June 2006

California's Climate Law: Boon or Boondoggle?

On September 27, 2006, California governor Arnold Schwarzenegger signed AB 32, an act that would cap California's greenhouse gas emissions at 1990 levels by 2020. This is the first law in the country establishing a mandatory cap on statewide greenhouse gas emissions.

At this AEI event, W. David Montgomery, a vice president at CRA International, presented a study he conducted in which he modeled the impact of the California law on the state's economy. Dallas Burtraw, an expert on environmental regulation at Resources for the Future, offered a critique of Montgomery's study and in part defended the benefits of the new law. Finally, Lee Lane, author of Strategic Options for Bush Administration Climate Policy, provided an analysis of the political ramifications of the law and the climate change policy debate in general. All three panelists then discussed the study and the future of climate change policy in California and across the country. AEI's Samuel Thernstrom moderated.

W. David Montgomery
CRA International

The Electric Power Research Institute commissioned a study to determine the economic impact of AB 32, the new California climate law that establishes a mandatory cap on statewide greenhouse gas emissions. Using a state-of-the-art economic modeling system, the study analyzes the potential costs of AB 32, taking into account a wide range of different scenarios. All the different scenarios taken into account in the study show the same thing: there will be significant costs to California's economy. However, a cap-and-trade system like the one in the California law is better and cheaper than a command-and-control system. One problem with the California law, though, is that the implementation of the cap-and-trade system is largely left up to state agencies. This could potentially have unintended consequences.

The California law dictates that the state must cut emissions to 1990 levels by 2020 and to 20 percent of 1990 levels by 2050. However, cutting emissions by 20 percent of 1990 levels by 2050 is economically infeasible. The economic models used in the study show that there would likely be a large increase in price volatility for carbon prices as a result of the new law, which would affect things like gas prices in the state. Also, because the California law lacks a safety valve measure, there might be unnecessary price volatility in the market.

Dallas Burtraw
Resources for the Future

There are many potential positive consequences of California's action on climate change. There is a good chance other states will follow California's lead in confronting climate change, which is crucial for reducing emissions in the United States and globally. That other states follow California's lead is important for avoiding economic leakages, which many critics of the law say is its biggest downside. The cap-and-trade system in the California law is a good compromise. It is certainly better than a command-and-control bill, which would perhaps be even more costly.

The Market Advisory Committee's recommendations to the governor are important to highlight as well. They included an economy-wide approach to cutting greenhouse emissions, auctioning emission credits to emitters as soon as possible, and granting generous offsets to emitters. There are also reasons to be skeptical of Montgomery's study. First, it is difficult to model the economic impact of a law in 2020, let alone in 2050. We have to be aware of changing preferences and technology. Ultimately, costs do matter. We need to wake up to the "emerging social norm," however, that climate change must be addressed, despite significant costs. Concerning Montgomery's charge that the law leaves the implementation aspect up in the air, California agencies have been very effective in the past at implementing broadly designed laws, and that there is little reason to worry in this instance.

Lee Lane
CRA International

Climate change policy would benefit from a focus on the interaction between politics and economics. Today's emission policies are leading to inefficient outcomes, with patchwork geography, laws, and policies. In other words, some of the largest emitters in the world are not regulating their greenhouse gas emissions under today's system. The norm today seems to be quantity-based emission controls, whereas most economists agree that price-based emission controls are more efficient--and perhaps lead to lower costs. Most polling, however, shows that people are not in favor of price incentives in environmental policy.

Concerning the economic efficiency of the law, it is important to remember that many of the leading environmental groups do not place a priority on the cost-effectiveness of environmental policy, and that the same is true of many politicians at the state level. According to recent polling, most people value increased environmental standards over economic efficiency, although the designs of these particular polls might not be optimal. Finally, we must remember that real-world policies might actually cost more than ideal policies, meaning that Montgomery's study might be underestimating the true costs of the California law.

AEI intern Evan Daar prepared this summary.