In Tuesday’s State of the State address, Governor Hochul adopted the Climate Action Council’s (CAC) Climate Act Scoping Plan lock, stock and barrel. The crown jewel in this plan is an emission allowance auction scheme called cap-and-invest. 

The plan would cap the total amount of greenhouse gas emissions that could be produced in the state and auction off allowances in tons of CO2 equivalents. Auctions would be held annually, with the statewide cap declining each year to meet the goals of the Climate Act. 

The proceeds could then be spent on a variety of Climate Act-related projects, from reducing the energy bills of lower-income residents to making buildings more energy efficient. The investment from the permit auctions, according to Hochul, is supposed to “jumpstart the entire clean energy economy.”  

The plan is essentially a new tax, one that the Legislature would otherwise have to vote explicitly to enact. But Hochul is following the CAC’s recommendation to make an end-run around the people’s representatives, directing bureaucrats in the Department of Environmental Conservation and the New York State Energy Research and Development Authority to develop it without legislative input.  

The upside of cap-and-invest is that economists agree that properly designed programs are the most economically efficient method to reduce greenhouse gases. As allowances become scarcer, businesses are incentivized to find ways to reduce their emissions, which they will do in the most cost-effective way.  

But there are at least two significant downsides. First, the scheme assumes we know the economically efficient amount of emissions, but we do not. The state has chosen to reduce greenhouse gas emissions by 85 percent economy-wide by 2050. But that target wasn’t derived from an economic formula; it’s a political calculation. It’s impossible for economists to pinpoint the ideal amount of emissions.  

In other words, however efficient the pathway, the goal itself may not make economic sense. The risk is that as we reduce emissions more and more, the economic costs end up outweighing the gains. 

Second, the most cost-effective way for a business to reduce its emissions in New York may be to move out of state. This would be a problem not just because of lost jobs, but because the Climate Act looks to avoid creating “fugitive” emissions. 

Economists recognize that the ideal emissions-cap program would be global in scope, because businesses would have no place to go to avoid it. The next best thing is to implement them on a national or multi-national scale and have border adjustments – tariffs that internalize the cost of emissions created by producing goods in another country. If the adjustment is high enough, it should discourage greenhouse gas emissions even by industries that have fled the country. 

But New York is prohibited by the U.S. Constitution from imposing border adjustments, so it can’t use that tool to discourage businesses from moving out of state and continuing their emissions elsewhere. So, the CAC proposes to protect what it calls “energy-intensive and trade-exposed” industries – encouraging them to stay in state – by giving them free emission allowances. 

Of course, that could drastically reduce the revenues received from the auction, making it harder to pay for all the investment Hochul promises. And if those industries can’t cost-effectively reduce emissions, the declining number of available allowances may force them out of state anyway. 

Other businesses will be affected, also. Neither the CAC nor Hochul spare much thought for energy-intensive but non-trade exposed industries. For example, propane distributors are not trade-exposed because they cannot easily move their businesses out of state. The goal of the state’s environmental policy is simply to shut them down.  

And any new or out-of-state business that is at all energy-intensive isn’t likely to choose New York as a place to set up shop. That includes many “green economy” and high-tech industries that the state would like to attract.  

It’s not clear whether this will be a “cap-and-trade” policy, where businesses that can more cheaply reduce their emissions can help pay for those improvements by selling their allowances to companies that find it more costly to reduce theirs. Hochul has promised a “carefully constructed” program, which is political speak for “We’ll worry about the details later.” 

One detail made clear is that offsets will be forbidden, even though those could produce a net emissions gain at lower cost. For example, a business would not be allowed to restore a wetland to act as a carbon sink and count it against excess emissions. This raises the question whether the primary goal is to reduce net emissions or to eliminate fossil fuels. 

Hochul also noted that a New York cap-and-invest program is intended to spur other states to follow New York’s lead. This is strange, considering that the Empire State is already part of the Regional Greenhouse Gas Initiative, a 12-state cap-and-trade program. And it’s doubtful that more conservative states in the South or Midwest will follow the path Hochul looks to blaze – instead they will be the suitors of trade-exposed New York businesses.  

The most cynical claim made by Hochul is that the plan will “reduce consumer costs.” But she did not explain how cost increases for business will translate into reductions in costs for consumers.  

To recap, cap-and-invest is the most economically efficient method for reducing emissions if well-designed and implemented on a large-enough scale. But a single state that cannot implement border adjustments is not the right scale.  New York may very well reduce greenhouse gas emissions coming from the state, but the actual overall reduction in emissions will be considerably smaller due to businesses leaving the state. 

The only hope for preventing this outcome is to give away emission allowances to energy-intensive and trade-exposed businesses. But the more allowances the State gives away to protect trade-exposed businesses, the less revenue the auctions will generate to support Climate Act policies. 

And because allowances must decline to meet Climate Act mandates, energy-intensive industries will eventually have to reduce their emissions – if they can afford to do so. And the more trade-exposed a business is, the more likely it is to move out of state, if not at once then in the not-so-distant future. Or, if it is already an out-of-state business, the less likely it is to move to New York. 

Cap-and-invest is certain to reduce greenhouse gas emissions, but it may also cause businesses to divest from the Empire State.

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