unique features of a global carbon market complicate the design and operation of the regulatory process. Finally, he analyzes the tradeoffs that policymakers face in addressing these challenges.

Lucas W. Davis, University of California, Berkeley and NBER

Evaluating the Slow Adoption of Energy Efficient Investments: Are Renters Less Likely to Have Energy Efficient Appliances? (NBER Working Paper 16114)

While public discussion of HR 2454 (the "Waxman/Markey Bill") has focused on the cap-and-trade program that would be established for carbon emissions, the bill also includes provisions that would tighten energy effciency standards for consumer appliances. Supporters argue that appliance standards help address a number of market failures. In particular, many studies have pointed out that landlords may buy cheap ineffcient appliances when their tenants pay the utility bill. Although this landlord-tenant problem has been widely discussed in the literature, there is little empirical evidence on the magnitude of the distortion. Davis compares appliance ownership patterns between homeowners and renters using household-level data from the Residential Energy Consumption Survey. The results show that, controlling for household income and other household characteristics, renters are significantly less likely to have energy-effcient refrigerators, clothes washers and dishwashers.

Arik Levinson, Georgetown University and NBER

Interactions among Climate Policy Regulations (NBER Working Paper 16109)

With few exceptions, economic analyses of "cap-and-trade" permit trading mechanisms for climate change mitigation have been based on first-best scenarios without pre-existing distortions or regulations. The reason for this is obvious: interactions between permit trading and other regulations will be complex. However, not only will climate policy proposed for the U.S. certainly interact with existing laws, but it will also likely include additional regulatory changes with their own sets of interactions. Major bills introduced in the U.S. Congress have included both permit trading and traditional command and control regulations. Levinson discusses interactions between these instruments, and begins to lay out a framework for thinking about them systematically. The most important determinant of how the two types of instruments interact involves whether or not the cap-and-trade permit price would induce more or less abatement than mandated by the more traditional regulatory standards. Moreover, economists' experience predicting the costs of environmental regulations suggests that we are more likely to overstate the costs of cap-and-trade, and therefore the price of carbon permits, than we are to overstate the costs of a traditional regulatory standard. Therefore, the regulatory standards will likely reduce the cost-effectiveness benefits of cap-and-trade.

V. Kerry Smith, Arizona State University and NBER

How Can Policy Encourage Climate Adaptation? (NBER Working Paper 16100)

Smith considers the role of incentive-based climate adaptation policies. First, he revisits the early literature on pricing and capacity choices under demand uncertainty. This literature provide a basis for understanding how incentives could be used to influence the availability of substitutes for the natural services provided by the current climate system (for example, a time profile of temperature and precipitation conditions expected for different seasons and locations around the world). Uncertainties in demand and natural substitutes are evaluated separately as influences on optimal pricing and capacity decisions. Second, Smith demonstrates how incentive-based adaptation policy influences the economic value of climate change mitigation. Finally, he treats the demand uncertainty that would arise under a given climate regime, as well as the uncertainty in climate-related services, as an independent component in the overall supply of water or pleasant living conditions. In the short run, this assumption may be reasonable. In the long run, changes in the climate regime and associated weather conditions probably would affect the nature of the demand for their substitutes. Will the impact of a shift in the climate regime affect the amount of the substitutes demanded and their variability, or will it influence the responsiveness of demand to changes in incentives? The answers to these questions will influence the relevance of these models for long-term policy design. In the last part of this paper, Smith offers some empirical evidence on changes in the price elasticity of demand with variations in seasonal precipitation. Using micro-level data for the Phoenix metropolitan area, he finds that there are marked differences between normal and dry conditions for residential water demand.

Severin Borenstein, University of California, Berkeley and NBER

Markets for Anthropogenic Carbon within the Larger Carbon Cycle (NBER Working Paper 16104)

Human activity has disrupted the natural balance of greenhouse gases in the atmosphere and is causing climate change. But burning fossil fuels and deforestation directly result in about nine gigatons of carbon (GtC) emissions per year, against the backdrop of the natural carbon flux -- emission and uptake -- to and from oceans, vegetation, soils and the atmosphere of about 210 GtC per year. Scientific research now indicates that humans are also affecting the natural carbon cycle through less direct, but very important, mechanisms that are more difficult to monitor and control. Borenstein explores the challenges that this presents to market or regulatory mechanisms that might be used to reduce greenhouse gases: scientific uncertainty about these indirect processes; pricing heterogeneous impacts of similar human behaviors; and the difficulty of assigning property rights to a far larger set of activities than has previously been contemplated. While this does not undermine arguments for market mechanisms to control direct anthropogenic release of greenhouse gases, it does suggest that more research is needed to determine how and whether these mechanisms can be extended to address indirect human impacts.

Matthew E. Kahn, University of California, Los Angeles and NBER

Urban Policy Effects on Carbon Mitigation (NBER Working Paper 16131)

Cities differ with respect to their carbon footprint, and the same household will produce different levels of carbon emissions depending on where it lives within the city. For example, the same household would produce less greenhouse gas emissions if it lived in San Francisco than in Houston. San Francisco is more "green" because of its temperate climate, high population density, accessible public transit system, and relatively clean electric utilities. Within a metropolitan area, households produce less greenhouse gas emissions if they live closer to the city center: such urban households drive less and live in smaller homes than their suburban counterparts. Kahn uses several datasets to measure the association between compact urban form and a household's carbon footprint. He also discusses policies that encourage households to live closer to the city center.

Michael J. Roberts and Wolfram Schlenker, Columbia University and NBER

Is Agricultural Production Becoming More or Less Sensitive to Extreme Heat? Evidence from U.S. Corn and Soybean Yields (NBER Working Paper 16308)

Extreme heat is the single best predictor of corn and soybean yields in the United States. While average yields have risen continuously since World War II, Roberts and Schlenker find no evidence that relative tolerance to extreme heat has improved between 1950 and 2005. Climate change forecasts project a sharp increase in extreme heat by the end of the century, with the potential to significantly reduce yields under current technologies.

Charles D. Kolstad, University of California, Santa Barbara and NBER

Regulatory Choice with Pollution and Innovation (NBER Working Paper 16303)

Kolstad develops a simple model of a polluting industry and an innovating firm. The polluting industry is faced with regulation and costly abatement. Regulation may take the form of taxes or marketable permits. The innovating firm invests in R and D and develops technologies that reduce the cost of pollution abatement -- it can patent this innovation and use a licensing fee to generate revenue. In a world of certainty, the first-best level of innovation and abatement can be supported either by a pollution tax or a marketable permit. However, the innovator's returns from innovation are not the same under the two regimes. A marketable permit system allows the innovator to capture all of the gains to innovation; a tax system involves sharing the gains between the innovator and the polluting industry.

Stephen P. Holland, University of North Carolina, Greensboro and NBER

Spillovers from Climate Policy (NBER Working Paper 16158)

Climate policy spillovers can be either positive or negative because firms change their production processes in response to climate policies, which may either increase or decrease emissions of other pollutants. Understanding these ancillary benefits or costs has important implications for climate policy design, modeling, and benefit-cost analysis. Holland shows how spillovers can be decomposed into output effects (which have ancillary benefits) and substitution effects (which may have ancillary benefits or ancillary costs). The ambiguous net effect highlights the importance of polluters' responses to climate policy. He then tests for climate policy spillovers in electricity power generation. His estimates are consistent with ancillary benefits from climate policy arising primarily from reductions in output (primarily at older plants) rather than from changes in emissions rates.

Kevin A. Hassett and Aparna Mathur, American Enterprise Institute, and Gilbert E. Metcalf, Tufts University and NBER

Distributional Impacts in a Comprehensive Climate Policy Package (NBER Working Paper 16101)

Metcalf, Mathur, and Hassett provide a simple analytic approach for measuring the burden of carbon pricing that does not require sophisticated and numerically intensive economic models but which is not limited to restricting assumptions of forward shifting of carbon prices. They also show how to adjust for the capital income bias contained in the Consumer Expenditure Survey, a bias towards regressivity in carbon pricing because of overreporting of capital income in lower income deciles in the Survey. Once one allows for backward shifting, carbon policies look more progressive than when full forward shifting is assumed. Perhaps more important than the findings from any one scenario, these results on the progressivity of the leading cap and trade proposals are robust to the assumptions made on forward and backward shifting of the burden of carbon pricing.

Hilary Sigman, Rutgers University and NBER

Monitoring and Enforcement of Climate Policy (NBER Working Paper 16121)

Sigman applies recent research on environmental enforcement to a potential U.S. program to control greenhouse gases, especially through emission trading. Climate change policies present the novel problem of integrating emissions reductions from sources that are relatively easy to monitor (such as carbon emissions from fossil fuels) with those from sources that are very difficult to monitor (such as other greenhouse gas emissions). Sigman documents the heterogeneity in monitoring costs across different parts of the carbon market. She argues, however, that a broad emission trading system that includes more difficult-to-enforce components can have higher overall compliance than a narrower program.

Meredith Fowlie, University of California, Berkeley and NBER

Updating the Allocation of Greenhouse Gas Emissions Permits in a Federal Cap-and-Trade Program (NBER Working Paper 16307)

U.S. adoption of a cap-and-trade program for greenhouse gases could place some domestic producers at a disadvantage relative to international competitors who do not face similar regulation. To address this issue, proposed federal climate change legislation includes a provision that would freely allocate (or rebate) emission allowances to eligible sectors using a continuously updating output-based formula. Eligibility for the rebates would be determined at the industry-level based on emissions (or energy) intensity and a measure of import penetration. Dynamic updating of permit allocations has the potential to significantly mitigate adverse competitiveness impacts and emissions leakage in eligible industries. It can also undermine the cost-effectiveness of permit market outcomes as more of the mandated emissions reductions are achieved by sources deemed ineligible for rebates. Fowlie investigates how both the benefits and the costs of output-based updating vary systematically with observable industry characteristics. Stark differences between proposed eligibility criteria and those consistent with standard measures of economic efficiency are identified. The analysis underlines the importance of taking both benefits and costs into account when determining the scale and scope of output-based rebating provisions in cap-and-trade programs.

Roberton C. Williams III, University of Maryland and NBER

Setting the Initial Time-Profile of Climate Policy (NBER Working Paper 16120)

Williams considers the question of under what circumstances a new environmental regulation should "phase in" gradually over time, rather than being immediately implemented at full force. He focuses particularly on climate policy, although most of the insights are more general. He shows that while there is a strong efficiency argument for phasing in a quantity-based regulation (or allowing intertemporal flexibility that creates the equivalent of a phase-in), this argument does not apply for price-based regulation. Indeed, in many cases, it will be more efficient to do just the opposite, setting an initially very high emissions price that then gradually falls over time. But other considerations, such as distributional concerns or monitoring and enforcement issues, may still argue for a gradual phase-in even for a price-based policy.

Erin T. Mansur, Yale University and NBER

Upstream versus Downstream Implementation of Climate Policy (NBER Working Paper 16116)

Mansur examines the tradeoffs of regulating upstream (coal, natural gas, and refined petroleum product) producers versus regulating downstream (direct) sources of greenhouse gases (GHG). In general, regulating at the source provides polluters with incentives to choose among more opportunities to abate pollution. Mansur develops a simple theoretical model that shows why this added flexibility achieves the lowest overall costs. The theory is then broadened to incorporate several reasons why these potential gains from trade may not be realized-transactions costs, leakage, and offsets-in the context of selecting the vertical segment of regulation.

Olivier Deschenes, University of California, Santa Barbara and NBER

Climate Policy and Labor Markets (NBER Working Paper 16111)

An important component of the debate surrounding climate legislation in the United States is its potential impact on labor markets. A main concern is that increasing energy prices will lead to the displacement of jobs from the United States to countries without carbon regulation. The key statistics to evaluate these potential employment effects are the short-run and long-run cross-elasticities of labor demand with respect to energy prices. Deschenes provides new estimates of the short-run relationship between real electricity prices and employment using data for 1976-2007. Importantly, he presents a first attempt at relying on within-state variation in electricity prices to identify his models. The resulting cross-sectional and time-series variation allows controls for unrestricted year, state, and industry shocks, as well as allowing for differential time trends across states or industries. The main finding is that employment rates are weakly related to electricity prices in the short run. The implied cross elasticity of full-time equivalent (FTE) employment with respect to electricity prices ranges from -0.15 percent to -0.08 percent. By comparison, the average annual change in FTE employment (normalized by population) over the sample period is about 1.5 percent, so the fluctuations in employment caused by electricity price shocks are well within the range of the normal historical variation. He also interprets these estimates in the context of H.R. 2454, the American Clean Energy and Security Act of 2009. To this end, he considers the possible employment effects that would be generated by increasing electricity prices by 3 percent, similar to what is predicted to occur under H.R. 2454. This approach suggests that FTE employment would decline by about 0.3 percent in the short run.

Kala Krishna, Pennsylvania State University and NBER

Limiting Emissions and Trade: Some Basic Ideas (NBER Working Paper 16147)

In a general rather than partial equilibrium setting, Krishna looks at emissions controls implemented via tradable permits. First, she uses a simpler (no joint production) yet in many ways more general (no functional form assumptions are needed) version of the setup in Copeland and Taylor to explain how restrictions on tradable emissions permits can affect emissions permit prices, factor prices, and outputs in the model. She then draws a parallel between the quotas on goods and emissions controls, which are basically quotas on the input "emissions." She concludes with some thoughts on the implementation of such tradable permits, drawing on the experiences in the Multi Fiber Arrangement (MFA), under which trade in textiles, yarn, and apparel was controlled by country and by product-specific bilateral quotas, and where a number of analogous issues arose.

James B. Bushnell, Iowa State University and NBER

The Economics of Carbon Offsets (NBER Working Paper 16305)

Bushnell notes that although international programs for carbon offsets play an important role in current and prospective climate change policy, they continue to be very controversial. Assymmetric information creates several incentive problems, include adverse selection and moral hazard, in offset markets. The current regulatory focus on additionality tends to paint all these problems with a broad brush without proper consideration of the context or their implications.

Christopher R. Knittel, University of California, Davis and NBER, and Ryan Sandler, University of California, Davis
Carbon Prices and Automobile Greenhouse Gas Emissions: The Extensive and Intensive Margins

The transportation sector accounts for nearly one third of U.S. greenhouse gas emissions. Despite this, U.S. policy to reduce greenhouse gas emissions from vehicles has been essentially stagnant since 1990. Policymakers have avoided directly pricing externalities from vehicles, in terms of both global and local pollutants, and Corporate Average Fuel Standards have changed little since the mid-1980s. Also, the emission reductions from policies designed to increase bio-fuel penetration have been called into question. Knittel and Sandler analyze how pricing carbon through either a cap and trade system or a carbon tax might affect greenhouse gas emissions from the transportation sector. They analyze the effect on both the intensive (vehicle miles travelled) and extensive (vehicle scrapping) margins, and find large effects on both margins.

Matthew J. Kotchen, Yale University and NBER

Climate Policy and Voluntary Initiatives: An Evaluation of the Connecticut Clean Energy Communities Program (NBER Working Paper 16117)

Can simple and relatively low-cost government programs effectively promote voluntary initiatives to reduce greenhouse gas emissions? Kotchen evaluates how the Connecticut Clean Energy Communities (CCEC) program affects voluntary household purchases of "green" electricity. His results suggest that within participating communities, subsidizing municipal solar panels upon reaching green-electricity enrollment targets increases the number of household purchases by 35 percent. The CCEC program serves as model for how mostly symbolic incentive programs can mobilize voluntary initiatives within communities, promote demand for renewable energy, and reduce greenhouse-gas emissions.

NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us