Implementing a federal cap-and-trade policy would complement the Inflation Reduction Act. Together, these two policies could reduce air pollution and retail electricity prices and ensure that the United States meets its national climate goals for 2030.
Under the Paris Agreement, the United States has committed to reducing economy-wide greenhouse gas emissions by 50–52 percent below 2005 emissions levels by 2030. The majority of these emissions reductions are expected to come from the power sector, both because options for reducing emissions in this sector currently are the most available and inexpensive, and because electrification will be key to eliminating fossil fuel combustion in other sectors of the economy. Many studies have established that a target of 50–52 percent for economy-wide emissions reductions corresponds to a related target in the power sector of reducing emissions to 80 percent below 2005 levels by 2030—the so-called “80x30” target.
To meet these targets, Congress passed the Inflation Reduction Act (IRA), which is the most significant piece of environmental policy that the United States has passed since the Clean Air Act in 1970. The law aims to help decarbonize the power sector by providing subsidies for clean electricity generation. We at Resources for the Future (RFF) previously modeled the impact of these subsidies, as have other collaborators, and found that, while the IRA achieves substantial emissions reductions, the law does not reduce emissions enough to reach the 80x30 target, and the emissions reductions that the law does achieve are uncertain, because outcomes will depend on political developments, private-sector investments, and other factors.
In a new working paper, we therefore decided to look at what would happen if—on top of the IRA—the United States adopts an emissions cap that requires the power sector to reach the 80x30 target. With this policy, the federal government would auction allowances that enable firms to emit greenhouse gases. Each allowance would let a firm emit a set amount (e.g., one ton of carbon dioxide), and the government would then reduce the total number of allowances that are auctioned—the emissions cap—over time. We also modeled an emissions cap that would achieve the projected level of emissions reductions under the IRA (which fall short of the climate targets) and a scenario that would achieve the 80x30 target without the IRA subsidies. We used RFF’s Haiku model to evaluate the US power sector impacts, and we paired it with the Estimating Air pollution Social Impact Using Regression model and RFF’s Social Welfare Incidence Model to consider how the policies would affect public health and costs for households.
We find that the IRA reduces by almost 60 percent the cost of achieving the 80x30 target with an emissions cap. Additionally, instituting an emissions cap alongside the IRA would improve the efficiency of the IRA, increase the law’s benefits for health, and lock in US emissions reductions.
Two Climate Polices Are Better than One
Reaching the 80x30 target will be much easier with the IRA in place. An emissions cap that aims for the target without the IRA would require an emissions allowance to cost $67 per metric ton, while such a cap with the IRA would require a cost of only $28 per metric ton. This difference may appear surprising at first, given that economists expect an emissions cap to reduce emissions at a lower total cost than subsidies. But with the IRA in place, the cost associated with each additional ton of emissions reductions is cheaper than the cost would have been without the IRA. Adding the emissions cap on top of the IRA also improves the efficiency of reducing emissions by providing an incentive for the power sector to switch from coal to natural gas, which would reduce the carbon intensity of fossil fuel–fired electricity generation on the grid, because natural gas–fired power plants produce less emissions than coal-fired power plants. This incentive to switch is missing in the IRA, because of the law’s exclusive use of subsidies for clean energy.
Instituting an emissions cap alongside the IRA would improve the efficiency of the IRA, increase the law’s benefits for health, and lock in US emissions reductions.
We have shown in prior work that the IRA reduces electricity costs for consumers. We’ve also seen that the law benefits lower-income households, because electricity costs represent a larger share of their income, and the subsidies that reduce electricity costs are funded through taxes that primarily fall on higher-income households. We explore this issue further in our working paper. Achieving the same emissions reductions that are expected through the IRA with only an emissions cap would entail increased electricity costs for consumers and disproportionately burden lower-income groups. But with the IRA already in place, adding an emissions cap to achieve the 80x30 target would bring down retail electricity prices. Importantly, lower electricity prices could help promote electrification throughout the economy, which is a crucial part of the US strategy to reach net zero after 2030. Reducing electricity prices also may enhance the efficiency of electrification, because electricity typically is priced well above the cost of electricity generation for society.
Adding a carbon price (in the form of cap and trade) on top of the IRA reduces the law’s fiscal burden, as well. Estimates of government spending on the IRA vary widely depending on assumptions about the uptake of the law’s subsidies, but the law is a significant government expenditure. The IRA partially pays for subsidies by increasing enforcement of corporate taxes. A carbon price, however, raises revenue, which can be used to cover some of the subsidy payments. Because the existence of the IRA reduces the carbon price that is necessary to reach the 80x30 target, the revenue raised in the presence of the IRA would be lower than the revenue raised without the IRA—but the revenue of a carbon price that could be instituted alongside the IRA still would offset a portion of government expenditures for the IRA.
Achieving the 80x30 target by adding an emissions cap also would increase the health benefits that are associated with the IRA. The scenarios that reach the 80x30 target lead to 2,290–2,359 deaths avoided per year in 2030, whereas the scenarios with the emissions reductions that the IRA alone is projected to achieve lead to 1,011–1,355 deaths avoided per year. These avoided deaths stem from reductions of secondary PM2.5, a harmful air pollutant. This PM2.5 forms from emissions of nitrogen oxides and sulfur dioxide from power plants, especially coal-fired power plants. Adding the emissions cap on top of the IRA leads to a greater reduction in coal-fired electricity generation and thus offers greater health benefits.
Above all, adding an emissions cap to help reach the 80x30 target would help lock in the emissions reductions that the IRA could achieve. As we discussed in a recent article in the journal Science that compares the potential effects of the IRA across nine models, substantial uncertainty exists about the emissions reductions that the law will deliver. Much of the projected variation in emissions reductions reflects uncertainty about future electricity demand, which depends on the speed and scale of electrification. Other important factors affecting emissions include fuel prices and the cost of renewable energy. But not all of the relevant uncertainties can be included in models. Delays connecting renewable generators to the grid, supply-chain issues, labor shortages, and obstacles to transmission build-out can’t be expressed in modeling, yet all these factors and more may affect emissions. In our paper, we consider how our modeling results are affected by gas prices, electricity demand, and regulations proposed by the US Environmental Protection Agency. Changes to these factors produce variation in the emissions reductions that are projected under the IRA. But adding the emissions cap on top of the IRA guarantees that the United States will achieve the 80x30 target, regardless of other variables.
En Route to 80x30
The IRA is the largest step that the United States has taken so far to mitigate climate change, but the law doesn’t quite get the US power sector to emissions reductions that are consistent with the goals in the Paris Agreement, and the law’s projected emissions reductions are not guaranteed. Adding a binding emissions cap on top of the IRA would ensure that the target will be achieved, and the IRA makes adding a cap less expensive and more politically feasible.
With the IRA in place, the cost of mitigating the additional tons of greenhouse gases that are required by the 80x30 target would be cheaper. The IRA would prevent the cap from raising retail electricity prices—thereby protecting consumers and supporting emissions reductions in other sectors of the US economy. Adding a cap could raise revenue that partially would offset government expenditures on tax credits for clean energy, and the reductions in coal-fired electricity generation would increase the number of lives saved due to reduced air pollution. Most importantly, adding an emissions cap to meet the 80x30 target would accelerate the United States toward goals in the Paris Agreement and ensure that the US pledge to reduce emissions is credible.