The SO2 Allowance Trading System and the Clean Air Act Amendments of 1990: Reflections on Twenty Years of Policy Innovation

Abstract

The introduction of the U.S. SO2 allowance-trading program to address the threat of acid rain as part of the Clean Air Act Amendments of 1990 is a landmark event in the history of environmental regulation. The program was a great success by almost all measures. This paper, which draws upon a research workshop and a policy roundtable held at Harvard in May 2011, investigates critically the design, enactment, implementation, performance, and implications of this path-breaking application of economic thinking to environmental regulation. Ironically, cap and trade seems especially well suited to addressing the problem of climate change, in that emitted greenhouse gases are evenly distributed throughout the world's atmosphere. Recent hostility toward cap and trade in debates about U.S. climate legislation may reflect the broader political environment of the climate debate more than the substantive merits of market-based regulation.

This report was referenced in the February 13, 2012, Forbes article, "Cap and Trade Curbed Acid Rain: 7 Reasons Why It Can Do The Same For Climate Change" by Justin Gerdes.

PREFACE

In 2009, the U.S. Congress considered but ultimately failed to enact legislation aimed at limiting U.S. greenhouse-gas (GHG) emissions.¹ Over several months of often contentious debate, millions of Americans were introduced to the phrase "cap and trade," a regulatory approach that first came to prominence in the 1990s as the centerpiece of a national program to address the threat of acid rain by limiting emissions of sulfur dioxide (SO₂), primarily from electric power plants.

The 1990 SO₂ cap-and-trade program was conceived by the administration of President George H. W. Bush and was widely viewed as a success. Yet cap and trade became a lightning rod for congressional opposition to climate legislation from 2009 through 2010. Some of that hostility reflected skepticism about whether climate change was real and, if it was, whether humans played a key role in causing it. A larger group of opponents in Congress worried about the proper role of government and the costs of combating climate change, particularly given the lack of commitments for action by the large emerging economies of China, India, Brazil, Korea, South Africa, and Mexico. The congressional debate touched only lightly on the relative merits of various policy options to reduce greenhouse-gas emissions. Thus, cap and trade may not have been defeated on its merits (or demerits), but rather as collateral damage in the larger climate policy wars.

Congress (to the extent it did assess policy alternatives to cap and trade), as well as the broader community of analysts and observers in the late 2000s, raised a number of substantive questions about the merits of this policy instrument as a means for responding to a major environmental policy challenge of the sort posed by climate change (Peace and Stavins 2010):

• Cap and trade is part of a larger class of policy approaches to alleviating pollution and managing natural resources that rely on market mechanisms.² How do the costs of such a market-based approach compare with traditional regulatory policies to reduce pollution?
• Can market-based policies—and the markets they create—be trusted to reduce emissions? That is, are they environmentally effective?
• What are the distributional impacts of market-based environmental policies; who are the winners and losers?
• How well does a cap-and-trade system stimulate technological innovation, as compared with an environmental policy that sets performance standards, specifies technologies for reducing pollution, or both?

In May 2011, the Harvard Environmental Economics Program hosted a two-day research workshop and policy roundtable in Cambridge, Massachusetts, to reflect on these and other questions in light of twenty years of experience implementing the SO₂ cap-and-trade program, established under Title IV of the Clean Air Act Amendments (CAAA) of 1990.³ Also known as the Acid Rain Program and the SO2 allowance-trading system, Title IV represented the first large-scale application of cap and trade to control pollution—in the United States or any other country.⁴

This policy brief synthesizes the main conclusions and insights that emerged from the May 2011 workshop and roundtable, which included economists and legal experts who had conducted extensive research on the SO₂ allowance-trading system, as well as leaders of non-governmental organizations and former government officials who had guided the formulation and passage of the CAAA.⁵ Participants discussed the SO₂ cap-and-trade program's design, implementation, performance, and legacy—and its implications for the issues that emerged in recent congressional debates about U.S. climate policy. This policy brief draws on their analysis and on supplementary evidence....⁶

The entire report may be downloaded below.

This report and the project of which it is part was supported by the Alfred P. Sloan Foundation

¹ The bill under consideration at that time, the American Clean Energy and Security Act of 2009, was the last in a series considered over several years. Sponsored by Representatives Henry Waxman (D-California) and Edward Markey (D-Massachusetts), the bill passed the U.S. House of Representatives but failed to win sufficient support in the Senate. No legislation was enacted, and by 2010, both Congress and the White House had abandoned efforts to pass federal climate legislation. For text of and information on the bill and its legislative context, see: www.govtrack.us/congress/bill.xpd?bill=h111-2454.

² The principal market-based alternative to cap and trade is a tax on emissions (see text box). For a comprehensive discussion of market-based environmental policy, see Stavins (2003).

³ For the text of the amendments and other information see www.epa.gov/airmarkets/progsregs/arp.

⁴ The largest emissions trading program in the world is now the European Union Emissions Trading System (EU ETS), a greenhouse-gas, cap-and-trade system that was implemented in 2005 and whose design was influenced by the U.S. SO₂ program.

⁵ See the list of participants inside the back cover.

⁶ For background on and analysis of the SO₂ allowance-trading program, see generally Ellerman, et al. (2000) and Stavins (1998).