Carbon Taxation by Regulation

PROGRESS, BUILDING THE 21ST CENTURY ECONOMY: THE CASE OF A PROGRESSIVE CARBON TAX (2016), https://www.americanprogress.org/issues/green/reports/. For an excellent discussion of some of the key components of optimal carbon tax design, see Gilbert E.

RATEMAKING AND THE EXISTING POWER GENERATION FLEET Beyond tax subsidies, state regulators' traditional approach

Economists have long questioned the economic inefficiencies produced by cost-of-service rate charging, which can distort asset investment decisions by perversely encouraging overinvestment in large-scale baseload power plants (i.e., necessary) with high fixed costs (known among economists as the "Averch-Johnson" effect or an inefficiently high capital-labor ratio).53 Over the past half century, state regulators have routinely approved new coal-fired power plants fossil and nuclear fuels, with an expectation of continued expansion in customer demand. 5 4 This encouraged the construction of an existing electricity generation fleet (supported by a network of transmission lines) that derives approximately sixty-four percent of its energy from fossil fuels and nearly twenty percent from nuclear power.55 Carbon i low resources remain by a significant margin in these more conventional power generation facilities, with non-hydro renewables (such as wind, solar and biomass) supplying only eight percent of electricity needs,56 at least in their best day.57 Vertical integration of services as well. See, e.g., Hammond & Spence, supra note 16 (discussing the perceived poor reliability attributes of non-dispatchable resources, such as solar and wind power, compared to traditional fossil-fueled plants and those nuclear).

PUBLIC GOOD CHALLENGES IN COMPETITIVE ENERGY MARKETS

EXISTING INTERNAL SUBSIDIES FOR CARBON REDUCTION

Just like a carbon tax, internal subsidies can direct private firms and individuals to invest in low-carbon energy infrastructure investments. 109 Based on the examples below, in Part IV I identify some principles to help regulators approach internal subsidies in the transition to a low-carbon energy system. To the extent that a carbon tax envisages the continuation of pollution control and other low-carbon energy mandates, it makes no attempt to coordinate how it is paid for and by whom.

In contrast to mandates, electric power subsidies reflect direct or indirect transfers to private firms to promote particular forms of investment in low-carbon energy sources.155 Much like long-standing federal programs that benefit legacy fossil fuels. Consistent with Posner's notion of taxation by regulation, both federal and state regulators are also increasingly relying on internal subsidies to promote low-carbon energy sources. Similar to long-standing tax subsidies that favor legacy sources of fossil fuel energy, many existing tax subsidies also aim to encourage investment in low-carbon energy projects.

Capital-intensive infrastructure projects, including most low-carbon sources of energy supply, also face high initial fixed costs. Similarly, rather than representing payments to specific companies, carbon sinks could be designed to finance new low-carbon infrastructure projects. Another legal barrier to domestic subsidies aimed at promoting low-carbon energy is the federalism scheme of the FPA.

ALLOCATING SUBSIDIES IN RETAIL CUSTOMER CHARGES Rate design is the process by which these internal subsidies

UNLEASHING INTERNAL SUBSIDIES FOR A LOW- CARBON FUTURE

Significant reforms to existing legislation and regulations will prove necessary to achieve CO2 reduction targets. It derives in part from Posner's important insight that regulation works as a form of taxation, given the basic principles of good institutional design of a carbon tax that addresses carbon reduction. 2017] CARBON TAXATION BY REGULATION 321 through internal subsidies leaves many important efficiency and social welfare questions unresolved.234.

These guidelines will require regulators to rely on domestic carbon reduction subsidies to identify the most efficient customer base for burden-sharing important public goods such as carbon reduction and grid reliability. They will also require regulators to pay more attention to horizontal and vertical fairness when applying the principles of non-discrimination when determining internal subsidies and rules for energy markets. In short, to the extent that regulators see domestic subsidies as creating the same public goods as a carbon tax, they must approach domestic subsidies with the same principles as they would a carbon tax.

Regardless of whether a carbon tax is ultimately adopted or not, such an approach will better align regulatory goals with promoting efficiency and social welfare in the transition to a low-carbon grid.

POLICY GUIDEPOSTS

Apparently, domestic subsidies for the advancement of low-carbon grid infrastructure should be distributed as widely as possible among the payers who benefit from them. Regulators imposing subsidies should be mindful of costs, including carbon leakage issues, and should make appropriate border adjustments or call upon regional or national regulators to address these concerns. Regulators should favor domestic subsidies that allow flexibility in energy resource investment decisions, rather than those that promote technological lock-in.

Federal regulators should encourage subnational experimentation with subsidies, treat any federal requirements or internal subsidies as floors, and should not be allowed to crowd out stricter state standards or innovations that promote the same public goods.236. Subnational internal subsidies should presumably be considered in line with interstate energy markets where they show benefits and make an effort to im-. Customer cost allocation, including retail costs, must be set in a way that is not only aware of limited notions of horizontal equity among energy suppliers, or simply treating customers as equals.

Based on these principles, the following sections examine some of the most promising policy responses by states and agencies, as well as Congress, to increase and recalibrate domestic subsidies to better unlock their carbon-reducing potential while also promoting efficiency and social welfare.

STATE REFORMS TO CARBON TAXATION BY REGULATION Given their roles in approving new energy infrastructure

To ensure a level playing field for new electricity generation technologies, countries should remove built-in regulatory barriers that serve as subsidies to incumbents and hinder new non-utility renewable energy projects. To better align consumer incentives with energy pricing, countries should also work to facilitate the adoption of incentives that enable consumer choice/investment, including unbundling, consumer demand response and smart metering. To encourage decisions about new sources of electricity supply that do not favor incumbents and their existing sources of electricity supply, countries should consider adopting an Independent Distribution Service Operator (IDSO) approach that separates the management of the distribution network (including customer interconnection and access to energy resources) from decisions regarding electricity supply.

Under federal law, states are specifically assigned the role of setting avoided cost tariffs as subsidies to encourage unprofitable forms of energy production, including renewable energy projects.239 In approaching avoided costs under PURPA, states must not limit their investigation to the marginal economic cost of deploying existing power generators, which systematically favors sources such as natural gas. States should also consider adopting incentive tariff programs aimed at ensuring long-term financial stability for targeted low-carbon energy generation options. To encourage experimentation, states should not limit the ability of local governments to enact their own PACE programs, RPS and energy efficiency mandates, and incentive programs such as net metering.

Countries should recognize that stable regulatory incentives can play an important role in reducing the uncertainty associated with low-carbon infrastructure,241 but to maintain flexibility in financing new projects, they could use carbon investment adders to establish a national regional fund and offer competitive bids for new low-carbon infrastructure projects.242.

FEDERAL AGENCIES AND THE EXPANSION OF INTERNAL SUBSIDIES

FERC Order 1000 provides that FERC has a role in ensuring that state RPSs and other policies related to power generation decisions are considered in the regional transmission planning process. It would benefit both agencies to pursue consultation strategies at early policy stages. See supra note 93 and accompanying text (referring to the renewable energy industry's challenge to PJM's capacity market rules in the DC Circuit).

Sections 205 and 206 of the FPA apply not only to existing energy sources, but may be expected to apply in the future to an even more diverse range of energy supply sources.2 60 Traditionally, FERC has interpreted nondiscrimination to mean narrowly, in means not treating different customers of the wholesale supply differently. Also, as FERC acknowledged in its order responding to the request,26 1 the notion of nondiscrimination in the FPA authorizes the agency to consider data on wholesale sales of electricity supply or energy-related services, including the efficiency of customer power and other customer resources such as battery storage. Under Section 210 of the FPA, the agency has the authority to mandate transmission interconnection where it is in “public .

While FERC has not provided much in the way of systematic policy updates to its original avoided cost rules, a number of public and private reports have examined and evaluated various methods of avoided costs.

A LEGISLATIVE PLATFORM FOR CARBON TAXATION BY REGULATION

Such an approach may arguably favor government internal subsidies explained in terms of carbon reduction or reliability benefits, as long as efforts are made to address their spillover effects to minimize intergovernmental energy distortions. A modest approach would be to create a national clean-energy credit program to facilitate and standardize national markets for tradable credits and address interstate carbon leakage issues. Any national program should allow utilities that do not produce clean energy themselves the flexibility to establish compliance with state programs through purchasing them.

Improving Information About Carbon Reduction Subsidies President Obama's administration asked agencies subject to presidential oversight to consider a social cost of carbon in the agencies' regulatory initiatives, although the current administration has rejected this approach.2 78 To provide an information about the use of carbon subsidies, Congress should consider requiring consideration of carbon costs in agency regulatory impact assessments and cost-benefit analysis, including by independent agencies and federal agencies that allocate funds to state and local governments.279 It can start by applying carbon impact analysis to its own tax and subsidy initiatives. 2017] REGULATORY CARBON TAXATION 339 The Joint Committee on Taxation and other government bodies, for example, could assess the cost-effectiveness of new and existing tax subsidies for various energy sources based on the social cost of carbon. If Congress revises municipal tax benefits, a social cost of carbon assessment could be used to determine which public energy infrastructure investment decisions qualify for tax-exempt bond financing.

Devashree Saha, Decree Legislation Supports Residential Property Assessed Clean Energy (PACE) Financing, REMAKING FEDERALISM: REJUVENATING ECON.