David A. Dana

A 'Switching Costs' Approach: EPA's Clean Power Plan as a Model for Allocating the Burden of Carbon Reductions Among Nations

In the proposed Clean Power Rule, EPA was required to allocate the burden of reducing carbon emissions from electricity production among the States. EPA chose a novel approach that is quite different from that adopted in Kyoto or the EU — what we call a “Switching Costs” approach. Under this approach, each State is allocated reduction percentages in emissions rates or mass emissions that depend heavily on the State’s switching opportunities — its opportunities to switch from coal to natural gas and from fossil-fuel energy sources to renewable energy. One result of the Switching Costs approach is that increases in electricity rates in the State should be more similar, closer to equal, than they would be under an approach that required emissions reductions without regard to variations in the switching opportunities available to each State. In Part I, this paper reviews the allocation plans that have been tried so far on an international scale and why they have not succeeded. In Part II, the paper explains EPA’s Clean Power Rule and what we are calling the switching opportunities approach that is at least roughly suggested by the Rule. In Part III, the paper discusses the two different “cost-sensitive” approaches adopted by the EPA under the Clean Air Act so far, and in Part IV, the paper discusses the basis for using the Clean Power Plan as a model and the advantages and disadvantages of “scaling up” the switching opportunities approach to the international arena. Overall, we find considerable merit in the switching opportunities approach, especially when its possible perverse incentive effects are tempered in the institutional design of the relevant regulations.