Environmental Policy Archives - Page 73 of 74 - An Economic View of the Environment

Moving Beyond Vintage-Differentiated Regulation

A common feature of many environmental policies in the United States is vintage-differentiated regulation (VDR), under which standards for regulated units are fixed in terms of the units’ respective dates of entry, with later vintages facing more stringent regulation. In the most common application, often referred to as “grandfathering,” units produced prior to a specific date are exempted from a new regulation or face less stringent requirements.

As I explain in this post, an economic perspective suggests that VDRs are likely to retard turnover in the capital stock, and thereby to reduce the cost-effectiveness of regulation in the long-term, compared with equivalent undifferentiated regulations. Further, under some conditions the result can be higher levels of pollutant emissions than would occur in the absence of regulation. Thus, economists have long argued that age-discriminatory environmental regulations retard investment, drive up the cost of environmental protection, and may even retard pollution abatement.

Why have VDRs been such a common feature of U.S. regulatory policy, despite these problems? Among the reasons frequently given are claims that VDRs are efficient and equitable. These are not unreasonable claims. In the short-term, it is frequently cheaper to control a given amount of pollution by adopting some technology at a new plant than by retrofitting that same or some other technology at an older, existing plant. Hence, VDRs appear to be cost-effective, at least in the short term. But this short-term view ignores the perverse incentive structure that such a time-differentiated standard puts in place. By driving up the cost of abatement with new vintages of plant or technology relative to older vintages, investments (in plants and/or technologies) are discouraged.

In terms of equity, it may indeed appear to be fair or equitable to avoid changing the rules for facilities that have already been built or products that have already been manufactured, and to focus instead only on new facilities and products. But, on the other hand, the distinct “lack of a level playing field” – an essential feature of any VDR – hardly appears equitable from the perspective of those facing the more stringent component of an age-differentiated regulation.

An additional and considerably broader explanation for the prevalence of VDRs is fundamentally political. Existing firms seek to erect entry barriers to restrict competition, and VDRs drive up the costs for firms to construct new facilities. And environmentalists may support strict standards for new sources because they represent environmental progress, at least symbolically. Most important, more stringent standards for new sources allow legislators to protect existing constituents and interests by placing the bulk of the pollution control burden on unbuilt factories.

Surely the most prominent example of VDRs in the environmental realm is New Source Review (NSR), a set of requirements under the Clean Air Act that date back to the 1970s. The lawyers and engineers who wrote the law thought they could secure faster environmental progress by imposing tougher emissions standards on new power plants (and certain other emission sources) than on existing ones. The theory was that emissions would fall as old plants were retired and replaced by new ones. But experience over the past 25 years has shown that this approach has been both excessively costly and environmentally counterproductive.

The reason is that it has motivated companies to keep old (and dirty) plants operating, and to hold back investments in new (and cleaner) power generation technologies. Not only has New Source Review deterred investment in newer, cleaner technologies; it has also discouraged companies from keeping power plants maintained. Plant owners contemplating maintenance activities have had to weigh the possible loss of considerable regulatory advantage if the work crosses a murky line between upkeep and new investment. Protracted legal wrangling has been inevitable over whether maintenance activities have crossed a threshold sufficient to justify forcing an old plant to meet new plant standards. Such deferral of maintenance has compromised the reliability of electricity generation plants, and thereby increased the risk of outages.

Research has demonstrated that the New Source Review process has driven up costs tremendously (not just for the electricity companies, but for their customers and shareholders, that is, for all of us) and has resulted in worse environmental quality than would have occurred if firms had not faced this disincentive to invest in new, cleaner technologies. In an article that appeared in 2006 in the Stanford Environmental Law Journal, I summarized and sought to synthesize much of the existing, relevant economic research.

The solution is a level playing field, where all electricity generators would have the same environmental requirements, whether plants are old or new. A sound and simple approach would be to cap total pollution, and use an emissions trading system to assure that any emissions increases at one plant are balanced by offsetting reductions at another. No matter how emissions were initially allocated across plants, the owners of existing plants and those who wished to build new ones would then face the correct incentives with respect to retirement decisions, investment decisions, and decisions regarding the use of alternative fuels and technologies to reduce pollution.

In this way, statutory environmental targets can be met in a truly cost-effective manner, that is, without introducing perverse incentives that discourage investment, drive up costs in the long run, and have counter-productive effects on environmental protection.

It is not only possible, but eminently reasonable to be both a strong advocate for environmental protection and an advocate for the elimination of vintage differentiated regulations, such as New Source Review. That is where an economic perspective and the available evidence leads.

A Tale of Two Taxes

Whether they are called “revenue enhancements” or “user charges,” fear of the political consequences of taxes restricts debate on energy and environmental policy options in Washington. In a March 7^th post on “Green Jobs,” in which I argued that it is not always best to try to address two challenges with a single policy instrument, I also noted that in some cases such dual-purpose policy instruments can be a good idea, and I gave gasoline taxes as an example.

Although a serious recession is clearly not the time to expect political receptivity to such a proposal, the time will come — we all hope very soon — when the economy turns around, employment rises, and a sustained period of economic growth ensues. When that happens, serious consideration should be given to increases in the Federal tax on gasoline.

A gas tax increase — coupled with an offsetting reduction in other taxes, such as the Social Security tax on wages — could make most American households better off, while reducing oil imports, local pollution, urban congestion, road accidents, and global climate change. This revenue-neutral tax reform would exemplify the market-based approaches to environmental protection and resource management I examined in previous posts.

Such a change need not constitute a new tax, but a reform of existing ones. It is well known – both from economic theory and numerous empirical studies – that taxes tend to reduce the extent to which people undertake the taxed activity. In the United States, most tax revenues are raised by levies on labor and investment; the resulting reduction in these fundamentally desirable activities is viewed as an unfortunate but unavoidable side-effect of the need to raise revenue for government operations. Would it not make more sense to raise the revenue we need by taxing undesirable activities, instead of desirable ones?

Combustion of gasoline in motor vehicles produces local air pollution as well as carbon dioxide that contributes to global climate change, increases imports of oil, and exacerbates urban highway congestion. Can anyone really claim that — given a choice between discouraging work and discouraging gasoline consumption — it is better to discourage work?

According to the U.S. Department of Energy, a 50 cent gas tax increase could eventually reduce gasoline consumption by 10 to 15%, reduce oil imports by perhaps 500 thousand barrels per day, and generate about $40 billion per year in revenue.

Furthermore, this approach would be far more effective than on-going proposals to increase the Corporate Average Fuel Economy (CAFE) standards, which affect only new vehicles and lead to serious safety problems by encouraging auto makers to produce lighter vehicles. Also, remember that a major effect of CAFE standards has been to accelerate the shift from cars to SUVs and light trucks (so that overall fuel efficiency of new vehicles sold is no better than it was a decade ago, despite the great strides that have taken place in fuel efficiency technologies). As my Harvard colleague Martin Feldstein pointed out in The Wall Street Journal in 2006, the conventional approach “does nothing to encourage individuals to drive less, to use their cars more efficiently, or to shift sooner to new and more fuel efficient [and cleaner] vehicles.” A more enlightened approach — a market-based approach — would reward consumers who economize on gasoline use. And that is what a revenue-neutral gas tax is all about.

The revenue from the gas tax could be transferred to the Social Security Trust Fund and credited to current workers. If $40 billion per year from new gas tax revenues were transferred to Social Security, the payroll tax — the employee contribution to Social Security — could be cut by perhaps a third: a worker with annual wages of $30,000 would take home an additional $750 per year! The extra income would more than offset the cost of the gas tax, unless the worker drove over 35,000 miles per year in a car getting 25 miles or less per gallon. Rebating the gas tax in this way addresses the greatest concern about higher gas taxes — that they can hit hardest those workers who drive to their jobs. Further, a tax of this magnitude could be phased in gradually, perhaps no more than 10 cents per year over 5 years, allowing individuals and firms to adjust their consuming and producing behavior.

Proposals for gasoline tax increases in recent sessions of Congress would have dedicated the revenue to public spending (for transportation and other programs). A key difference is that the proposal I have outlined here is for a revenue-neutral change in which the gas tax revenue would be returned to Americans through reduced payroll taxes. To adopt some of the language I developed in my previous posts, such a change can be both efficient and equitable, and — for those reasons — perhaps even politically feasible.

Of course, such a scheme is not a panacea for U.S. energy and environmental problems. But it would make a significant contribution if enacted. On the other hand, political fear of the T-word in Washington may mean that it is never discussed seriously in public, let alone adopted. Most fear of taxes is due to politicians’ anxieties about asking their constituents to pay more. But an increase in the Federal gas tax, rebated through reduced payroll taxes would not cost most Americans any more and would have significant long-term benefits for the country. Still, fear of the T-word looms large; maybe it should be called an “All-American Ecologically Sound, Fully Recyclable, Anti-Terror, Energy-Independence Assessment.”

Green Jobs

The January 12, 2009 issue of The New Yorker includes a well-written and in some ways inspiring article by Elizabeth Kolbert, profiling Van Jones, founder and president of Green for All. In the article, “Greening the Ghetto: Can a Remedy Serve for Both Global Warming and Poverty,” Kolbert includes the following passage:

When I presented Jones’s arguments to Robert Stavins, a professor of business and government at Harvard who studies the economics of environmental regulation, he offered the following analogy: “Let’s say I want to have a dinner party. It’s important that I cook dinner, and I’d also like to take a shower before the guests arrive. You might think, Well, it would be really efficient for me to cook dinner in the shower. But it turns out that if I try that I’m not going to get very clean and it’s not going to be a very good dinner. And that is an illustration of the fact that it is not always best to try to address two challenges with what in the policy world we call a single policy instrument.”

That brief quote generated a considerable amount of commentary in the blogosphere, much of it negative, and some of it downright hostile. This surprised me, because I didn’t consider the proposition to be controversial, and I had chosen my words carefully, simply stating that “it is not always best to try to address two challenges with … a single policy instrument.” Two activities — each with a sensible purpose — can be very effective if done separately, but sometimes combining them means that one does a poor job with one, the other, or even both.

In the policy world, such dual-purpose policy instruments are sometimes a good, even great idea (gas taxes are an example), but other times, they are not. Whether trying to kill two birds with one stone makes sense depends upon the proximity of the birds, the weapon being used, and the accuracy of the stoner. In the real world of important policy challenges — such as environmental degradation and economic recession — these are empirical questions and need to be examined case by case, which was my point in the brief quote. Since my further explanation of this point in the green jobs context (in an interview that lasted 30 to 60 minutes — I don’t recall) did not find its way into Ms. Kolbert’s article (no fault of hers — she had plenty of sources, plenty of material, and limited space), let me provide that explanation here.

In 1990, when Congress sought to cut sulfur dioxide (SO₂) emissions from coal-fired power plants by 50% to reduce acid rain, Senator Robert Byrd (West Virginia) argued against the proposal for a national cap-and-trade system, because it would displace Appalachian coal mining jobs through reduced demand for high-sulfur coal. He recommended instead a national requirement for all plants to install scrubbers, which would have increased costs nationally by $1 billion per year in perpetuity.

Fortunately, Senator Ted Kennedy (Massachusetts) recognized that these two problems (acid rain and displaced miners) called for two separate policy instruments. Simultaneous with the passage of the Clean Air Act amendments of 1990, which established the path-breaking SO₂ allowance trading program, Congress passed a job training and compensation initiative for Appalachian coal miners, at a one-time cost of $250 million. Acid rain was cut by 50%, $1 billion per year was saved for the economy, and sensible and meaningful aid was provided to the displaced miners. Two different policies were used to address two different purposes. Sometimes that is the wisest course.

What about two current challenges: concern about the environment, in particular global climate change, on the one hand, and the need to turn around the economy, on the other hand? Can “green jobs” be the answer to both?

Will an economic stimulus package — properly designed — lead to job creation in the short term? Yes, but to some degree this will be by moving forward in time the date of job creation, as opposed to creating additional jobs in the long run. Of course, at a time of recession and increasing unemployment, that can be a sensible thing to do. So, by expanding economic activity, an economic stimulus package can surely create jobs — green or otherwise — in the short term.

But will a stimulus package — such as subsidies for renewable energy — create net jobs from the change in the nature of economic activity? The key question here is whether the encouraged economic activities in green sectors are more labor-intensive than the discouraged economic activities in other sectors, such as with a shift to renewables from fossil fuels.

This is considerably less clear, but there are cases where it is likely to be valid. Solar rooftop installation, for example, is labor-intensive. And the greatest consistency between economic stimulus and greening the economy is within the energy-efficiency realm, in particular, activities such as the weatherization of homes and businesses. Such projects are highly labor-intensive, can be done quickly, and will save energy. And, importantly, they will reduce the long-term cost of meeting climate objectives.

But some other areas, such as new green infrastructure, will happen much more slowly — partly because of NIMBY (“not in my backyard”) problems — and so are less consistent with the purpose of economic stimulus. An example of the challenge is presented by the current interest in expanding and improving our national electricity grid.

A more interlinked and better grid is needed for increased reliance on renewable energy sources, which will be needed to address climate change. First, greater use of renewable resources will require an expanded grid just to transmit electricity from the Great Plains, for example, to cities with high demand for power. And, second, this will also require the use of a so-called “smart grid,” so that greater reliance on intermittent sources of electricity, such as from wind farms, can be balanced with cuts in consumer demand when power is scarce.

But the timing of grid expansion — important for the use of renewables and achieving climate goals — is not coincident with the appropriate timing of the economic stimulus. As was reported in an article by Matthew Wald in the New York Times (“Hurdles (Not Financial Ones) Await Electric Grid Update,” January 7, 2009, p. A11), the CEO of the American Transmission Company — which operates in four midwestern states — said that the firm’s most recent major project, a 200-mile transmission line from Minnesota to Wisconsin, took 2 years to build, but 8 years prior to that to win the necessary permits!

Likewise, an article by Peter Behr in Climate Wire (“Green Power Express line gets derailed by patchwork grid rules,” Feburary 12, 2009, p. 1) focuses on the dilemma facing ITC Holdings, the nation’s largest independent electric transmission company, which has been seeking permission from the Federal Energy Regulatory Commission to build a line to bring wind power from the Great Plains to the Midwest and East. The company’s chairman and CEO, Joseph Welch, indicates that a greater hurdle than the necessary money or “even the ever-present citizen opposition to new transmission projects” is a set of rules for interstate transmission lines that effectively prohibits projects that are not immediately required to maintain the grid’s reliability. A project intended to provide future green power does not meet the test.

These are just two examples of the unpleasant reality of the pace of investment and change in this important category of green infrastructure frequently talked about in the context of quick economic stimulus. Surely, economic recovery, increased reliance on renewable sources of energy, and a smarter, inter-connected grid are all important. But that does not mean they are best addressed with a single policy instrument – the economic stimulus package.

So, the strongest support for “green job creation” is with regard to economic expansion, as opposed to changes in the economy. Of course, the key economic question remains whether even more jobs would be created with a different sort of expansion. In any event, while we are expanding economic activity through the economic stimulus package, it makes sense to reduce any tendency to lock in new capital stock that would make it more difficult and costly to achieve long-term environmental goals. But that is very different from claiming that all substitution of green activities for brown activities creates jobs in the long-term.

As the government uses economic stimulus to expand economic activity, it can and should tilt the expansion in a green direction. But rather than a “broad-brush green painting of the stimulus,” this may call for some careful, selective, and well thought-through “green tinting.”

Addressing the worst economic recession in generations calls for the most effective economic stimulus package that can be devised, not a stimulus package that is diminished in effectiveness through excessive bells and whistles meant to address a myriad of other (legitimate) social concerns. And, likewise, getting serious about global climate change will require the enactment and implementation of meaningful, dedicated climate policies, most likely a comprehensive national CO₂ cap-and-trade system. These are two serious but different policy problems, and they call for two serious, carefully-crafted policy responses.

After I wrote this brief essay, someone brought to my attention an article posted at Slate by Michael Levi, a senior fellow at the Council on Foreign Relations(“Barking Up the Wrong Tree: Why ‘Green Jobs’ May Not Save the Economy or the Environment,” March 4, 2009). I found Levi’s assessment to be sensible and compelling, but I may be biased by two realities: one is that he and I are fundamentally in agreement; and the other is that we have been professionally affiliated, because he is the co-author of a paper (“Policies for Developing Country Engagement” ) which is part of the Harvard Project on International Climate Agreements, a global research and outreach initiative which I direct. Rather than summarize or repeat any of Michael Levi’s article, I urge you to read it in its entirety at the Slate web address above.