Assessing California’s Climate Policies—An Overview

Assessing California’s Climate Policies— An Overview MAC TAYLOR LEGISLATIVE ANALYST DECEMBER 2018 analysis full gutter AN LAO REPORT LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Executive Summary Overview of Report. Chapter 135 of 2017 (AB 398, E. Garcia) requires our office to annually report on the economic impacts and benefits of California’s statutory greenhouse gas (GHG) emission goals—statewide emissions to 1990 levels by 2020 and to 40 percent below 1990 levels by 2030. This report provides a conceptual overview of the potential economic effects of policies intended to help meet these goals—both positive and negative—as well as identifies some key issues for the Legislature to consider when designing and evaluating state climate policies. In a companion report, Assessing California’s Climate Policies—Transportation, we provide more detailed information and comments on the state’s major policies aimed at reducing emissions from the transportation sector. Climate Policies Have a Wide Variety of Effects. The state’s wide range of climate policies to reduce GHGs likely have many different effects. Such effects include: • GHG Reductions. Since GHG emissions cause economic damage, there is a global benefit to reducing those emissions. • Co-Benefits. Policies that reduce GHGs can have other benefits, such as reducing co-pollutants that affect local air quality, reducing future energy costs, and/or correcting other existing market distortions. • Direct Costs. In addressing emission reductions, there are often costs for businesses or households that require some type of additional monetary payment, such as households paying for more expensive types of electricity or businesses paying to produce more expensive goods. Other costs are not explicit monetary losses, but households nonetheless give up something valuable to them, such as comfort, convenience, or time. • Indirect Effects. Some direct costs have indirect effects in other areas of the economy as markets adjust to changes in how households and businesses behave. • Economic Transfers. Some of the most visible effects of state climate policies—such as cap-and-trade allowance auctions—largely reflect economic “transfers” between different households or businesses. Key Challenges in Estimating Policy Effects. There are a variety of challenges in accurately estimating the overall net effects of California’s climate policies—both before (prospective) and after (retrospective). Some of the key challenges include (1) controlling for factors that are largely unrelated to state climate policy (such as changes in economic conditions, technological progress, and federal policies), (2) assessing GHG effects that extend beyond the state’s formal system for monitoring statewide emissions (such as emissions related to biofuels, upstream emissions from imported goods, and leakage of emissions into other jurisdictions), (3) measuring implicit and indirect effects, and (4) considering interactions between different state and federal policies. Issues for Legislative Consideration. Given the wide variety of effects that state climate policies generate and the challenges associated with estimating those effects, we identify the following key issues for the Legislature to consider in regards to future climate policy design and evaluation: www.lao.ca.gov 1 analysis full gutter AN LAO REPORT • Use economywide carbon pricing to achieve low-cost GHG reductions. • Implement “complementary” policies only in circumstances when they are well-targeted and justified to ensure they are achieving benefits that carbon pricing would not. Examples might include policies that effectively promote innovation or reduce other types of pollution. • Focus on policies that are most likely to encourage GHG reductions in other jurisdictions to maximize the overall GHG reduction benefits for California. • Establish a robust system for climate policy evaluation that helps ensure the Legislature has more complete information about the effects of state climate policies. 2 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT INTRODUCTION Chapter 135 of 2017 (AB 398, E. Garcia) implemented to achieve those targets, (2) describe requires our office to annually report on the the general types of economic effects associated economic impacts and benefits of California’s with these policies, (3) identify key challenges statutory greenhouse gas (GHG) emission goals— in estimating the magnitude of these effects, limiting GHG emissions statewide to 1990 levels by and (4) discuss key issues for the Legislature to 2020 and to 40 percent below 1990 levels by 2030. consider in regards to future climate policy design The state has implemented a range of policies and evaluation. In a companion report, Assessing intended to help meet these GHG limits, hereafter California’s Climate Policies—Transportation, we referred to as climate policies or programs. These provide more detailed information and comments policies have a wide variety of economic effects— on the state’s major policies aimed at reducing both positive and negative. This report provides emissions from the transportation sector. In a conceptual overview of these effects, as well subsequent reports, we intend to assess policies as some key issues to consider when designing that reduce emissions from other sources, such and evaluating state climate policies. Specifically, as electricity generation and short-lived climate we (1) provide a general overview of the state’s pollutants. GHG limits and the major policies that are being STATE GHG TARGETS AND POLICIES Emissions Come From a Wide Variety of since AB 32 was enacted—dropping to below the Sources. Figure 1 (see page 4) shows the 2020 limit in 2016. However, the rate of reductions different sources of GHG emissions in California, needed to meet the SB 32 target are much greater. as measured by the California Air Resources Reduction in Emissions Driven by Electricity Board’s (CARB’s) inventory. The inventory is Sector. The reduction in emissions since 2006 are CARB’s estimate of statewide emissions, consisting the result of a wide variety of factors, including mainly of emissions that occur from in-state state policies, technological advancements, and the combustion of fossil fuels (such as gasoline, diesel, Great Recession. As Figure 3 (see page 6) shows, and natural gas) and production of goods (such most of the reductions have come from electricity, as refining oil into gasoline and manufacturing and almost all of those reductions have come from cement). In general, emissions associated with electricity that is imported from out-of-state. goods produced out-of-state, but imported into State Has Many Policies to Reduce GHGs. California, are excluded. (We discuss some of the State law requires CARB to develop a Scoping emissions that are excluded from the inventory in Plan to achieve the emissions limits and update more detail later in this report.) One key exception the plan periodically. The first Scoping Plan was is that the inventory includes estimated emissions approved by CARB in 2008, then updated in from electricity that is generated out-of-state, but 2014 and 2017. The state has dozens of different consumed in California. policies in place to reduce emissions. Figure 4 AB 32 and SB 32 Establish State GHG Limits. (see page 6) summarizes the major policies in the Chapter 488 of 2006 (AB 32, Núñez/Pavley) 2017 Scoping Plan intended to help the state meet established the goal of limiting GHG emissions its 2030 GHG target. CARB administers many statewide to 1990 levels by 2020. In 2016, of the major climate policies, but some policies Chapter 249 (SB 32, Pavley) extended the limit to are administered by other state agencies. For 40 percent below 1990 levels by 2030. As shown example, the renewable portfolio standards and in Figure 2 (see page 5), emissions have decreased energy efficiency programs are largely administered www.lao.ca.gov 3 analysis full gutter AN LAO REPORT by the California Public Utilities Commission and be implemented to meet the goals and how they the California Energy Commission. Many of these are designed. In other cases, such as the low policies have been operating for the last several carbon fuel standard (LCFS), state agencies are years to help the state meet its 2020 target and given discretion to determine whether a policy is are being expanded to achieve the 2030 goals. implemented and how. In some cases, such as the renewable portfolio standard, the Legislature provides specific direction to agencies about which policies should Figure 1 GHG Emissions Come From a Wide Variety of Sources Other Cement Oil and Gas Extraction General Fuse Use Light-Duty Vehicles Refineries Other Industrial Commercial Natural Gas Transportation Commercial and Residential Residential Natural Gas Agriculture, Waste, and High GWP Other Substances Heavy-Duty Vehicles Electricity Landfills ODS Other Substitutes Livestock and Manure Management Imported In-State Generation Electricity GHG = greenhouse gas; GWP = global warming potential; and ODS = ozone depleting substance. 4 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Figure 2 State Met 2020 Goal Early, but 2030 Goal More Ambitious Million Metric Tons of Greenhouse Gases 500 450 2020 400 AB 32 Target 350 300 2030 250 Actual Emissions SB 32 Target 200 150 100 50 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 POLICIES HAVE A WIDE VARIETY OF EFFECTS Social Benefits and Costs quantifying the economic effects of these actions is challenging because they each have different Households, businesses, and governments trade-offs—both monetary and nonmonetary. can take a variety of different actions to reduce Economists often attempt to measure these emissions. Figure 5 (see page 7) provides trade-offs in terms of “social” costs and benefits. examples of some of the major actions. State In short, this is the net value of what society as a policies encourage these actions through market whole gains and loses by reallocating resources— incentives, regulations, and financial subsidies. such as time and money—to a different set of For example, building regulations require new activities. One advantage of using social costs home builders to install rooftop solar. However, and benefits to measure economic effects is that www.lao.ca.gov 5 analysis full gutter AN LAO REPORT Figure 3 Electricity Is Biggest Driver of Emission Reductions Million Metric Tons of Carbon Dioxide 200 180 Transportation 160 140 120 100 Industrial Electricity 80 60 Agriculture, Waste, and High GWP 40 Commercial and Residential 20 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 GWP = global warming potential. Figure 4 Major Policies to Meet Statewide Greenhouse Gas Limits Cap-and-Trade. Regulation that establishes a “cap” on overall emissions from large emitters by issuing a limited number of permits (also known as allowances). Allowances can be bought and sold (traded), which creates a market price for allowances and an incentive for lowest cost reductions. Short-Lived Climate Pollutants. Regulations and incentives intended to reduce certain types of emissions from dairies, landfills, and refrigeration equipment. Renewable Portfolio Standard. Regulations that require utilities to provide a certain percentage of electricity from qualifying renewable sources, such as wind and solar. Energy Efficiency. Regulations and financial incentives to encourage more efficient energy use in commercial buildings, homes, and manufacturing facilities. Low Carbon Fuel Standard. Regulation that requires transportation fuel suppliers to reduce the amount of greenhouse gases per unit of fuel used in California—also known as carbon intensity of fuels. Vehicle-Related Programs. Regulations and incentives to encourage more efficient light- and heavy-duty vehicles, as well as promote certain types of technologies such as electric vehicles. Vehicle Miles Traveled. Planning strategies and financial incentives intended to reduce the amount of light-duty vehicle use through such things as increased transit and changes to land use. 6 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT it allows policymakers to compare across a wide bought and sold in a marketplace. We discuss the variety of different types of costs and benefits. For major types of social benefits and costs in more example, social benefits includes the estimated detail below. value of environmental benefits (such as GHG We note that a wide variety of other metrics— reductions), even though they are typically not including energy prices, jobs, and gross domestic Figure 5 Many Different Actions Reduce Greenhouse Gas Emissions Transportation Reduce Driving Use Different Vehicles Use Different Fuels Energy Use Less Energy Use Different Sources of Energy Develop Technologies to Capture Carbon Other Reduce Methane Emissions Sequester Carbon in Natural Lands www.lao.ca.gov 7 analysis full gutter AN LAO REPORT product (GDP)—are often used to describe the the effect on gasoline prices often does not reflect economic effects of climate change policies. the net economic costs of a policy because (1) it Although these metrics can provide information includes economic transfers, which are distinct about some of the effects of state policies, they from economic costs, and (2) it ignores other costs often have key limitations as a primary tool for that are not reflected in gasoline prices. (Please evaluating overall economic effects. For example, COMMONLY USED METRICS FOR EVALUATION HAVE LIMITATIONS A few metrics that are commonly used to describe the economic effects of climate policies include energy prices, jobs, and gross domestic product (GDP). Although these metrics can provide some useful information, as we discuss below, each of them has key limitations that policymakers should consider when evaluating state climate policies. Given these limitations, we caution against using any one of them as the primary metric for evaluating the net economic effects of a policy. Effects on Energy Prices Climate policies often affect prices for different types of energy, such as electricity, natural gas, gasoline, and/or diesel fuel. These changes can have significant effects on certain types of energy spending, but they are often poor measures of the overall net economic effects of a policy. This is because they ignore other costs, benefits, and transfers that might occur as a result of a policy. For example, changes in gasoline prices are often used to describe the costs of a policy. However, gasoline price changes fail to capture overall net economic costs in a couple of key ways. Often Reflects Economic Transfers, Not Economic Costs. In some cases, higher gasoline prices paid by households and businesses is simply a transfer of money, rather than a net economic cost. For example, by design, cap-and-trade increases gasoline prices as a way to encourage less consumption. The price increase has two main effects: • Economic Costs. There are economic costs associated with actions taken to reduce gasoline consumption. The economic costs could be such things as the cost of buying a more efficient vehicle or the time lost because a person takes an alternative form of transportation that takes longer (such as public transit). These changes in behavior—and their costs—are often difficult to identify and measure. • Economic Transfers. In contrast, the most visible effect of the policy—and the one that is reflected in gasoline prices—reflects a transfer of money from drivers to state government. Essentially, these transfers occur because the state auctions allowances to transportation fuel suppliers and generates revenue. Transportation fuel suppliers then pass the costs of purchasing allowances on to drivers in the form of higher gasoline prices. In effect, drivers pay for the allowances to cover the emissions from the gasoline they continue to consume. The net effect of these actions is largely a shift of money from households that purchase gasoline to the state government, not a net economic cost. Importantly, the transfers are distinct from economic costs because the government can redistribute it back to households in a way that offsets the higher gasoline prices and still maintains the incentive to reduce gasoline consumption, or use the cap-and-trade auction 8 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT see the nearby box for a detailed discussion of the associated with climate change. The estimated various limitations of commonly used metrics.) global damages from a ton of carbon dioxide—the most common GHG—is known as the Social Cost Types of Social Benefits of Carbon (SCC). Some of the estimated damages GHG Reductions. Reducing GHGs has a included in SCC are higher heat-related mortality, social benefit because it reduces the damages increased flood damages, and increased energy revenue for other socially beneficial activities. For example, if the funds were rebated to households on a lump-sum basis, many households could actually have more money as a result of the transfer and still have an incentive to lower their fuel consumption. Ignores Other Costs That Do Not Affect Gasoline Prices. Many of the state’s policies have costs that are not reflected in gasoline prices. For example, the renewable portfolio standard can increase electricity prices, but likely has very little effect on gasoline prices. Similarly, vehicle efficiency standards impose costs related to producing more efficient vehicles, but could actually decrease gasoline prices by reducing demand for gasoline. As a result, changes in gasoline prices provide no information about the relative costs of these policies. Jobs Although stakeholders often use changes in employment to illustrate the economic effects of policies, economists generally express caution about using this as a primary metric for climate policy evaluation. First, many estimates of employment effects are misleading because they show changes in employment for a subset of specific industries, such as renewable energy providers or fossil fuel producers. They often do not show how a policy affects overall employment because they ignore changes in other parts of the economy. There might be significant effects on some workers who lose jobs in certain industries, which merits some attention from policymakers. However, most research suggests that overall changes in employment from climate policies are relatively modest, at least in the long run. Second, even if government policies create additional net jobs, this job creation often comes with trade-offs. This is because the money used to pay the wages of these additional jobs comes from somewhere else in the economy. For example, the money used to pay these workers could come from households paying higher prices or higher taxes or fees. These households would have otherwise spent the money on some other economic activity. Similarly, businesses might have otherwise used the money to increase wages for existing jobs, invest in new technologies, or expand production. GDP GDP is a common, and generally reasonable, measure of many types of economic activity. It measures the market value of all final goods and services produced. However, it does not measure all things that are valuable to households. For example, such things as environmental benefits, leisure time, and product quality are not fully captured in this measure. In addition, modeling the effects of climate policies on statewide GDP can be difficult given the size of California’s economy and the complicated nature of economic relationships. www.lao.ca.gov 9 analysis full gutter AN LAO REPORT costs. The magnitude of these and other costs is GHGs (carbon dioxide), as well as criteria the subject of much research and debate. The most pollutants (nitrous oxides) and toxic air widely used SCC estimate was developed by the pollutants (diesel particulate matter). Reducing Obama Administration’s Interagency Working Group these co-pollutants has public health benefits on the Social Cost of Greenhouse Gases. Its central by improving local and regional air quality. estimate was roughly $50 per ton. However, there • Reduced Energy Costs. Policies that is substantial uncertainty around and disagreement promote efficiency—such as efficiency about this estimate. Some economists estimate the standards for buildings, appliances, and SCC is about $10 per ton while others estimate the vehicles—can lower the amount of money cost is hundreds of dollars per ton. The variation spent on energy or fuel. This means is caused by differences in modeling methods and households and businesses can use the assumptions, including discount rates. money for other activities. While the specific value of GHG reductions is • Correcting Other Market Distortions. In subject to uncertainty, the following issues are some cases, policies can reduce existing important considerations when evaluating the market distortions that have economic costs. benefits of GHG reductions in California: For example, revenue from cap-and-trade auctions could be used to reduce other state • Effects of GHGs Are Global. Unlike other taxes that reduce economic activity, such as types of air pollutants, GHGs—mainly carbon income taxes and certain types of sales taxes. dioxide—are dispersed into the global atmosphere. This means the costs are borne Types of Social Costs by people around the world. As a result, most of the benefits of reducing GHGs in California In concept, economic costs occur when accrue to other parts of the world. Similarly, people give up something valuable as a result reductions in other parts of the world will have of actions taken to reduce emissions—also benefits in California. referred to as “opportunity costs.” In practice, this • California Represents a Very Small Share means households have less money to spend on of Global GHGs. California emits roughly goods and services they value, or the products 1 percent of global GHGs. Without reductions they consume have less of some other valuable in other jurisdictions, large reductions in attribute—such as reliability, convenience, or California’s GHG emissions will have almost performance. We explain some of the general types no effect on global climate change. On the of costs in more detail below. These include both other hand, policies that lead to reductions direct costs—explicit and implicit—as well as the in other jurisdictions will have benefits that indirect effects that stem from those direct costs. exceed the value of the reductions that occur Explicit Direct Costs. Direct costs are borne only within California. As we discuss later by businesses or consumers that are directly in the report, this is critical context as the affected by a state policy. Some direct costs are Legislature designs its climate policies and relatively explicit because they require additional evaluates their overall effects. monetary payments. For example, regulations might force utilities to pay for more expensive Co-Benefits. Many policies that reduce GHGs sources of electricity (such as renewables) or have other benefits—sometimes called co-benefits. require businesses to produce more expensive Some examples include: goods (such as more energy efficient products). • Reduction in Co-Pollutants. Many activities Businesses also often have administrative costs to that reduce GHGs also reduce other types comply with a regulation, including internal staff to of pollutants, known as co-pollutants. For ensure compliance and the payment of government example, incentives to replace older diesel fees to support state agencies that implement the engines with newer technologies can reduce regulation. 10 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Although many of these costs are initially borne households trade off something valuable, such as by the businesses—such as fuel suppliers, utilities, comfort, convenience, or time. or manufacturers—the costs are ultimately borne Indirect Effects. Some direct costs have indirect by households. For example, many of the business’ effects. For example, in response to higher energy costs are likely passed on to consumers through prices, households and businesses will change their higher product prices. This often means consumers overall spending on energy, as well as other goods have less money to spend on other goods and and services. As a result, markets for these other services. When businesses cannot pass costs on to goods will adjust through changes in prices, output, consumers through higher prices, the costs are still and wages. As we discuss in more detail below, borne by households in the form of lower wages estimating indirect costs can be difficult because it for workers and/or lower profits for households that requires more complex models and a wide variety own those businesses (including shareholders). of assumptions about how different businesses and Implicit Direct Costs. Some direct costs are households interact. not explicit monetary losses, but households Distributional Effects nonetheless give up something valuable. These are sometimes called implicit costs. Some examples In addition to overall net economic effects, include: the distribution of costs and benefits is often an important criterion for evaluating policies. These • In response to higher prices for gasoline, effects can vary across households based on people might chose an alternative mode of such things as geographic location and income transportation to get to work (such as rail or level. Below, we discuss some key distributional transit). In this scenario, they might give up considerations when evaluating state climate (1) leisure time at home if the trip takes longer, policies. (2) convenience related to being able to travel Distribution of GHG Benefits Mostly Global, when you want rather than being on a fixed Co-Benefits More Local. As discussed above, the transit schedule, and/or (3) comfort related to direct benefits of GHG reductions are distributed being in their own vehicle rather than sharing across the globe. The location of where the space on transit. emissions are reduced does not have any impact • In response to higher electricity prices, on who benefits. However, many of the potential households might adjust their thermostat to co-benefits from actions taken to reduce GHGs use their furnace and air conditioning less in California—such as co-pollutant reductions— often. This could make their homes somewhat accrue primarily to California residents. In addition, less comfortable in the summer and winter. the location of the reduced emissions does affect • Car manufacturers might meet electric vehicle who receives the co-benefits. For example, requirements by producing vehicles that have programs to replace diesel freight equipment at less range, or other attributes that drivers ports in Southern California produce air quality value. benefits to a different group of people than • Prices for certain goods that are programs that replace agricultural equipment in the GHG-intensive—such as certain processed Central Valley. food products—become more expensive, Distribution of Costs Depends on Who thereby encouraging consumers to purchase Produces and Consumes GHG-Intensive Goods. less of it. As a result, households could lose Costs are generally greater for households that the value they would have otherwise gotten spend more on GHG-intensive products (such as from consuming the item. electricity and gasoline) or receive income from Although implicit costs are often more difficult GHG-intensive industries (such as workers or to quantify than direct monetary payments, they shareholders). However, the distribution of costs nonetheless reflect important costs because ultimately depend on which specific policies are implemented. For example, a policy that increases www.lao.ca.gov 11 analysis full gutter AN LAO REPORT costs to provide electricity disproportionately visible effects of state climate policies are transfers affects households that spend a greater share of of money, rather than net economic costs. For their income on electricity or work for businesses example, cap-and-trade results in a large transfer that produce or consume a lot of electricity. On of money from households and businesses that the other hand, policies that increase costs for pay—either directly or indirectly—for allowances transportation fuels have a greater effect on needed to cover their emissions. This increases households that consume a lot of transportation costs for these households and businesses. fuels or work for businesses that produce or However, these allowances are generally sold consume a lot of transportation fuels. Furthermore, by the state government and utilities, who then as we discuss below, the distributional effects of use the revenue to benefit certain households carbon pricing policies (such as cap-and-trade) and businesses. Currently, utilities mostly use the depend heavily on how the government allocates revenue to provide bill credits to customers and allowances and auction revenue. the state funds a range of different programs. As Some Policies Result in Substantial Economic a result, the net distributional effects of the policy Transfers. As discussed earlier, some of the most largely depend on how the auction revenue is allocated to different businesses and households. KEY CHALLENGES IN ESTIMATING POLICY EFFECTS There are a variety of challenges to estimating Similarly, for prospective analyses of the effects the effects of California’s climate policies—both of state climate policies, forecasting economic before (prospective) and after (retrospective) they conditions and technological advancements over have been implemented. In general, the accuracy the next 10 to 12 years is subject to substantial of any estimates depend on how effectively uncertainty. researchers address these challenges. Below, we Assessing GHG Effects That Extend Beyond discuss the challenges of measuring (1) effects of State’s Inventory. CARB uses its GHG inventory factors unrelated to climate policy, (2) effects not to track the state’s progress in meeting the reflected in the state’s GHG inventory, (3) implicit statewide emissions limits. As discussed earlier, the and indirect effects, and (4) the interactions with inventory includes emissions that occur in-state, other policies. as well as emissions associated with electricity Controlling for Factors Unrelated to Climate that is imported from other states. While this is a Policy. Many different factors affect the costs and reasonable starting point for measuring California’s benefits of meeting the state’s GHG limits, including GHG emissions given various technical and economic conditions, technological changes, and financial constraints, it does not fully capture the federal policies that would have otherwise occurred impact of activities in California on global GHGs. in the absence of state climate policies. Controlling For example, the current GHG inventory does not for these external factors is a key challenge when reflect the effect of the following: trying to isolate the effects of just state policies. • Biofuels. The state inventory generally For example, if economic growth is slow or excludes emissions related to burning negative, emissions could decline even without the biofuels, such as ethanol used in cars and implementation of state climate policies. Similarly, biodiesel for trucks. This is consistent with unexpected technological advancements for common GHG accounting principles, which low-GHG technologies (and lower prices for these assume that carbon from the biological technologies) can reduce emissions absent state materials used to produce the fuels would policies. For retrospective analyses, it is difficult have eventually been released back to the to know how these and other factors would have atmosphere as part of the natural carbon changed emissions in the absence of state policy. 12 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT cycle. However, in some cases, there are the state’s inventory, such as forestry activities likely other emissions related to indirect land that store more carbon. As a result, any use changes needed to grow plants used to reductions that occur from these projects are produce biofuels. For example, CARB’s LCFS not counted in the inventory. program estimates emissions associated with Measuring Implicit and Indirect Effects. converting forests and pasturelands to grow Most available estimates of economic costs— crops that are used to produce ethanol. including those used in CARB’s 2017 Scoping • “Upstream” Emissions From Imports. Plan—are largely based on what are known as The inventory includes emissions associated “bottom-up,” “engineering,” or “techno-economic” with consuming fossil fuels in California. models. These models generally focus on the However, it does not capture all of the explicit costs and benefits of adopting certain emissions from producing these fuels—also technologies. Researchers use their understanding known as upstream emissions. For example, of the technologies that might be used to reduce emissions related to oil extraction and refining emissions (such as electric vehicles and more that occurs in California are included, but efficient household appliances) and estimate the upstream emissions from gasoline that is monetary costs and benefits to produce, install, imported from out-of-state are not. Emissions and/or operate these technologies. Although associated with producing other goods that these estimates can provide information about are imported into California, such as cement, some of the effects of these changes, they also are not currently estimated. It is worth noting have significant limitations. For example, they that CARB currently estimates the upstream often ignore how the technological changes might emissions for transportation fuels, but they are affect producer and consumer behavior. They not included in the inventory. also do not assess implicit costs associated with • Leakage. Policies that increase the costs of the new technologies—for example, whether a producing goods in California could result in product loses some other type of attribute that a shift in some production to other states or households value, such as reliability, performance, countries. In this scenario, emissions would or convenience. decline in California, but increase elsewhere. Researchers also use outputs from engineering This is known as emissions leakage. models that estimate explicit direct costs as • Natural and Working Lands. The net inputs into economic models that estimate change to carbon stored in plants, soils, and indirect economic effects. For example, CARB wetlands—commonly known as “natural and uses an economic model to estimate effects on working lands”—is not currently included employment and GDP. Such models require a the state’s inventory. Chapter 368 of 2016 substantial number of assumptions about how (SB 859, Committee on Budget and Fiscal households and businesses behave and interact. Review) requires CARB to develop an As we discussed in our 2017 report, Improving inventory for natural and working lands by the California’s Regulatory Analysis, the Legislature end of 2018. should be cautious about relying heavily on these • Offsets. Entities subject to the state’s estimates. This is because they have substantial cap-and-trade program can cover their uncertainty and it can be difficult for policymakers, emissions by purchasing either allowances stakeholders, and the public to evaluate some of or offsets. (The number of offsets that can the underlying modeling and assumptions that drive be used is subject to limitations.) Offsets the results. are generated through certain types of Considering Interactions With Other Policies. projects that reduce GHGs from sources not State climate policies often interact with other covered by the emissions cap. Most of these federal, state, and local policies in complicated reductions (1) occur out-of-state or (2) are ways. For example, as we discussed in our from sources that are not currently included in www.lao.ca.gov 13 analysis full gutter AN LAO REPORT 2016 report, Cap-and-Trade Revenues: Strategies we discuss in our companion report, Assessing for Promoting Legislative Priorities, policies that California’s Climate Policies—Transportation, the reduce emissions in capped sectors might simply state has a wide variety of policies to promote change the source of emissions without changing zero-emission vehicles that interact with one the overall level of emissions. This is because a another, as well as with federal policies meant policy that reduces emissions from one covered to encourage fuel efficiency. These types of entity would free-up an allowance to be used by interactions make it difficult to evaluate the effects a different covered entity. As a result, there would of any one state policy. be no net change in emissions. In addition, as ISSUES FOR LEGISLATIVE CONSIDERATION As discussed above, the broad scope of state payments (which we characterize as transfers climate policies, the wide variety of benefits above) by providing rebates or reducing other and costs they generate, and the complicated taxes, particularly if allowance prices increase interactions between them make it challenging to significantly in future years. estimate their effects. In light of these challenges, Complementary Policies Should Be we identify below a few issues for the Legislature Well-Targeted and Justified. There are some to consider. Our comments aim to inform future limited instances when non-carbon pricing policies climate policy design and evaluation in a way that (often referred to as “complementary policies”) can helps the Legislature achieve its GHG goals in the help encourage socially beneficial activities that most cost-effective manner. reduce GHGs. Two such activities include: Use Carbon Pricing to Achieve Low-Cost • Innovation. Most economists think that GHG Reductions. There are benefits associated private businesses underinvest in innovation. with reducing GHGs, but there are also costs that This is because many of the benefits from have real impacts on households. These costs are the knowledge that is created from this likely to become more significant as the state’s innovative technology will “spillover” to other GHG reduction goals become more ambitious. As businesses, rather than being captured as a result, it is important for the state to prioritize profits for the innovator. Thus, there is an strategies that reduce GHGs at the lowest cost. A economic argument for government support large body of academic literature indicates carbon to help promote greater research and pricing policies, such as cap-and-trade, are a more development. In addition, as discussed below, cost-effective strategy to reduce emissions than the largest benefit of California’s policies could other regulatory strategies. The potential for lower be related to how they affect emissions in costs stems from the fact that the businesses and other jurisdictions. Promoting technological households that have to pay the carbon price have innovation could make emission reduction better information than policymakers and regulators activities cheaper for other jurisdictions to about which reduction activities are least costly. implement. (For additional information on how cap-and-trade • Addressing Other Environmental Pollution. encourages cost-effective GHG reductions, see our Certain regions and communities in California 2017 report The 2017-18 Budget: Cap-and-Trade.) have environmental problems beyond climate It is also worth noting that the overall change, such as poor air quality. Many of the effects—especially the distributional effects— policies that reduce GHGs can also reduce of cap-and-trade largely depend on how the these other sources of pollution, such as allowances and revenue are allocated. We continue criteria and toxic air pollutants. to recommend the Legislature consider using most or all of the revenue to offset the higher energy 14 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT Even with a carbon price in place, there could be other jurisdictions. For example, demonstrating a rationale for targeted policies that address these which policies cost-effectively reduce emissions types of issues. However, when considering these (and which ones do not) can provide valuable other policies, the Legislature should ensure that information to other jurisdictions considering there is strong evidence of other “market failures” policies to reduce emissions. A high-quality that a carbon price does not adequately address evaluation of the effects of California’s policies— prior to adopting them. This will help ensure there is including what works and what does not work—is a a basis for adopting complementary policies, even critical part of such a demonstration. if they are more costly ways to reduce GHGs. In Establishing a robust system to evaluate state addition, the Legislature should ensure that (1) the climate policies helps ensure the Legislature—and policies are designed in a way that achieves these other entities—have more complete information on other goals most effectively and (2) these other the overall effects of these polices. This information benefits outweigh the higher costs. could help the Legislature make better decisions Effects on Emissions in Other Jurisdictions about which policies or programs to adopt, modify, Are Important. California emits a very small or eliminate in the future. To ensure the state has portion of global GHGs. As a result, perhaps such a system in place, the Legislature might want the most significant effect of California’s climate to consider the following actions: policies will be how they influence GHG emissions • Require Additional Information in Statewide in other jurisdictions. For example, demonstrating GHG Inventory Reports. As discussed to other countries how to design and implement above, there are certain emissions currently cost-effective policies to reduce GHGs could not included in CARB’s statewide GHG make them more likely to implement such policies. inventory reports. The Legislature could direct In addition, policies that encourage innovation CARB to include some of this information in and low-GHG technologies could make such its future reports. Certain information—such technologies less expensive. As a result, this could as offsets and upstream transportation fuel increase the likelihood of these technologies being emissions—is already being collected and adopted in other jurisdictions. The Legislature would simply need to be reported alongside should design and evaluate its climate policies, in the current inventory. Other types of effects— part, with a focus on which policies are most likely such as leakage—are more difficult, and to encourage GHG reductions in other jurisdictions. potentially costly, to estimate. The value of these GHG reductions could far • Require Greater Use of Independent exceed those that occur strictly within California. Reviewers to Assess Policy Effects. Evaluation Is Especially Critical for State In addition, the Legislature could require Climate Policies. Evaluation is an important aspect agencies to make greater use of independent of all state policies, not just those related to climate reviewers (such as academic economists) change. They help inform future decisions about to assess the economic effects of policies, whether to continue, expand, modify, or eliminate both prospectively and retrospectively. For policies or programs. In our view, robust evaluation example, the Legislature has created the of climate policies is even more critical than for Independent Emissions Market Advisory typical state policies, for a couple of reasons. Committee to report on the environmental First, climate policies are among the broadest, and economic performance of cap-and-trade and potentially costly, set of state regulatory and other relevant climate policies. As we policies. Given the magnitude of the effects, it is discussed in our December 2017 report, particularly important to ensure that the state is Cap-and-Trade Extension: Issues for implementing such policies in an effective manner. Legislative Oversight, the Legislature will want Second, as discussed above, the most significant to be clear about the role of this committee, impact California can have on global GHGs is likely or similar committees, to ensure it provides going to be how its policies affect emissions in www.lao.ca.gov 15 analysis full gutter AN LAO REPORT the information that is most valuable to • Prioritize and Design Policies That Promote policymakers. Transparency. Lastly, the Legislature could • Require Early Planning of Retrospective prioritize and design policies that promote Evaluations. The Legislature could also transparency about their costs and/or require agencies, perhaps in collaboration with benefits. For example, cap-and-trade and independent researchers or other oversight LCFS have market prices for allowances and entities, to plan for retrospective evaluations credits, respectively. These prices provide as regulations are being developed. (Please information on the marginal costs of reducing see our report 2017 report, Improving a ton of GHG under each program. Such California’s Regulatory Analysis, for a more information is typically not available in other detailed discussion of this issue.) regulatory programs and, as a result, the costs are often much less transparent. CONCLUSION State climate policies have many different A companion report, Assessing California’s types of effects, and many of them are difficult to Climate Policies—Transportation, provides more quantify. This report provides a general overview detailed comments about the state’s major of some of the key conceptual issues to consider transportation climate policies. In the future, when assessing the economic impacts and benefits consistent with the requirements of AB 398, we of state climate policies. We also identify some plan to issue additional reports on the effects of general issues for the Legislature to consider, other state policies intended to reduce GHGs. which are aimed at promoting climate policies that These reports aim to inform future legislative are designed in a way that maximize benefits and decisions about what mix of policies can most minimize costs. effectively achieve the Legislature’s GHG goals. 16 LEGISLATIVE ANALYST’S OFFICE analysis full gutter AN LAO REPORT www.lao.ca.gov 17 analysis full gutter AN LAO REPORT LAO PUBLICATIONS This report was prepared by Ross Brown and reviewed by Anthony Simbol. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. To request publications call (916) 445-4656. This report and others, as well as an e-mail subscription service, are available on the LAO’s website at www.lao.ca.gov. The LAO is located at 925 L Street, Suite 1000, Sacramento, CA 95814. 18 LEGISLATIVE ANALYST’S OFFICE