Cost Containment - An Introduction to Climate Change Legislation

Cost Containment

Mechanisms to stabilize the cost of a policy (usually viewed as the price of permits) increase compliance flexibility - above and beyond typical trading programs - in order to reduce cost uncertainty. In general, these cost containment mechanisms make a quantity-based instrument (a cap-and-trade program) behave somewhat more like a price-based instrument (a carbon tax).

Allowing the trade of quantities (in this case, emissions permits) over time through banking and borrowing can deliver greater near-term price stability. A safety valve limits cost uncertainty by simply setting a ceiling on allowance prices, with the government selling an unlimited number of additional allowances at the safety valve price. (In some proposals, this is coupled with a corresponding allowance price floor.)

Other cost-containment mechanisms include a reserve, which is essentially a quantity-limited safety valve (although typically reserve allowances must be made up in the far future); "circuit breakers" that would stop a ramp-down in annual emissions caps over time if permit prices exceed a specified trigger; and other trigger mechanisms that would temporarily make the program more flexible through more offsets or more borrowing, if prices exceed a specified trigger. Finally, proposals such as the "Carbon Market Efficiency Board" (CMEB) in Lieberman-Warner take a more discretionary approach to cost containment, entrusting an independent board with the power to intervene in permit markets. Regardless of the specific mechanism, the cost and flexibility of compliance have to be weighed against a potential reduction in environmental efficacy.