Would Limiting Carbon Emissions Destroy The Economy?

First published on ClimateProgress.org, a project of the Center for American Progress Action Fund, which was recently named one of Time magazine’s Top 25 blogs of 2010.

To hear his critics tell it, President Obama proposed setting off a bomb in the American economy earlier this year.

To be more precise, Obama wants the Environmental Protection Agency (EPA) to, for the first time, place limits on carbon pollution emissions from the nation’s power plants. It’s the centerpiece of his wide-ranging plan to use the executive branch’s regulatory authority to combat climate change.

Senate Minority Leader Mitch McConnell (R-KY) is not a fan. He’s called the plan “open war on coal jobs,” and on “the residents, jobs, and businesses” across Kentucky. The National Republican Senatorial Committee and even Sen. Joe Manchin (D-WV) hit similar notes.

This is the perennial response when lawmakers try to clean up the environment, cut pollution, or reduce greenhouse gas emissions: you can do it, but only if you’re prepared to wreck the economy.

People or the environment. Jobs or the planet. That is the tradeoff.

There’s just one problem: the historical record provides scant evidence this tradeoff exists. America entered the environmental regulation businesses in earnest in 1970, with the creation of the EPA and the passage of major legislation like the Clean Air Act. Since then, a reliable pattern has emerged: new regulations are proposed, warnings of crushing costs and job losses ensue, and then — if the regulation survives — little of the prophesied destruction comes to pass.

“Most of the time,” according to Brian McLean, a nearly four-decade EPA veteran, “the cost is lower than what people thought.”

And probably no example demonstrates this better than the 1990 Clean Air Act amendments, which included one of the central accomplishments of McLean’s career.

The Fight Against Acid Rain

“I did a painting when I was in the Navy,” McLean recalled as we talked on the phone. “It was sort of an abstract art thing that showed that by the year 2000 the environment would be destroyed. So I think I was very concerned about the long-term future.” After the Navy, McLean landed a summer job at the EPA in 1972, while doing postgraduate work on urban planning, transportation, and air quality. It was a heady time for the environmental movement, an exciting place to work, and one where McLean felt he could make a difference.

Up until that point, U.S. environmental regulations had dealt with local nuisances: a plant emits pollution that causes hassles and health problems for people in the immediate vicinity. The idea of pollution as a systemic problem — something created by the whole economy, with interstate or even international effects — hadn’t broken through yet. The burgeoning awareness of acid rain changed that.

When fossil fuels are burned — especially coal in power plants — they release a whole smorgasbord of pollutants along with the carbon dioxide, including sulfur dioxide and nitrous oxide. McLean, long-used to the policy shorthand, refers to them as ‘SOX’ and ‘NOX.’ They mix with other elements in the atmosphere to form acids, which then ride precipitation back down to earth. The resulting acid rain corrodes building materials, gets into lakes and rivers, and reduces fish populations. It degrades soil quality and damages forests. Closer to the ground, SOX and NOX are crucial ingredients in smog.

Awareness of the acid rain problem built through the 1970s, and McLean ended up on a task force formed in 1983. They studied the science, prepped ideas, and built the case. Then, in 1990, the George H.W. Bush Administration decided it wanted an environmental legacy, and lawmakers pulled the trigger.

McLean and a small group at the EPA handled the bill’s policy details, while legislators and the White House set broad goals. McLean was among those pushing for flexibility and simplicity: “Power plants are built at different times, using different materials, sometimes designed to burn different types of coal,” he explained. “There are certain things you can do at some plants that you may not be able to do at other plants.”

For SOX, they created something new and ambitious. Power plants would be given allowances, permitting one ton of SOX emissions each, and plants could “burn off” each allowance when they saw fit. Most importantly, plants could buy and sell the allowances amongst themselves, effectively creating a market in SOX emissions. The cost of buying allowances created an incentive to keep emissions down, as did the profits from cutting emissions beyond what was needed and then selling the excess allowances. All the EPA had to do was monitor compliance and set the emissions cap. How to cut and who would cut would be hashed out by power plants themselves through old-fashioned market trading.

Concerns that the technology wasn’t ready forced a more modesty approach to NOX. Each power plant got an emissions rate to hit: only a certain amount of NOX could be emitted for each unit of electricity generated. The twist was that an operator with multiple plants could average the rates across their units. If one of the units performed worse than required, but another performed better, it could still average out to overall compliance.

McLean remembered one time when the vice-president of a New York state utility company caught him at an airport. “He said, ‘I just wanted to tell you that I think this is a really good program. What I really like about it is I can explain it to my CEO in 20 minutes.’”

Not everyone was so enthused. As the legislation loomed, prophecies of economic doom bubbled up. The National Association of Manufacturers said it could render the U.S. “a second-class industrial power.” An Edison Electric Institute study, cited in Congressional testimony, predicted a $7.1 billion annual hike in American’s electricity bills by 2000. The U.S. Business Roundtable anticipated two million jobs would be lost, and the Chamber of Commerce foresaw compliance costs of $20 billion a year.

The acid rain program passed anyway, along with a sweeping barrage of other amendments to the Clean Air Act.

“It Changes Your Perception Of What’s Possible”

McLean became director of the EPA’s Acid Rain Division in 1991 (it later became the Clean Air Markets Division), giving him a front row seat for the results.

Before the program launched, vendors told McLean that scrubbers — the devices that clean SOX pollution out of power plant emissions — could cut 90 percent from an existing plant, maybe 92 percent with tweaks. After the launch, Appalachian Power in West Virginia got an order from General Electric. The scrubbers cut 98 percent. “I was really shocked,” McLean said. “It had never been mentioned as a possibility.” It also turned out that coal from some parts of the country had lower sulfur content, so plants tried new mixes, bought from different mines, and took advantage of dropping rail transport prices. Meanwhile, conventional wisdom said low-NOX burners could deliver a five or ten percent cut to a plant’s NOX emissions. Once the acid rain program was underway, a plant in Pennsylvania discovered it could cut 20 to 30 percent by increasing the combustion air to the burners.

“Nobody had heard numbers like that,” McLean remembers. “It was significant enough that it changes your perception of what’s possible.”

The most concrete measure of the acid rain program’s cost was the price of the SOX allowances. The EPA originally projected they would be $750 in 1990. But all those breakthroughs meant the rules could be met at a lower cost to the plant operator. So the allowances began trading between $250 and $300, then dropped below $200 and stayed there through the start of compliance, and through Phase II, which expanded the system and lowered the emissions cap. They briefly spiked around the time the Clean Air Interstate Rule tightened the screws further. But the allowances fell back under $400 by 2008.

Nationally, the inflation-adjusted cost of electricity peaked in 1982, then dropped right through the start of emissions trading and compliance. It fluctuated after that, but never went higher than where it was when the program started. It was the same story for prices in the residential and industrial sectors.

There was some regional variation. The Midwest, heavily dependent on coal power, saw its electricity prices tick up. But the region already enjoyed the cheapest prices in the country, and the increases on top of that baseline were miniscule. McLean recalled receiving a letter from an Ohio resident, worried that his electric bill had climbed from $80 to $81 a month.

Manufacturing employment showed no reaction throughout the 1990s, and its later plunges coincided with recessions and major liberalizations of international trade laws, creating more competition from overseas. Coal industry jobs were already in steep decline by the 1980s, and a 2001 EPA study found that just five percent of the slide from 1990 to 2000 could be attributed to the Clean Air Act.

The flexibility and market incentives built into the acid rain program proved a huge advantage. They allowed each operator and each plant to find the cheapest way to cut the most SOX emissions in their particular circumstance. Beyond installing scrubbers, “people experimented and learned how to mix in low sulfur western coal to reduce the sulfur content,” Richard Schmalensee, a professor of economics emeritus at the MIT SloanSchool of Management, and a former economic adviser to the president, told me. “You might well not run a dirty coal plant when you would have and you’d run a clean gas plant instead. And then some old dirty plants just got shut down, because it just wasn’t worth it to keep them running.”

“So all those things happened, and the world didn’t end.”

The world didn’t end, and acid rain plummeted. SOX emissions in 2011 were 5.7 million tons — well below the Clean Air Act’s goal. And they’re expected to continue dropping to drop below four million tons by 2025. NOX emissions are also well below what the law was aiming for.

Not An Isolated Incident

Go through the history of environmental regulations, and you’ll find this basic story repeats itself time and again, even with traditional command-and-control regulations that don’t boast the acid rain program’s market mimicry. Companies that have to follow regulations — and even the agencies that enforce them — routinely overestimate the cost of compliance. Sometimes wildly.

Analysis in 1997 by the left-leaning Economic Policy Institute (EPI), found sometimes vastly overestimated costs for one environmental regulation after another, going back four decades.

Coke ovens, for instance, were furnaces that burn a specialized form of coal, used primarily in the steel and iron industries. They emitted a whole slew of gases during use, many of which were linked to exceedingly high cancer rates for coke oven workers. So in both 1976 and 1987, the EPA came in with new operating standards. Studies after the fact found the rules’ actual compliance costs were around one tenth of what was predicted. The same thing happened when asbestos exposure was limited, when chemical plants had to cut benzene emissions, when chlorofluorocarbons were phased out of refrigeration, when new controls were issued for surface mining, and when smog standards were tightened in 1997.

EPI returned to this issue with a 2006 study; out of 21 regulations, the costs of 13 were overestimated, and only three were underestimated.

It’s not even limited to environmental matters. In 1966, two laws finally made seat belts mandatory in all U.S. automobiles. Henry Ford’s reaction?

“We’ll have to close down.”

How Do We Keep Getting This Wrong?

McLean’s stories about the SOX scrubbers and low-NOX burners give a hint as to what’s going on here. All other things being equal, no businesses wants to voluntarily make things harder on itself. They’re not going to push the envelope on their own. Because pollution is what economists call an “externality” — damage that one person causes, but another person has to pay for — there’s no inherent profit motive to avoid it. Any business that tries will just leave itself at a disadvantage to its competitors.

This is the basic conceptual justification for regulation: it makes pollution control just another feature of the land a business and its rivals all have to navigate. Whoever does it cheaply and effectively reaps the biggest profit, and then everyone else follows suit.

“Once the rules are in place,” McLean said, “people go out to see ‘Well, can I get more out of this?’”

There’s also a big-picture, macroeconomic layer to all this. It’s a key reason all those job losses and hits to economic growth stubbornly refuse to materialize, and it’s a point free-market conservatives make regularly in other contexts: economies are really complex. They’re mind-bogglingly huge webs of moving parts, and each part will react in its own particular way to new regulations.

But that uncertainty cuts both ways. Faced with the unknowable future, the assumption is often that the unforeseen consequences of government regulation will be bad. Which is rather like throwing a cue ball onto a pool table, and only worrying about the balls you’ll knock onto the floor. You could sink a few as well.

The Unseen Benefits Of Regulation

Perhaps the biggest surprise of the acid rain program was the realization that, even when the legislation passed in 1990, policymakers were still seriously underestimating the health damage of SOX and NOX. Beyond acid rain, they contribute to fine particle pollution and smog. Those drive up heart and lung disease, aggravate asthma rates, and wreak all sorts of havoc on human respiratory systems.

So after the acid rain program kicked in, people became healthier and more productive. Money that would have been spent managing their illnesses was spent creating new wealth instead. Multiply those effects across all of the people in the American economy, and the results are enormous. A 2011 EPA study found the 1990 Clean Air Amendments led to 137 million additional work days, 26.6 million more school days, 1.4 million prevented heart attacks, and 1.8 million lives saved.

Furthermore, the pollution controls and energy efficiency advancements that stem from regulations also drive new innovations, creating jobs and opportunities for investment.

Add it all up, and it’s clear that regulations regularly do as much or more to lift up the economy as drag it down. The Office of Management and Budget releases annual reports comparing the costs and benefits of regulations across government agencies. Most years, the low-end benefit estimates beat the high-end cost estimates by tens of billions of dollars. And the bulk of those benefits come from EPA regulations.

In short, opponents of regulations are themselves routinely tripped up by complexity. They only tally up one side of the ledger. Because businesses provide our jobs, making their life harder tends to make voters and politicians nervous. But in a basic sense, it’s not clear how making a business’ life harder through regulation is any different from making it harder through rival competitors, demanding consumers, or the need to cut costs. The general argument is that regulations are different because they reduce rather than increase productivity, but as history shows, that isn’t necessarily the case. The argument also tends to rest on the a priori assumption that regulations are frivolous or driven by mere aesthetic concerns. But they’re often responding to real damage to our health and ecology. That damage carries real economic consequences. And so does preventing that damage.

All other things being equal, the market-based approach of the acid rain program is ideal. But even traditional regulations are consistently met for less cost than feared, and deliver unexpected benefits.

They do so because of the most simple and uncontroversial of truths: markets work.

How To Tackle Climate Change

This brings us back to where we started, and President Obama’s effort to finally bring the EPA’s regulatory guns to bear on carbon dioxide. Will history repeat itself again?

Maybe. The EPA’s rules for new plants are already out. They hue to the command-and-control approach, handing each plant the same emission rate to hit. But it probably won’t matter for the immediate future. Competition from the natural gas boom and rising renewable energy has left coal power almost entirely unprofitable. No more coal plants are being built, proposed coal export terminals are being canceled, and new coal tract leases are going without any mining bids at all — all for market reasons, even before the burden of new regulations factor in.

The rubber will really hit the road with the rules for existing coal-fired power plants, due in June 2014. The thing is, Congress wrote specific legislation authorizing the cap-and-trade approach to acid rain. But a similar bill for carbon dioxide failed in 2009, and the Clean Air Act hasn’t been updated since 1990. So the EPA will have to rely on older statutes — and the almost talmudic ongoing dialogue between the agency, the industry, and the courts — to build the existing plant rules.

“I’d like to see them try to structure it as cap-and-trade,” Schmalensee said. “That’s going to depend on whether their lawyers tell them they can get away with it. That would be a great step forward.”

The EPA is also legally required to consider technological feasibility as it crafts the rules. For reducing power plants’ carbon pollution emissions, that means carbon capture and storage (CCS) — and despite some interesting advancements, its readiness to be deployed at scale is hotly debated. Schmalensee is doubtful, as is Climate Progress’ own Joe Romm. McLean thinks the situation may parallel what happened with NOX; the technology was working overseas, and eventually came here, but wasn’t sufficiently obvious when the law was written. For its part, the EPA identified several projects, still under construction, that it thinks can demonstrate CCS at scale. The industry certainly won’t have any incentive to try and make CCS work without the regulations.

The most fleshed-out proposal for how the EPA can proceed came from the Natural Resources Defense Council (NRDC) in December. Each state gets an emission rate to hit by 2020, based on its particular energy needs. And in similar fashion to the NOX rule in 1990, states can average the rate across all their plants. It’s not the hard cap on emissions you’d get with cap-and-trade, but it does create similar flexibility, and something like a market incentive.

That means operators will have options. If CCS doesn’t pan out, there are other advanced technologies a power plant could bring on board to at least reduce their emission rates. Most coal plants are old, and often badly in need of an equipment upgrade. Or a utility could just run its coal plants less, while scaling up it’s natural gas plants and renewables. And yes, in some cases coal plants will just have to be shut down.

The NRDC simulated its plan with a model the EPA uses to game out its regulations. The results match the historical pattern: changes in electricity prices are nearly imperceptible, and the $4 billion in compliance costs are dwarfed by the $10 to $26 billion in health benefits. (Cutting CO2 inevitably cuts SOX and NOX as well.) Then add many tens of billions more in longer-term economic pay-offs, thanks to all the damage we’ll avoid from rising seas, stronger storms, heat waves, fires, floods, altered precipitation, collapsing food supplies, and the other effects of climate change.

Keep Adding Up The Lessons

McLean eventually became director of the EPA’s Office of Atmospheric Programs in 2002, before finally retiring just three years ago. He knows getting the regulation right isn’t easy.

Once, while discussing the acid rain program, McLean told some government officials he wanted the rules to be workable. “What do you mean by ‘workable?’” one replied. Another time, a judge responded to how EPA had written a rule by retorting, “It’s nice to be cost effective, but it doesn’t say that in the statute.”

“I sort of brought like fifteen, eighteen years of frustrating experience” to writing the acid rain program, McLain said. And the success of the system, along with the success of other regulations, testifies that whatever the sausage-making, the process generally works.

McLean finished on a philosophic note. “As I moved from one thing to another, I took the lessons I learned from the last experience and kept adding them up.”

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