University of Illinois at Urbana-Champaign
From the SelectedWorks of Don Fullerton
2017
Potential State-Level Carbon Revenue under the
Clean Power Plan
Don Fullerton
Daniel H Karney, Ohio University
Available at: https://works.bepress.com/don_fullerton/78/
POTENTIAL STATE-LEVEL CARBON REVENUE UNDER THE CLEAN
POWER PLAN
DON FULLERTON and DANIEL H. KARNEY∗
In 2015, the U.S. Environmental Protection Agency issued the Clean Power Plan
under which each state can set a mass-based target to meet its assigned electric
power sector carbon dioxide emission reductions. If it proceeds, states can design
policies to meet those requirements and also raise revenue via a carbon tax or cap-andtrade program with auctioned permits. We calculate each state’s potential revenue and
demonstrate its significance. In 13 states, carbon revenue could replace all of corporate
tax revenue. In addition, we collect budget projections from six key states to determine
if and how carbon revenue can substantially reduce deficits. While such revenue is not
free money, we discuss its advantages over use of distortionary taxation. Finally, we
consider distributional aspects and potential external fiscal effects on federal revenue.
(JEL H2, H3, H7, Q5)
I.
of ways. Not all of the compliance possibilities
raise revenue.
The CPP was promulgated by the U.S. Environmental Protection Agency (EPA) and published in the Federal Register in October 2015
(U.S. Environmental Protection Agency 2015a).
In contrast to previous efforts at the federal level,
including the failed Waxman-Markey bill (officially the American Clean Energy and Security
Act [ACES] of 2009), this executive action uses
existing authority granted by the Clean Air Act to
regulate CO2 emissions following EPA’s endangerment finding (U.S. Environmental Protection
Agency 2009a). The CPP applies to most existing
fossil-fuel-fired electric generating units (EGUs)
in the electric power sector. It would take effect
in 2022 and run until 2030. The CPP sets statelevel targets that come in two different forms:
“rate-based” targets are set in pounds of CO2 per
megawatt hour, while “mass-based” targets are
set in tons of CO2 . Under either approach, the
INTRODUCTION
Many states suffer severe budget problems,
with some states experiencing substantial deficits
(State Budget Crisis Task Force [SBCTF] 2014).
In Illinois, for example, the deficit under current
law is expected to hit $14 billion in FY2025 (Dye
et al. 2014). While fixing state budgetary problems generally requires a mix of expenditure cuts
and new revenues, we focus on a relatively new
source of potential revenue for states: “carbon
revenue” under the Clean Power Plan (CPP). The
CPP is a new federal proposal to restrict carbon
dioxide (CO2 ) from existing power plants, and
states can comply with it by using a cap-and-trade
policy with auctioned permits or an equivalent
carbon tax. Either of those compliance options
raises carbon revenue. We calculate potential revenue for every state and compare it to existing
revenue sources to see what fraction it represents
of existing sales tax, corporate tax, or income tax
revenue. We also describe the CPP in some detail,
as states have the flexibility to comply in a variety
ABBREVIATIONS
ACES: American Clean Energy and Security Act
APF: Alaska Permanent Fund
BAU: Business-As-Usual
CPP: Clean Power Plan
EPA: U.S. Environmental Protection Agency
EGU: Electric Generating Units
LDCs: Local Distribution Companies
MCA: Marginal Cost of Abatement
SBCTF: State Budget Crisis Task Force
∗ The
authors are grateful for comments and suggestions from Kathy Baylis, Dallas Burtraw, Tatyana Deryugina,
Julian Reif, and anonymous referees. The research for this
paper was not based on any financial support.
Fullerton: Professor, Department of Finance and IGPA, University of Illinois at Urbana-Champaign, Champaign, IL
61820. Phone 512-750-6012, Fax 217-244-3102, E-mail
[email protected]
Karney: Assistant Professor, Department of Economics,
Ohio University, Athens, OH 45701. Phone 740-5971239, Fax 740-593-0181, E-mail [email protected]
1
Contemporary Economic Policy (ISSN 1465-7287)
doi:10.1111/coep.12221
© 2017 Western Economic Association International
2
CONTEMPORARY ECONOMIC POLICY
CPP achieves an aggregate 32% CO2 reduction
across all states relative to 2005 levels (U.S. Environmental Protection Agency 2015b, ES-8). Each
state must select which type of target it wants
to meet and submit its plan to EPA on how it
will meet that 2030 target. The plans were due
to EPA in late 2016, although extensions can be
obtained through 2018 to allow for the completion of stakeholder and administrative processes.1
In 2011 dollars, the EPA calculates a total
annual incremental compliance cost of $5.1
billion by 2030 under the mass-based approach
and $8.8 billion under the rate-based approach
(U.S. Environmental Protection Agency 2015b,
ES-9). The rate-based approach costs more
because it provides an implicit production subsidy (Fischer 2003). However, the CPP explicitly
discusses the potential use of market-based
mechanisms to guarantee least-cost compliance
under either approach (U.S. Environmental Protection Agency 2015a, 64977). Overall, the CPP
is expected to yield substantial net benefits. The
exact dollar value of those benefits depends on
many factors including the assumed discount
rate and whether health benefits are included
alongside the climate benefits. Under both the
rate- and mass-based approaches, assuming a 3%
discount rate, the climate benefits alone in 2030
are expected to be worth $20 billion annually.
Adding the health benefits from reductions in
mortality and morbidity increases the annual
benefits to an estimated range of $32–48 billion
(U.S. Environmental Protection Agency 2015b,
ES-20-21). Driscoll et al. (2015) present an
independent analysis of the benefits and costs of
carbon standards on U.S. power plants and finds
similarly large net benefits.
As an executive order, the CPP is a federal
mandate. It is an additional requirement upon
the states. Despite its large projected climate and
health benefits, the CPP will require states to
incur costs of compliance, so it would seem to
make state budget problems even worse. The
irony, perhaps, is that the federal government has
often cut funding to the states, and it has been
unable to enact a carbon tax or any major new
1. In February of 2016, the U.S. Supreme Court stayed
the implementation of the CPP. An appeals court will hear
the case, so the stay remains in effect while the losing side
petitions the Supreme Court. If the Supreme Court accepts the
case, a final decision may not be available until 2017 or later.
See Barnes and Mufson (2016). In addition, the November
2016 election throws more doubt on the outcome of this
proposal. As we show below, however, states may want to
implement a carbon tax or cap-and-trade policy anyway, as
done in California since 2006.
revenue source of its own, but it now leaves this
major new revenue opportunity to the states. Yet,
states already could enact cap-and-trade policies
to raise revenue, so one might wonder why we
refer to the CPP as a “new” revenue opportunity.2
The reason is that a federal mandate to enact
state-level climate policies may reduce the need
for states to obtain political buy-in from polluters.
Indeed, the federal mandate shifts the political
economy of state action and provides the option
to hit two birds with one stone: satisfy the federal
mandate and at the same time raise revenue at
minimum cost to cut the deficit or to reduce other
state taxes.
Our first section below provides more detail
about the CPP, which has significantly different impacts on CO2 emissions across states.
Under the mass-based approach, some states
have to reduce emissions by more than 40%
from the 2012 baseline. Other states are assigned
only small reductions, and some states can even
increase their emission level in 2030 relative to
2012. Yet, EPA projects carbon prices in the case
where market-based policies are used to comply
with mass-based targets, and these prices make
clear that emission reductions are not necessarily correlated with cost or stringency. That is,
some states with small reductions may have high
marginal abatement costs and prices, while some
states with high levels of abatement can have low
marginal abatement costs and prices.3
Then we calculate potential carbon revenue
of each state under revenue-raising policies that
comply with the CPP, using the EPA’s statespecific carbon price projection. Under these differential prices, states in 2030 could cumulatively
generate $18.8 billion from carbon revenue (in
2011 dollars), assuming states implement carbon
taxes or cap-and-trade programs with auction of
2. California enacted a cap-and-trade program called AB32 in 2006, and Goulder (2013) indicates the state is “moving toward auctioning more than half of their allowances
[p. 97]” to raise revenue. However, Burtraw and McCormack
(2016) describe how revenue from consignment auctions of
allowances before 2015 was earmarked for “the benefit of
ratepayers,” often taking the form of bi-yearly dividend payments. Burtraw et al. (2012) provide a discussion of California’s cap-and-trade program, with particular attention paid to
the allowance value created and the potential distribution of
that value under the program.
3. The reason is that EPA applies uniform CO2 emission
rate standards on existing fossil-fuel-fired EGUs across all
states (U.S. Environmental Protection Agency 2015b, ES2). These standards are then used to set the targets under
the rate-based approach accounting for different generation
mixes across states. Those rate targets are then converted to
mass targets.
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
all permits. In some states, potential carbon revenue comprises a large share of existing state revenue. For example, carbon revenue could allow
13 states to replace revenue from the repeal of
all existing corporate taxes. Revenue is also calculated for uniform carbon price scenarios, since
the CPP allows states to enter multistate coalitions for carbon trading to achieve compliance.
Revenue-raising policies are generally not feasible under the rate-based approach.
In addition, we examine in further detail the
budget position of the six states prominently featured in the Final Report of the State Budget Crisis Task Force [SBCTF] (2014). We show that,
for some states, eventual levels of carbon revenue (for 2030) could have significantly reduced
near-term budgetary shortfalls.4 For example, we
find that carbon revenue could reduce Illinois’
projected budget deficit by nearly 14%. In other
states, carbon revenue has little impact on the
budget outlook. Finally, we discuss two kinds
of economic efficiency from carbon pricing: its
allocation of abatement has lower cost of compliance than for mandates, and it raises revenue
with less deadweight loss than alternative distortionary taxes. That is, carbon revenue could be
used to cut sales or income taxes that reduce the
incentive to work and thus create excess burden.
We also address distributional aspects of climate
policy, and the potential for state carbon revenue
to impact federal revenues through changes in the
tax base.
II.
THE CLEAN POWER PLAN
In August 2015, EPA announced its final
CPP to regulate CO2 emissions from existing fossil fuel-fired EGUs (or simply “power
plants”). In the United States, coal and natural
gas are the two fossil fuels most burned by
power plants, and their emissions constitute
nearly one-third of total annual U.S. greenhouse gas emissions. The rule was published
in the Federal Register on October 23, 2015
as the “Carbon Pollution Emission Guidelines
for Existing Stationary Sources: Electric Utility Generating Units” (U.S. Environmental
Protection Agency 2015a). The CPP utilizes
authority granted by the Clean Air Act following the EPA’s endangerment finding that the
4. Long-term budget deficit projections are not available.
This calculation compares eventual revenue to earlier deficits,
but only to illustrate the potential long-run size of carbon
revenue relative to a normal year’s budget deficit.
3
emission of anthropogenic greenhouse gases
“threatens the public health and welfare of current and future generations” (U.S. Environmental
Protection Agency 2009a, 66496).
For every new fossil-fuel-fired EGU, a
prior policy sets a uniform rate-based standard
(Kotchen and Mansur 2014). In contrast, the CPP
applies to existing power plants and allows states
to comply under one of two different standards:
rate-based or mass-based. This policy option
creates a strategic choice for a state deciding
which standard to adopt (Bushnell et al. 2017).
Furthermore, a state can select to include new
power plants under a mass-based compliance
plan and receive an additional “new source complement” that potentially loosens their standard’s
stringency, adding yet another dimension for
policymakers to consider (Burtraw et al. 2016).
The rate-based targets in the CPP are set in
terms of pounds of CO2 per net megawatt-hour
(lbs.CO2 /MWh). Under the policy for 2030, for
example, the state of Ohio has a rate-based target
of 1,190 lbs.CO2 /MWh from existing power
plants, where “existing” means in operation or
commenced construction as of January 8, 2014
(U.S. Environmental Protection Agency 2015b,
1–5). Under the mass-based approach, Ohio has
a 2030 target of 73.8 million short tons of CO2
from existing power plants.
The CPP calculates each state target based
on nationwide emission performance expectations for two subcategories of existing fossil fuelfired EGUs: (1) fossil fuel-fired steam generators
and (2) stationary combustion turbines. The fossil fuel-fired steam generators have a 2030 emission performance rate of 1,305 lbs.CO2 /MWh,
while stationary combustion turbines have a 2030
emission performance rate of 771 lbs.CO2 /MWh.
(U.S. Environmental Protection Agency 2015b,
ES-2). These expectations are set by the degree
of emission rate reduction available via the “best
system of emission reduction” criteria as required
by the Clean Air Act’s authorizing provisions.5
5. In the CPP’s final version, the BSER is determined
by three building blocks: (1) make coal-fired power plants
more efficient; (2) switch from coal to natural gas generation; and (3) expand renewable generation capacity. A fourth
building block in the preliminary CPP was energy efficiency
(i.e., demand reduction), but that block was removed. In the
final version, however, states can still count emission reduction from energy efficiency toward CPP compliance. Building
blocks (2) and (3) are included in most analyses of greenhouse
gas emission policies, but block (1) is a bit unusual because
operational characteristics of power plants are often considered exogenous. Linn et al. (2014) find that the cost of fuel
positively impacts coal-fired power plant efficiency, so a price
on carbon may improve efficiency.
4
CONTEMPORARY ECONOMIC POLICY
The performance expectations then determine state-specific, rate-based targets. However,
since states differ in their existing mix of power
plants—with some states more dependent on
coal-fired, steam generation than others—then
the CPP’s rate-based targets differ by state.
Next, the CPP translates rate targets into corresponding mass targets by multiplying the rate
(lbs.CO2 /MWh) by projected generation (MWh)
to get emissions (CO2 ). Each state selects the
type of target it wants to meet and then submits
a plan to EPA outlining how it will achieve the
selected target. States are not required to have a
market-based policy (e.g., cap-and-trade) to meet
their targets and may instead use a commandand-control regime. As guidance to the states,
however, EPA provides “illustrative” plans for
rate- and mass-based approaches that employ
within-state, market-based trading schemes that
help reduce compliance costs. In the end, if a
state does not submit a plan or select one of
the illustrative plans, then a default federal plan
will be implemented, although EPA has yet to
specify if the default plan is a rate-based or massbased approach (U.S. Environmental Protection
Agency 2015b).
States can form multistate coalitions under
either the rate- or mass-based approach to help
reduce costs and stabilize regional electricity
markets (U.S. Environmental Protection Agency
2015a, 64668). Also, while the CPP is scheduled
to take effect in 2022, the plan includes provisions to encourage early action as soon as 2016
when the state plans are initially due to EPA
(although states can get extensions to submit their
plans until 2018). While revenue-raising policies
are not required, both cap-and-trade with auctioning and a carbon tax are within the range of
CPP compliance options under the mass-based
approach. However, a carbon tax can only be
applied to meet the mass-based target under the
so-called state measures approach, where a state
has to demonstrate to EPA via economic modeling that their carbon tax will achieve the required
reductions. A carbon tax plan also requires establishing a backstop emission standard regime if
the tax does not achieve the forecasted reductions
(U.S. Environmental Protection Agency 2015a,
64668). In order to avoid the emission standard
backstop, the carbon tax could be ratcheted up
over time if a state is not meeting its massbased target under the initial, lower tax (Klaassen
and Førsund 2012). For states that do implement
revenue-raising policies, we note that carbon
tax and cap-and-trade policies potentially have
different administrative burdens to the state, but
from an accounting standpoint firms have the
same income tax liability under either a carbon
tax or cap-and-trade policy as long as permits
are purchased and used during the same year.
Complicating the accounting process, however,
the CPP allows for banking and borrowing provisions designed to smooth allowance prices over
the compliance period (U.S. Environmental Protection Agency 2015a, 64890).
Figure 1 summarizes information about the
CPP’s mass-based reduction targets. The states of
Alaska and Hawaii are exempt from the CPP, as
they are not part of the contiguous 48 states, and
the District of Columbia and Vermont are exempt
too because they have no fossil-fuel power plants
subject to the policy. Also, power plants located
in Native American reservations—despite being
connected to the electricity grid—are not necessarily covered by the CPP. Moreover, the inclusion of such plants under state policies would not
affect our state revenue calculation, assuming that
revenue would be shared with the tribe in proportion to emissions.6
For Figure 1, the horizontal axis is the 2012
baseline emission rate by state.7 The vertical axis
records the percent reduction from those baseline
emissions to the 2030 CPP mass-based targets.
Each state is indicated by its two-letter U.S.
postal abbreviation. The unweighted, average
reduction is 23.2%. At the upper end, Montana
(MT) would need to reduce emissions by 41.0%.
Interestingly, three states—Connecticut (CT),
Maine (ME), and Idaho (ID)—have negative
reductions, which means that the 2030 target is
set above the 2012 baseline emission level, and
so these states can increase their emissions relative to the baseline with a mass-based approach.
The common factor among these three states is
that almost all of their existing fossil-fuel-fired
generation comes from very efficient natural
6. The inclusion of power plants on tribal land under the
CPP is somewhat ambiguous. The official regulation says, “In
the case of a tribe that has one or more affected EGUs in its
area of Indian country the tribe has the opportunity, but not the
obligation, to establish a CAA section 111(d) plan for its area
of Indian country. If [such] a tribe does not … receive EPA
approval of a submitted plan, the EPA has the responsibility
to establish a plan for that area if it determines that such a plan
is necessary or appropriate” (U.S. Environmental Protection
Agency 2015a, 64708–9). However, it appears the U.S. EPA
would try to work with tribal governments to reduce emissions
from these sources.
7. EPA uses 2012 baseline year when applying the BSER
calculations. The 2012 baseline emission rates are adjusted
from the actual 2012 emission rates to reflect typical hydroelectric production and affected EGUs under construction.
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
5
FIGURE 1
2030 CPP Mass-Based Reduction Relative 2012 CO2 Emissions by State
Source: Authors’ calculations.
Notes: This figure includes the lower 48 U.S. states but excludes DC and VT. The line plots the fitted values from an
unweighted regression of the y-axis variable on the x-axis variable with an intercept.
gas combined cycle power plants. However, this
possible increase relative to the 2012 baseline
does not mean increasing emissions under the
CPP in 2030 relative to the 2030 business-asusual (BAU) scenario. The U.S. EPA forecasts
Connecticut and Maine to have higher carbon
emissions from large, fossil-fuel-fired power
plants without the policy. Idaho is forecast to
have higher emissions with the CPP, but it also
has the smallest mass-based emission target of
any state—mitigating the potential impact of
the policy. The fitted line in Figure 1 demonstrates a strong, positive correlation between
the baseline emission rates and the required
reduction percentages.
Importantly, the reduction percentages shown
in Figure 1 determine neither policy stringency nor costs of compliance. Figure 2 plots
the EPA’s projection of allowance price (e.g.,
shadow carbon price) if each state implements
a separate cap-and-trade policy under the massbased approach (U.S. Environmental Protection
Agency 2015a). Under cap-and-trade, firms need
a permit to emit each ton of CO2 , so the fixed
number of permits is the “cap” on emissions,
and firms can “trade” those permits. The price
of a permit discourages emissions, just like a tax
on emissions. The CPP encourages use of such
market mechanisms, because they reduce pollution in a way that minimizes the cost of achieving
any particular level of abatement (Baumol and
Oates 1988).
To make Figure 2 easily comparable to
Figure 1, the horizontal axis still records the
2012 baseline emission rate. In general, the high
reduction states from Figure 1 have high permit
prices in Figure 2. However, some states with low,
or even negative, reduction percentages as plotted in Figure 1 can have high permit prices. For
example, Idaho (ID) has a mass-based reduction
percentage from 2012 to 2030 of negative 3.7%,
but an accompanying projected 2030 CO2 price
of $24.5 per ton (in 2011 dollars). The converse is
also possible, as Kentucky (KY) has a high 2012
baseline emission rate and mass-based reduction
percentage of 32.0%, but a low-projected permit
price of $2.13 per ton. This seemingly odd result
occurs because the projected permit price for
each state depends on its relative difficulty of
moving from 2030 BAU to 2030 CPP mass
6
CONTEMPORARY ECONOMIC POLICY
FIGURE 2
Projected 2030 CO2 Allowance Prices under Mass-Based Policies by State
Source: Authors’ calculations.
Notes: This figure includes the lower 48 U.S. states but excludes DC and VT. The line plots the fitted values from an
unweighted regression of the y-axis variable on the x-axis variable with an intercept.
targets, and not on the percentage reduction from
2012 to 2030. The cap-weighted average price
is $11.46.
The fitted line in Figure 2 shows a positive correlation between the baseline emission rates and
the projected permit prices, although not as strong
as the correlation in Figure 1. Interestingly, seven
states have a zero price—including Rhode Island
(RI) and Washington (WA)—which means that
in a scenario where every state implements a capand-trade policy under the mass-based approach,
the CPP will not be binding in those states by
2030. Separate state cap-and-trade programs with
different prices must reflect allocation inefficiencies relative to a national cap-and-trade policy
that could exploit gains from trade by allowing
high-cost states to abate less while low-cost states
abate more.
III.
PROJECTED REVENUE BY STATE
This section calculates the possible revenue
that states could collect by the sale of permits
under cap-and-trade policies (or an equivalent
carbon tax), and it compares this potential carbon revenue to existing tax levels. Calculations
are based on the CPP’s state-specific, mass-based
targets and the EPA’s analysis of those targets to
project state-specific 2030 permit prices. Figure 2
above plots the state-specific prices. We focus
on the mass-based targets in subsequent revenue
calculations because the CPP allows any state
to proceed under the mass-based approach and
then sell permits under a cap-and-trade program.8
To explain the intuition of our revenue calculations, consider a simple partial equilibrium model
with competitive markets, no uncertainty, and
no adjustment costs. Without the CPP, suppose
firms would have chosen emissions E0 . Thus E0
represents the maximum amount of abatement
under the CPP in Figure 3, where the horizontal axis measures abatement from left to right.
In other words, abatement = E0 would mean zero
8. The CPP’s design allows for existing carbon mitigation
policies like California’s cap-and-trade that commenced in
2006 to serve as state policy for compliance. California’s
policy is already raising revenue for the State, and that amount
is expected to increase over time (Siders 2014).
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
7
FIGURE 3
Emissions Quantity, Price, and MCA
emissions. If costs are convex, continuous, and
differentiable, then the envelope theorem suggests that the first unit of abatement has no cost.
In Figure 3, the simple linear marginal cost of
abatement (MCA) rises from left to right, but it
can also be read from right to left as the marginal
product of emissions as an input to production
(since the cost of not emitting a ton is the value
of the output it could have produced). Under the
mass-based approach E′ is the mandated emission limit, so A′ is the required abatement (where
E′ + A′ = E0 ). The marginal shadow value is P′ ,
so the “scarcity rents” are the rectangle P′ × E′ .
With tradable permits in a cap-and-trade program
to meet the mass-based target, the market price
would be P′ , and the handout of permits would
provide P′ × E′ of profits to recipients. Relative to
that handout of profits, the state could instead sell
the permits and capture the rents with no deadweight loss (Fullerton and Metcalf 2001).
Moreover, the total cost of abatement is the
triangular area under the MCA from zero to A′ .
The exact MCA curve is uncertain, however,
because of the uncertainty in the EPA’s projected
prices summarized in Figure 2. Thus the total
abatement cost area under the MCA curve is also
uncertain. The EPA’s projection of each price
does not have an error range, and yet they vary
from zero to just over $25 per ton. As a rough
check on those prices and costs, consider the
following intuitions:
1. By 2030 the CPP requires 413 million metric tons (MMtonnes) of CO2 reductions relative to the BAU scenario under a mass-based
approach for all states (U.S. Environmental Protection Agency 2015b, ES-7). The EPA also
projects the total annual cost of compliance to
be $5.1 billion in 2030 (U.S. Environmental Protection Agency 2015b, ES-9). If the triangular
area in Figure 3 represents this cost ($5.1 billion),
measured as one-half the base (413 MMtonnes)
times the height, then the height is P′ = $22.4 per
(short) ton, a bit less than the maximum projected
state-specific price.
2. However, states may not start from zero
abatement. Several Northeastern states participate in the Regional Greenhouse Gas Initiative.
California has its own cap-and-trade policy, and
other states have voluntary plans or other mandates. For a different simple calculation, suppose
the MCA is already at the price that will apply
under the new plan, and thus the MCA curve is
flat from the current amount of abatement to the
required abatement. Then the cost ($5.1 billion)
is a rectangle with base of 413 MMtonnes and
height of P′ = $11.2 per short ton. This price is
close to the cap-weighted average price ($11.46
per ton).
8
CONTEMPORARY ECONOMIC POLICY
3. Before the CPP was announced, Burtraw
et al. (2014) used a large computer model to
analyze a CPP-like national cap-and-trade plan
with 400 million short tons of abatement and
found a projected price of $18 per ton.
4. The EPA’s projected permit price for the
cap-and-trade portion of the ACES Act of 2009
was from $17 to $22 per ton in the year 2020
(U.S. Environmental Protection Agency 2009b).
Also known as the Waxman-Markey bill after its
Congressional sponsors, ACES was a legislative
proposal that in part implemented a nationwide,
cap-and-trade policy on CO2 emissions from the
electric power sector as well as transportation
fuels.
These checks demonstrate that the CPP’s projected range of permit prices is broadly consistent
with back of the envelope calculations, detailed
economic modeling, and prior price projections
for comparable legislative efforts. We find it reassuring that the four calculations outlined here
yield prices that fall within the range of the statespecific prices.
Assuming every state implements its own capand-trade mass-based policy, Table 1 shows the
CPP’s 2030 state-specific emission caps (column
1), projected state-specific permit prices (column 2), and revenue under these prices assuming
full permit auctioning (column 3). State revenue
would be less if a portion of the permits were
handed out (i.e., freely allocated) to satisfy distributional or political concerns.9 The total revenue
in column 3 is the product of columns 1 and 2,
while the per capita revenue using 2012 state populations (U.S. Census Bureau 2013) is reported in
column 4. The seven states with a zero-projected
price have no projected revenue. Including those
zero-revenue states, the simple average of state
revenue in 2030 of the 47 states in Table 1 is over
$400 million per year. Total state revenue is over
$18.8 billion (in 2011 dollars). With a projected
U.S. population of almost 360 million in 2030
(U.S. Census Bureau 2012), the total projected
annual revenue translates to $52 per person.
9. In theory, with perfectly competitive markets, handing
out permits does not alter cost-effectiveness; even if hand-out
of permits leads to windfall profits, cap-and-trade policy still
achieves the required abatement at lowest total cost (Baumol
and Oates 1988). In practice, however, allowances might be
freely allocated to regulated entities (e.g., local distribution
companies) under the CPP, with their value directed to benefit
ratepayers. A simple mechanism to achieve this goal is a
consignment auction (Burtraw and McCormack 2016). Any
benefit to ratepayers through lower electricity prices would
mute the demand-side response and reduce cost effectiveness
(Burtraw et al. 2014).
Our revenue projections are based on the
EPA’s own estimate of each state’s allowance
price. The EPA does not provide a range of
possible outcomes, but uncertainty arises from
many sources. For example, continued improvements in energy efficiency and renewable technology could make compliance with the CPP
easier and thus reduce potential revenue. Other
sources of uncertainty include the pace of economic growth and public policy choices about
extending production and investment tax credits
for wind and solar electricity production.
The CPP also allows states to enter “multistate regional groups” to achieve compliance,
and thus states under the mass-based approach
could combine caps and implement a multistate,
cap-and-trade program with a single price. If
so, the multistate permit price would be a price
within the range of the state-specific prices of
the regional group. In the extreme, a national
coalition of all states could arise, and in this case
the cap-weighted average price of $11.46 per ton
is a reasonable estimate of the national price.10
To determine an estimate of state revenue for the
case of a national cap-and-trade policy under the
CPP, Table 1 column 5 shows each state’s revenue
using the $11.46 per ton uniform price, while
column 6 contains the per capita revenue.
Figure 4 plots the potential per capita revenue by state under state-specific, differential
prices (using the results from Table 1 column 4).
These projections vary greatly across states, with
a maximum of almost $1,000 per person per year,
although many states have small per capita revenue. Thus, the figure is plotted using a log-scaled
vertical axis. In general, states with above average
2012 baseline emission rates tend to have above
average per capita potential revenue. This result is
driven by two factors. First, states with high baselines tend to have high CO2 prices in Figure 2,
leading to large revenue, all else equal. Second,
some of the high baseline states have small populations, such as Wyoming (WY), West Virginia
(WV), and North Dakota (ND). Without adjusting for population, Texas has the highest potential revenue at almost $2.5 billion, with per capita
revenue of $95 (in 2011 dollars). Using 2012 populations, the population-weighted national average is $60 per capita, while the unweighted
national average is $102 per capita (as lowpopulation outliers increase the simple average).
10. The allowance price with a national coalition would
probably be lower than $11.46 per ton, however, because
states with nonbinding polices have “slack” that would pull
down the price.
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
9
TABLE 1
Potential Annual State Revenue from Cap-and-Trade (or Carbon Tax) in 2030 under Mass-Based CPP
Plans (in 2011 Dollars)
2030 CPP
Information
State
Emission
Capa (million
short tons)
(1)
Alabama (AL)
Arkansas (AR)
Arizona (AZ)
California (CA)
Colorado (CO)
Connecticut (CT)
Delaware (DE)
Florida (FL)
Georgia (GA)
Iowa (IA)
Idaho (ID)
Illinois (IL)
Indiana (IN)
Kansas (KS)
Kentucky (KY)
Louisiana (LA)
Massachusetts (MA)
Maryland (MD)
Maine (ME)
Michigan (MI)
Minnesota (MN)
Missouri (MO)
Mississippi (MS)
Montana (MT)
North Carolina (NC)
North Dakota (ND)
Nebraska (NE)
New Hampshire (NH)
New Jersey (NJ)
New Mexico (NM)
Nevada (NV)
New York (NY)
Ohio (OH)
Oklahoma (OK)
Oregon (OR)
Pennsylvania (PA)
Rhode Island (RI)
South Carolina (SC)
South Dakota (SD)
Tennessee (TN)
Texas (TX)
Utah (UT)
Virginia (VA)
Washington (WA)
West Virginia (WV)
Wisconsin (WI)
Wyoming (WY)
Total
Average
56.9
30.3
30.2
48.4
29.9
6.9
4.7
105.1
46.3
25.0
1.5
66.5
76.1
22.0
63.1
35.4
12.1
14.3
2.1
47.5
22.7
55.5
25.3
11.3
51.3
20.9
18.3
4.0
16.6
12.4
13.5
31.3
73.8
40.5
8.1
89.8
3.5
26.0
3.5
28.3
189.6
23.8
27.4
10.7
51.3
28.0
31.6
1, 643.6
35.0
Revenue with
Differential Prices
Projected
CO2 Priceb
($/ton)
(2)
11.19
10.05
20.18
15.40
21.09
0.73
0.00
11.76
14.91
15.04
24.47
10.08
16.91
19.70
2.13
1.79
0.00
4.15
1.72
5.30
17.47
16.18
10.18
20.49
0.55
11.96
24.35
0.00
4.75
13.10
13.94
0.00
14.19
14.24
0.00
5.71
0.00
5.94
13.99
14.83
13.02
25.59
3.52
0.00
15.04
15.91
18.22
—
11.46d
Total
($ million)
(3)
636.5
304.6
608.7
745.4
630.7
5.0
0.0
1236.0
691.0
376.2
36.5
669.8
1287.3
433.1
134.2
63.3
0.0
59.6
3.6
252.2
396.3
897.3
257.7
231.6
28.3
249.7
444.9
0.0
78.9
162.5
188.5
0.0
1047.1
576.4
0.0
512.7
0.0
154.4
49.5
420.4
2467.7
608.4
96.5
0.0
772.1
445.3
576.4
18, 836.6
400.8
Note: This table includes the lower 48 U.S. states but excludes DC and VT.
a Source: U.S. EPA (2015a).
b Source: U.S. EPA (2015b).
c Total revenue divided by 2012 population.
d Weighted-average price by 2030 emission cap.
e Weighted-average revenue by 2012 population.
Per Capitac
($/person)
(4)
132.1
103.3
92.9
19.6
121.5
1.4
0.0
64.0
69.7
122.3
22.9
52.0
196.9
150.1
30.7
13.8
0.0
10.1
2.7
25.5
73.7
148.9
86.3
230.4
2.9
356.0
239.8
0.0
8.9
78.0
68.4
0.0
90.6
151.1
0.0
40.2
0.0
32.7
59.4
65.1
94.7
213.1
11.8
0.0
415.9
77.8
999.6
—
60.0e
Revenue withUniform
Price ($11.46/ton)
Total
($ million)
(5)
651.9
347.5
345.8
554.8
342.7
79.6
54.0
1204.5
531.2
286.7
17.1
761.9
872.3
252.0
723.5
406.0
138.7
164.4
23.8
544.9
259.9
635.7
290.0
129.5
587.6
239.3
209.4
45.8
190.2
142.3
155.0
358.2
845.5
464.0
93.0
1029.4
40.4
298.0
40.6
324.9
2172.9
272.5
314.4
123.1
588.2
320.8
362.6
18, 836.6
400.8
Per Capitac
($/person)
(6)
135.3
117.8
52.8
14.6
66.0
22.1
58.9
62.3
53.6
93.2
10.7
59.2
133.4
87.3
165.2
88.2
20.9
27.9
17.9
55.1
48.3
105.5
97.1
128.8
60.3
341.3
112.9
34.7
21.5
68.3
56.3
18.3
73.2
121.6
23.9
80.6
38.4
63.1
48.6
50.3
83.4
95.5
38.4
17.8
316.8
56.0
628.8
—
60.0e
10
CONTEMPORARY ECONOMIC POLICY
FIGURE 4
Potential Per Capita Revenue from Cap-and-Trade in 2030 by State, with Differential Prices
Source: Authors’ calculations.
Note: This figure includes the lower 48 U.S. states but excludes DC and VT.
In contrast, since high-population states on average have larger emissions to use as a tax base,
the population-weighted average total revenue
per state of $638.4 million is higher than the
unweighted average of $400.8 million.
The projected 2030 permit prices calculated
by the EPA are uncertain, and confidence intervals are not available. Therefore, to provide a
plausible range of revenues by state, alternative
price scenarios are reported in Table 2. Indeed,
under cap-and-trade policies for each state, the
actual 2030 permit prices depend on several
factors, including natural gas prices, economic
growth, and technology. Specifically, Table 2
reports state revenue projections for the two alternative uniform prices of $5.75 and $23 (approximately half and twice the cap-weighted average
price of $11.46, respectively). Both total and per
capita amounts are reported, where the state populations are fixed at 2012 levels. The low price
might apply for some states, while the high price
might apply in others. Under a uniform $23 permit price, total potential revenue in 2030 is $37.8
billion, with an unweighted average of $804.3
million per state (in 2011 dollars). At the $23 permit price, 14 states could generate annual carbon
revenues of $1 billion or more.
In addition to considering uncertainty in
2030 revenue, we note that within-state revenue
may vary year-to-year from the start of CPP
compliance in 2022 until 2030. In fact, the EPA
projects that 20 states will have a zero allowance
price at the beginning of the CPP compliance
period (although allowance banking, if allowed,
would smooth prices). Again, states may comply
with the CPP using carbon tax under the “state
measures” approach, and doing so would provide
short-run revenue stability as the tax guarantees
a price per unit of emissions. However, the tax
would likely need to be adjusted over time so
that the state hits its mass-based target, leading
to continued, long-run variability in the carbon
price. States that do use a cap-and-trade to comply with the CPP can implement allowance price
discovery mechanisms—such as consignment
auctions for freely allocated allowances—to
reduce price variability and volatility (Burtraw
and McCormack 2016).
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
11
TABLE 2
Potential Annual State Revenue from Cap-and-Trade (or Carbon Tax) in 2030 under Mass-Based CPP
Plans: Alternate Price Scenarios (2011 Dollars)
Half Uniform National Price ($5.75/ton)
State
Total
($ million)
(1)
Alabama (AL)
Arkansas (AR)
Arizona (AZ)
California (CA)
Colorado (CO)
Connecticut (CT)
Delaware (DE)
Florida (FL)
Georgia (GA)
Iowa (IA)
Idaho (ID)
Illinois (IL)
Indiana (IN)
Kansas (KS)
Kentucky (KY)
Louisiana (LA)
Massachusetts (MA)
Maryland (MD)
Maine (ME)
Michigan (MI)
Minnesota (MN)
Missouri (MO)
Mississippi (MS)
Montana (MT)
North Carolina (NC)
North Dakota (ND)
Nebraska (NE)
New Hampshire (NH)
New Jersey (NJ)
New Mexico (NM)
Nevada (NV)
New York (NY)
Ohio (OH)
Oklahoma (OK)
Oregon (OR)
Pennsylvania (PA)
Rhode Island (RI)
South Carolina (SC)
South Dakota (SD)
Tennessee (TN)
Texas (TX)
Utah (UT)
Virginia (VA)
Washington (WA)
West Virginia (WV)
Wisconsin (WI)
Wyoming (WY)
Total
Average
327.1
174.4
173.5
278.4
171.9
39.9
27.1
604.3
266.5
143.9
8.6
382.2
437.7
126.4
363.0
203.7
69.6
82.5
11.9
273.4
130.4
318.9
145.5
65.0
294.8
120.1
105.1
23.0
95.4
71.4
77.8
179.7
424.2
232.8
46.7
516.5
20.3
149.5
20.4
163.0
1, 090.1
136.7
157.7
61.8
295.1
160.9
181.9
9, 450.4
201.1
Capitaa
Twice Uniform National Price ($23/ton)
Per
($/person)
(2)
Total
($ million)
(3)
67.9
59.1
26.5
7.3
33.1
11.1
29.5
31.3
26.9
46.8
5.4
29.7
66.9
43.8
82.9
44.3
10.5
14.0
9.0
27.7
24.2
52.9
48.7
64.6
30.2
171.2
56.6
17.4
10.8
34.3
28.2
9.2
36.7
61.0
12.0
40.5
19.3
31.6
24.4
25.3
41.8
47.9
19.3
9.0
159.0
28.1
315.5
—
30.1b
1, 308.3
697.4
693.9
1, 113.4
687.7
159.7
108.4
2, 417.2
1, 066.0
575.4
34.3
1, 529.0
1, 750.6
505.8
1, 451.9
814.8
278.4
330.0
47.7
1, 093.5
521.6
1, 275.6
582.0
260.0
1, 179.1
480.3
420.3
91.9
381.8
285.5
311.0
718.9
1, 696.7
931.2
186.7
2, 065.9
81.0
598.0
81.4
652.0
4, 360.5
546.9
631.0
247.0
1, 180.5
643.7
727.6
37, 801.7
804.3
Note: This table includes the lower 48 U.S. states but excludes DC and VT.
a Total revenue divided by 2012 population.
b Weighted-average revenue by 2012 population.
Source: Authors’ calculations.
Per Capitaa
($/person)
(4)
271.6
236.4
105.9
29.3
132.5
44.5
118.2
125.1
107.5
187.1
21.5
118.8
267.8
175.3
331.5
177.1
41.9
56.1
35.9
110.7
97.0
211.7
194.9
258.6
121.0
684.8
226.5
69.6
43.1
137.0
112.9
36.7
146.9
244.0
47.9
161.8
77.1
126.6
97.6
101.0
167.3
191.6
77.1
35.8
635.8
112.4
1,261.8
—
120.4b
12
CONTEMPORARY ECONOMIC POLICY
FIGURE 5
Potential Carbon Revenue as a Percent of Existing State Budget Revenues, under Differential Prices.
Source: Authors’ calculations.
Notes: This figure includes the lower 48 U.S. states but excludes DC and VT. The line plots the fitted values from an
unweighted regression of the y-axis variable on the x-axis variable with an intercept.
To show the relative impact that carbon revenues might have on various state budgets, we
calculate potential 2030 carbon revenue as a share
of existing state tax revenue. Figure 5 plots the
share of potential carbon revenue relative to existing state revenue. We use the latest available
state tax revenue from 2014 (in 2011 dollars)
as the denominator (U.S. Census Bureau 2014),
while carbon revenue in the numerator assumes
state-specific permit prices under the mass-based
approach (as reported in Table 1 column 3). The
simple average of the 47 states in Table 3 could
collect carbon revenue equal to 3.8% of current total tax revenue. Figure 5 shows a positive
relationship between the 2012 baseline emission
rate and potential carbon revenue as a share of
state revenue. The states of Nebraska (NE) and
Wyoming (WY) appear as outliers, with share
values over 20%. West Virginia (WV) and Indiana (IN) also have relatively high shares over
15%. These states tend to have small budgets and
rely on coal generation (leading to a large carbon
tax base).
Table 3 reports 2030 potential carbon revenue
as a share of particular 2014 state tax revenue
categories, including: general sales and gross
receipts tax, individual income tax, net corporate
income tax, and severance tax. Conveniently, the
Census Bureau conducts annual surveys of state
tax revenues by source (U.S. Census Bureau
2014). As before, these revenue share calculations by source assume differential, state-specific
carbon prices under the mass-based approach.
Table 3 column 5 also reports this potential
carbon revenue as a share of total state revenue
(as plotted in Figure 5). This table demonstrates
that potential carbon revenue could replace entire
categories of tax revenue for some states. For
instance, carbon revenue in Iowa (IA) could
replace 4.8% of total state revenue or 101.9% of
net corporate tax revenue. In fact, carbon revenue
could replace all of corporate tax revenue in 13
states. For the eight states with revenue from
severance taxes that exceeds 4% of total state
revenue, potential carbon revenue could replace
more than 50% of that revenue in half of those
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
13
TABLE 3
Potential Annual Cap-and-Trade (or Carbon Tax) Revenue in 2030 as a Percent of 2014 Tax Revenue
Streams by State (with Differential Prices)
State
Alabama (AL)
Arizona (AZ)
Arkansas (AR)
California (CA)
Colorado (CO)
Connecticut (CT)
Delaware (DE)
Florida (FL)
Georgia (GA)
Idaho (ID)
Illinois (IL)
Indiana (IN)
Iowa (IA)
Kansas (KS)
Kentucky (KY)
Louisiana (LA)
Maine (ME)
Maryland (MD)
Massachusetts (MA)
Michigan (MI)
Minnesota (MN)
Mississippi (MS)
Missouri (MO)
Montana (MT)
Nebraska (NE)
Nevada (NV)
New Hampshire (NH)
New Jersey (NJ)
New Mexico (NM)
New York (NY)
North Carolina (NC)
North Dakota (ND)
Ohio (OH)
Oklahoma (OK)
Oregon (OR)
Pennsylvania (PA)
Rhode Island (RI)
South Carolina (SC)
South Dakota (SD)
Tennessee (TN)
Texas (TX)
Utah (UT)
Virginia (VA)
Washington (WA)
West Virginia (WV)
Wisconsin (WI)
Wyoming (WY)
General Sales and
Gross Receipts
(1)
Individual
Income
(2)
28.0
10.7
10.2
2.1
25.4
0.1
—
6.1
14.2
2.8
8.3
19.3
14.9
15.3
4.5
2.3
0.3
1.5
0.0
3.2
7.7
8.2
28.7
—
26.6
5.2
—
0.9
8.2
0.0
0.5
19.9
10.8
23.3
—
5.7
0.0
4.8
5.7
7.1
8.0
35.1
2.9
0.0
66.5
10.1
79.2
20.9
18.5
12.3
1.2
11.7
0.1
0.0
—
8.1
2.9
4.4
27.7
12.4
18.1
3.8
2.4
0.3
0.8
0.0
3.4
4.4
16.3
17.6
22.9
22.0
—
0.0
0.7
13.2
0.0
0.3
52.7
13.1
20.5
0.0
5.0
0.0
4.7
—
184.9
—
22.2
0.9
—
45.9
6.9
—
Corporate
Net Income
(3)
164.8
111.4
80.5
8.9
92.5
0.8
0.0
63.6
77.1
20.2
16.5
156.3
101.9
138.1
20.9
13.8
2.1
6.4
0.0
30.1
31.7
51.5
264.0
162.4
152.7
—
0.0
3.5
83.2
0.0
2.2
104.9
—
152.7
0.0
23.4
0.0
49.6
209.9
37.6
—
208.0
13.7
—
399.3
47.5
—
Severancea
(4)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
7.7
—
—
—
—
—
—
—
79.8
—
—
—
—
16.0
—
—
8.0
—
89.3
—
—
—
—
—
—
43.2
—
—
—
119.2
—
68.7
Total
(5)
7.2
4.9
3.6
0.6
5.6
0.0
0.0
3.7
3.9
1.0
1.8
8.0
4.8
6.2
1.3
0.7
0.1
0.3
0.0
1.1
1.8
3.6
8.4
9.2
9.6
2.8
0.0
0.3
3.0
0.0
0.1
4.3
4.1
6.7
0.0
1.6
0.0
1.8
3.2
3.7
4.7
10.1
0.5
0.0
15.1
2.9
26.8
Note: This table includes the lower 48 U.S. states but excludes DC and VT.
a Severance tax percentages are calculated only for states where this tax is more than 4% of total revenue.
Source: Authors’ calculations.
states and all of the severance tax revenue in
West Virginia (WV). Carbon revenue could also
replace large portions of income and sales tax
revenue in some states. Thus, carbon revenue
could be an important component of future
state budgets.
IV.
CASE STUDIES
This section conducts case studies of the
six large states analyzed most closely by the
SBCTF: California, Illinois, New Jersey, New
York, Texas, and Virginia (State Budget Crisis
14
CONTEMPORARY ECONOMIC POLICY
Task Force [SBCTF] 2014). The Task Force’s
report documents high-existing state deficits, as
well as underfunded liabilities and poor budgeting methods, but it does not make projections of
future deficits. Therefore, we collect data on the
six highlighted states’ own projections of future
budget deficits in the next couple of years. We
calculate the fraction of each projected near-term
state budget deficit that could have been covered
if the state already had the 2030 level of potential
revenue from carbon taxes or sale of emission
permits. This budget deficit exercise differs
fundamentally from revenue share calculations,
because it implicitly considers the expenditure
side of state budgets.
Results here are meant to illustrate the fact
that revenue from a carbon tax or cap-and-trade
policy could substantially impact some state budgets, even for the six states that were deemed to
have significant fiscal difficulties by the SBCTF.
Yet, we note a few caveats about state budget
data. Many state constitutions require a balanced
budget, which they define in different ways. Any
given state’s official budget may or may not
include the revenue and spending associated with
a highway trust fund, a state pension fund, or any
other special purpose fund with its own source
of revenue. Implications are: (1) different state
budgets generally are not directly comparable,
(2) each state’s data for current and past years
generally show a balanced budget, as required,
and (3) no single source provides complete and
comparable data on state tax and spending projections into future years. An individual state showing its own projections of a future budget deficit
under current law might just mean that legislators must cut spending or raise more revenue to
satisfy the state constitutional requirement of a
balanced budget.
For these reasons, we study data from each
state to find its own projected budget surplus or
deficit. These data are not comparable to each
other: one state may show a balanced budget that
excludes projected pension underfunding, while
another state in the same situation shows a deficit
that does account for pensions. The purpose,
however, is not to compare states; it is to show
the extent to which each state could cover its own
definition of a future deficit using carbon revenue.
We discuss each state highlighted by the SBCTF
in alphabetical order using the best available
information with the range and scope of future
deficit per surplus calculations varying by state.
California. A cap-and-trade program already
exists in California, and thus carbon revenue
is already included in their present and future
budget calculations. California projects multibillion dollar surpluses into the foreseeable
future.11
Illinois. Carbon revenue can make a large
impact on the Illinois deficit. Deficits are near
$350 per capita through 2017. Meanwhile, potential carbon revenue is about $50 per capita.
Therefore, carbon revenue can cut the deficit by
approximately 14%.12
New Jersey. With a projected 2016 deficit of
only $38 million, or $4 per capita, even a small
amount of carbon revenue would close the budget
gap. Indeed, carbon revenue is projected to be a
bit more than $8 per capita in New Jersey, and
thus would balance the budget.13
New York. The CPP is not expected to be binding in New York, and thus no carbon revenue is
projected. Yet, some revenue would be welcome,
as a recent report projects the state will have a
$2.7 billion deficit in 2017 that is equivalent to
$140 per person.14
Texas. The State of Texas has robust carbon
revenue potential of more than $2.5 billion annually or $95 per capita at current population levels
(see Table 1). However, Texas is projected to have
strong population growth that will lower the per
capita carbon revenue potential. Texas currently
reports a budget surplus.15
Virginia. The projected carbon price in Virginia under the CPP is only $3.50 per ton, so it
could collect only $11 per capita in carbon revenue. In contrast, the state reports a large 2015
deficit of $740 million or nearly $90 per capita.
Therefore, carbon revenue could have cut the current deficit by approximately 12%.16
In summary, for the six states considered by
the SBCTF, the 2030 projected carbon revenue
could only have made an impact on the nearterm budget deficits in Illinois, New Jersey, and
11. Source for CA: “The 2015–2016 Budget: California’s Fiscal Outlook.” Burtraw et al. (2012) point out that
under California’s policy “[d]irecting [carbon] revenue to
the general fund for new, unrelated programs or to reduce
marginal tax rates appears to be precluded.” In other words,
most of California’s carbon revenue goes toward new government programs and dedicated expenditures.
12. Source for IL: “Governor’s Office of Management
and Budget 2014 Three Year Projection.”
13. Source for NJ: “The Governor’s FY 2016 Budget
Summary (and FY 2015 Budget Summary).”
14. Source for NY: “Report on the State Fiscal Year
2013–14 Enacted Budget and Financial Plan, July 2013.”
15. Sources for TX: Biennial Revenue Estimate—83rd
Legislature; Legislative Budget Board Statewide Appropriations (excluding trusts).
16. Source for VA: Datapoint Virginia.
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
Virginia. However, the large relative impact in
New Jersey occurs because the projected deficit
is small. The CPP is not projected to generate any
revenue in New York and thus will not impact
the state’s significant deficit. California already
has a budget surplus and a revenue-raising carbon
policy. Texas also has a reported budget surplus
despite robust carbon revenue potential. Carbon
revenue can make significant, but not dramatic,
impacts on the deficits in Illinois and Virginia, as
deficits in those states are quite large relative to
carbon revenue potential.
V. DISCUSSION
In this section we review some of the pros and
cons of pricing carbon emissions to raise state
revenue. A key advantage of pricing carbon to
comply with the federal mandate to cut emissions
comes in the form of improvements in economic
efficiency. We then proceed to possible disadvantages such as distributional effects, other considerations, caveats, and limitations.
A. Economic Efficiency in Two Forms
The first form of economic efficiency from a
carbon tax (or permit price) is that it provides
incentives for each different electricity producer
to find the cheapest ways to cut its own emissions
per unit output and for each different consumer
facing higher output prices to reduce their use of
electricity. It thus minimizes the cost of the abatement required by the CPP.17 Most noneconomists
abhor the higher electricity prices, so legislators
often prefer energy efficiency mandates that just
reduce emissions per unit of output. Those mandates have less effect on output prices, but they
miss the incentive for consumers to reduce emissions in easy ways—perhaps just turning out the
lights upon leaving the room.18
A second form of economic efficiency from
carbon pricing is that it could provide lump sum
revenue to the state: it creates no excess burden
if it captures the scarcity rents otherwise handed
out for free to existing polluters (Fullerton and
17. See Baumol and Oates 1988. For instance, Newell
and Stavins (2003, 56) find that “our model predicts 51% cost
savings from employing a market-based policy instrument
relative to a uniform emission rate standard.”
18. Bushnell et al. (2017) also show that the massbased approach achieves higher welfare than the rate-based
approach for the individual states covered in their study. For
those states, cap-and-trade programs raise social welfare by
a total of $0.51 billion per year, while rate-based programs
yield a loss of $0.55 billion per year.
15
Metcalf 2001). For example, Table 3 above
shows that carbon revenue could offset all of
corporate taxes in 13 states, yielding the potential
for a “double dividend.” According to Goulder
(1995), a pollution tax has a “weak” double
dividend if the revenue is used to cut distorting
taxes and reduce total deadweight loss. It has a
“strong” double dividend if the reduction in total
deadweight loss outweighs the cost of abatement, such that pollution reduction has negative
total costs (irrespective of environmental gains).
If the purpose of the carbon pricing is just to
comply with the CPP at least social cost, and not
necessarily to increase the size of government or
to reduce the deficit, then the logic of the double
dividend is simply that the carbon revenue in
each state could be used to cut whatever current
source of revenue has the largest deadweight loss
per dollar of revenue.
The province of British Columbia has enacted
a revenue-neutral carbon tax, where revenues
are dedicated to reducing other taxes.19 Alternatively, Barnes (2001) suggests that carbon revenue could be placed in a trust that yields dividends to citizens, along the lines of the Alaska
Permanent Fund (APF) that collects severance
tax revenue and invests it on behalf of the citizens.
In 2015, APF distributed a dividend of $2,072 to
each eligible citizen, and the Fund had assets of
over $52 billion (Alaska Permanent Fund Corporation [APFC] 2015). This direct dividend to citizens could garner widespread political support
for ongoing, revenue-raising carbon policies.
B. Leakage
In response to power sector emission reductions under the CPP, other sectors of the U.S.
economy or other countries could increase carbon emissions. This “leakage” is particularly
important for carbon emissions, because climate damages do not depend on the source of
emissions. Many studies quantify global leakage
from one country’s unilateral carbon policy (e.g.,
Elliott et al. 2010). Conversely, other studies
look for situations where unilateral carbon policy
may induce “negative leakage” where emissions are reduced elsewhere (e.g., Chua 2003;
Copeland and Scott Taylor 2005; Baylis et al.
2014). For the CPP, positive carbon leakage
could occur within the United States in other
sectors such as manufacturing, or even within
19.
.htm
http://www.fin.gov.bc.ca/tbs/tp/climate/carbon_tax
16
CONTEMPORARY ECONOMIC POLICY
the electric power sector itself from new power
plants not covered by the CPP. Burtraw et al.
(2016) discuss approaches to mitigate carbon
leakage by new power plants. The CPP directly
applies to existing power plants, but states can
choose to include new power plants in their CPP
compliance programs in exchange for a “new
source complement,” potentially reducing stringency of CPP mass-based targets. Alternatively,
EPA could require an “updating output based
allocation” mechanism to provide an incentive
for existing, low-carbon, gas-fired power plants
to continue production. Such a mechanism provides a production subsidy similar to a rate-based
approach (Burtraw et al. 2016).
C. Distributional Effects
Tables straight from the Consumer Expenditure Survey (CEX) show that electricity spending is about 4% of total spending for the lowestincome household category and falls monotonically to about 2% of total spending for the
highest-income category.20 Since carbon pricing
is expected to raise the price of electricity, many
studies show that the burden on the uses side is
regressive.21 If carbon pricing has general equilibrium effects on factor prices, it could have
either regressive or progressive effects on the
sources side (e.g., Fullerton et al. 2012).
Burtraw et al. (2014) calculate that a CPPstyle, nationwide cap-and-trade policy with auction of all permits would generate $28 billion in
revenue, a corresponding loss of consumer surplus equal to $33 billion, and a gain in producer
surplus of $2 billion. The sum of those effects is a
net loss of $3 billion—the economic cost of the
required abatement. In their analysis, electricity
prices rise by 9%. Therefore, some of the revenue
might be used to offset regressivity on the uses
side; that is, to help low-income families offset
the raised cost of electricity. Indeed, the WaxmanMarkey bill that passed the U.S. House of Representatives in 2009, but failed to become law,
earmarked 30% of permits to be used by local distribution companies (LDCs) to reduce electricity
bills. In another scenario, Burtraw et al. (2014)
20. See http://www.bls.gov/cex/2013/aggregate/quintile
.pdf. That calculation has the advantage of simplicity, but the
CEX table categorizes households by an imperfect measure
of income. A better measure of well-being might be based
on permanent income, which can be proxied by annual consumption. Other studies that provide better measures of distributional effects of carbon taxes include Burtraw et al. (2009),
Hassett et al. (2009), and Williams et al. (2015).
21. For reviews, see Fullerton (2011) or Bento (2013).
find that a cap-and-trade policy that requires
LDCs to reduce electricity prices still leads to an
$8 billion loss for consumers.22 While this loss
in consumer surplus is significantly smaller than
in the case with full permit auction ($33 billion),
the use of revenue to prevent increases in electricity prices does not minimize the overall cost
of abatement and does not leave as much revenue
to offset state budget deficits.
D. Use of the Revenue
If states do use this required carbon abatement
as an opportunity to raise revenue, then it certainly matters what is done with the money. For
instance, the revenue might be used to increase
government spending, to cut existing taxes, to
cover future deficits, or to retire accrued debt.
Those choices are political and not the topic of
our paper. Here, we just note that this carbon revenue opportunity is not the same as “free money”
to the states. Carbon pricing would indeed impose
costs on state residents and electricity ratepayers, even if such costs are smaller than for other
sources of revenue.
On the other hand, states may be compelled
by the political process to use carbon revenue
for particular purposes. Many environmental
groups or other observers think it logically
necessary to earmark carbon tax revenue for
environmental purposes such as energy efficiency programs—even though carbon pricing
by itself can address the externality efficiently
and completely without specifying use of the
revenue. In any case, any number of lobbies
can think of other uses for carbon revenue, so
states will undoubtedly have trouble preserving
all permit revenue for use in reducing state
budget deficits or cutting personal income tax
rates. Also, of course, new state CO2 emissions
policies may require administrative costs, monitoring costs, and enforcement programs.
E. Fiscal Externalities
Horizontal fiscal externalities might arise
when tax policy in one jurisdiction impacts
tax revenue of another jurisdiction at the same
governmental level. This kind of tax competition
22. The model underlying this loss calculation assumes
that consumers respond to the average electricity price rather
than the marginal price (Ito 2014). As a result, rebating carbon
revenue to consumers via the LDCs means that consumers
perceive a lower electricity bill even if the rebate is applied
only to the fixed portion of the bill.
FULLERTON & KARNEY: POTENTIAL CARBON REVENUE
among states can lead to tax rates that are too
low (Kothenburger 2004). Furthermore, other
non-tax policy such as a state emissions mandate
also could affect revenue in other jurisdictions.
These considerations might help explain the
reluctance of states to enact unilateral climate
policy, up until now. A federal mandate that
requires all states to enact climate policy can
help overcome this problem.
Vertical fiscal externalities arise in a “federation when the taxes or expenditures of one level
of government affect the budget constraint of
another level of government” (Dahlby and Wilson 2003, 917). For example, a state’s sales tax
or income tax might reduce labor supply and
thus reduce federal income tax revenue. In the
CPP context, a cap-and-trade policy that raises
revenue for state governments would reduce the
demand for fossil fuel and potentially reduce federal royalties for resource extraction on federal
land. Since the federal government does not tax
carbon emissions, however, a direct vertical fiscal
externality on the same tax base does not apply.
Yet, the use of carbon revenue to reduce distortionary state taxes might positively affect labor
supply and other economic activity and thus positively affect federal tax revenue. The net vertical
fiscal externality from carbon policy at the state
level is ultimately an empirical question.
VI.
CONCLUSION
This paper demonstrates that U.S. states have
the opportunity simultaneously to comply with
the CPP and to raise substantial revenue. For
some states, carbon revenue could exceed $1
billion annually. Other states could get low total
carbon revenue but relatively high per capita
revenue. These differences in revenue potential
arise both from differences in state carbon prices
induced by the CPP and differences in the tax
base (carbon emissions). Indeed, under massbased compliance, the CPP is binding in most
states. The degree of stringency for the binding
states ranges widely, as the implied carbon price
varies from less than $1 per ton to over $25
per ton (of CO2 in 2011 dollars). We show that
carbon revenue under the CPP could account for
a substantial share of many current state budgets
and could help close existing budget deficits in
some states.
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