The use of fossil fuels incurs what economists call negative externalities — costs that are not directly borne by the user. For instance, burning coal to generate electricity emits harmful pollutants, which can impact the health of nearby communities. The coal plant's owners, however, may not themselves live near enough to the plant to be affected, and so have no financial incentive to reduce the plant's emissions or to switch to a cleaner fuel. Economists agree that such negative externalities must be properly taken into account and priced in order to prevent harm to third parties and ensure the proper functioning of markets. From a climate policy standpoint, that means CO2 emissions and other greenhouse gases (methane, soot, hydrofluorocarbons (HFCs)) must be regulated, taxed or traded at a price that reflects their true environmental and social costs. Once this happens, market forces will be set in motion that will lead us to more sustainable solutions.

Within the past few years, the dialogue in both chambers of Congress over how to address climate change in the United States has included a variety of measures that would assign a cost to greenhouse gas emissions. The two comprehensive approaches that have emerged as the most likely next step for U.S. climate policy include a nationwide cap and trade system on greenhouse gas emissions or a carbon tax. Another possible avenue for the United States to reduce its carbon emissions is through the Environmental Protection Agency (EPA). The EPA has proposed New Source Performance Standards which mandate that new electricity generating facilities emit less than 1,000 pounds of carbon dioxide per megawatt-hour of electricity.


Cap and Trade

In a cap and trade system, an overall cap would be placed on greenhouse gas emissions in the United States, to be lowered incrementally (over the course of several years), until it reaches a specified target level. Parties responsible for these emissions, such as electricity generators or fuel refiners, would obtain allowances to emit a specific amount of these greenhouse gases within the cap, with allowances distributed either through an auction or free allocation. Should a participating member of the cap and trade system emit more than its allotted amount, it would be required to purchase more allowances. These allowances could be purchased from members who did not need all of their allowances and are now able to sell off their remaining allowances within the emission trading system (ETS). While this approach has the benefit of ensuring emissions are capped at a specific level, some critics of the system argue that it is less transparent than other policy options and requires significant administrative support.


Carbon Pricing / Carbon Tax

A carbon tax would tax goods based upon the amount of carbon (and therefore, potential as greenhouse gas emissions) it contains. The revenue generated from this tax (or similarly, from the auctioning of cap and trade allowances) could be used for a variety of purposes, including investment in research, development and deployment of new energy technologies or relief for low-income populations who are harder hit by high energy prices, among others. The carbon tax option is often touted as a simple, straightforward approach to inducing individuals and businesses to find less carbon-intensive products and services. It does not, however, ensure a specific reduction in greenhouse gas emissions.

Despite the debate on what approach policymakers choose to mitigate greenhouse gas emissions, there is widespread acknowledgment that complementary measures must also be in place to ensure the broadest reduction in emissions. Examples of such measures are a national renewable electricity standard (RES), renewable energy payments (also known as feed-in tariffs), a renewable fuel standard and/or low carbon fuel standard, high fuel efficiency standards for motor vehicles, energy efficiency resource standards, appliance/equipment efficiency standards, stricter building codes, the use of smart meters, and smart growth in urban planning.