Key questions on the Biden Climate Plan
The US climate plan will have profound domestic and international macro-economic consequences. There are several key questions to assess its potential effects.
Dear All,
The Biden administration has made of Climate its primary international and domestic policy focus. It seems to infuse all aspects of policymaking and to be seen as an important vehicle for job creation and economic justice.
Yet while there was a clear Biden candidate policy set of proposals, there is little clarity on what the actual Biden President Climate Plan really is. The climate Summit planned by the US for April 22nd will force some clarification by then but will probably leave some fundamental questions unanswered.
Beyond the re-joining the Paris Agreement, committing to carbon neutrality in 2050 and possibly announcing a new Nationally Determined Contribution (NDC) that would commit the US to reduce its emissions by 50% by 2030 (compared to the level of 2005), there is little clarity on the actual policy building blocks underpinning these commitments.
There are several critical questions for this administration to answer and they will each have profound domestic and international implications. While the recently voted USD 1.9 trillion COVID recovery stimulus has created much market jitters, it has been politically fairly easy to pass.
A climate policy bills would be undoubtedly be more challenging and have profound budgetary implications. For a start, the size of full and ambitious climate plan that would include energy infrastructure would be in the range of USD 1.5 to 4 trillion depending on the options chosen before taking into account any offsets from higher revenues (possibly stemming from a carbon tax (less likely) or corporate tax reform (more likely but I will discuss that in a separate note). This size and nature of this package will have a tremendous consequence on the US and the international economic outlook.
I. Energy demand suppression vs. Greening Energy Supply
§ The new NDC / US plan is critical to assess the US’ ambition and the path of its energy transition. In sum, how much demand suppression/energy efficiency and how much clean supply.
§ This is quite central choice because it would play a central role in orienting and sizing public and private investment flows. To put it simply if energy efficiency is the focus: building materials, isolation, electrification of transport will be central. In particular, it would imply as per the IEA’s plan a very meaningful contribution from technological performance and Carbon Capture Utilization and Storage (CCUS), a technology that remains experimental.
§ The underlying assumptions and policy focus will therefore be central to assess the focus and true ambition of the plan.
II. Pricing carbon / Subsidizing transition?
§ Will the US price carbon or will it try to use the regulatory route to achieve transition? Economists tend to agree that pricing carbon is the most effective way to achieve transition and one that also provides fiscal resources to allow for a carbon dividend improve substantially economic outcomes.
o Despite the attempts to create a national/federal emissions/permits trading markets under Obama, the US doesn’t have one and has largely relied on state efforts to price carbon. Will there be a new attempt?
o The Climate Leadership Council suggests that a Carbon tax starting from USD 40 per ton and escalating by 5% every year could decarbonize the entire US by 2050, for a total abatement cost of USD 75/ton, while unlocking USD 3.5trn of investment.
§ However, resistance to carbon pricing in the United States remains strong—nine carbon tax bills since 2018 have failed. While the democrats now control Congress. The majority in the Senate is razor thin and largely dependent on Senator Joe Manchin from West Virginia, who isn’t expected to support such a tax.
§ Alternatives to a proper carbon tax have been proposed, most notably by the IMF recently to create “carbon feebates”. For example:
o A tax on new vehicles equal to the product of a carbon price, the difference between the vehicle’s emissions per mile and the fleet average, and the average lifetime mileage of a vehicle. A feebate with a shadow price of USd 200 per ton of carbon dioxide would provide a subsidy of USD 5,000 for electric vehicles and a surcharge of USD 1,200 for a vehicle with fuel economy of 30 mpg. Analogous schemes could be applied to other sectors, including power generation, industry, buildings, forestry, and agriculture.
o State level experimentations could also be rolled out at the Federal level such as the Californian Zero Emission Vehicle (ZEV) by the California Air Resources Board (CARB), which essentially forces electrification of their vehicles by automakers and introduces a permit mechanism that allows each to trade their quota or purchase credits from the State.
§ But all these mechanisms of carbon pricing might be very politically challenging even if the proceeds are fully redistributed through a carbon dividend. The political deal to allow for carbon pricing might be an immensely progressive carbon dividend or a very large stimulus bill (infrastructure, transfers to States). All in all, it might also well be that a less effective and more costly set of subsidy/tax credit programmes is quite likely
o Some subsidies today costing USD 300-600/ton but could be crucial in getting some technologies off the ground (building isolation, CCUS or other…). The extension of the Solar Investment Tax Credit (ITC) and Wind Energy Production Tax credit (PTC) annually or until 2024 could be an important element of the Biden plan. The danger however is that concentrated subsidies/tax credits on renewables could create bubbles and profound inefficiencies but also given much higher abatement cost profoundly increase the fiscal cost of the US transition towards carbon neutrality and have important macroeconomic consequences.
o A few important tax credits stand out however as being potentially particularly important to secure transition:
§ Tax credit for farmers to encourage carbon capture, reduction of farmland dedicated to
§ Tax credit to the nuclear industry to ensure that existing power plants’ life span can be extended and/or new ones built. The phasing out of the US nuclear energy capacity would sharply increase natural gaz demand in the years to come.
§ Electric vehicles tax credits: There is a federal gas guzzler tax of USD 7,700 applying to passenger vehicles with fuel economy below 12.5 mpg, as well as a tax credit of USD 7,500 for EVs, and tax credits of between USD 4,500 and USD 7,500 for plugin EVs. This could easily be expanded.
o There are currently no less than 23 corporate tax credits, 4 Corporate tax deductions and 4 corporate tax exemptions across the 51 States. Providing some simplification and federalizing some of these could certainly go a long way in incentivizing change.
o A potential consequence of the absence of a carbon pricing initiative would be a more decentralized system of subsidies that would empower States but limit the visibility and predictability of the US plan.
What regulatory agenda?
Beyond taxing and subsidizing, the US administration can also regulate its carbon footprint away. This would require an ambitious sectoral regulatory agenda. Here, a few critical issues stand out:
§ Under the 2015 Clean Power Plan (CPP) states were responsible for developing strategies for meeting emissions targets, which amounted to projected nationwide reductions of 32 percent for the power sector by 2030 relative to 2005 levels—the CPP was repealed in 2017 and could be reinstated as part of the Biden plan, thereby largely decentralizing the emissions reduction efforts. This might be a way to empower States rather than Federal government and could go some way in enlisting the support of some Republicans for the transition agenda.
§ The Corporate Average Fuel Economy (CAFE) program which sets standards for new light-duty vehicle sales fleets. These standards were to rise 5% a year from 2021 to reach (on average) a projected 46.7 miles per gallon (mpg) in model year 2026, but in 2019 the annual requirement was reduced to 1.5%.
§ Shale gaz exploration/production remains a point of particular uncertainty and acute political sensitivity given the role it plays in US energy independence and production. While barring exploration on federal land might be symbolically important, it won’t discourage production and exploration where permits have already been granted. It is hard to imagine a very hard set of constraints on shell production.
§ Nuclear: According to the IEA, US nuclear energy is not expected to rise meaningfully in electricity production, which is striking. Overall, hydrogen (a nascent technology) is expected to become more important to energy production than nuclear over a relatively short period of time. The IEA also calls the investment in nuclear energy insufficient to meet the transition objectives. There are important regulatory incentives here to encourage nuclear investment. Bill Gates seems to believe that this is inevitable but mostly through the development of “off the shelf” Small Modular Reactors (SMRs) rather than the current large reactors.
§ Sustainable finance: Perhaps most striking is the absence of clear Sustainable Finance agenda stemming from the US. While the administration has made high profile hires on this topic (Sarah Bloom-Raskin at the Treasury) and Gary Gensler at the SEC and taking on an important role by leading with China the Sustainable Finance track at the G20, there are few signs of the direction of travel. A few critical questions will have to be addressed soon:
o Is the US embarking on a taxonomy of Green activities of its own or will it borrow/try work with the EU as France has called for?
o Will the US embrace the UK inspired / Financial Stability Board led Task Force for Carbon Disclosure (TCFD)?
o How will the SEC bring about a tighter degree of carbon disclosure by both Investment Management and Listed Corporations? And how much will be aligned with the EU’s Non-Financial Reporting Directive given the SEC’s claimed objective of achieving a global framework?
o How is this going to weigh on Accounting norms and standards in particular between the IFRS and the nascent Sustainable Accounting Standards Board (SASB) and how much will this lead to divergences in disclosure standards?
Conclusion: International spill-overs
· These domestic choices will be defining for the cost and the effectiveness of the US transition. But this has profound international ramifications: the greater its fiscal cost, the greater the incentives to limit carbon leakage and US fiscal/current account deficit from ballooning.
· As a result, the question of US carbon border adjustment mechanism should be considered a very live policy option. In particular, given the political resistance to revenue generating measures.
· This is potentially very important both politically because the US administration envisaged climate policy as a token of its return to a multilateral and cooperative foreign policy and economically because a CBAM would certainly provoke at least Chinese reaction, while a European one could be avoided if the CBAM is developed in a transatlantic fashion.
· The US could try to mitigate these tensions by playing a leading role in coordinating a successful COP26 outcome around a few critical deliverables for example an international carbon price floor (ICPF) but this requires rebuilding ties with the EU as well as with China and perhaps the United Kingdom (as president of COP 26).
· These issues will be critical to the macro-outlook for the coming years. We should have more clarity before the April 22nd Climate Summit but the real political battles will be fought over in Congress over budget reconciliation and could take months to shape up.
Thanks Shahin for this interesting analysis. Could you explain why a focus on energy efficiency would mean a stronger reliance on CCUS? I find this idea surprising - because lower energy demand due to higher efficiency would actually make the achievement of climate targets easier, and potentially lessen the need for largely untested CCUS technologies?
Furthermore, did you ever think about the compatibility of CBAM with WTO rules in the absence of a meaningful internal carbon price? To the extent that I read the literature (e.g. https://www.cambridge.org/core/journals/american-journal-of-international-law/article/designing-border-carbon-adjustments-for-enhanced-climate-action/BF4266550F09E5E4A7479E09C047B984 ) it is imperative that any CBAM would not clash with WTO rules, which might be challenging in the absence of an explicit C price.