Framework for Cap-and-Trade Investment Plan Needs Further Development

Concept Paper for Second Investment Plan Recently Released. In July, the Air Resources Board (ARB) released a concept paper related to the Second Investment Plan for cap-and-trade auction revenues. (The ARB’s first investment plan was released in 2013.) The investment plan is meant to identify general strategies for allocating auction proceeds over the next three years, and the ARB’s concept paper is the first step in the public process of developing the final investment plan.

The concept paper identifies spending options in three broad categories: (1) transportation and sustainable communities, (2) clean energy and energy efficiency, and (3) natural resources and waste diversion. The paper also provides, among other things, a “needs assessment,” which identifies the types of projects that should be considered for additional funding within each category of spending. Below, we discuss the importance of the investment plan for making spending decisions, and we identify issues to make the plan a more useful document for policymakers. (For more background on the state’s cap-and-trade program to reduce greenhouse gas [GHG] emissions, please see our past reports, such as this one.)

The Importance of the Investment Plan. The purpose of the investment plan is to provide information that will help the Legislature and Governor target cap-and-trade funding to programs and projects that maximize the achievement of policy goals, particularly the reduction of GHG emissions in the state. In other words, the investment plan can provide a general framework for how policymakers evaluate different spending options so that they can compare the relative costs and benefits of these options. For example, the framework could guide how to compare different investment options that are estimated to yield different GHG emission reduction totals and different types of co-benefits, such as improved air quality or improved natural habitats. The plan could also provide information about estimated GHG reductions associated with different types of programs (to the extent that such data is available). The Legislature could then rely on this framework and associated data to evaluate specific budget proposals in order to better target funding to the mix of programs that would best maximize policy goals. 

Analytical Framework in Concept Paper Too Limited. The ARB’s concept paper identifies a wide range of programs and industries where the state could spend auction proceeds to reduce GHGs. However, it lacks information that can be used to select or prioritize among these options. In particular, the administration’s concept paper does not include the following information that could be used to guide future budget allocations:

• No Clear Analytical Justification for Prioritizing Funds for Certain Programs. The analytical basis for identifying how proceeds should be allocated is often unclear in the concept paper. This is evident in the “needs assessment” included for each category of spending. For example, as part of the needs assessment for clean energy programs, the ARB suggests that bio-energy systems need additional financial support from the state, arguing that additional investment will help advance the market for these technologies. However, there is no analysis of how the costs for, or projected benefits of, such investments are likely to compare to other expenditure options. In addition, the paper suggests that the transportation sector is one of the highest priorities for investment because it is the largest source of GHG emissions. However, it is unclear why spending a proportionate amount of cap-and-trade funding on that sector would result in greater GHG reductions and/or achieve other goals compared to spending an equivalent amount on other options. In the end, funding bio-energy or transportation projects might have significant merit. However, additional information is needed to determine if increased spending of auction revenues in these areas is likely to yield the greatest reduction in GHG emissions or improvements in other co-benefits.

• Unclear When Spending Programs Are the Most Appropriate Policy Tool. In addition to the programs funded with auction proceeds, the state has a wide variety of regulations that are intended to reduce GHG emissions, such as regulations to reduce consumption and carbon intensity of fuel. Even if it is determined that the state should reduce GHG emissions from a particular source, the concept paper does not propose a strategy for identifying instances where providing additional funding for emission reductions is more effective than relying on regulations to achieve GHG goals.  

• Does Not Consider How Spending Options Interact With Cap-and-Trade Program. Many of the spending options discussed in the concept paper would reduce emissions from entities that are subject to cap-and-trade—also known as covered entities. The cap-and-trade program is intended to reduce overall emissions in the state and achieve those reductions cost-effectively. As we have written previously (here and here), spending money on activities that reduce GHG emissions from covered entities might not actually reduce overall GHG emissions but instead simply change the mix of emission reduction activities. In addition, it may reduce the overall cost-effectiveness of emission reductions achieved. However, the concept paper does not discuss these interactions or how they should inform spending decisions.

How the Investment Plan Can Establish a Framework for Spending Decisions. The administration is still in the initial stages of developing the Second Investment Plan, the first draft of which is scheduled to be released this fall. In our view, the investment plan process is an appropriate venue to have a high-level discussion of how auction proceeds should be spent—not just were the money could be spent. The science is complicated and constantly being updated. So, the investment plan provides ARB with an opportunity to provide policy makers current information about the best available science and a framework for how they should weigh the potential benefits, tradeoffs, and risks inherent in different funding choices. This information can allow lawmakers to direct future spending where it can accomplish the most benefit and reduce the likelihood that these dollars are spent on less effective projects. To that end, we believe the investment plan process should consider the following questions:

• What is the basis for prioritizing funding for one program over another?

• What is the appropriate framework for thinking about how funds can be targeted in a way that maximizes GHG reductions and other legislative goals? How should co-benefits, costs, and risk be calculated and incorporated in funding decisions?

• What is the appropriate role of spending cap-and-trade auction revenues in the state’s larger strategy for addressing climate change, which includes various existing regulations?

• In light of the interactions with the cap-and-trade program, what net benefits are being achieved by spending funds in a way that reduce emissions from covered entities? How should the state take this interaction into consideration when allocating cap-and-trade funds?