The Business View on I-732

As voters consider I-732 this election, it’s important to have accurate information on this initiative, the first in our nation proposing a carbon tax. Much has been written about I-732, some of it inaccurate.  

Sightline Institute published a series of blog articles analyzing some important questions related to I-732 (Weighing the Critiques of CarbonWA’s I-732Does I-732 Really Have a “Budget Hole”?Weighing CarbonWA’s Tax Swap Ballot Initiative), concluding that the policy’s flaws were “dwarfed by I-732’s potential benefits.” These articles dug deep into many important concerns:

  • Revenue Neutrality: The Office of Financial Management produced an analysis concluding that I-732 is revenue negative. Sightline reviewed that analysis carefully, and concluded: “To the degree that anyone can accurately forecast, the [I-732] tax swap is revenue-neutral.”
  • Tax Regressivity: “It will put money in the pockets of hundreds of thousands of low-income families” leading to the “biggest improvement in the progressivity of Washington’s state tax system in 40 years.” However, some low-income families not eligible for the Working Families Tax Credit would be tens to as much as a few hundred dollars in the hole each year “because the sales tax cut won’t fully offset their increased carbon costs.”  There are also uneven outcomes statewide, “leaving benefits and costs…to a matter of geographic luck.”
  • Impact on Business: “I-732’s approach to protecting EITE industries may be blunt and over-generous, but it simple—extremely simple to understand and to implement”, however this approach may “give money to businesses that don’t necessarily need it… It gives a big windfall to Boeing,” according to Sightline.

However, for the business community there are several questions not sufficiently answered as we consider I-732. The Washington Business Alliance has built a research base on carbon issues, and has developed a business centered approach termed Low Carbon Prosperity, with the twin goals of vigorous economic growth and reduced carbon emissions.  

During the 2016 Legislative Session, the Business Alliance led robust discussions among major business and environmental groups on a possible alternative to I-732. While the proposal did not reach a vote, stakeholders and legislators debated concepts and language up until the end of session, revealing substantive insights that offer a blueprint for future reform should I-732 pass, or for a new policy action if I-732 fails. These debates highlighted major questions:

  • How well will I-732 reduce carbon?
  • What will be the impact of I-732 on business?
  • How will I-732, the Clean Air Rule & the Clean Power Plan mesh?
  • And, how can I-732 be improved to become more effective?

We explore these issues in a series of articles from the Business Alliance’s perspective — how business leaders view issues.  This article deals with the first question.

How well will I-732 reduce carbon?

Meeting the state’s 2035 carbon reduction target will require an average 2.1% per year reduction starting in 2017.  We estimate that I-732 will help the state achieve about 50% of its 2035 target, with a likely range between 30-70% (Endnote 1).

Carbon Reduction Goals and Progress

In 2008, the state legislature passed statutory goals to reduce Washington’s overall emissions of greenhouse gases to 1990 levels by 2020, 25% below 1990 levels by 2035, and 50% below 1990 levels by 2050.  To achieve the 2035 goal requires reductions of about 2% per year in absolute terms (Figure 1, green line) (Endnote 2).

So far, Washington has made little if any progress in reducing its total greenhouse gas emissions (Endnote 3). This is despite an estimated 18% reduction in commercial and industrial CO emissions between 1990 and 2011, a result of the closure of a handful of aluminum smelters following a spike in power prices of several hundred percent or more during widespread power shortages (Endnote 4).

Carbon Reduction Projections

Carbon reduction from I-732 is expected to come from price elasticity as well as replacement of energy consuming products with different or new technologies.  “Price elasticity” is the relationship between consumption and price, defined as:

                       Price Elasticity = % Change in Demand                                                 % Change in Price

Using the latest version of , released in September 2016,  we project that the price elasticity effect of I-732 would achieve about 30% of the state’s 2035 reduction goal (Figure 1, orange line) (Endnote 5). CTAM takes into account the transportation-dominated emissions profile of Washington state, includes all electricity consumed in-state, and relies on consumer response to fuel price changes.

Figure 1: Baseline & projected greenhouse gas emissions under I-732

The estimate based on CTAM modeling likely represents a low bound because the effects beyond price elasticity may be substantial.  These effects include fuel-switching replacements (e.g., from a natural gas water heater to an electric heat pump water heater), and motivating technological or other changes.  We identify two sectors with compelling evidence for a significantly greater impact than CTAM price elasticity alone:

  1. Power: Greater energy conservation and ramping of existing natural gas power plants to displace coal.  Estimated add towards 2035 goal:  15% +/- 15%.  (See Fig. 1, dark blue line).
  2. Road Transport: Possible increased elasticity in consumer response to tax-induced changes in gasoline price.  Estimated add towards 2035 goal:  5% +/- 5%.  (See Fig 1, light blue line).

Reductions from Power

CTAM for Washington state power consumption projects a cumulative 12% reduction through 2035 from I-732 based on price elasticity alone. In the power sector, prices also impact the mix of fuels used to generate power, an impact CTAM does not capture outside of the scheduled retirement of the TransAlta coal power plant in Centralia.

Washington, Oregon, Idaho, and Montana are part of the Northwest Power and Conservation Council. The Council’s 7th Northwest Power Plan (“NWPP”) suggests a higher percentage drop in power sector emissions from a regionally applied carbon tax similar to I-732. The NWPP includes a change in fuel mix as a function of carbon pricing, while CTAM does not.  The predominant reason NWPP projects a greater drop in regional power sector emissions than CTAM does for Washington is because a changing fuel mix results in a much greater use of existing natural gas power plants through at least 2035 (NWPP Figure 3 – 12) (Endnote 6).

The graph below (Figure 2) displays several alternative strategies for carbon reduction detailed in the NWPP (Endnote 7).  Each dot is placed corresponding its total system cost and total carbon reduced in the period ending 2035.  Dots on the lower right are far less effective than those in the upper left.  Note that this data, based on the NWPP, pertains to the entire region, and hence isn’t a perfect predictor for Washington state.

FIGURE 2: INCREMENTAL EMISSION REDUCTIONS VS INCREMENTAL SYSTEM COST PACIFIC NW POWER SYSTEM THROUGH 2035

The NWPPmid-range CO2 tax (Endnote 8) produces the best outcome — highest CO2 reduction at an indicated cost savings.  However, this is a higher carbon price than I-732; the NWPPLow CO2 tax tracks I-732 more closely (Endnote 9). The NWPPLow CO2 tax scenario reduces NWPP carbon emissions by approximately 25% relative to existing policies from 2017 through 2035.    

Meanwhile, the Regional 35% Renewable Portfolio Standard scenario would result in about 1/3rd less reduction than the NWPP Low CO2 tax, at over 50% more in incremental costs.

Washington state’s Clean Air Rule (Endnote 10) finalized in September by the Department of Ecology, caps only emissions from in-state natural gas plants within the power sector. Therefore, the Clean Air Rule would make only a marginal difference in electric sector emissions in Washington. These reductions for the power sector as a whole would materialize only if coal power (not covered by the cap) did not increase to fill much of the decrease in natural gas use in power plants.  

Reductions from Transportation

The largest source of Washington State carbon emissions is transportation, totaling over half of energy-related CO2 alone. Even small changes in consumer behavior in this sector can have a significant impact on Washington’s carbon emissions. Our analysis of per capita consumption trends in British Columbia, updating work done by CarbonWA with an additional three years through 2015 (Endnote 11), suggests a price elasticity twice that which CTAM uses, which would contribute an additional 10% towards meeting 2035 targets.

Note that other strategies for reducing carbon can operate whether or not I-732 passes, and might be accelerated by I-732 pricing. For example, electrification of vehicles in Washington State maximizes carbon benefits of electric vehicles (EVs) through use of hydro-based power source. Due to both a grid that is much less carbon intensive than gasoline and other power grids, and the greater efficiency of electric motors relative to internal combustion engines, a gasoline powered vehicle would have to get 380 MPG to achieve the same greenhouse gas reduction benefits as an EV charged in Washington. Mass transit and commute mitigation also have significant carbon reduction potential.

Summary of reduction projections

There are some additional sources of emission reduction beyond the price elasticity analysis provided by CTAM for the 2035 goal. The Power Sector might provide about twice the reductions predicted from price elasticity.

The Transport Sector upside is also significant, provided the BC experience can be attributed fully to the tax and replicated in Washington. This potential impact is about one-third that of the Power Sector.

These additional potential reductions have uncertainty that suggests their impacts be factored. Therefore, we estimate that I-732 is likely to achieve about 50% of the state’s 2035 carbon reduction goals.  

Improving carbon reduction performance

Two pathways appear possible to modify I-732, if it passes, to achieve the full 2035 targets.  Pricing alone would require tax significantly higher than I-732’s $100/MTCO  maximum. This would pose serious political challenges

An attractive alternative is reallocating some of the revenue to invest directly in carbon reduction projects within our state. To a large extent, “it’s the revenue that matters” in carbon strategy. Some such projects can achieve carbon reductions very cost effectively, typically for less than $20/MTCO, or even “negative costs” in some cases (Endnote 12).

We recommend that if I-732 is enacted, the state develop a Carbon Reduction Fund (“CRF”) to purchase in-state reductions that are cost effective and incremental to what price elasticity alone motivates, and sufficient to meet our state’s goals. Our preliminary analysis shows that no more than 30% of I-732 revenue would be needed to ensure the state targets are met under an I-732 style carbon tax, and even less if the effects of the I-732 price are greater than CTAM alone projects. The goals of the CRF would be:

  • Achieve Washington state’s carbon reduction goals in combination with an underlying pricing program, while maximizing the benefit to the Washington state economy.  
  • Develop and manage a market-based, technology-neutral system that pays for verified reductions beyond the baseline from carbon pricing revenues.  In other words, assure funds are spent to achieve emissions reduction with the best overall long term outcome.
  • Assist businesses transition to operating in a low carbon economy.   

If highly successful the CRF approach can provide the opportunity to either reduce the carbon pricing, or return more of the funds directly to people and business.

Conclusion

Initiative 732 prices carbon to encourage businesses and consumers to use less of it, provides a predictable market to encourage innovation, and reduces other taxes to be effectively revenue neutral for the state and the average consumer.  When applied uniformly in a market like the entire US and its major trading partners, a level playing field protects the competitors.  However, to be successful I-732 needs to work for a single state acting alone — strengthening the economy while making a meaningful and cost-effective contribution to the  state’s carbon reduction goals.

The Washington Business Alliance projects that I-732 is likely to achieve about 50% of the state targets through 2035, with some uncertainty. There are some adjustments that can be applied if I-732 passes — establish a market fund (CRF) using a subset of the carbon revenue to invest in carbon reduction programs within the state, while making other desired adjustments, (e.g., greater protection for vulnerable businesses and public).

When the legislature passed the state carbon targets in 2008, it never created a policy vehicle to reach the goals. The Washington public wants a solution.  From the perspective of reducing carbon, I-732 makes a meaningful contribution toward the state’s climate goals. While designed to be revenue neutral, subsequent action directing a portion of revenues toward investments in carbon reduction can strengthen the result without driving the overall carbon price higher.

We’ll explore ways to broaden the appeal of taking action to business and position Washington as a successful leader in national carbon policy in future articles.  

ENDnotes
  1. This range is estimated with the most recent version of the Department of Commerce’s “Carbon Tax Assessment Model” (CTAM), version 3.2c (released in September). Beyond CTAM we estimate additional  power and road transport sector emissions reduction as described later in this section.

  2. Emissions in 1990 were 88.4 million MtCO2e, emissions in 2017 are projected to be 97.7 million MtCO2e (CTAM).  To get to 25% below 1990 levels (66.7 million MtCO2e) by 2035, the rate of decline needs to be 2.1% per year across all greenhouse gases tracked in the Washington state inventory.  Note that CTAM does not forecast emissions from fossil fuel industry fugitive gases, waste management, and agriculture.  We assume these will remain at 2007-2011 averages (9.5 million MtCO2e) through 2035.

  3. Washington state GHG emissions were up nearly 5% in 2011 and 2012 compared to 1990 (Department of Ecology GHG Inventory). Projections derived from CTAM indicate nearly 10% greater emissions in 2016 and 2017 than in 1990.

  4. Five aluminum plants in Washington state shut down permanently following an 2000 and 2001 energy crisis leading to high prices along the west coast

  5. Compared to a slightly increasing emissions baseline, a 2.1% per year reduction from 2017 through 2035 would result in a cumulative reduction of roughly 275 million MtCO2e. The I-732 price signal, as evaluated by our analysis using CTAM, would result in just over 80 million MtCO2e reduced relative to the baseline (Fig. 1, red line).

  6. As the NWPP figures show, increased use of existing natural gas (Figure 3 -12, 1,000 to 1,500 average Megawatts, aMW) would satisfy at least 70% of the average demand shift from the existing policies under a mid-range CO2 price (“SCC – Mid-Range).  Conservation (Figure 3 – 3, ~200 aMWs), and new natural gas development (Figure 3 – 11, ~100 aMWs by 2035) also contribute to the incremental resource development projections relative to Existing Policies.

  7. Data for all except the Clean Air Rule, which is separate WaBA analysis, comes from Tables 3 – 1, 15 – 7, and O – 4 of the 7th NWPP.

  8. Called “Social Cost of Carbon – Mid-Range” scenario in the 7th Power Plan.

  9. This, the “Carbon Cost Risk” scenario of the NWPP, starts out significantly lower than the I-732 price through 2021 (by $5 to $20/tCO2), equals the I-732 price in 2022 and then exceeds it through 2034 (maximum difference is $8 and average difference from 2022-2034 is $5).

  10. Data for this chart regarding the Clean Air Rule derived from Ecology’s Final Cost-Benefit Analysis

  11. We update the analysis of CarbonWA using the same data sources and CTAM modeling tool.  Data for per capita petroleum fuel consumption in British Columbia and in the rest of Canada is derived from CANSIM databases (petroleum fuels from Table 134-004, and population data from Table 051-0001).  In CTAM, we increased the price elasticity for petroleum fuel consumption until the predicted decline in consumption in the rest of Canada from 2008 through 2015 matched the observed decline over the same period in British Columbia.  This required a doubling of the price elasticity used in CTAM (from -0.062 to -0.124).

  12. Some negative cost examples from Oregon include smart meters, biogas electricity production, and enhanced building materials.