On December 30, The U.S. Court of Appeals for Washington, D.C. stayed implementation of the Environmental Protection Agency’s proposed Cross-State Air Pollution Rule (CSAPR), which was to take effect on January 1, 2012. The EPA maintains that CSAPR would save 13,000 to 34,000 premature deaths annually, as well as lead to improvements in visibility in national and state parks, and increased protection for sensitive ecosystems including Adirondack lakes and Appalachian streams, coastal waters and estuaries, and forests. The stay was the latest in a long series of setbacks to EPA efforts to regulate a family of air pollutants from coal-fired power plants and other sources, including sulfur dioxide (SO2), oxides of nitrogen (NOx), ozone, and fine particulates.
The long and tangled regulatory history leading up to the CSAPR stay begins with the 1970 Clean Air Act, which set the first ambient air standards for several pollutants, including SO2. In a classic case of unintended consequences, power plants avoided local concentrations of SO2 that exceeded those standards by building very tall smokestacks. As a result, pollutants from Midwestern power plants were lofted high into the air where they became the precursors of increased acid rain that fell along the Eastern Seaboard. In the days before global climate change became headline news, acid rain was seen as the single most serious environmental problem facing the United States.
In 1977, Congress amended the Clean Air Act to tighten control over SO2 and other acid rain precursors. The regulations required all new power plants to install scrubbers to remove pollutants from stack gasses after combustion. That approach also turned out to be deeply flawed. First, scrubbing was not necessarily the least- cost abatement method. Switching to low-sulfur coal was often cheaper, but was opposed by Eastern mining companies and their unions, which had more political clout than Western producers of cleaner coal. Second, the 1977 amendments exempted existing plants. Regulators expected them to be replaced, over time, by newer and cleaner plants, but the old plants were so much cheaper to operate that they were kept in service indefinitely.
With little progress to show against acid rain, in 1990 Congress amended the Clean Air Act yet again. The new amendments authorized the EPA to establish an emission trading system, which it finally got around to doing in 1995. The cap-and-trade approach, which first covered SO2 and later NOx, became one of the great environmental success stories of the period. The markets for trading permits operated well, acid raid depositions fell steadily, and the cost of the program to polluters was less than expected. But SO2 trading turned out to be a success story without a happy ending.
To make a long story short (see here for details), it turned out that the emissions trading system, although good, was not perfect from either an economic or a legal point of view. The economic problem was that regulatory rules allowed interstate trading of permits within the entire Eastern United States, but neither the sources of pollution nor the harm from it were uniformly distributed. Depending on who was downwind from whom, pollution from some states made it harder for other states to meet ambient air quality standards. Buying and selling permits at a uniform price could thus cause marginal abatement costs to diverge from marginal harm done by pollution, depending on the exact location of pollution sources.
The legal problem with the EPA’s emission trading scheme stems from language in the amended Clean Air Act that recognizes the issue of geographical diversity. Under the so-called “good neighbor” provisions of the law, the EPA is supposed to make sure that emissions from one state do not make it more difficult for another state to meet air quality standards. In a 2008 ruling, a federal appeals court struck down the EPA’s Clean Air Interstate Rule (CAIR), as the 2005 version of its cap-and-trade regulations were known, on the grounds that they did not “connect states’ emissions reductions to any measure of their own significant contributions.”
The 2008 court ruling threw SO2 emissions trading into disarray. Permit prices plunged to record lows, causing huge losses to firms that had spent millions to clean up their act and leaving little incentive for those who had not done so to change their ways. With prices so low, some plants might find it cheaper to buy permits than to operate scrubbers that had already been installed at great expense.
There were two possible ways out of the situation. One would be to limit interstate trading in a way that recognized geographic diversity. Traders reacted negatively to that approach. According to Paul Tesoriero, director of emissions markets at the brokerage Evolution Markets Inc., “Traders like commodity markets to be homogeneous.” Breaking the market into segments “restricts the purpose of trading.”
The other alternative would be to persuade Congress to amend the Clean Air Act yet again in a way that would legalize the kind of broad interstate trading that seemed to work so well from 1995 to 2008. Urged on by the Environmental Markets Association, Senators Tom Carper (D-Del.) and Lamar Alexander (R-Tenn.) introduced a bill, S 2995, that would give the EPA explicit authority to establish an interstate trading program for SO2, NOx and mercury. Unfortunately, in a political atmosphere where many legislators see any kind of environmental regulation as a third-rail hazard, the bill went nowhere.
That left the EPA facing a Catch 22. They wanted to put pollution control back on track, but the best tool they had for doing it, emissions trading, was of questionable legality. The regulation known as CSAPR, finalized in July 2011, with an effective date of January 2012, was the EPA’s heroic effort to thread the needle. CSAPR was to allow substantial, but not unrestricted, interstate permit trading of a kind that would realize environmental and economic benefits while complying with the law.
Now, though, the courts have thrown CSAPR into limbo, too. The December court decision did not rule on the merits of the regulations. That will come later in the year. Meanwhile, in issuing its stay, the court evidently was responding to complaints from some polluters that the 2012 effective date did not give sufficient time to come into compliance.
A recent article in The New York Times highlights one of the reasons that it can in fact be time consuming to comply with air pollution regulations. Emissions trading, by intent, raises energy prices. Higher prices conform to the principle that polluters should pay, and, when they pass along at least part of the cost of abatement, their customers should pay, too. However, regulated electric utilities, which are the biggest sources of SO2 and NOx, cannot raise their prices at will to reflect higher abatement costs. At that point, EPA regulations, which have the effect of pushing up energy prices, come into conflict with traditional utility regulation, which has the objective of keeping prices low, pollution or no.
Given time, utilities can petition for and eventually receive rate increases to cover the cost of pollution control, but the rate regulation process cannot even begin until the environmental regulations have been issued and are in force. Utilities cannot go to their state regulatory commissions and ask for rate increases to fund the construction of equipment that might be needed to meet future EPA regulations, or that might (heaven forbid!) simply be good for the planet.
The bottom line: When it comes to environmental regulation, simpler is sometimes better. Yes, cap and trade is a less-than-perfect regulatory instrument. To the extent that trading rules are not fine-tuned to local differences in marginal costs and benefits, they can be inefficient. Cap and trade can also be unfair. Some pollution remains even after the cap has been met, and the downwind victims of that residual pollution are left with neither compensation nor redress. Still, what are the alternatives from which we must actually choose? One is a set of regulations that ideally captures every nuance of geography, technology, and fairness, but is indefinitely postponed in its implementation. The other is a system that, although admittedly imperfect, once worked tolerably well, but has now been indefinitely suspended. Facing that choice, I say, don’t let the best be the enemy of the good.
Who is going to fix the mess? Not the courts; they only interpret the law. Although they have some latitude in doing so, ultimately they are constrained by their raw material. Not the EPA; it can only work within the law as the courts interpret it. Only Congress, which writes the laws, can fix their flaws. Our representatives in Congress are going to have to decide which side they are on. Are they on the side of the “affordable energy” crowd, for whom dirty air is a source of pride and a token of a strong economy? Or are they on the side of the TANSTAAFL principle: There Ain’t No Such Thing as a Free Lunch. If it ain’t free, the polluters—and that includes all of us who consume goods and services that generate the pollution—are the ones who should pay.
By. Ed Dolan
"This post originally appeared on Ed Dolan's Econ Blog at Economonitor.com, and is reprinted here with permission."