Impose a Price on Emissions of Greenhouse Gases

The accumulation of greenhouse gases in the atmosphere-- particularly carbon dioxide (CO2) released as a result of deforestation and the use of fossil fuels--could create costly changes in regional climates throughout the world. The damage could include water shortages, the loss of land in coastal areas because of rising sea levels, acidification of the world's oceans, and the extinction of various species. Concern about such damage has led policymakers and analysts to consider policies designed to reduce emissions of those gases.

Greenhouse gas emissions could be reduced by requiring emitters of large amounts to pay a price to emit those gases. Such a policy could be instituted as a tax on emissions or as part of a cap-and-trade system. In either case, the cost of producing and consuming goods and services would increase in proportion to the amount of greenhouse gases emitted as a result of that production and consumption. Ultimately, those costs would be passed on to consumers in the form of higher prices. Those higher prices, in turn, would create incentives throughout the U.S. economy to reduce emissions of greenhouse gases. This option would establish a cap-and-trade program governing emissions of greenhouse gases in the United States. Emissions would be measured in CO2 equivalents (CO2e)--that is, the amount of carbon dioxide that would cause an equivalent amount of warming. Under such a program, a decreasing number of allowances-- which would convey the right to emit 1 metric ton of CO2e apiece--would be sold at open auction, beginning in 2012 and ending in 2050. According to estimates by the Congressional Budget Office, emissions from the sectors that were subject to the cap-and-trade policy would fall by roughly 20 percent from their projected amounts in 2025 and by 50 percent from their projected amounts in 2050. Firms would be allowed to shift their use of allowances from one year to another by "banking" unused allowances or by "borrowing" allowances from future allocations for current use. However, firms would not be allowed to comply with the cap by submitting "offset credits," which reflect reductions in emissions from sectors that otherwise would not be subject to the cap.

If implemented, this option would raise revenues by close to $500 billion from 2012 through 2016 and by $1.2 trillion from 2012 through 2021. (Because it would reduce the tax base of income and payroll taxes, the option would lead to reductions in revenue from those sources. The estimates shown here reflect those reductions.)

Those revenue estimates are based on an estimated allowance price in 2012 of $20 that would increase at an annual rate of 5.6 percent. Such a price would motivate firms and households to undertake reductions that cost up to $20 per metric ton of CO2e to achieve in the initial year of the policy. The reductions would be economically justified if those costs were less than the long-term benefits of each ton of emissions that was reduced. An interagency federal analysis published in 2010 estimated the value of the benefit (that is, the damage that would be avoided) from reducing baseline emissions--those that would have occurred in the absence of any policy limiting emissions--by 1 metric ton. According to that study, the value of that benefit would range from an estimated $5 to $40 per metric ton in 2012.

An argument that is made in favor of a cap-and-trade program such as the one described here is that an initial allowance price of $20 would be justified by the benefits resulting from the program. In addition to the direct benefits from reducing the damage associated with climate change, such a program would generate "co-benefits." Co-benefits would occur when measures taken to reduce emissions--such as generating electricity from natural gas rather than from coal--reduced other pollutants not explicitly limited by the cap, thereby reducing the harmful effects associated with those emissions. The magnitude of those co-benefits is uncertain and depends on which standards were already in place to limit such pollutants. However, in terms of the benefits to human health, a literature survey published in 2010 indicates that the reductions in other pollutants that would occur as a by-product of limiting CO2 emissions could be as large as, or larger than, the direct benefits of reducing CO2 emissions.

Another argument in favor of the option is that setting an economywide price on emissions of greenhouse gases would impose a smaller cost on the economy than the alternative approach of achieving the same reductions through various provisions in the existing Clean Air Act (CAA). Setting an economywide price on greenhouse gas emissions would lower the cost of reducing emissions by allowing market forces to determine where, how, and--to some extent--when such reductions could be achieved. In contrast, standards issued under the CAA (for example, specifying an emissions rate for a plant or an energy efficiency standard for a given product) would offer less flexibility and, as a result, would achieve emission reduc tions at a higher cost. Finally, an economywide tax or cap-and-trade program would provide a potential source of revenue for the federal government, an option that would not be available under the existing CAA. The government could use some of those revenues to accomplish various goals such as reducing taxes, offsetting the costs of the cap-and-trade program for certain groups or industries that are put at a competitive disadvantage by the program, or reducing the federal deficit.

An argument that is made against policies that limit emissions is that any attempt to curtail U.S. emissions in the near term would burden the economy by raising prices for emissions-intensive goods and services while yielding benefits of an uncertain magnitude. In addition, most of those benefits might occur outside the United States, particularly in developing countries. It is also argued that reductions in domestic emissions could be offset by increases in emissions overseas if carbon-intensive industries relocated to countries that did not impose restrictions on emissions. Another argument against the option is that the budgetary savings from a cap-and-trade program would be diminished if the revenues were used to fund generous subsidies to industries and households affected by the program. Moreover, averting the risk of future damage caused by climate change would depend on collective global efforts to cut emissions. Most analysts agree that if other countries with high levels of emissions do not cut those pollutants over the same period that the United States does and by roughly the same percentage, efforts in this country would produce small climate- related benefits.