Climate Solutions Group

Boost to Cap and Trade Legitimacy in California


Apr 2017


On April 6th, the California Court of Appeal upheld the California Air Resource Board’s cap and trade program. This is a big deal. California is the world’s sixth largest economy and it is balancing the priorities of economic growth tackling climate change. This sets a precedent for other jurisdictions and shows that cap and trade is a viable mechanism for incentivizing cost effective emission reductions.

The California Court of Appeal needed to determine whether the cap and trade program created a new unconstitutional tax. In California, based on Proposition 13, the creation of a new special tax needs to be approved by two thirds majority in both legislative houses. There is a two part test used determine whether a payment to the California government is a tax. A payment is a tax if (1) it is be compulsory (participating in an auction), and (2) it does not grant any special benefit to the payer.

This is where it gets interesting. The Court of Appeal determined that participating in auctions is actually not compulsory. Why? Because regulated emitters can comply with the cap and trade program by reducing emissions, or purchasing emission allowances of carbon offsets from third parties. Ultimately, the court determined that businesses do not have a vested right to pollute and that continuing business and polluting is a voluntary decision that businesses must make if they want to continue operations in California.

For the second part of the test, determining the payment does not grant any special benefit to the payer, the majority of court found that an emission allowance gives holders the specific privilege (a benefit) to emit pollution (greenhouse gasses). Thus, an emission allowance is distinguished from a tax because it provides the owner with a benefit.

The decision from the California Court of Appeal sets a strong precedent and increases the legitimacy of cap and trade, which is critically important for both Quebec and Ontario who are involved in the multi-jurisdictional Western Climate Initiative (WCI). The decision also provides more certainty to the legitimacy and legality of cap and trade. As a result, the next emission allowance auction on May 16th might see an uptick in participation from regulated emitters.

Despite the promising news for the development of carbon markets, a level of uncertainty remains. The decision is being appealed and will be reviewed by the Supreme Court of California. Furthermore, the California Legislature will be deciding whether to extend the cap and trade program past the 2020 expiration date.

A two thirds majority decision in favour of cap and trade will seal the deal and provide certainty so the system can to move forward and work as designed – to decrease GHG emissions. There might be some degree of bipartisan support for the vote, and Californian leaders might see the approval of cap and trade as a slight jab to the Drumpf administration. Then, California will be able maintain its reputation as an environmental leader, with Ontario and Quebec in tow.

Photo Courtesy of Coolcaesar

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