Last update: 7/22/2008

In my last post I touted the benefits of a fully refunded emissions tax. Let’s take a look at how it could work in California.

When it comes to a refunded tax, more money for industry doesn’t mean less money for consumers. Case in point: Today’s gasoline prices in California are averaging $4.58/gal, which equates1 to $536/MT-CO2e. That’s how much California drivers are currently paying to emit CO2 — and how much they could save from fuel economy improvements.

The same approach used by the Swedish program could be applied to motivate efficiency improvements in vehicles, consumer appliances, etc., by employing feebates, which can be implemented as a kind of refunded emission tax. The tax would be applied to projected lifecycle emissions (direct or upstream) and would be refunded in proportion to some measure of economic utility (e.g. refrigeration capacity, illumination output, etc.). The tax and refund together would incentivize lower emissions per unit of economic utility. Feebates could be used as an alternative to traditional performance standards, or could be used to effectively impose a price floor on a tradable standard.

The potential benefits of this approach can be illustrated in relation to California’s vehicle GHG regulations, the Pavley standards (AB 1493). The state will be relying on Pavley to achieve emission reductions in transportation, as required by its new AB 32 legislation, which requires that statewide GHG emissions be reduced to or below 1990-level emissions by 2020. (Governor Schwarzenegger has also established a long-term goal of reducing emissions by 80% below the 1990 level in 2050.)

The following figure shows projected emissions from light-duty vehicles in California for “business-as-usual” (baseline), with the Pavley standards (including a proposed “Pavley II” extension), and with just the federal CAFE standards (as recently proposed by NHTSA)2. Even with the more stringent Pavley rules, emissions will still be significantly above the 1990 level in 2020, indicating that other industries would need to achieve correspondingly greater emission reductions. (Light-duty transport accounts for about one-quarter of California’s emissions.)

Pavley scenarios
Projected California light-duty transportation emissions

The baseline projection in the figure is somewhat misleading, because it assumes that vehicle emission performance stays at the 2002 level, disregarding efficiency improvements that would occur under a business-as-usual scenario. Of course, there is nothing “usual” about $4/gal, and a fundamental question is how the regulatory incentive would compare to natural market incentives for improved fuel economy.

Some insight on this question can be gleaned from a report published by the governor-appointed Climate Action Team in October, 2007, which projected average compliance costs for the Pavley standards at $44/MT CO2e, which are balanced by benefits of $221/MT.3 In terms of fuel price equivalents, the costs and benefits of fuel economy improvements under AB 1493 equate to $0.38/gal and $1.89/gal, respectively. This represents a 5-to-1 benefit/cost ratio, which is premised on a fuel price of $2.28/gal in 2020.4

An average regulatory cost of just $0.38/gal — compared to today’s gasoline price of $4.58/gal — suggests that natural market forces could possibly surpass the Pavley standards. This raises a more fundamental question: Is the $0.38/gal cost really representative of the “maximum feasible and cost-effective reduction of greenhouse gas emissions from motor vehicles” that were mandated by the AB 1493 legislation?5 And how might a feebate-type policy perform?

“Cost-effective” was defined an interpreted to have a very specific meaning in AB 1493: The regulatory costs were required to be entirely offset by fuel savings, assuming a fuel price of $2.30/gal6, which translates to a discounted present-value cost threshold of $1.58/gal.7 In other words, it should cost no more than $1.58 to reduce a vehicle’s lifetime fuel consumption by 1 gallon (and achieve associated emission reductions).

In developing the AB 1493 regulations, the California Air Resources Board considered a broad range of vehicle emission technologies that were almost all within the $1.58/gal limit8, but the regulations were premised on technologies that all had costs below $0.80/gal — basically incremental, off-the-shelf technologies. Higher-cost technologies such as gas-electric hybrids, though “cost-effective” by CARB’s standards, were deemed to be “infeasible” for the purpose of establishing the standard.9

A feebate-type policy would not need to be limited by this kind of excessive technology conservatism. The emission price could simply be set to $1.58/gal (equivalently, $185/MT-CO2e) — or whatever the established cost-effectiveness threshold is — and it would be up to the market to determine what technologies are or are not feasible within that cost limit.

A feebate would conventionally use fees on high-emission vehicles to finance rebates on low-emission vehicles, but in practice there need not be any revenue transfers between buyers. Fees could be effectively treated as a down payment on future fuel expenditures, which would be returned to the vehicle owner, e.g., as 16 annual payments to partially cover fuel costs. Rebates could similarly be treated as a loan, which would be paid off over a 16 year period. (Fuel savings would exceed the loan payments.) In effect, the feebate would internalize a portion of the lifecycle fuel costs or savings in the vehicle purchase price, which would induce buyers (and manufacturers) to make more intelligent long-term investment decisions in their vehicle choices. With fuel prices as high as they are, the fuel price incentive alone may be more than sufficient to incentivize advanced technologies such as plug-in hybrids.

The climate crisis won’t be solved with incremental, off-the-shelf technologies like those assumed in the Pavley regulations; and it similarly won’t be solved with incremental, off-the-shelf policies like the Pavley rules themselves. Regulations grounded on a logical and coherent policy foundation must be devised and adopted to avert the cataclysm that may overtake us if we continue to follow regulatory strategies that are based primarily on precedent, political fashion, and ideological dogmatism.

1 based on a fuel emissions factor of 8.55 kg CO2e per gallon, from Exhibit 4 in the October, 2007 CAT report.

2 This data is based on CARB’s May 8, 2008 addendum to its February 25, 2008 assessment report on the Pavley regulations. (The CARB reports do not include baseline data, but the data can be obtained from the authors.)

3 Costs and benefits are derived from Exhibit 11 in the CAT report.

4 Energy price forecasts are tabulated in Exhibit 8 of the CAT report.

5 AB 32 contains similar language requiring “the maximum technologically feasible and cost-effective greenhouse gas emission reductions”, but in the context of AB 32 CARB does not recognize the requirement for maximum emission reductions as having any legally operative meaning. Consequently, CARB is considering the use of feebate-type policies as a contingency option only if the legality of the Pavley regulations cannot be successfully defended, and only to match the emission reductions under Pavley. (See pages 20-21, 37 in the June, 2008 draft Scoping Plan.)

[7/22/2008 update: According to the Draft Plan Appendix C (released on 7/22), CARB actually is considering the use of feebates as an adjunct – not just an alternative – to Pavley: “A Feebate program could also result in additional reductions prior to 2020 by creating an incentive for manufacturers to improve vehicles beyond what would be required by Pavley.” (page C-37)]

6 CARB’s initial analysis assumed a $1.74/gal fuel price, but the August, 2004 ISOR was updated to use a more realistic (at that time) price projection of $2.30/gal.

7 5% discount rate, amortized over a 16-year vehicle life

8 Tables 5.2-5 to 5.2-9, 6.2-6 and 6.2-7 in the ISOR, September 2004 Addendum. (Also see Scoping Plan Submittals — Transportation, “Attribute-Based Vehicle Feebate”, spreadsheet attachment.)

9 “… although using a fuel price of $2.30 per gallon reduces the payback period and increases the net present value for all technology packages, this change by itself would not allow staff to set a more stringent standard. Rather, the limiting factor on the standard is the availability of technology packages for widespread deployment.” (August, 2004 ISOR, page xi)