Analysis of the 2007-08 Budget Bill: Resources

Implementation of “AB 32”—Global Warming Solutions Act of 2006

The budget proposes $35.8 million across several state agencies to begin implementation of the Global Warming Solutions Act of 2006 (commonly known as “AB 32”), which focuses on reducing California’s greenhouse gas (GHG) emissions. In this analysis, we describe the Governor’s budget proposal and discuss cases where the proposal appears in conflict with legislative direction as expressed in AB 32. We then make recommendations to assist the Legislature in overseeing development and implementation of the state’s regulation of GHG emissions in order to better align the budget proposal with AB 32 and to address long-term funding issues.

California a Significant Emitter of Gases Contributing to Climate Change

California’s GHG Emissions and Climate Change. Greenhouse gases are those that trap solar heat within the earth’s atmosphere, thereby warming the earth’s temperature. While both natural phenomenon (mainly water evaporation) and human activity (principally burning fossil fuels) produce GHGs, increasing concern has been placed on concentrations of GHGs resulting from human activities and their relation to increases in average global temperatures.

California is a significant emitter of GHGs. As a populous state with a robust economy, California is the second largest emitter of GHGs in the United States and one of the largest emitters of GHGs in the world, when compared to other countries’ emissions. For more information on California GHG emissions, please see our discussion of the “Governor’s Climate Change Initiative” in our Analysis of the 2006-07 Budget Bill.

The Global Warming Solutions Act of 2006 (AB 32)

Passage of AB 32 commits the state to reducing, by 2020, California’s greenhouse gas (GHG) emissions to 1990 levels. The act charges the Air Resources Board (ARB) with monitoring and regulating the state’s sources of GHGs and establishes a timeline by which ARB is to complete various specified actions.

Act Declares State’s Interest in Limiting Global Warming. Last year, the Legislature enacted Chapter 488, Statutes of 2006 (AB 32, Nuñez)—The Global Warming Solutions Act of 2006. The act states that global warming poses a threat to California’s economy, public health, natural resources, and environment, and states the necessity of federal and international action to effectively combat global warming. However, the act also notes that California’s early efforts to reduce GHG emissions can encourage similar actions by other states, the federal government, and the other countries and position California’s economy to benefit from future efforts to limit GHG emissions in other jurisdictions.

ARB in Charge of State’s Multiagency Emissions Reduction Efforts. The act charges ARB as the sole state agency responsible for monitoring and regulating sources of GHG emissions and gives ARB a role in coordinating with other state agencies and stakeholders in implementing AB 32. The ARB is to require and monitor comprehensive reporting of statewide GHG emissions, determine the state’s GHG emissions levels in 1990, and adopt regulations to reduce statewide GHG emissions, by the year 2020, to what they were in 1990.

The act also calls for the Climate Action Team—the multiagency body established in 2005 by executive order and led by the Secretary for Environmental Protection—to continue its coordination of overall climate policy.

Emissions Reduction Goal and Timelines. The act lays out the broad goal of reducing statewide GHG emissions. In addition, the act establishes a timeline by which ARB is to have taken specific actions, as shown in Figure 1.

GHG Emissions Reduction Measures Must Satisfy Extensive, Specific Criteria. The act also lays out numerous, detailed criteria that any GHG emissions reduction measure must satisfy in order for ARB to adopt it. The act states that ARB’s regulations should achieve maximum technologically feasible and cost-effective reductions, and that they should be complementary and nonduplicative. The act also states that ARB’s regulation of GHG emissions should achieve the following specific goals:

• Minimize costs.

• Maximize benefits.

• Encourage early action.

• Not disproportionately affect low-income communities.

• Credit early, voluntary GHG emission reductions.

• Complement federal and state air quality efforts.

• Consider indirect benefits of GHG reduction regulations (such as air pollution reductions, energy source diversification, and other economic, environmental, and public health benefits).

• Minimize administrative burden.

• Minimize displacement of California GHG emissions to out-of-state sources (a phenomenon known as “leakage”).

• Consider the significance of the regulated sources’ contribution to statewide emissions of GHGs.

In addition, GHG emission reductions are to be real, permanent, quantifiable, verifiable, and enforceable by the state. To the extent feasible, program activities, such as providing financial incentives for GHG emissions reduction, are to direct investment to the most disadvantaged communities.

Market-Based Mechanisms Permissible, but Must Meet Additional Criteria. The act allows, but does not require, ARB to adopt “market-based compliance mechanisms” as part of its regulations to be adopted by January 1, 2011. (Market-based compliance mechanisms, in very general terms, refer to flexible regulatory programs in which government sets a market signal, such as a price per unit of emission to be paid by regulated entities, and then allows regulated sources to set their own emission levels in response to that signal.)

However, the act allows ARB to include such market mechanisms in its regulations only if (1) the regulations meet the criteria applicable to all GHG emission regulations, as described above, and (2) ARB takes a number of significant actions in its evaluation and design of such mechanisms, namely:

• Considering the potential for these mechanisms to result in adverse emissions effects on communities already harmed by air pollution.

• Designing any market-based mechanism to prevent an increase in emissions of toxic air contaminants or other air pollutants regulated by the state.

• Maximizing additional environmental and economic benefits to the state.

Governor’s Budget Proposal

The budget proposes $35.8 million and 151 positions across several state agencies to begin implementation of AB 32.

The budget proposes $35.8 million from various special and bond funds and 151 positions across a number of state agencies to implement AB 32. Figure 2 lists the proposed expenditures, number of positions, and funding sources, on an agency-by-agency basis. Figure 3 lists the same information, on an activity-by-activity basis.

Budget Includes Additional Funding for Climate Change-Related Activities. While the administration has indicated that $35.8 million is the total of proposed expenditures for AB 32 implementation, we note that the budget includes other expenditures for climate change-related activities that were approved as ongoing expenditures in prior-year budgets. These include at least the following:

• $3.15 million ($2.65 million Motor Vehicle Account, $500,000 Air Pollution Control Fund), 15.5 Positions. For ARB for regulatory development and research activities related to the Governor’s Climate Change Initiative.

• $981,000 ($666,000 Air Pollution Control Fund, $180,000 Motor Vehicle Account, $135,000 General Fund), Two Positions. For the Secretary for Environmental Protection to fund coordination, oversight, outreach, and analysis related to the Governor’s Climate Change Initiative.

• $539,000 (Public Utilities Reimbursement Account), Six Positions. For the California Public Utilities Commission (CPUC) for research activities related to the Governor’s Climate Change Initiative.

Secretary’s Proposal Goes Beyond Coordination

In passing AB 32, the Legislature placed the Air Resources Board in charge of implementation of the act while recognizing that the Secretary for Environmental Protection would have a coordination role in terms of the state’s overall climate change policy. We find that the budget proposal expands the Secretary’s role beyond coordination to include activities such as planning, monitoring, technical analysis, and oversight, many of which are clearly programmatic activities. Therefore, we recommend denying the budget request for the Secretary. (Reduce Item 0555-001-0115 by $1.4 million.)

Secretary’s Budget Request Proposes $1.4 Million, Five Positions. Citing an increased workload resulting from the state’s expanding GHG emissions reduction activities, the Secretary requests $1.4 million from the Air Pollution Control Fund (APCF) for five new positions and $700,000 in external contracts related to AB 32.

Secretary’s Proposal Goes Beyond Coordination. According to the budget proposal, funding would allow the Secretary to plan, coordinate, monitor, analyze, and oversee GHG emissions reduction activities at various state departments and agencies. We believe that these activities, as described in the proposal, would go beyond coordination, particularly given the types of positions being requested. Specifically, of the five positions requested, three are Air Pollution Specialists, which are highly technical staff typical of those employed by ARB for monitoring and regulating sources of air pollution. A fourth position is for a similarly technical Air Resources Supervisor who would oversee the other three technical positions. The fifth position would help the Secretary with public education and outreach. In addition, the proposal requests $700,000 to pay for external contracts for such activities as analysis of related job growth, technology exports, and other economic effects.

Legislature Charged ARB With State’s GHG Emissions Reductions Policy-Making Authority. The budget proposal, in effect, attempts to establish a policy-making role for the Secretary in implementing AB  32—a role that the administration proposed when the Legislature was considering AB 32. In the final version of AB 32, the Legislature eliminated the Secretary’s policy-making role from the bill and, for purposes of implementing the act, it limited the Secretary’s role to coordination and specifically assigned policy-related decision-making authority to ARB.

Recommend Denial of Secretary’s Funding Request. The budget proposal does not justify the need for the requested technical positions and contracted services based on its role in coordinating the state’s GHG emission reduction activities. We find that the highly technical positions would be more effectively employed at an entity, such as ARB, that directly undertakes technical monitoring and regulation of GHGs and has established programs and technical expertise in the subject area. Similarly, we believe that technical and economic analysis is better performed by or contracted through an entity such as ARB. Finally, we believe it is already within the Secretary’s day-to-day duties to coordinate public participation and outreach and think that such activities could be performed with existing resources. Therefore, we recommend denying the Secretary’s $1.4 million funding request, and associated positions.

CPUC Funding Proposal Premature and Contrary to Legislative Direction

The budget proposal includes $1.3 million for the California Public Utilities Commission (CPUC) to implement a cap on greenhouse gases and to conduct climate change-related research. The CPUC has also stated its intent to establish a “cap-and-trade” market mechanism for utilities. We recommend denying the CPUC’s funding request since it is premature until the Air Resources Board conducts a number of statutorily directed actions. (Reduce Item 8660-001-0462 by $1.3 million.)

CPUC Proposes Funding for Climate Change-Related Proceedings and Research. The budget proposes $1.3 million and three positions for CPUC to conduct climate change-related proceedings. Of that funding, $1 million is for consulting contracts to model GHG emission cap scenarios and to establish a protocol for development and measurement of GHG emissions reductions in the power sector. These positions are in addition to six positions the Legislature authorized in the current year to research climate change at the CPUC.

CPUC Signaled Its Intent to Establish Cap-and-Trade Market Mechanisms and Baseline for GHG Measurements. During a recent commission hearing on climate change, the commission publicly stated its intent to establish a cap-and-trade market mechanism on emissions for investor-owned utilities (currently regulated by the commission) and publicly owned utilities (currently not regulated by the commission). The commission also stated its intent to conduct a proceeding to determine the base year for the cap-and-trade program. (In cap-and-trade programs that have been established elsewhere, the government sets a limit on, or “caps”, emissions, issues a limited number of emissions allowances, and allows regulated sources to buy and sell, or “trade”, those emissions allowances.)

CPUC Funding Proposal Premature, Contrary to Legislative Direction. We find CPUC’s intention to hold climate change-related proceedings, and in particular its intention to move ahead with a very specific market mechanism, contrary to the intent of AB 32. This is because the act charges ARB with identifying and establishing GHG emission reduction measures, and with determining whether those measures will include market-based mechanisms. The act also clearly established a GHG emissions base year of 1990, making the CPUC’s determination of a baseline unnecessary.

Recommend Denial of CPUC’s Funding Request. Given that the CPUC’s budget request inappropriately moves ahead of the statutorily directed effort at ARB, we recommend that the Legislature deny the request for $1.3 million for CPUC. We also recommend adoption of the following budget bill language to prohibit CPUC from spending resources to develop and/or implement market mechanisms:

Item 8660-001-0462. Of the funding appropriated in this or any other item, no funds may be expended by the commission in connection with the implementation of market mechanisms as a greenhouse gas (GHG) emission reduction strategy until the Air Resources Board has completed its statutorily required statewide GHG emissions reduction plan, has included these mechanisms in the plan, and has directed the commission to begin to implement them.

Market-Based Measures Should Be Carefully Considered Prior to Their Inclusion in Climate Change Regulations

The budget proposal assumes the inclusion of market-based mechanisms in the Air Resources Board (ARB) regulations and provides funding for their implementation. We note that market-based measures represent a relatively new approach in California to regulate emissions and involve significant policy choices in which the Legislature should be involved. Therefore, we recommend that 24 positions at ARB for development and implementation of market-based measures be made two-year limited term. We also recommend the adoption of budget bill language prohibiting implementation of market-based measures, pending legislative review of ARB’s evaluation of such measures.

ARB’s Proposal Assumes Implementation of Market-Based Mechanisms. The budget proposal assumes the inclusion of market-based measures in the state’s GHG emissions reduction regulations. For example, for 24 of its requested 123 permanent positions, ARB’s proposal describes tasks involving, in part, the implementation of market-based mechanisms. In addition, ARB’s proposal specifies the anticipated use of one particular type of market-based mechanism, known as cap-and-trade. However, when the administration was asked what evaluation led it to assume the inclusion of market-based measures in the state’s GHG emissions reduction efforts, the administration could cite only a bibliography of academic publications and the prevalence of market-based measures as part of GHG emissions reduction programs in other jurisdictions.

Use of Market-Based Measures Represents a Relatively New Regulatory Approach With Significant Policy Implications. Economic theory establishes the theoretical rationale for the use of market-based mechanisms to reduce GHG emissions—the potential for greater cost-effectiveness through flexible regulatory compliance. Many jurisdictions (including the United Kingdom, the European Union, and Japan) have chosen or are considering to employ market-based mechanisms in their attempts to reduce GHG emissions, with some success. We therefore think that there is merit to considering the potential for market-based mechanisms as a component of the state’s GHG emission reduction strategies.

However, the inclusion of market-based mechanisms as part of California’s GHG emissions reduction efforts deserves careful legislative consideration. To date, no California environmental regulatory agency has employed market-based mechanisms statewide. In addition, experience with market-based GHG emissions reduction systems in other jurisdictions is limited, the outcomes are difficult to assess and, in some instances, those outcomes have unfavorably affected environmental quality.

The use of market-based mechanisms to control GHG emissions in California involves important policy choices and inherent tradeoffs in which we believe the Legislature should be involved. While all market-based systems have in common some degree of flexibility being granted to regulated sources and the establishment of cost signals, there is substantial variation among potential market-based systems. For example, that variation can include such fundamental issues as whether government chooses to set the quantity of allowable emission (as in a trading program) or to set the “price” of emissions (as under a fee-for-emitting program); whether such a program will generate revenue and, if so, how to distribute that revenue; and what sectors or entities will bear the costs imposed by such a program.

In addition, ARB’s budget proposal mentions designing a market-based mechanism to accommodate possible linkages between California’s market-based GHG emissions reduction program and similar programs operating or that may come to operate in other states, regions, and countries. We believe the Legislature should be made aware of and carefully consider any such system before California joins its regulatory efforts to those of jurisdictions over which the state has no authority. Given the major policy implications, any linkages with other jurisdictions should be ratified in a policy bill.

Act Requires Evaluation of Market-Based Measures Before Their Inclusion in ARB Regulations. As described earlier, the act specifies evaluations that ARB must complete before it includes market-based mechanisms in its GHG emissions regulations. As ARB has yet to conduct these evaluations, the Legislature therefore lacks information that it thought important to an assessment of any proposed market-based regulatory system to control GHG emissions. In addition, it is premature to authorize funding and positions to implement a very specific market mechanism (namely, cap-and-trade), until these evaluations have been conducted.

Positions Associated With Market-Based Mechanisms Should Be Limited Term. As described above, the administration proposes 24 permanent, full-time positions associated with market-based mechanisms to reduce California’s GHG emissions. We recommend two changes to this aspect of the administration’s proposal. First, we recommend that the Legislature approve the 24 positions for a three-year, limited term only. We think this three-year period will give ARB staff sufficient time to develop and evaluate various market-based mechanisms, but prevent it from undertaking implementation activities, consistent with our recommendation below. These evaluations can form the basis of legislative consideration of whether to include market-based mechanisms in the state’s GHG emission reduction regulations.

Specify Funding Is Not to Pay For Implementation of Market-Based Mechanisms. Second, to ensure that funds are not used for ARB staff to work on implementing market-based mechanisms until ARB has presented the findings of its evaluation of those mechanisms, we recommend the adoption of the following budget bill language:

Item 3900-001-0115. Of the funding appropriated in this or any other item, no funds may be expended by the Air Resources Board for the implementation of market mechanisms as a greenhouse gas (GHG) emissions reduction strategy until the board has completed its evaluation of these mechanisms as required by Chapter 488, Statutes of 2006 (AB 32, Nuñez) and submitted its findings and recommendations for its evaluation in a report to the Legislature for its review.

Funding for Budget Proposal Unsustainable

Funding for the proposal relies mostly on special funds, some of which face substantial future pressures and based on our review cannot support the state’s greenhouse gas (GHG) emissions reduction program, even as early as 2008-09, without significant fee increases. The budget proposal does not include any new fees, even though AB 32 provides the Air Resources Board with the authority to assess fees for purposes of implementing the act. We recommend that the administration report at budget hearings on its long-term funding plan for the state’s GHG emission reduction activities. We also recommend the adoption of supplemental report language to require such a long-term funding plan be presented in conjunction with submittal of the 2008-09 Governor’s Budget.

GHG Emission Reduction Program Funding Unsustainable; Long-Term Funding Plan Unknown. The budget proposal funds the state’s GHG emission reduction activities mostly from existing fee-supported fund sources—the APCF being the largest source ($25.7 million). The budget does not rely on any increases of existing fees, nor does it propose any new fees, even though AB 32 provides ARB with the authority to assess fees for purposes of implementing the act. In fact, in the case of funding proposed from APCF, the budget relies on drawing down substantial fund balances carried over from previous years, along with a $15.2 million loan to APCF from the Motor Vehicle Account—an account with the potential for major future-year pressures—to provide the funding budgeted for 2007-08. This level of funding would not be available from APCF in 2008-09, unless significant fee increases or APCF-funded program reductions in other areas were made.

Require Administration to Report on Its Long-Term Funding Plan. The budget’s funding proposal for AB 32 implementation is clearly not sustainable. However, when asked, the administration was unable to specify its long-term funding plan for the state’s GHG emissions reduction activities or whether such a plan would include use of ARB’s statutory authority to assess new fees. This lack of planning is particularly problematic given that the activities described in the budget proposal represent only the initial development stages of the state’s GHG reduction programs. The programs that result from this initial ramp up activity could involve costs well beyond the $35.8 million included in this year’s budget proposal.

We believe it important that the Legislature, in evaluating the administration’s proposal, be informed of the administration’s long-term plan to fund the state’s GHG emissions reduction programs. Therefore, we recommend that the administration report at budget hearings on its long-term funding plan, including its estimate of future-year costs of the state’s GHG emissions reduction programs, how these future-year costs would be funded, and whether the administration anticipates either increasing existing fees and/or creating new fees to support the identified funding requirements. To ensure that the Legislature is advised of the administration’s long-term funding plans for these programs when it evaluates next year’s budget, we recommend the adoption of the following supplemental report language:

Item 3900-001-0115. The Air Resources Board shall submit a report to the Legislature, in conjunction with the submittal of the 2008-09 Governor’s Budget, on its long-term funding plan to fund the state’s greenhouse gas emissions reduction programs, including its estimate of future-year costs of these programs, how these future-year costs would be funded, and whether the administration proposes either increasing existing fees and/or creating new fees to support the identified funding requirements.

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