Can cap and trade work in the US?
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Kenny, when economists consider the problem of climate change, you know what kind of problem they see? Economic problem would be my guess, Keith. Yes. Yes, 1000% an economic problem. Because when they look at climate change wearing their economics tinted glasses, what they see is a classic marketer.

market failure. So to fix climate change, all you have to do is fix the market. Yeah. And, you know, look, the idea is that for the most part, these big polluting companies and, you know, regular people driving their cars, they're doing damage to the climate that they do not pay for directly. But perhaps if they did pay for all that damage, they would start making some different choices, me think.

Yeah, the price of emitting carbon is too low. So one thing you could do is raise the price by slapping on a carbon tax. This solution is kind of an economist's favorite solution.

But carbon taxes, tough sell politically. New taxes, not always that popular. Which then leads us to economists, I guess, second favorite solution to this problem, what is called a cap and trade system. Still fixes the market failure, theoretically, but no one has to say the word tax out loud.

Okay, here is how cap and trade works. Basically, the government gets to say, we're only going to allow a certain amount of carbon emissions. The government puts a cap on the total amount.

And then it issues that amount of permits to pollute, like a little permission slip that says, I am allowed to put one ton of carbon into the atmosphere. Now, those permits, of course, add up to the cap, and then companies are allowed to trade those permits. Like, you know, have at, buy them and sell them for whatever price makes sense to you all. Who cares? As long as that cap exists, greenhouse gases have a ceiling and are under control. Economists love...

love carbon taxes and cap and trade so, so much. They are like, dear world, please take a look at our textbooks. We have solved climate change for you. You're welcome. Now, the world has not always been as receptive to these ideas as economists might have liked. But, you know, every now and then they will catch someone's eye. One of the people thus bewitched was a lawyer named Luke Martland.

I'm originally from New York and was working in criminal justice. I was an assistant DA in Manhattan. I was in the New York State AG's office. But...

A little over a decade ago, Luke took a job as the chief counsel to the Vermont legislature. One of his responsibilities there was to help draft legislation on climate change and clean energy. He started to nerd out on the different ways a state could try to address the problem, trying to figure out the best way to turn a carbon tax or a cap-and-trade system into concrete policy.

but most of the bills you write, maybe they get passed, maybe they don't get passed, but they're not having a huge impact.

And even the climate legislation that did get passed, Luke says, it was well-intentioned. But it wasn't something that was really addressing climate change in the real world. It was a little too ivory tower for me. Finally, after 10 years of working there, Luke was like, there's got to be something else. Which is around the time his husband showed him a posting for a new job in Washington state. Not to help write a bill that would establish a committee to develop a plan to maybe someday solve climate change. No.

Washington had already passed a law that established that economist's holy grail, a cap and trade system. The state was going to cut carbon emissions almost in half by 2030 and cut it 95% by 2050. And?

I was like, wow, this is a state that's really going there. This is a state that's building a program to decarbonize their whole economy. They just needed somebody to set up and run that system. Luke, he applied, and they were like, how fast can you start? We sold our house. We packed up all our things. And my husband, our, at that point, six-month-year-old daughter, and our

bulldog piled into our 15-year-old Prius and drove cross-country. So this was a huge change, but I thought it was a job of a lifetime.

Hello and welcome to Planet Money. I'm Kenny Malone. And I'm Keith Romer. Luke's job of a lifetime was incredibly exciting. But the stakes were also incredibly high, because no matter how beautiful cap-and-trade looks to economists, it has had a hard time fully taking hold in the real world, especially in the U.S. On the one hand, if Washington's very ambitious system worked, it could convince other states to try their own version.

But if it failed, it would serve as a cautionary tale. Send the message to any other state who wanted to try this very hard thing to not even bother. Today on the show, Washington state's grand experiment with cap and trade. And what happens when this beautiful abstract idea from economics moves from the textbook to the real world.

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Okay, little biographical disclosure before we start here. The state agency in charge of Washington's new cap-and-trade system was the Department of Ecology, which is where my mother worked until she retired in the year 2000. Hi, Mom.

I'd also like to say hi to my mom. She worked at First District Elementary School in Medieval Penn. Hi, Mrs. Vallone. Do you need to disclose this? Okay, to be clear, my mom did not work on any of this stuff for the Department of Ecology. The law establishing cap and trade in Washington got passed two decades after she stopped working there. But still, full disclosure. Done. We are fully disclosed, yes. Okay, so let us jump forward in time from Keith's mom's retirement party to the year 2021.

Luke Martland and his husband and their baby daughter and their bulldog, who is named Fritzie, by the way, they have just driven across the country so that Luke can take on his dream job running a real-life cap-and-trade system. It was a really challenging opportunity. It was scary, but it was something really innovative, really cool. And if you care about climate change,

This was a job to have because it was doing something in the real world. Only a few other states had ever tried anything like this. There were some states in the Northeast that had a cap-and-trade system, but it only covered power plants. There was also California's, which covered way more of the economy. But Washington's plan was like California's on steroids. The Environmental Defense Fund called it the new gold standard for climate policy.

Luke had this sense that the eyes of the whole country were on him, that states all around the country would be watching to see if Washington could actually pull this off. And Luke says there was one detail that made the challenge that much trickier. So the legislation had been signed by the governor in the summer, and that legislation only gave a year and a half to get the program up and running. Did that give you any pause, the 18 months timeline? No.

Oh, yeah. A huge pause. I mean, you're building a program that's going to impact the economy of the whole state.

You're building a program that's huge in scope and purpose and that will raise hundreds of millions or billions of dollars. So this is a big thing that you're building in a tight time frame. Luke had to figure out how to take this 80-page law that had just been passed and turn it into a real-life carbon market that would cover the entire state of Washington.

How do you go about doing this? Like, is there, like, cap-and-trade-for-dummies book that you go buy? And, like, how do you prepare? You work your butt off, you try to do everything you can, and you make mistakes, and you keep going. Okay, so the first challenge facing Luke, the cap part of cap-and-trade...

For 2023, Washington was going to limit big polluters to a total of 63 million tons of carbon emissions. And then each year, little by little, the state would decrease that cap. In 2024, it would go down to 58 million tons, then 53 million tons the year after that. This would affect every business or organization in the state that emitted a large amount of carbon. So big

Big gas distributors like BP and Marathon, local power utilities, even the state's two big universities who used giant fossil fuel burning boilers. But when Luke's team reached out to them, they discovered that not everyone was totally up to speed. We learned that a lot of the businesses and entities that were covered by the program had no idea about the program.

They didn't know about it. They didn't know what it was. They weren't prepared for it. Yeah, kind of hard to set up a carbon market if the people who are supposed to be in the market don't even know it exists. So, OK, step one, little teaching, little outreach. While that was going on, Luke was also figuring out the trade part of cap and trade. The key here are what are called allowances, those permission slips that give a company the right to emit one metric ton of carbon.

Now, the 80-page law that set up Washington's system spelled out two ways that a company could get permits from the state.

In some cases, the state would just give allowances to companies for free. But otherwise, companies would have to participate in auctions where Washington would sell millions of these allowances, millions of these coupons in one fell swoop. And the idea of these auctions is fascinating because they were designed to basically let polluters set a price on how much it's worth to them to get to keep polluting. Luke says that price, it's what makes the whole system work.

You want to incentivize companies and businesses to reduce their carbon emissions. And the only way to incentivize is to have some kind of bite. Some companies might look at the price for allowances and say, you know what? It's going to be cheaper for me in the long run to go ahead and swap out my dirty smokestacks for cleaner ones or whatever.

Other companies might decide, it's actually going to be so expensive for me to pollute less that I'm just going to take the hit and buy these allowances. Yeah, cap and trade uses the power of the market to make decarbonizing as efficient as possible.

Instead of the state telling individual companies how to lower their carbon emissions, it just sets the cap and lets companies figure out how they want to deal with it. But Luke and his team, they didn't want this new system to be too much of a burden. You're trying to have that balance. You're trying to have sufficient bite to incentivize reductions.

But you're not trying to have prices go so high that you're going to drive that business out of business or force them to relocate to another state or impose extreme costs on the customers. So the auctions had a built-in safety valve to make sure allowances didn't get too expensive. If the prices got too high, they would trigger this kind of bonus auction where extra permits would be added to the market to increase the supply.

And Luke says the rationale here went beyond just economics. There's also the political aspect of it. If prices go too high and some or all of those costs are passed on to consumers, then that leads to great political pressure to change a program or actually perhaps repeal it. Big gas distributors in Washington like BP and Phillips 66, they emitted millions.

millions of tons of carbon every year. So the price of those carbon permits would matter quite a lot to their bottom lines. For the early estimates, the Department of Ecology had used the price from California's carbon market, $32 per ton of carbon. But that was California. The only way they could know for sure where the market would land in Washington was to open up the bidding. So the first auction was held on February 28th of...

Luke's auction team went into this secure room at the Department of Ecology. They had to put their phones away to make sure no info leaked out that would let companies tweak their bidding strategies. And I remember sitting there. I hoped I appeared calm, but I know I was thinking, gee, is it going to something going to blow up? Is it not going to work? Finally, at 10 in the morning, the auction went live on this big screen at one end of the room. Luke and his team could watch the whole thing playing out intelligently.

in real time.

You see company A would put in a bid for a certain amount of allowances at a certain price. And then you see company B put in a bid for a certain amount of allowances at a certain price. And as that is occurring, there is constantly a program running that would estimate the settlement price. For three hours, companies and organizations put in bid after bid after bid to Luke's great relief. The whole thing went off without a hitch. He and his team had pulled this off.

What's the vibe in the room? Are you high-fiving? Are you hugging? We didn't hug. I'm not much of a hugger, so maybe it was a high-five or fist bump or something like that. But we were really...

Altogether, they had received more than 16 million bids for the 6 million allowances they were selling that day.

The final price the auction came to, in order to emit one ton of carbon, companies would have to pay $48.50. Now that was way higher than their original estimate for how much a permit would go for. So a little pricey, but I don't know, probably fine. And then in the second auction Washington held, the price went up by another $7 per permit. And then it went up again in the third auction.

When prices began to go up to the level of $63 in August of 2023, I think that raised concerns for a lot of people. Is this politically sustainable? Is it sustainable in the market? Yeah. Were the oil companies going to launch some lobbying campaign to get rid of this program? Were businesses going to close up shop because the allowances were too expensive? This was all new. No one had any idea how it would all play out.

On the other hand, those high prices did mean lots of money for the state of Washington. In 2023, it took in $1.8 billion from all of these auctions. And from the beginning, the state had actually branded the program not as just a cap and trade program, but as a cap and invest program. Yeah, there are a lot of things Washington could have chosen to do with that money, right? Could have built public parks or added to its education budget.

or even just giving the money back to people who live there as a tax rebate. But the state wanted to double down on climate. They had decided to use the money they took in on green projects that would lower emissions even more. Here is Washington's governor, Jay Inslee, talking up the program. Our state's new cap and invest program will allow us this year to transform how we invest in transportation in our communities.

Look, heat pumps for low-income families, charging stations across the state, hybrid electric ferries, free transit for youth, grants to clean up air pollution. The list goes on. But that $1.8 billion, it did not just appear out of thin air. It came from all those companies buying all those allowances to emit carbon. And that was $1.8 billion they had not had to pay before.

Now, a cap-and-trade system is not technically a tax. The government isn't the one setting the price for carbon emissions. But for companies, it can basically amount to the same thing. Yeah. Gas distributors in particular, they were now paying millions and millions of dollars to buy up carbon allowances. And they started looking to consumers to cover that cost. The whole thing became a big story in Washington.

Well, gas prices are on the rise again, in some cases 70 to 80 cents above the national average. It's horrible. It's a joke. I just can't do it. You feel it every time you go to the pump. Washington state already had some of the highest gas prices in the country, and economists estimate that the cap and invest program added somewhere between 20 and 60 cents per gallon to what people were paying at the pump.

Which not everybody liked. After the break, political blowback comes to the evergreen state and what that blowback could mean for the future of cap and trade across the country.

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Okay, so remember, the whole point of a cap-and-trade system is to fix a market failure, to make emitting carbon cost people something instead of being free.

But when you raise the price of something, well, you raise the price. Last year, people in Washington, like the rest of us, were already dealing with the lingering effects of bonkers inflation. And then on top of that, their new cap and invest program made their gas prices go up even higher. Which gave opponents of cap and invest a pretty big stick to wave around. Maybe the biggest opponent of all is Brian Haywood. Immediately after the cap and trade went into effect,

We hit number one in the nation for gas prices for a while. We're generally about number three. Hawaii and California are still above us. Brian is a hedge fund manager, self-described libertarian, has a ranch that was originally named after a character from an Ayn Rand book. And Brian, he's a very intentional thorn in the side of Democrats in Washington state.

We shouldn't be anywhere close to Hawaii who has to import all of their gas. That's crazy. We're on the coast. We've got, I mean, there's no reason our gas should be that expensive. Brian has been playing around the edges of Washington politics for a while now. But he made a big splash in the last year by pouring millions of dollars into ballot initiative drives for causes he supports.

Among other things, he wants to eliminate the capital gains tax in Washington, and he wants to repeal the law that established the cap and invest program. Brian's campaigns got enough signatures that four of his initiatives will be on the ballot this November, including Initiative 2117, which asks voters to decide whether they want to keep, cap, and invest, or scrap it. Now, some of Brian's position boils down to kind of standard fiscal conservatism.

To him, the cap-and-trade system is just another tax. And Brian generally is not a big fan of taxes. We took $2 billion out of the wallets of everyday commuters. $2 billion is a huge, huge tax. Okay, how are you spending that money? Who is it going to? And what are the criteria for them to use the money? And then we can probably get a list of who the money is going to. But if you ask...

Are you tracking how effective those are at reducing carbon itself? There's no plan for that. There's nothing. Obviously, not all of the money the state raised actually comes from commuters. But still, you get it. Some of Brian's opposition to Capn Invest is just his distrust of government taxing and spending. But another piece is based on this even more fundamental question. Brian, he acknowledges that climate change is real, but...

He's like, in the grand scheme of things, isn't the whole cap and invest system just political theater? You know, Washington emits something like 0.3% of the world's carbon emissions. I don't really believe that what we're doing in Washington state has a significant enough impact that it even matters. It's like if you're on an airplane full of smokers and you're the one non-smoker,

Your non-smoking doesn't do anything at all for that airplane or for the clean air. And Brian is getting at something really interesting here. Climate change is often described as a collective action problem. How do you convince all the people and all the companies to stop doing this bad thing to the atmosphere when, you know, some people would prefer not to do their part?

Yeah, Washington put a system in place that addresses that collective action problem within its state boundaries, with its cap and trade system. But there is still this much larger collective action problem. Right now, just two states in the country have economy-wide cap and trade systems, Washington and California. The other 48 states are mostly still puffing away on that metaphorical plane.

let alone all the other countries outside the U.S. who also don't have serious carbon regulations. They're smoking cigars on the plane, Keith. Exactly. I asked Luke Martland, who ran Washington's Captain Invest program, about all of this, and his first answer was like, look, putting carbon into the atmosphere is bad for the climate, so Washington should just do whatever it can to emit less carbon. I think any really important problem that we face is,

as a society, there's always this issue. But if you care about fixing problems, then you and your community, in your state, in your country, whatever it is, you take steps to address it, even if you can't solve it all on your own. But his point was not just to do it because he thought it was the right thing to do. His point was to do it so that other states might be more willing to do it too. What Washington state did was incredible.

And that showed other jurisdictions, other states, that this can be done. And this can be done well in a very tight period of time, year and a half, two years. So Washington state was a proof of concept, a great example of what could be done. And other states are looking at Washington state. Looking to see whether cap and trade succeeds there or whether it's so hard to make work in practice that they shouldn't even bother trying.

Right. Washington is a pretty environmentally friendly state. And if cap and trade gets repealed there after just three years, it doesn't look great. But the prices for the carbon allowances at those auctions have come down this year. And for lots of different reasons, so have gas prices. The most recent public poll on the ballot initiative suggests cap and invest will probably survive. But about a quarter of the people they asked were still undecided. So who knows?

People in Washington are still figuring out whether they like this new system or whether they'd rather put it back in the textbook.

If you are looking for more economic stories specifically about Washington state, well, check out the podcast Booming from KUOW. It is like Planet Money, but for Washington. They just did their own incredible episode about cap and invest. And on our latest bonus episode, we ask an economist your questions on energy, the environment, and electric vehicles, including the challenges to driving them.

There's this lack of pricing transparency that makes it almost impossible for us to know what we're actually going to pay through public charging, depending on where we are, at what time of day we show up, and so on. That's from our latest bonus episode just for Planet Money Plus subscribers. If you haven't signed up for Plus, it's a great way to support our work and get sponsor-free listing. Just go to plus.npr.org.

Special thanks today to Reuven Carlisle, Bellamy Pailthorpe, and John O'Brien. This episode was produced by Emma Peasley and edited by Emily Siner. It was fact-checked by Ciara Juarez and engineered by Valentina Rodriguez-Sanchez. Alex Goldmark is our executive producer. I'm Keith Romer. I'm Kenny Malone. This is NPR. Thanks for listening.

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