JEEL June 8 Issue by The George Washington University Law School

THE GEORGE WASHINGTON JOURNAL OF ENERGY AND ENVIRONMENTAL LAW

CONTENTS Articles Debra Jacobson & Colin High, U.S. Policy Action Necessary to Ensure Accurate Assessment of the Air Emission Reduction Benefits of Increased Use of Energy Efficiency and Renewable Energy Technologies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Gary M. Lucas, Jr., The Taxation of Emissions Permits Distributed for Free As Part of a Carbon Cap-and-Trade Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Peter Manus, Seems Like Old Times For Environmental Law: The Supreme Court’s Conservative Turn In 2008–09 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Note Trevor Salter, “Carbon Cowboys”: How to Rein in Deceptive Sellers in the Carbon Offset Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

Cover photo courtesy of The George Washington University Law School. Copyright © 2010, Environmental Law Institute® All rights reserved. ELR®, Environmental Law Reporter®, and the Environmental Law Institute® are registered trademarks of the Environmental Law Institute. Third-class postage paid at Washington, D.C. POSTMASTER: Send address changes to Journal of Energy and Environmentl Law, 2000 L Street NW, Suite 620, Washington, DC 20036.

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JOURNAL OF ENERGY & ENVIRONMENTAL LAW

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THE GEORGE WASHINGTON JOURNAL OF ENERGY AND ENVIRONMENTAL LAW

We are pleased to introduce The George Washington Journal of Energy & Environmental Law, a student run journal published by The George Washington University Law School in cooperation with the Environmental Law Institute. The intersections between energy, environment, and climate law are increasingly important in producing more sustainable environmental outcomes. Although the Journal will publish articles across the full range of environmental issues, the energy-environmentclimate interaction will be our focus. As this is the Journalâ&#x20AC;&#x2122;s inaugural issue, we have published approximately half the amount of content that will be published in future issues. Future issues will continue to feature traditional law review articles, including student notes. However, because of the nature of our audience, we will also publish shorter pieces written by legal practitioners and policy makers that provide perspectives on critical energy and environmental issues. The Journal will have a unique audience. In addition to reaching the traditional law journal audience, the Journal will be circulated to the subscribers of Environmental Law Reporter News & Analysis. News & Analysis is one of the most highly ranked and most frequently cited environmental law journals in the country. The association with ELR News & Analysis opens up a broad readership to our authors that includes academics, law firms, government agencies, and others. We are grateful to the Environmental Law Institute for the opportunity to partner on our new publication. The Journal will be published twice each year. Those interested in subscribing to or publishing in the Journal should contact gwjeel@gmail.com. Thank you for your interest. We hope that you rely upon The George Washington Journal of Energy & Environmental Law as a source of legal analysis for many years to come.

Sincerely, Trevor Salter Editor-in-Chief Volume 1, Issue 1 Lee Paddock Associate Dean for Environmental Studies and Professorial Lecturer in Law

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JOURNAL OF ENERGY & ENVIRONMENTAL LAW

iii

U.S. Policy Action Necessary to Ensure Accurate Assessment of the Air Emission Reduction Beneﬁts of Increased Use of Energy Efﬁciency and Renewable Energy Technologies Debra Jacobson & Colin High* Introduction Policies encouraging energy efficiency and renewable energy (“EERE”) technologies need to ensure that the air emission reduction benefits of these technologies are calculated accurately. Otherwise, the market will not fully capture their important economic and social benefits. Federal, state, and local governments and private entities have developed protocols for reporting greenhouse gases (“GHG”) and other air emissions.1 Many of these protocols have been designed to allow emissions from individual sources to be aggregated into total emissions for an entire entity, such as a corporation or a governmental body, while appropriately emphasizing consistency, transparency, and the use of publicly available data. When measuring indirect emissions from electric power generation, these protocols have widely relied on total output emissions rates (the

*This Article was prepared by Debra Jacobson and Colin High, and most of its underlying research was funded by the Clean Energy/Air Quality Integration Initiative of the U.S. Department of Energy’s (“DOE”) Office of Energy Efficiency and Renewable Energy. Although we appreciate DOE’s strong support for our work, the views expressed in this Article are those of the authors alone. Ms. Jacobson is the owner of DJ Consulting, LLC and conducted the primary work for the Article in that capacity. She is also Co-Director of the Solar Institute at The George Washington University (“GW”), a Research Professor at GW, and a Professorial Lecturer in Law at GW Law School. The Solar Institute provided some additional support in the final stages of this Article. Ms. Jacobson can be contacted at djacobson@law.gwu.edu. Dr. High is Chairman of Resource Systems Group, Inc. (“RSG”) in White River Junction, Vermont. RSG compiled the initial database and designed the software used to support the Time Matched Marginal (“TMM”) methodology discussed in this Article and used in the final stages of this project. Dr. High can be contacted at chigh@rsginc.com 1.

See, e.g., World Res. Inst. & World Bus. Council for Sustainable Dev., The Greenhouse Gas Protocol: A Corporate Accounting and Reporting Standard 3 (2004) [hereinafter GreenHouse Gas Protocol], available at http://pdf.wri.org/ghg_protocol_2004.pdf.

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“eGRID system average methodology”2), which are based on information in the Emissions & Generation Resource Integrated Database (“eGRID”). The eGRID system average methodology is acceptable for reporting by corporations, governmental bodies, or other entities when they are aggregating emissions from all sources into an inventory.3 However, inadequate attention has been focused on methodologies for measuring the air emission reduction benefits of increased use of EERE and other low-emission technologies. This Article, presenting results of original research completed in 2008 and 2009, demonstrates that many individuals have misapplied the most commonly used methodology—the eGRID system average methodology. The eGRID system average methodology undervalues the GHG emission reduction benefits of increased use of EERE technologies in most regions of the country.4 This Article demonstrates that the eGRID system average methodology, when compared to the Resource System Group’s Time Matched Marginal emissions methodology,5 understates the carbon dioxide (“CO2”) and nitrogen oxide (“NOx”) emission reduction benefits of five EERE technologies6 by approximately 65% to 165% in the two power markets studied.7 This Article also concludes that the emission reduction benefits of increased use of EERE technologies calculated with the Environmental Protection Agency’s (“EPA”) eGRID non-baseload methodology also are significantly higher than those calculated with the eGRID system aver2.

3. 4. 5. 6.

As used in this Article, the term “eGRID system average methodology” is not a methodology “of ” eGRID, but refers to a methodology that uses eGRID total output emission rates when verified, utility-specific emissions data is not available. See generally U.S. Environmental Protection Agency, eGRID Frequently Asked Questions, http://www.epa.gov/cleanenergy/energy-resources/egrid/ faq.html (last visited Mar. 25, 2010) [hereinafter eGRID Frequently Asked Questions] (explaining that eGRID as used by EPA is an inventory of air emission data based on information from US electricity-generating plants). See infra Part I.A (discussing two types of GHG protocols). See infra Part II. See infra Part I.B.3. The five technologies studied in this 2008 and 2009 research work are wind energy, solar photovoltaic energy (“PV”), high-efficiency commercial air conditioning, high-efficiency commercial lighting, and LED traffic signal retrofits. See infra Part II (introductory text). The study focused on the PJM Interconnection and the Upstate New York power markets. See infra Part II.

JOURNAL OF ENERGY & ENVIRONMENTAL LAW

age methodology.8 Recent studies across all regions confirm that these findings are not isolated results but are indicative of widespread misapplication of the eGRID system average methodology by many users.9 Although the eGRID system average methodology is generally appropriate for estimating indirect emissions from electricity purchases (“scope 2 emissions”) for general emission inventory purposes,10 it does not accurately estimate the year-to-year impacts on GHG levels resulting from increased use of EERE technologies. The Climate Registry,11 hundreds of local governments, and others have relied on the eGRID system average methodology since 2008 in their protocols for estimating emissions from electricity purchases in their GHG emission inventories.12 This Article recommends that The Climate Registry consider developing an additional protocol and registry during the 2010 planned revision of its General Reporting Protocol to more accurately reflect the emission reduction benefits from increased use of EERE technologies by states and other entities. Similarly, EPA should consider developing an additional protocol in its mandatory GHG reporting rule to fully value emission reduction benefits from increased use of EERE technologies. Specifically, regulatory agencies should use a methodology that calculates emission reductions at marginal units.13 Ideally, these emission reductions should be calculated on an hourly basis. Finally, this Article recommends addressing these problems in a cost-effective manner. An investment of limited funds by the Department of Energy (“DOE”), EPA, or state agencies to create an enhanced database of marginal electric generating units would enable government agencies and businesses to more accurately evaluate the cost-effectiveness of EERE programs in reducing emissions.

Background

Role of EERE in Reducing Air Emissions from Electric Power Generation

The electric power sector is responsible for approximately forty percent of the CO2 emissions in the United States14 as well as significant direct and indirect emissions of methane and other greenhouse gases.15 According to leading 8. See infra Part I.B.2 and Table 1. 9. See infra Part II. 10. The Climate Registry, The General Reporting Protocol for the Voluntary Reporting Program, Version 1, at 97 (2008), available at http:// www.theclimateregistry.org/downloads/GRP.pdf. 11. Id. at 8, 99. 12. See infra Part III.A. 13. Marginal units are fossil fuel-fired units whose power output varies with the overall level of power demand over time. See World Res. Inst. & World Bus. Council for Sustainable Dev., Guidelines for Quantifying GHG Reductions from Grid-Connected Electricity Projects 13-14, 54-57 (2007) [hereinafter Quantifying GHG Reductions], available at http://pdf. wri.org/GHGProtocol-Electricity.pdf. 14. Energy Info. Admin., Annual Energy Outlook 2010, Early Release Overview 11 (2009), available at http://www.eia.gov/oiaf/aeo/pdf/overview. pdf. 15. See U.S. Envtl. Prot. Agency, eGRID 2007, Year 2005 Summary Tables 1 (2008) [hereinafter eGRID Summary Tables], available at http://www.epa.

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energy experts, the electric power sector requires a dramatic transformation to meet national targets for GHG emission reductions over the next several decades.16 Adopting energy efficiency and zero or low-carbon emission technologies, such as renewable energy, is a key part of this transformation.17 For example, the International Energy Agency has stated that a “global revolution is needed in ways that energy is supplied and used,” and it has cited energy efficiency and renewable energy as central to this energy revolution.18 Building and product efficiency measures, such as high-efficiency lighting and appliances, and dramatic increases in the use of wind and solar energy, are among the high priority technologies cited by the Agency.19 In addition, many promising strategies for reducing GHG emissions from the transportation sector involve advanced energy technologies, such as plug-in electric hybrid vehicles and electric cars, which reduce petroleum use through electrification.20 Implementing these strategies will increase the importance of ensuring the accurate assessment of the effects of EERE technologies on the electric grid, particularly hourly and seasonal differences in GHG emissions. In order to comprehensively report GHG emissions and to measure costeffectiveness, it is necessary to improve the accuracy and lower the costs of methodologies applied by state and local governments and the private sector to estimate the emission reduction benefits of increased use of EERE technologies.21 Other air quality goals, including reducing ozone levels, also can be advanced by increasing use of EERE technologies and practices.22 Many of these air quality problems are most serious during certain seasons, such as the summer ozone season, and certain hours of the day, such as summer afternoons.23 Federal, state, and local agencies benefit from accurate and low-cost methodologies to estimate the impact of EERE strategies in the air quality planning process.24 In all energy sectors, it is important not only to use improved methods but also to obtain agreement on consistent protocols for quantification and reporting GHG emissions.25

16.

17. 18. 19. 20. 21. 22.

23.

24. 25.

gov/cleanenergy/documents/egridzips/eGRID2007V1_1_year05_SummaryTables.pdf. See Int’l Energy Agency, Launching an Energy Revolution in a Time of Economic Crisis: The Case for a Low-Carbon Energy Technology Platform 3 (2009), available at http://www.iea.org/G8/docs/Energy_Revolution_g8july09.pdf. Id. Int’l Energy Agency, Energy Technology Perspectives 2008: Scenarios and Strategies to 2050 in Support of the G8 Plan of action 1-7 (2008). Id. Int’l Energy Agency, Transport, Energy, and CO2: Moving Towards Sustainability, Executive Summary 32-33 (2009), available at http://www. iea.org/Textbase/npsum/transport2009SUM.pdf. See infra Part I.B. U.S. Envtl. Prot. Agency, Guidance on State Implementation Plan (SIP) Credits for Emission Reductions from Electric-Sector Energy Efficiency and Renewable Energy Measures 1 (2004) [hereinafter Guidance on State Implementation Plan]. Debra Jacobson & Colin High, Role of Energy Efficiency Programs in Buildings in Addressing Air Quality and Greenhouse Gas Reduction Goals 1-3 (2008) [hereinafter Role of Energy Efficiency Programs], available at http://apps1.eere.energy.gov/wip/pdfs/tap_webcast_20080717_ fact_sheet.pdf. See infra Part III. See generally id. (discussing technological improvements that would enhance federal and local air quality programs).

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

The need for more accurate methodologies intensified when the EPA adopted the first mandatory GHG reporting rules last year.26 Moreover, the EPA is now considering options to expand its GHG registry to include indirect emissions from electricity purchases.27 There are currently two types of protocols relating to GHG emissions from the use of electric power. Confusion about the appropriate use of these two types of protocols lies at the heart of the issues discussed in this Article. The first type of protocol is an emissions inventory to provide accounting of GHG emissions for a corporation or other entity.28 The protocol is designed to facilitate reporting by the owners or operators of individual units, such as business plants and government buildings, so that these emissions can be aggregated for an entire corporation or governmental unit.29 This protocol typically requires reporting of both indirect emissions and direct emissions.30 Indirect emissions, also known as Scope 2 emissions, are air emissions that result from activities, such as electricity purchases, of one entity that occur at sources owned or controlled by another entity, such as an electric generating plant.31 In contrast, direct emissions, also known as Scope 1 emissions, are air emissions from sources owned or operated by the reporting entity, such as GHG emissions from the smokestacks owned by a power generating company.32 The Greenhouse Gas Protocol of the World Resources Institute and the General Reporting Protocol of The Climate Registry are examples of emissions inventories that track both scope 1 and scope 2 emissions.33 Electricity emission factors from the eGRID system average database are often used under these protocols to represent the amount of GHGs emitted per unit of electricity consumed.34 These emission factors are “usually reported in units of pounds of GHGs per kilowatt-hour or megawatt-hour.”35 A second type of protocol has been developed to quantify reductions in GHG emissions that result from projects that either generate low-carbon electricity or reduce the consumption of electricity transmitted over electric power grids.36 The most well-known protocol in this area is the Guidelines for Quantifying GHG Reductions from Grid-Connected Elec26. Mandatory Reporting of Greenhouse Gases, 74 Fed. Reg. 56,260 (Oct. 30, 2009) (to be codified at 40 C.F.R pt. 98); see also infra Part III.B. 27. Mandatory Reporting of Greenhouse Gases, 74 Fed. Reg. at 56,288. 28. Greenhouse Gas Protocol, supra note 1, at 3. 29. Id. 30. Id. at 26-27. Under reporting standards developed by the World Resources Institute and the World Business Council for Sustainable Development, operational boundaries have been established with respect to direct emissions and indirect emissions to assist entities in better managing the full spectrum of GHG risks and opportunities for reducing such risks. For many companies, indirect emissions from purchased electricity represent one of the largest sources of GHG emissions and the most significant opportunity to reduce these emissions. Id. 31. Id. at 25-27. 32. Id. at 27. 33. Id. at 25; The Climate Registry, supra note 10, at 1. The eGRID system average methodology is typically used in cases where no verified, utility-specific data is available. See infra Part I.B.1 for a fuller discussion of the eGRID system average database and calculations. 34. Greenhouse Gas Protocol, supra note 1, at 99. 35. Id. 36. See Quantifying GHG Reductions, supra note 13, at 4.

tricity Projects, developed by the World Resources Institute (“WRI Guidelines”).37 The WRI Guidelines are intended for use by two primary groups: (1) “project developers seeking to quantify GHG reductions outside the context of a particular GHG offset program or regulatory program”; and (2) “designers of initiatives, systems, and programs that incorporate grid-connected GHG projects.”38 The basic approach set forth by the WRI Guidelines involves the calculation of both an “operating margin” and a “build margin.”39 According to the WRI Guidelines, the operating margin is defined as “electricity generation from existing power plants whose output is reduced in response to a project activity.”40 The WRI Guidelines use EERE technologies as the primary examples of such project activities.41 The WRI Guidelines state that: [Operating margin] emissions are estimated using methods that attempt to approximate the emissions from the specific power plants whose operation is displaced. In theory, this estimation requires identifying which power plants are providing electricity at the margin . . . during the times that the project activity is operating. . . . Generation provided or avoided by the project activity may therefore affect a different marginal resource in each hour. . . . [E]stimating [operating margin] emissions can be a complex and data intensive task, matching a project activity’s output to the marginal generating sources in each hour. In practice, a diversity of estimation methods can be used that vary in their complexity and accuracy.42

A spectrum of methodologies thus exist that have been used (and misused)43 to estimate the operating margin. At one end of the spectrum are imprecise tools that estimate the impact of EERE measures on the average mix of emissions in the grid.44 On the other end of the spectrum are methodologies, such as computer-based “hourly dispatch” models, that “capture a high level of detail on the specific electric generating units displaced by [EERE] projects or programs.”45 These dispatch models can be expensive and “difficult for non-experts to evaluate,”46 and are therefore too advanced for most state and local governments. In addition, these dispatch models are generally proprietary,47 which means that the assumptions used in calculating emission reduction benefits are not transparent to third parties.

Id. Id. at 6. Id. at 11-16. Id. at 13. Id. at 11. Id. See infra Part I.B. Steven R. Schiller, National Action Plan for Energy Efficiency Model Energy Efficiency Program Impact Evaluation Guide 6-5 (2007), available at http://www.epa.gov/cleanenergy/documents/evaluation_guide. pdf. 45. Id. at 6-7. 46. Id. 47. Id. 37. 38. 39. 40. 41. 42. 43. 44.

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Methodologies for Calculating Emission Reductions from EERE Technologies

Grid-connected EERE technologies, such as wind power, have zero direct air emissions48 and displace emissions from fossil fuel-fired electric power generation.49 These emission reductions occur because of the way the electric power system works. EERE technologies have zero fuel costs and very low incremental operating costs. In other words, when renewable generation produces power, electricity supplies from other sources generally will be reduced or not brought on-line.50 For example, “a wind-generated kilowatthour displaces a kilowatthour that would have been generated by another source—usually one that burns a fossil fuel. . . The wind-generated kilowatthour therefore avoids the fuel consumption and emissions associated with that fossil-fuel kilowatthour.”51 When available, EERE technologies generally will displace generation at facilities with higher operating costs and varying output over time.52 The specific mix of coal, oil and gas-fired power units that will be displaced by EERE technologies varies significantly among states and regions of the country.53 Some states, such as West Virginia and Pennsylvania, rely on coal plants for a majority of their generation, and in those States, coal units are displaced by EERE technologies during some seasons and times of day.54 In comparison, natural gas units are more typically displaced in other states and regions, such as California and New England.55 EERE technologies “almost never displace nuclear power on the electric grid. Nuclear power plants are normally operated as baseload generators that run at full capacity (unless there is a planned or unplanned outage) because of low operating costs.”56 In addition, EERE technologies generally do “not reduce hydroelectric power on the grid because of its low operating costs and flow constraints.”57 Although the operators of hydroelectric plants may shift the timing of their generation 48. Debra Jacobson & Colin High, U.S. Dep’t of Energy Office of Energy Efficiency & Renewable Energy, Comparison of Alternative Avoided Emissions Methodologies Applied To Selected Northeast Power Markets 4, available at http://www.mwcog.org/uploads/committee-documents/ bf5dwFtb20081216140014.pdf. 49. Quantifying GHG Reductions, supra note 13, at 11-12. In our Article, EERE is generally used to refer to energy efficiency and zero-emission renewable electric power generation, including solar energy, wind energy, geothermal energy, and tidal energy. Other renewable energy technologies, such as biomass, waste-to-energy, and landfill gas, do have some direct GHG emissions from combustion and other processes. 50. Id. at 10. 51. Michael Milligan et al., Wind Power Myths Debunked, IEEE Power & Energy Mag., Nov.-Dec. 2009, at 89, 94. 52. Debra Jacobson & Colin High, Nat’l Renewable Energy Lab. Subcontractor Report #Sr-500-42616, Wind Energy and Air Emission Benefits: A Primer 9-10 (2008), available at http://www.windpoweringamerica. gov/pdfs/policy/wind_air_emissions.pdf. For more information on the complexities of analyzing avoided emissions under cap-and-trade programs, see id. at 12-17. 53. Id. at 10. 54. Id. 55. Id. 56. Id. 57. Id.

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as a result of renewable energy use or energy savings, the “[t]otal generation at such hydroelectric plants is generally not reduced on average.”58 Finally, the total amount of emission reductions resulting from EERE technologies also varies by time of day and season.59 For example, emission reductions are highest in the middle of the day because energy efficiency savings, particularly from high-efficiency commercial air conditioners, “are greatest at the hours of the day with the highest temperatures and the highest electricity demand in offices and other commercial buildings.”60 Similarly, the energy savings and air emission reduction benefits of high-efficiency air conditioners are “concentrated in the summer months” whereas “highefficiency refrigerators and dishwashers provide year‐round energy savings.”61 In this Article, we review three common methodologies used for quantifying emission reductions from increased use of EERE technologies, along with specific examples to illustrate the range of results. The three methodologies produce data with the following parameters: eGRID system average emission rates, eGRID non-baseload emission rates, and Time Matched Marginal (“TMM”) emission rates. Proprietary electric grid system dispatch models also have been used as a basis for calculating marginal emission rates from EERE technologies.62 These models are not reviewed because they are proprietary, and as a result, the costs are often prohibitive. They also are not sufficiently transparent or replicable to be suitable for use in public accounting of air emissions.

EPA eGRID System Average Methodology

The eGRID database is maintained by the EPA and is “a comprehensive inventory of environmental attributes of electric power systems” in the United States.63 According to EPA, eGRID is “[t]he preeminent source of air emissions data for the electric power sector. . . .”64 The eGRID database is derived from: [A]vailable plant-specific data for all U.S. electricity generating plants that provide power to the electric grid and report data to the U.S. government. eGRID integrates many different federal data sources on power plants and power companies, from three different federal agencies: EPA, the Energy Information Administration (EIA), and the Federal Energy Regulatory Commission (FERC).65 58. Id. The operating schedule of hydroelectric plants also may be limited by environmental constraints. Id. 59. Role of Energy Efficiency Programs, supra note 23, at 1-4. See also Press Release, PJM Interconnection, PJM Reports New Carbon Dioxide Emissions Data (Mar. 25, 2010) [hereinafter PJM Press Release], available at http:// www.pjm.com/~/media/about-pjm/newsroom/2010-releases/20100325-pjmreports-new-carbon-dioxide-emissions-data.ashx (attached graphic and tables comparing CO2 emission rates of marginal generating units compared to CO2 emission rates of system average generating units for 2005 to 2009). 60. Id. at 3. 61. Id. at 1. 62. See supra text accompanying note 45-47. 63. eGRID Frequently Asked Questions, supra note 2. 64. Id. 65. Id.

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

This database contains air emissions data for several GHGs, including CO2, methane (“CH4”) and nitrous oxide (“N2O”).66 It also provides data for the following criteria and hazardous air pollutants: NOx, sulfur dioxide (“SO2”), and mercury (“Hg”).67 The eGRID database is provided in a web-based application, eGRIDweb, as well as in Microsoft Excel format.68 The database is publicly accessible on the EPA’s web site.69 The EPA funds a contractor70 to compile various types of data, including aggregated emissions data by state, electric generating company, parent company, power control area, eGRID subregion, North American Electric Reliability Corporation (“NERC”) region, and total U.S. levels.71 “Total emissions and emission rates, and total generation and resource mix are displayed for each of these levels.”72 The two most important eGRID output emission rates are the system average emission rates (also called “total output emission rates”) and the non-baseload emission rates.73 The system average emissions rate is calculated by dividing the total annual emissions of a particular pollutant74 from all units in a region or power system (i.e., within the relevant grid boundary) by the total energy output of those units over the year.75 This system, or grid average, includes all units that report data to the government, including nuclear power plants, hydroelectric plants, and other zero-emission sources as well as fossil fuel-fired generation units.76 The system average emission rates rely on information from electric generation companies required to provide emissions data to both the EPA, including data from Continuous Emissions Monitors (“CEMs”), and to the Energy Information Administration.77 The EPA reports the system average emission rates for the NERC regions and eGRID subregions shown in Figure 1.78 The twenty-six eGRID subregions are subsets of the NERC regions.79

66. Id. 67. Id. 68. Susy Rothschild & Art Diem Et Al., The Value of Egrid and Egridweb to GHG Inventories 1 (2009). 69. See U.S. Environmental Protection Agency, eGRID, http://www.epa.gov/egrid (last visited Mar. 25, 2010) [hereinafter eGRID]. 70. See E.H. Pechan & Assoc., Inc., eGRID Emissions and Generation Resource Integrated Database Version 1.0 User’s Manual (2009). 71. eGRID, supra note 69. 72. Id. 73. See Rothschild & Diem et al., supra note 68, at 5-7. 74. Measurements are typically in pounds. See Schiller, supra note 44, at 6-5. 75. See id. Total energy output of units over a year is typically measured in Megawatt-hours or MWh. 76. See E.H. Pechan & Assoc., Inc., The Emissions & Generation Resource Integrated Database for 2007 Technical Support Document (2008), available at http://www.epa.gov/RDEE/documents/egridzips/ eGRID2007TechnicalSupportDocument.pdf. 77. See id. at 4. 78. eGRID Summary Tables, supra note 15, at 6, 10. 79. eGRID Frequently Asked Questions, supra note 2; see Rothschild & Diem et al., supra note 68, at 1.

Figure 1: Map of U.S. EPA eGRID Subregions

The most recent eGRID database available includes emissions data for calendar year 2005.80 The eGRID system average emission rates for each eGRID subregion vary considerably depending on the amount of zero emission sources, such as nuclear and hydroelectric power, in the subregion.81 Analyses conducted by Resource Systems Group, Inc. (“RSG”) reveal that the system average emission rates are the lowest of the three methods discussed here in most eGRID subregions.82 The methodology for calculating indirect emissions from electricity purchases, as adopted by The Climate Registry, relies on system average emission rates (when verified, utilityspecific data is not available).83 As a result, this methodology implicitly values emission reduction benefits of EERE technologies at the same emissions rate as the system average rate. Under the system average methodology, year-to-year changes in electric power purchases resulting from increased use of EERE technologies are accounted for by calculating the difference between the indirect emissions from electricity purchases in successive years based on the eGRID system average emission rates.84 However, according to the WRI Guidelines, ”because calculating a simple average is significantly less precise than other methods,” the system average approach “should only be used where other methods are not practicable [for calculating the operating margin for EERE projects].”85 As discussed below, the eGRID system average methodology has been found to significantly understate the emission reduction benefits of increased use of EERE technologies in most regions.86 80. See eGRID, supra note 69. 81. The EPA eGRID summary tables provide information on the generation resource mix (percent of generation from coal, oil, natural gas, other fossil fuels, biomass, hydro, nuclear, wind, solar, geothermal, and other) in each of the eGRID subregion. These summary tables also provide information on the eGRID emissions rates in each of these regions. A comparison of these tables demonstrates that the eGRID system average emission rates are lower when a subregion or region has a high percentage of nuclear and hydro resources in the generation mix. See eGRID Summary Tables, supra note 15, at 6, 10. 82. See infra Part II. 83. The Climate Registry, supra note 10, at 99. 84. See id. at 99-100. 85. Quantifying GHG Reductions, supra note 13, at 55. 86. See discussion infra Part II. See also PJM Press Release, supra note 59 (attached graphic and tables comparing CO2 emission rates of marginal generating units

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eGRID Non-Baseload Average Methodology

The eGRID non-baseload methodology is based on an understanding of the way in which increased EERE technology use displaces fossil fuel-fired electric generation.87 This type of methodology focuses on electric generating units whose output varies according to the overall level of power demand (the “load” level) in the regional power market.88 These load-following generating units are generally fossil fuel-fired, and include generating units usually classified as intermediate (shoulder) load and peak load plants.89 These units are also called “marginal units” because they provide electricity “at the margin,” and their output varies depending on the load.90 Baseload units are generally excluded but may function as marginal units during certain hours and seasons of the year.91 For example, some coal plants operate as intermediate plants in the PJM92 Interconnection power market during certain times of the year.93 Figure 2 highlights the distinction between baseload and non-baseload (shoulder/ intermediate and peak load) generating units.94

Figure 2: Baseload and NonBaseload Generating Units

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the avoided emissions rate. Whereas the eGRID system average methodology considers the emissions of all generating units operating on the regional or subregional power grid, the non-baseload calculation excludes all generation from resources that are not fossil fuel-fired.96 Thus, “[p]lants with 100% hydro, nuclear, wind, solar, and/or geothermal generation are removed from the nonbaseload calculation.”97 In addition, “[no] generation at plants with high capacity factors (0.8 and greater) is considered in the calculation of the non-baseload emissions rate.”98 Thus, the non-baseload average emission rates do not include consideration of emissions from baseload units99 such as nuclear power plants, hydroelectric power plants, and many coal-fired plants.100 As highlighted by a sample of subregional power markets in the 2005 eGRID Subregion Emission Rates table, the eGRID non-baseload emission rate is significantly higher than the system average rate in most regions101 because it excludes zero-emission nuclear and hydropower units and renewable energy generation.102

Table 1: Comparison of eGRID NonBaseload Methodology and eGRID System Average Methodology for Selected eGRID Subregions103 Subregional Power Market

Non-Baseload Methodology (lb. CO2 /MWh)

System Average Methodology (lb. CO2 /MWh)

Midwest (MROW)

2,158.79

1,821.84

Midwest (SRMW)

2,101.16

1,830.51

Mid-Atlantic (RFCE)

1,790.50

1,139.07

California (CAMX)

1,083.02

724.12

Southwest (AZNM)

1,201.44

1,311.05

The major difference between the eGRID system average methodology and the eGRID non-baseload methodology is the group of generating units that is considered in calculating

Comparison of the eGRID database reveals that the eGRID non-baseload emissions rate is higher than the eGRID system average rate in twenty out of the twenty-six eGRID subregions.104 Experts involved in the 2005 eGRID database confirmed this conclusion in a recently published paper, stating that “in general, with few exceptions, the non-

compared to CO2 emission rates of system average generating units for 2005 to 2009). See supra Part I.B.1. Quantifying GHG Reductions, supra note 13, at Annex A.1. Matthew Brown et al., Nat’l Conference of State Legislatures, Energy and Air Quality: The Power Industry and Air Quality 6-7 (2005). Quantifying GHG Reductions, supra note 13, at 55. Jacobson & High, supra note 52, at 10. PJM is a regional transmission organization supplying Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. See PJM: Who We Are, http://www.pjm.com/about-pjm/who-we-are.aspx (last visited Mar. 25, 2010). Jacobson & High, supra note 52, at 10. Brown et al., supra note 89, at 6. Id.

96. See E.H. Pechan & Assoc., Inc., supra note 76, at 15. 97. Id. 98. Id. According to the technical document, the non-baseload average is calculated from a percentage of each plants emissions and generation (depending upon capacity factor) that combusts fuel and has a capacity factor of less than 0.8. Id. at 15. 99. Id. 100. Id. Nuclear, hydroelectric, and coal plants are considered baseload plants because their capacity factor is greater than 0.8. Id. 101. See eGRID Summary Tables, supra note 15, at 6. 102. E.H. Pechan & Assoc., Inc., supra note 76, at 15. 103. eGRID Summary Tables, supra note 15, at 6. 104. eGRID Summary Tables, supra note 15, at 6.

Source: National Conference on State Legislatures, 2005.95

87. 88. 89. 90. 91. 92.

93. 94. 95.

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

baseload values are larger than the total output emission rates.”105 The eGRID non-baseload average emission rates for eGRID subregions are also provided by the EPA on its website and in its summary reports.106 The EPA’s Green Power Partnership appropriately relies on the eGRID non-baseload average methodology in calculating emission reductions resulting from the use of renewable energy generation.107 This EPA program has developed a calculator tool that incorporates the eGRID non-baseload methodology.108

Time-Matched Marginal Emissions Methodology (“TMM”)

Over the course of several years, Resource Systems Group (“RSG”) has developed a methodology for estimating air emissions avoided by the increased use of EERE technologies. This TMM emissions methodology differs from the eGRID system average approach in several fundamental ways. First, the TMM methodology is based on emissions monitoring data for each of the 8,760 hours of the year for generating units that submit hourly data to EPA. In comparison, the eGRID database focuses on annual averages of emissions for grid-connected electric generators.109 The significance of this difference is underscored by the National Action Plan for Energy Efficiency, a coalition of the DOE, EPA, and more than fifty other agencies and organizations.110 The National Action Plan’s Model Energy Efficiency Program Evaluation Guide, released in November 2007, emphasizes that the eGRID system average approach to estimating avoided emissions has several major limitations.111 The first major limitation is summarized as follows: [One] shortcoming of this approach is that energy efficiency savings tend to vary over time, such as savings from an office lighting retrofit that only occurs during the workday. Using an annual average emission factor that lumps daytime, nighttime, weekday, and weekend values together can skew the actual emissions benefits calculation.112

The second difference between the TMM methodology and the eGRID system average methodology is that the TMM methodology focuses on the actual generating units expected to be displaced when renewable energy generation 105. Rothschild & Diem et al., supra note 68, at 7. 106. Id. 107. See U.S. Environmental Protection Agency, Green Power Partnership, http:// www.epa.gov/greenpower/index.htm (last visited Mar. 5, 2010) [hereinafter Green Power Partnership]. The Green Power Partnership is a voluntary EPA program that supports the organizational procurement of green power by offering expert advice, technical support, tools and resources. For purposes of this program, green power is defined as electricity produced from a subset of renewable resources, such as solar, wind, geothermal, biomass, and low-impact hydro. See id. 108. See U.S. Environmental Protection Agency, Green Power Equivalency Calculator, http://www.epa.gov/greenpower/pubs/calculator.htm (last visited Mar. 5, 2010). This tool is only available to Partnership members. 109. See supra Part I.B.1. 110. Schiller, supra note 44. 111. Id. at 6-5. 112. Id.

or energy savings take place. Nuclear units and hydropower units are thus generally not considered by the TMM methodology when calculating avoided emissions. In comparison, the eGRID system average methodology considers nuclear and hydroelectric units in calculating avoided emissions, even though such units are rarely displaced by increased use of EERE technologies.113 The National Action Plan’s Program Evaluation Guide views the inclusion of nuclear and hydroelectric units as a shortcoming of the methodology: A shortcoming of this [system average] approach is that it does not account for the complexity of regional power systems. . . . In many regions, the marginal units displaced by energy efficiency programs can have very different emissions characteristics from the base load units [such as nuclear and hydropower] that dominate the average emissions rate.114

The eGRID non-baseload methodology also shares the first limitation of the eGRID system average methodology because it is based on the annual average avoided emissions,115 instead of a more accurate hourly measure. However, it differs from the system average methodology and shares a benefit of the TMM methodology because it focuses on the non-baseload units that are actually displaced when EERE technology comes online.116 Thus, RSG’s TMM methodology provides a marginal rather than a system average emission rate. In addition, it uses a time-matching approach that is specific to the EERE technology under consideration. The TMM methodology is based on the following steps: 1. Estimating the hourly electric power generation for each fossil fuel-fired unit in a specific power market area; 2. Identifying the marginal fossil fuel-fired units at each hour by using the hourly generation to identify units that follow the total load at each hour. Based on this information, RSG’s TMM method estimates average emission rates of the marginal units based on their incremental contribution to the load; 3. Using data to compile a profile of the energy savings or energy generation on an hourly basis over the 8760 hours of the year. This profile is prepared for a particular technology, such as wind power or high-efficiency commercial air conditioning, and for a particular region;117 4. The “time-matching” occurs when the load profile is matched for a specific technology on an hourly basis against the marginal emissions profile for the same hours;

113. See Part I.B. 114. Schiller, supra note 44, at 6-5. 115. E.H. Pechan & Assoc., Inc., supra note 76, at 15. 116. Id. 117. The recommendations in Part IV, infra, highlight the need for additional work to refine these load profiles and to make them publicly available.

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5. The avoided emission rates can be used to produce, in Microsoft Excel format, a calculator that provides total avoided emissions from annual generation or savings, using either project-specific profiles or default regional profiles. This calculator also can be used to estimate avoided emissions on a monthly or seasonal basis.

its evaluation of comparative GHG and air emission reduction benefits of projects competing for loan guarantees.127

Although RSG pioneered the TMM methodology, at least one other prominent energy consulting firm has used a conceptually similar approach. In July 2008, Synapse Energy Economics published a report for the EPA using an hourly approach to estimate avoided emissions based on hourly EPA CEM data from intermediate and peak load generating units.118 This report, entitled Analysis of Indirect Emissions Benefits of Wind, Landfill Gas, and Municipal Solid Waste Generation, calculates avoided emissions for the three selected renewable energy technologies in each of the EPA’s twenty-two eGRID subregions in the continental U.S.119 The regional, hourly power profiles for each of the three renewable resources are combined with the hourly indirect emissions factors to yield annual indirect emissions benefits for each type of resource for each eGRID subregion.120 Researchers at the Laboratory for Energy and the Environment at the Massachusetts Institute of Technology (“MIT”) also have studied the emission reductions from another renewable energy technology, solar photovoltaics (“PV”), using a methodology similar to the TMM method.121 The MIT study relies on “matching up PV generation with associated changes in unit generation on an hourly basis.”122 It focuses on the fossil fuel units offset by PV generation in each region and each hour of the day.123 Moreover, the MIT study expresses serious concerns about the system average approach.124 The researchers stressed that “[t]his report also challenges the simple averages approach on the ground that there is no evidence that average . . . emission rates occurring when PV is generating are representative of the fossil units that respond to changes in load, to be met by dispatchable generation.”125 Finally, the DOE’s Loan Guarantee Program Office (“LGPO”) has adopted the RSG TMM methodology as a component in its review of loan guarantee applications for EERE projects.126 The LGPO is applying the methodology in

In 2008, RSG conducted an analysis of results from the three different methodologies that measure the emissions impact of increased use of EERE technologies. The analysis focused on five EERE technologies: high-efficiency commercial lighting, high-efficiency commercial air conditioning, LED traffic lights, solar PV, and wind energy. In each case, RSG compared the avoided emissions from a specific technology using its TMM methodology, the eGRID system average methodology, and the eGRID non-baseload methodology. RSG analyzed both the PJM Interconnection power market and the Upstate New York power market. The findings of this analysis are as follows:

118. See Bruce Biewald et al., U.S. Envtl. Prot. Agency, Office of Research and Dev., Analysis of Indirect Emissions Benefits of Wind, Landfill Gas, and Municipal Solid Waste Generation i (2008), available at http:// www.synapse-energy.com/Downloads/SynapseReport.2008-07.EPA.EPAIndirect-Emissions-Benefits.06-087.pdf. 119. Id. 120. Id. 121. See The Analysis Group for Reg’l Energy Alternatives, Emissions Reductions from Solar Photovoltaic (PV) Systems 1-4 (2004), available at http://web.mit.edu/agrea/docs/MIT-LFEE_2004-003a_ES.pdf. 122. Id. at 1-2. 123. Id. at ES-1. 124. Id. at 1-4. 125. Id. 126. The LGPO subcontracted with RSG to conduct the analysis of GHG and air emission reduction benefits on the electric grid resulting from alternative technologies competing for loan guarantees, and RSG is applying its TMM methodology in this process. See generally RSG, Inc., Avoided CO2 Emissions, http://www.rsginc.com/avoided-co2-emissions-2/ (last visited Mar. 25, 2010). The DOE required applicants to set forth the hourly load profiles for electric

II.

Findings From Comparison of Three Avoided Emissions Methodologies

1. Avoided air emission benefits for the five EERE technologies for CO2 and NOx are from 65% to 165% or more higher using the TMM methodology when compared to the eGRID system average method; 2. Avoided air emissions benefits for the five EERE technologies for CO2 are from approximately fifteen percent higher using the TMM methodology when compared to the eGRID non-baseload methodology; 3. Within the two power market areas studied, the emission reduction benefits associated with the five different EERE technologies varied by only up to three percent. The variability is mainly associated with the degree of seasonal variation in electricity savings or additional renewable energy generation. 4. In all cases, the results for NOx are more complicated and more variable than the results for CO2. This complexity is related to the highly variable emission rates for NOx resulting from large differences in the efficiency of pollution control technologies for this pollutant. In comparison, there are no pollution controls for CO2 on the units studied. Figure 3 highlights these results, and the actual data relating to these summary findings is set forth in the Appendix.

generation or savings under their technologies as part of the loan guarantee application process. See Loan Guarantee Program Office, U.S. Dep’t of Energy, Electrical Profiles—Generation, Purchases, Savings and Transfers Worksheet (2008), available at http://www.lgprogram.energy. gov/lew.xls. 127. Id.

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

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Figure 3: Comparison of RSG TMM Avoided Emissions Rates for NOx and CO2 with eGRID Emission Rates for the Upstate New York and PJM Interconnection Power Markets The wide variation in the results poses significant challenges to state and local governments in preparing GHG inventories and conducting other GHG accounting.128 The following hypothetical example highlights the differences among the three methodologies. (It should, however, be noted that the eGRID system average methodology is not recommended for this type of estimation even though it is often inappropriately used for calculating emission reductions resulting from increased use of EERE technologies).129 This hypothetical involves a municipality in western New York that is tracking its GHG emissions and reporting under The Climate Registry protocolsâ&#x20AC;&#x201D;using system average emission rates for its purchase of electricity. Assume that the municipality decided to reduce its GHG emissions to meet a target in its Climate Action Plan and decided to install a municipal wind farm to power its own facilities and generate 10,000 MWh per year. The reported avoided emissions from the three alternative emissions assessment methodologies are shown in Table 2. 128. In this example (and for simplicity), we only have considered avoided emissions from operational changes in generation in the near-term. We have not considered the added complexity that additional generation may have on reducing the need to build new electric generating capacity in the future. 129. See generally Part III (discussing the widespread use of the eGRID system average methodology).

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Table 2: Avoided CO2 Emissions from 10,000 MWh of Wind Energy Generation in Upstate New York. Based on 2005 Data

Avoided Emissions Methodology

Avoided CO2 Emissions (Tons per Organization Using Year) Methodology

eGRID System Average

3,600

Climate Registry1

eGRID Non-Baseload Average

7,571

EPA Green Power Partnership

Time-Matched Marginal (TMM)

9,160

DOE Loan Guarantee Program, Metro Washington COG

See infra Part III.A.

Under this example, the municipalityâ&#x20AC;&#x2122;s own wind power project would result in a decrease in reported CO2 emissions to The Climate Registry of approximately 3,600 tons per year.130 On the other hand, the municipality might be a member of EPAâ&#x20AC;&#x2122;s Green Power Partnership and calculate the air emission benefits from its new wind farm using the eGRID non-baseload methodology. Under this methodology, the emission reduction benefits claimed would be 130. The Climate Registryâ&#x20AC;&#x2122;s General Protocol does suggest the reporting of supplemental information about green power purchases in its entity-wide report on indirect emissions from electricity purchases. The Climate Registry, supra note 10, at 101. However, the indirect emissions that are reported as scope 2 emissions from electricity purchases would only be reduced by 3,600 tons.

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7,571 tons of CO2.131 The amount of avoided CO2 emissions reported under this non-baseload methodology would thus differ substantially from the amount of avoided CO2 emissions calculated under the eGRID system average methodology. Moreover, using an hourly marginal emissions analysis, such as the TMM method, a more accurate estimate of the avoided emissions benefits of a municipal purchase of 10,000 MWh of wind power would be about 9,160 tons of CO2. If the municipality wanted to quantify its progress toward a GHG reduction target, the TMM methodology would be most accurate in the near-term. This hypothetical illustrates the need for greater consistency and accuracy in calculating and reporting CO2 reduction benefits. The analysis described above is based on only two of the twenty-six NERC subregions. However, subsequent to the completion of the research included in this Article, RSG analyzed the emission reduction benefits of a wide range of EERE projects across all of the NERC regions and virtually all of the NERC subregions. RSG’s analysis confirms that the use of the TMM methodology results in significantly higher emission reduction benefits than using the eGRID system average methodology in most regions of the country. The comparison with the non-baseload average is more complex, making it difficult to draw clear conclusions. Thus, this recent work further confirms that the eGRID system average methodology is an inappropriate approach for assessing the avoided emissions benefits of specific EERE programs and projects, which is implicit in how state and national registries and accounting programs currently estimate indirect emissions from electricity purchases.132 This conclusion was supported by EPA eGRID experts at the recent Energy and Environmental Conference 2010 (commonly called the EUEC 2010) in Phoenix.133 According to a paper presented by the eGRID experts, the eGRID nonbaseload emission rates, rather than the eGRID total output emission rates (system average rates), are recommended for use in estimating “the emissions benefits of reductions in grid supplied electricity use, especially those that are somewhat coincident with peak demand.”134 The experts specifically recommended the eGRID non-baseload methodology to calculate emission reductions from using high-efficiency air conditioning.135

131. U.S. Environmental Protection Agency, eGRID2007 Version 1.1 Year 2005 GHG Annual Output Emission Rates, http://cfpub.epa.gov/egridweb/ghg (last visited Mar. 23, 2010) (listing the “[a]nnual non-baseload output emissions rates” for Upstate New York (NYUP) as 1511.14 lb CO2/KWH); U.S. Environmental Protection Agency, Green Power Partnership, Green Power Equivalency Calculator, http://www.epa.gov/greenpower/pubs/calculator.htm (last visited Mar. 23, 2010). 132. See infra Part III.C. 133. See Rothschild & Diem et al., supra note 68, at 6. 134. Id. 135. See id.

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III. Improved Methodologies Would Beneﬁt Federal and State Climate and Air Quality Programs A.

The Climate Registry’s Reliance on the eGRID System Average Methodology

It is very important to promptly address the inappropriate use of the eGRID system average methodology for calculating changes in CO2 emissions resulting from increased use of EERE technologies. Unfortunately, a large majority of states and hundreds of local governments and private entities using GHG emission protocols are misapplying the system average avoided emissions methodology in these circumstances.136 Reliance on the eGRID system average methodology has significant ramifications because of the possibility that other government entities and the authors of national climate legislation will follow this precedent. Most importantly, the General Reporting Protocol of The Climate Registry—a non-profit organization comprised of forty states and the District of Columbia—recommends the use of system average emissions rates to calculate indirect GHG emissions from electricity purchases if utility-specific emissions information is not available.137 The Climate Registry’s General Reporting Protocol incorporates a table that contains specific emission factors to apply in such cases—the eGRID system average.138 The General Reporting Protocol does suggest the reporting of supplemental information regarding green power purchases in its entity-wide report on indirect emissions from electricity purchases.139 However, this Protocol does not require any reductions in the level of indirect emissions from electricity purchases (scope 2 emissions) reported as a result of the increased use of renewable energy technologies and does not require an additional inventory to reflect emission reductions that result from increased use of renewable energy technologies.140 The General Reporting Protocol, moreover, does not discuss any adjustments to account for reductions in energy use from major energy efficiency projects undertaken by an entity.141 In comparison to the TMM methodology, the General Reporting Protocol methodology does not involve marginal emissions rates, nor does it require time-varying profiles of specific EERE technologies.142 A companion Protocol developed by the Local Governments for Sustainability (“ICLEI”) in partnership with The Climate Registry, the California 136. See infra notes 171-73 and accompanying text. 137. See The Climate Registry, supra note 10, at 99. The Climate Registry is a non-profit organization that supports public reporting of greenhouse gas emissions throughout North America in a single unified registry. The Protocol indicates that generator-specific emission factors are preferred instead of eGRID data but allows the use of eGRID data when such generator-specific emission factors are not available. Even with respect to the generator-specific data, the Protocol does not require the use of marginal emissions data. See id. at 99. 138. See id. at 99, 104. 139. See id. at 101. 140. See id. 141. See id. at 97-108. 142. Compare id., with supra Part I.B.3 (discussing TMM methodology).

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

Climate Action Registry, and the California Air Resources Board, uses a similar approach.143 In addition, as discussed below, Climate Registry protocols have been referenced in several major pieces of national climate legislation.144 It should be noted that The Climate Registry’s General Reporting Protocol “recognizes the need to develop a specific accounting framework for green power purchases in order to encourage and incentivize emission reduction efforts.”145 The General Reporting Protocol, however, asserts that “[t]here is not yet consensus on how to accurately and credibly track green power purchases in an accounting framework, beyond allowing Reporters to provide supplementary information about their green power purchases in annual emission reports.”146 In its General Reporting Protocol, The Climate Registry committed to “incorporating a framework for accounting for contractual purchases of electricity, such as green power,” as it “develop[ed] an industry specific protocol for the power and utility sector. . . .”147 Unfortunately, The Climate Registry did not resolve this issue when it issued its voluntary reporting protocol for the electric power sector in June 2009.148 The Climate Registry’s Protocols raise particular concerns about the disconnect between year-to-year changes in CO2 emissions reported to The Climate Registry, as compared to energy efficiency savings, and related GHG emission reductions reported by state energy agencies and electric utilities. For example, if the State of Maryland—a member of The Climate Registry—reports its CO2 inventory under the General Reporting Protocol, it is likely to underestimate the benefits of energy savings from high-efficiency heating equipment in the State for a variety of reasons, including the fact that the eGRID system average methodology does not reflect seasonal changes in avoided emissions.149 This issue of seasonal variation is significant because the avoided CO2 emissions from energy efficiency technologies in Maryland are greater in the winter months.150 The fossil fuel-fired units displaced in the regional power market are more often coal-fired units with high CO2 emissions.151 As Maryland implements its new EmPOWER Maryland efficiency initiative,152 The Climate Registry methodology is thus unlikely to reflect the full benefits of the new initiative. 143. Local Gov’ts for Sustainability et al., Local Government Operations Protocol, Version 1.0, at 169, 175-76 (2008), available at http://www.icleiusa.org/action-center/tools/lgo-protocol-1 (using system average data in Tables providing default electricity emissions factors). 144. See infra notes 160-67 and accompanying text. 145. The Climate Registry, supra note 10, at 101. 146. Id. 147. Id. 148. The Climate Registry, Electric Power Sector Protocol for the Voluntary Reporting Program, Annex 1 to the General Reporting Protocol, Version 1.0, at 54, 64-67, 76-77 (2009), available at http://www.theclimateregistry.org/downloads/2009/05/Electric-Power-Sector-Protocol_v1.0.pdf. 149. See Nat’l Action Plan for Energy Efficiency, Model Energy Efficiency Program Impact Guide 6-5 (2007), available at http://www.epa.gov/cleanenergy/energy-programs/napee/resources/guides.html#guide5. 150. Information is based on RSG Inc. TMM emissions methodology discussed supra Part I.B.3. 151. Id. 152. See Maryland Energy Administration, Energy Facts and Programs, http:// www.energy.maryland.gov/facts/empower/index.asp (last visited Mar. 25, 2010). Under Maryland’s “EmPOWER Maryland” initiative, the state is work-

The eGRID system average methodology also will not provide an accurate comparison of the cost-effectiveness of alternative GHG reduction strategies that rely on EERE technologies, particularly comparisons of actions in different regions and power markets. For example, the MIT study emphasized that the degree of reliance on higher emitting fossil fuel-fired electricity in a particular power grid will be a greater determinant of the level of avoided emissions from solar photovoltaic energy than the amount of sunshine in a particular region.153 This fact may heighten the CO2 reduction value of solar energy in certain regions, such as the Northern Plains and the Tennessee Valley, which generally are not viewed as promising solar generation areas.154 Furthermore, the adoption of time-of-use pricing in electricity markets155 will require increased emphasis on time-of-use avoided emissions analysis if the cost-effectiveness of energy efficiency programs is to be properly evaluated. The misapplication of the eGRID system average is likely to have sweeping impacts because the broad geographic membership of The Climate Registry has spurred partnerships with other important organizations. For example, in December 2008, ICLEI announced a partnership with The Climate Registry to encourage local governments to report their emissions as members of The Climate Registry.156 Previously, ICLEI had worked with The Climate Registry to develop the Local Government Operations Protocol to facilitate reporting of GHGs by local governments.157 More than 600 local governments in the United States are members of the ICLEI organization.158 Several pieces of national climate legislation also have referenced The Climate Registry’s protocol. For example, H.R. 2454, the American Clean Energy and Security Act of 2009, approved by the House of Representatives in June 2009, references The Climate Registry in its provisions establishing a greenhouse gas registry.159 Section 713(b)(1) requires the EPA Administrator to issue regulations establishing a feding with its utilities to require actions to reduce energy consumption by fifteen percent by the year 2015. Id. 153. Stephen Connors et al., Lab. for Energy & the Env’t, Emissions Reductions from Solar Photovoltaic Systems ES-2, at 8-1 (2005), available at http://solar.gwu.edu/index_files/Resources_files/MIT_Solar%20PV%20Report2004.pdf. 154. Id. at 6-7. 155. Time-of-use rates provide electric consumers with rates that vary over time to reflect the “value and cost of electricity in different time periods.” The purpose of this approach is to encourage consumers “to use less electricity at times when electricity prices are high.” U.S. Dep’t of Energy, Benefits of Demand Response in Electricity Markets and Recommendations for Achieving Them: a Report to the U.S. Congress Pursuant to Section 1252 of the Energy Policy Act of 2005, at v, xi (2006), available at http://www. oe.energy.gov/DocumentsandMedia/congress_1252d.pdf. 156. Press Release, The Climate Registry and Local Gov’ts for Sustainability, ICLEI and the Climate Registry Partner to Track Rigorous GHG Emissions Accounting for Local Governments (Dec. 2, 2008). 157. See Open Letter from Rachel Tornek, Senior Policy Manager, Cal. Climate Action Registry & Garrett Fitzgerald, Dir. Of Programs, ICLEI — Local Govt’s for Sustainability, Local Government Protocol Invitation (Mar. 2, 2008), available at http://www.icleiusa.org/programs/climate/protocol-invitation-letter/?s earchterm=LocalGovernmentOperationsProtocol. 158. ICLEI — Local Governments for Sustainability, About ICLEI, http://www. icleiusa.org/about-iclei (last visited Mar. 5, 2010). 159. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 713 (2009).

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eral greenhouse gas registry, and subsection (b)(1)(E) requires the Administrator to: “[T]ake into account the best practices from the most recent federal, state, tribal and international protocols for the measurement, accounting, reporting, and verification of greenhouse gas emissions, including protocols from The Climate Registry and other mandatory state or multistate authorized programs.”160 Moreover, H.R. 2454 requires the EPA Administrator to explain any major differences in the approach between the registry established under the new regulations and The Climate Registry and other mandatory state and multistate programs.161 The Climate Registry is defined in the legislation as “the greenhouse gas emissions registry jointly established and managed by more than 40 States and Indian tribes in 2007 to collect high-quality greenhouse gas emission data from facilities, corporations, and other organizations to support various greenhouse gas emission reporting and reduction policies for the member States and Indian tribes.”162 Similarly, the provisions of the Senate version of climate legislation establishing a GHG registry also reference The Climate Registry protocols.163 Section 713(b)(1)(E) of the Clean Energy Jobs and American Power Act states that the regulations issued by the EPA Administrator to establish a GHG registry shall “take into account the best practices from the most recent Federal, State, tribal and international protocols for the measurement, accounting, reporting, and verification of greenhouse gas emissions, including protocols from The Climate Registry and other mandatory State or multistate authorized programs.”164 In summary, The Climate Registry is in a key position to develop additional protocols that more accurately reflect the emission reduction benefits of increased use of EERE technologies. The leadership of the Climate Registry has emphasized that corrections and clarifications to its General Reporting Protocol will be necessary as the program evolves.165 The organization has announced plans to release a new version of its General Protocol in 2010,166 and the Authors have sought to facilitate necessary clarifications by sharing the results of the methodology issues raised in this Article with the Climate Registry staff.

Mandatory GHG Reporting Rules

On October 30, 2009, the EPA published a final rule requiring the first-ever national mandatory reporting system for GHGs in the United States.167 Although the October 2009 rule only focused on direct emissions and did not require 160. H.R. 2454 §§ 713(b)(1), (b)(1)(E) (emphasis added). 161. H.R. 2454 § 713. 162. H.R. 2454 § 713(a)(1). 163. Clean Energy Jobs and American Power Act, S. 1733, 111th Cong. § 713(b) (1)(E) (2009). 164. S. 1733 § 713(b)(1)(E) (emphasis added). 165. The Climate Registry, General Reporting Protocol 1.1 Clarifications and Corrections 1 (2008), available at http://www.theclimateregistry.org/ downloads/08.11.24_GRP_Clarifications_and_Corrections.pdf. 166. Id. 167. Mandatory Reporting of Greenhouse Gases, 74 Fed. Reg. 56,260 (Oct. 30, 2009) (to be codified at 40 C.F.R. pt. 98).

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reporting of indirect emissions from electricity purchases,168 the preamble to the final rule indicated that reporting of indirect emissions was likely to be considered in the future.169 Any methodology ultimately adopted by the EPA in a future rulemaking for mandatory reporting of GHG emissions will be extremely important in establishing a precedent for the treatment of indirect emissions from electricity purchases. According to the preamble, the EPA stated: While EPA is not collecting data on electricity purchases in this rule, we understand that acquiring such data may be important in the future. Therefore, we are exploring options for possible future data collection on electricity purchases and indirect emissions, and the uses of such data. Such a future data collection on indirect emissions would complement EPA’s interest in spurring investment in energy efficiency and renewable energy.170

To date, the EPA has not addressed the option of developing two separate inventories for indirect emissions—one to help aggregate reports of GHG emissions from individual entities and a second to account for changes in GHG emissions resulting from increased use of EERE technologies.171 However, since the EPA views the encouragement of EERE technologies as an important goal, it is essential for the EPA to use the appropriate methodology to accomplish its objective. Consistent with the WRI Guidelines, the EPA should use a marginal emissions methodology in any emissions inventory intended to measure reductions in GHGs resulting from increased use of EERE.172 Businesses and policymakers seeking a level playing field for EERE technologies should closely follow EPA’s future rulemaking activities in this area. Moreover, EERE technologies are not the only technologies affected by this methodological problem. The evaluation of air emissions reductions from other electric technologies, such as fuel cells, grid-connected batteries, compressed air and pumped storage and plug-in electric hybrid vehicles, also need appropriate marginal emissions analysis.

Use of TMM Methodology and Related Tools Will Facilitate Inclusion of EERE Measures in State Air Quality Plans

Improved avoided emissions methodologies also would be very beneficial to states seeking credit for reduced emissions resulting from EERE measures as they revise their state air quality plans, formally known as State Implementation Plans (“SIPs”). There is a major opportunity in the next few years to incorporate EERE measures into SIPs as states move forward to revise their plans to meet the eight-hour ozone standard. This effort would be greatly facilitated by providing 168. Id. at 56,289. 169. Id. 170. Id. 171. See id. 172. See infra Part IV (providing a more extensive elaboration of this recommendation); see supra Part I.B.2.-3 (providing a description of the non-baseload and TMM methodologies).

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

user-friendly tools for state and local agency staff to calculate the avoided emissions benefits of EERE technologies. In recent years, the inclusion of EERE measures in state air quality plans has become more important in meeting national air quality standards for several reasons. First, the EPA issued a regulation in March 2008 setting forth a more stringent National Ambient Air Quality Standard for Ozone.173 This regulation revised the eight-hour ozone standard to 0.075 parts per million (ppm), which is more stringent than the previous level of 0.084 ppm.174 In January 2010, the EPA proposed a rule to reduce the ozone air quality standard further, setting the “primary” standard to protect public health at a level between 0.060 and 0.070 ppm.175 As a result of the revised ozone standard, all states will be required to revise their SIPs to demonstrate actions that will bring the state into attainment with the new ozone standard.176 It is anticipated that the states will be required to submit these revised SIPs to the EPA by December 2013.177 Second, although many areas of the country have instituted traditional emission control strategies, they continue to face difficulties in complying with air quality requirements.178 EERE measures offer innovative approaches that can save money and can help reduce emissions at peak demand periods.179 The EPA first authorized states to include avoided emissions from EERE measures in SIPs in August 2004.180 However, since that time, only a handful of states have used the authority to include EERE measures in their SIPs to meet the ozone air quality standard.181 The only states and local governments to include EERE measures in their SIPs have been those assisted by the DOE’s Clean Energy/Air Quality Integration Initiative or by the State & Local Clean Energy-Environment Programs Branch of the EPA’s Office of Air and Radiation.182 These states and local governments include Maryland, Virginia, the District of Columbia, and Connecticut and the Shreveport, Louisiana and Dallas, Texas air quality districts.183 State and local governments generally cannot afford the cost of using proprietary power plant dispatch models, nor do they generally have skilled staff to run the models.184 173. See National Air Quality Standards for Ozone, 40 C.F.R. §§ 50, 58 (2009). 174. See 40 C.F.R. § 50.10 (2009). 175. 40 C.F.R. §§ 50, 58 (2009). 176. See 42 U.S.C. § 7410 (2006). 177. See U.S. Envtl. Prot. Agency, Fact Sheet — Proposal to Revise the National Ambient Air Quality Standards for Ozone 3 (2010), available at http://www.epa.gov/air/ozonepollution/pdfs/fs20100106std.pdf; see also 42 U.S.C. § 7410(a)(1) (2006) (requiring that states adopt revised air quality plans within three years of a new air quality standard being adopted). 178. See Guidance on State Implementation Plan, supra note 22, at 1. 179. See id. 180. Id. 181. See Art Diem, U.S. Envtl. Prot. Agency, Presentation for a Webcast of the Dept. of Energy Clean Energy/Air Quality Integration Initiative 10 (2006) (referencing the Maryland and Dallas SIPs). 182. See U.S. Dept. of Energy, Fact Sheet: States Address Air Pollution from Energy through Energy Efficiency and Renewable Energy Programs (2007), available at http://www.nrel.gov/docs/fy08osti/42168.pdf. 183. Id. 184. See Schiller, supra note 44, at 6-5.

As more counties are designated nonattainment areas under the new eight-hour ozone standard,185 and as ozone nonattainment increases with the “higher concentrations of ground-level ozone in urban areas related to climate change,”186 it is essential to provide states user-friendly tools that allow them to easily and independently incorporate EERE measures into their SIPs. The TMM emissions calculator, which has been developed with support from the DOE Clean Energy/Air Quality Integration Initiative, could fulfill this essential need. It has already been employed by the Metropolitan Washington Council of Governments (MWCOG), the Commonwealth of Virginia, the State of Maryland, and the District of Columbia.187 The MWCOG calculator, which is based on the RSG TMM methodology, allows the user to use standard load profiles for a specific renewable energy or energy savings technology, or project-specific load profiles, and to enter these profiles into an Excel-based spreadsheet.188 In developing its air quality plan to meet the eight-hour ozone standard, the MWCOG staff used the calculator to compute the annual or monthly avoided emission estimates for NOX using the hourly TMM emission rates that were embedded in the calculator.189 An hourly marginal emissions methodology is also ideally suited to assess the benefits of EERE measures on high electric demand days. Energy savings measures that reduce summer electric use “during the days and hours with the highest electrical demand, such as high-efficiency air conditioning and commercial lighting, are particularly valuable in reducing emissions of NOX—a precursor to ground-level 185. See U.S. Envtl. Prot. Agency, Ozone Standards Maps (2010), available at http://www.epa.gov/air/ozonepollution/pdfs/20100104maps.pdf. 186. Intergovernmental Panel on Climate Change, Climate Change 2007: Synthesis Report 48 (2007), available at http://www.ipcc.ch/pdf/assessment-report/ar4/syr/ar4_syr.pdf. 187. The following document issued by the Metropolitan Washington Council of Governments (“MWCOG”) relies on the analysis from the TMM calculator in its chapter on voluntary control measures (Chapter 6) and in Appendix H. Metro. Wash. Council of Gov’ts, Plan to Improve Air Quality in the Metropolitan Washington, DC-MD-VA Region: State Implementation Plan for 8-Hour Ozone Standard 6-61 to 6-82, Appendix H (2007), available at http://www.mwcog.org/environment/air/downloads/SIP_APP/ default.asp. The calculator tools are set forth in Appendix H of the MWCOG document for LED traffic lights, wind energy and the DC RPS. The methodology underlying the calculator tools is set forth in the following document contained in Appendix H of the MWCOG document. See Colin High & Kevin Hathaway, Res. Systems Group, Avoided Air Emissions from Energy Efficiency and Renewable Energy Power Generation in the PJM Interconnection Power Market Area (2007), available at http://www.mwcog.org/environment/air/downloads/SIP_APP/App_H_-_RSG_Avoided_Emissions_Rept_523-07_Draft_Final.pdf. 188. Metro. Wash. Council of Gov’ts, supra note 188, at 6-61. 189. Id. The calculator tool that was initially developed in 2007 has been refined in 2008 and 2009 under a grant issued by the DOE’s Office of Energy Efficiency and Renewable Energy (EERE). The grant was issued to the Virginia Department of Mines, Minerals and Energy under the EERE’s state Energy Program to support a project titled “Promoting Air Quality with Clean Energy in the Metropolitan Washington Region.” The methodology has been further refined under work performed for the DOE’s Loan Guarantee Project Office to encompass GHGs and other pollutants. In view of the NOx emissions trading regime in effect in Maryland, the District of Columbia, and Virginia, the air agencies in these jurisdictions committed to retire NOx allowances in an amount commensurate with the amount of calculated emissions. See id. at Appendix H.

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ozone that causes adverse respiratory effects in adults and children.”190 “Ozone is formed on hot summer days, and the hottest summer days also are typically the days of highest electrical demand—the so-called ‘high electric demand days.”191 Research has demonstrated that daily NOX emissions on high electric demand days from fossil fuel-fired electric generating units in certain regions of the country, such as the Northeast and the Mid-Atlantic regions, substantially exceed emissions on more typical summer days.192 “This result occurs because the peak load generating units used on these limited number of days each year (generally fewer than a dozen days) are typically older units with limited pollution controls.”193 There is a major opportunity to provide access to the TMM method and calculator to state and local governments. States have time to develop and distribute the database and calculator prior to the submission of the SIPs in 2013 and to train state employees to use this tool.

IV.

Recommendations

Based on the findings presented above, this Article offers five recommendations. Adopting these recommendations would substantially advance efforts to measure the full air emission reduction benefits of EERE technologies. First, DOE, EPA, and state air, climate, and energy agencies, including the Board of The Climate Registry, should fund an enhancement of the eGRID database to provide a profile of hourly marginal emissions for each of the 8,760 hours of the year in each of the eGRID subregions. This enhanced eGRID database should cover all power markets as well as all regions and subregions of the North American Electric Reliability Corporation. The enhanced eGRID database would include additional information based on the TMM methodology or a similar methodology (initially using data from Continuous Emission Monitors and other data reported to the EPA). As a result, it should be possible to compile this database for a relatively modest amount of funding relative to the potential benefits. Since the enhanced eGRID database would be extremely useful in obtaining air quality, climate, and energy goals by federal, state, and local agencies, some type of cost-sharing arrangement among these agencies appears reasonable. Alternatively, it seems appropriate to fund such a database on a longer-term basis with funds from allowance auction revenues generated under regional or national climate change legislation. This funding can be justified on the grounds that the data will directly facilitate the development of more accurate GHG reduction estimates. Second, as an interim measure pending the completion of the eGRID enhancement set forth in our first recommendation, the federal government and states should utilize the eGRID non-baseload emissions methodology for calculating 190. Role of Energy Efficiency Programs, supra note 23, at 2. 191. Id. 192. See Ne. States for Coordinated Air Use Mgmt., Final White Paper: High Electric Demand Day and Air Quality in the Northeast (2006). 193. Role of Energy Efficiency Programs, supra note 23, at 2.

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the emission reduction benefits of increased use of EERE technologies. This non-baseload methodology is far more representative than the eGRID system average methodology and has already been developed by the EPA. Moreover, the eGRID non-baseload methodology is recommended for estimating emissions reductions from EERE,194 and this methodology has been adopted by the EPA Green Power Partnership to calculate the GHG emission reduction benefits of renewable power.195 The eGRID non-baseload methodology could therefore serve as a valuable interim approach. During the interim period before the development of an enhanced eGRID database, appropriate agencies should consider allowing state and local governments, such as the MWCOG, and private entities to submit marginal emissions calculations from other verified sources, such as the RSG TMM, instead of using the EPA non-baseload emissions estimates.196 As noted above, recent research by RSG has determined that the difference between the eGRID non-baseload methodology and the TMM methodology can be quite significant for certain regions and technologies. Therefore, reliance on this eGRID non-baseload approach should be only an interim step. Third, DOE, the EPA, and other interested agencies and parties should consider continuing their support of the Northeast Energy Efficiency Partnerships (“NEEP”) Evaluation, Measurement, and Verification (“EMV”) Forum,197 and other similar efforts to develop hourly load profiles for specific EE technologies. The EMV Forum was initiated in 2008 with funding from a number of entities, including DOE and the EPA. There remains strong synergy between the proposed work of the EMV Forum to compile hourly load profiles of various energy efficiency measures with the proposed compilation of hourly marginal emission rates under the TMM and the eGRID non-baseload methodologies. As stated in Part I.B.3, supra, the “time-matching” aspect of the TMM methodology involves matching the load profile for a specific technology against the emissions profile of the marginal units.198 The recommendation for the eGRID enhancement would provide information to generate the hourly emissions data on the marginal units, but the NEEP process and other similar efforts will provide the second piece of the puzzle for energy efficiency resources—the load profile for specific energy efficiency technologies, such as high-

194. Rothschild & Diem et al., supra note 68, at 6. 195. See Green Power Partnership, supra note 107. 196. For example, shortly before the publication of this Article, the PJM Interconnection announced the availability of CO2 emissions data for marginal generating units from January 2005 to December 2009. The related press release stated that this data “can be used to estimate carbon dioxide reductions from demand response, energy efficiency measures and increases in emissions-free generation.” PJM Press Release, supra note 59 (attached graphic and tables comparing CO2 emission rates of marginal generating units compared to CO2 emission rates of system average generating units for 2005 to 2009). 197. See Susan Coakley et al., Ne. Energy Efficiency P’ship, Northeast Evaluation Measurement and Verification Forum: Three-Year Plan 3 (2008), available at http://neep.org/uploads/EMV%20Forum/EMV_forum_ plan_4.08.pdf. 198. See supra Part I.B.3.

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AIR EMISSION REDUCTION BENEFITS OF EERE TECHNOLOGIES

efficiency commercial air conditioning and high-efficiency residential lighting.199 Fourth, DOE, the EPA, and other agencies and entities should initiate additional research to refine the time-matched marginal emissions methodology. Although both marginal emissions methodologies are far more accurate than the system average methodology in estimating avoided emissions from EERE technologies, these marginal methodologies require additional research to overcome certain limitations discussed below.200 Federal and state agencies should consider funding this research to increase the value of the marginal methodologies measurement approach. The most valuable improvement in both the eGRID nonbaseload and TMM methodologies would be an expansion of the methodologies to include the impact of significant grid changes in the mid-term and long-term. This refinement would capture changes in emissions caused by the construction of new power generation units and by the retirement of old units. The two eGRID methodologies and the initial TMM methodology (used for the analysis of the two power markets discussed in this Article) only capture the displacement of existing fossil fuel-fired units on the grid by EERE technologies because they are based on the analysis of historic data. These analyses thus reflect the so-called operating margin201 that dominates near-term changes in emissions. However, leading experts on GHG emission analysis emphasize that the analysis of avoided emissions from gridconnected electric generation over several decades also must consider the impact of new units that may be built on the grid—the so-called build margin.202 Further work is needed to develop cost-effective and transparent methods to capture this “build margin.”203 In addition, electric generation modeling experts suggest that it would be useful to compare the results of at least one leading proprietary dispatch model with the results of the TMM methodology.204 This comparison would be useful to further validate the methodology and to identify any areas of necessary improvement. 199. With respect to renewable energy resources, many of the load shape profiles are already readily available. For example, the National Renewable Energy Laboratory has developed the PVWattsTM calculator to allow researchers to easily determine the energy production of grid-connected “PV” energy systems in different regions of the U.S. and the world. National Renewable Energy Laboratory, Renewable Resource Data Center, PVWatts, http://www.nrel.gov/ rredc/pvwatts (last visited Mar. 5, 2010). The PVWatts calculator works by creating hour-by-hour performance simulations that provide estimated monthly and annual energy production in kilowatts and energy value. Users can select a location and choose to use default values or their own system parameters for size, electric cost, array type, tilt angle, and azimuth angle. In addition, the PVWatts calculator can provide hourly performance data for the selected location. See id. 200. See infra Part I.B.3. 201. See Quantifying GHG Reductions, supra note 13, at 13. 202. See Id. 203. RSG has undertaken initial work related to three NERC subregions to expand its TMM methodology to include projections of the construction of new electric generating capacity based on construction in progress, planned additions, and projections of future plant additions (reflecting alternative public policy scenarios). 204. Telephone Interview with Chris James, Senior Assoc., Synapse Energy Econ., & Jeremy Fisher, Scientist, Synapse Energy Econ. (Winter, 2009).

Finally, we recommend that federal and state regulatory agencies, as well as electric utilities and their trade associations, consider the GHG emission profiles of electric generation in evaluating charging strategies for electric and plug-in hybrid vehicles as well as energy storage technologies. The GHG emissions profile of electric generation varies by region, season, and hour of the day. Unless governmental agencies consider the specific emissions profile of each region, they may fail to develop the optimal strategy for reducing GHG emissions from new technologies for energy storage and advanced electric vehicles.

Conclusion Federal and state agencies involved in climate, air pollution, and energy matters should act promptly to ensure that accurate methodologies are used in calculating reductions in emissions of GHGs and other air pollutants resulting from increased use of EERE technologies on the electric power grid. In particular, the forty states involved in The Climate Registry should consider developing an additional protocol and registry during their planned revisions of the General Reporting Protocol in 2010. The proposed supplementary protocol should incorporate a more accurate methodology based on marginal emissions to account for the increased use of EERE technologies on the electric power grid. Such an approach also should be incorporated into EPA’s Mandatory Greenhouse Gas Reporting Rule and in requirements of climate legislation relating to GHG inventories.

The Taxation of Emissions Permits Distributed for Free As Part of a Carbon Cap-and-Trade Program Gary M. Lucas, Jr.* Introduction Climate change legislation is one of the Obama administration’s top priorities.1 The administration has proposed regulating carbon emissions using a cap-and-trade program.2 If adopted, the program will place a cap on the aggregate carbon emissions of certain firms. Under the program, the government will create emissions permits in an amount corresponding to the cap and will require certain firms to surrender a permit for each ton of carbon emitted. After the government initially distributes permits, firms will be able to buy and sell them on a secondary market. Both the administration3 and many economists prefer that the government initially distribute permits by auction.4 Auctioning permits would raise billions of dollars in revenue and force firms to pay for their emissions.5 Nevertheless, Congress seems unlikely to adopt legislation that auctions all permits.6 In prior cap-and-trade programs, including the acid rain program, the government gave away permits to the firms required to surrender them.7 Similarly, the Waxman*Associate Professor of Law, Texas Wesleyan University School of Law. I thank Marty McMahon and Yariv Brauner for comments on earlier drafts and the participants in the 2009 Central States Law Schools Association Conference for helpful suggestions and ideas. All errors are my own. I also thank my wife, Lisa, for her patience and support. 1.

2. 3. 4. 5. 6. 7.

See Office of Mgmt. & Budget, Exec. Office of the President, A New Era of Responsibility: Renewing America’s Promise 100–01 (2009) [hereinafter OMB Budget Overview]; John M. Broder, Setting ‘Green’ Goals, N.Y. Times, Feb. 27, 2009, at A16; John M. Broder, Obama’s Greenhouse Gas Gamble, N.Y. Times, Feb. 28, 2009, at A15. OMB Budget Overview, supra note 1, at 100–01. See id.; John M. Broder, Adding Something for Everyone, House Leaders Gained a Climate Bill, N.Y. Times, July 1, 2009, at A20. See, e.g., Alan D. Viard, Don’t Give Away the Cap-and-Trade Permits!, 123 Tax Notes 613, 616–17 (2009). See Cong. Budget Office, Cost Estimate: H.R. 2454 American Clean Energy and Security Act of 2009, at 10–12 (2009) [hereinafter Cost Estimate]; OMB Budget Overview, supra note 1, at 100. David Wessel, Pollution Politics and the Climate-Bill Giveaway, Wall St. J., May 23, 2009, at A2 (noting that giving away permits “may be the only politically possible way to get any cap on carbon emissions through Congress”). Terry M. Dinan & Diane Lim Rogers, Distributional Effects of Carbon Allowance Trading: How Government Decisions Determine Winners and Losers, 55 Nat’l Tax J. 199, 201 (2002). Note, however, that the government is not lim-

Markey cap-and-trade bill passed by the House of Representatives in June of 2009 gives away a large portion of permits.8 Assuming that the government gives away emissions permits, an important unresolved issue is whether recipient firms should pay federal income tax on any permits that they receive. This Article addresses that question.9 After adoption of the acid rain cap-and-trade program, which regulates sulfur dioxide emissions, the Internal Revenue Service (“IRS”) issued administrative guidance that allows firms receiving sulfur dioxide permits to exclude the permits from income.10 This means that the permits are not taxed when received. Instead, excluded permits have a tax cost basis11 of zero,12 so a firm that sells permits that it received for free will be taxed on the full amount of the sales proceeds.13 The result is that free permits are not permanently exempt from tax, but instead the tax is deferred. Tax deferral provides firms with a benefit similar to receiving an interest-free loan from the government.14 So deferral is valuable to firms and costly to the government. This Article argues that the government should not extend the tax exclusion that currently applies to free sulfur dioxide permits to free carbon permits.15 Instead, free carbon permits should be taxed when received, which would eliminate costly tax deferral.16

8. 9. 10. 11. 12.

13. 14. 15. 16.

ited to giving permits to the firms required to surrender them. Because they can be sold, permits are valuable even to firms not covered by cap-and-trade. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 782 (2009). The Waxman-Markey bill does not address the taxation of free permits. Rev. Rul. 92-16, 1992-1 C.B. 15. For an explanation of tax cost basis, see infra note 107. See Rev. Rul. 92-16, 1992-1 C.B. 15. A firm receiving free permits might have to capitalize transaction costs, e.g., legal fees, incurred in obtaining those permits, in which case the permits’ tax basis would include the transaction costs. See Rev. Proc. 92-91, 1992-2 C.B. 503. For simplicity, the Article will ignore this possibility and assume that the tax basis of free permits is zero. See I.R.C. § 1001 (2006). See Michael J. Graetz & Deborah H. Schenck, Federal Income Taxation: Principles and Policies 297 (6th ed. 2009) (discussing the benefits of tax deferral). Given that carbon permits will have significant value, eliminating deferral could produce substantial revenue. See infra notes 100 and 110. If permits were taxed upon receipt, they would have a tax basis equal to their initial value and this basis would reduce the taxable gain upon any subsequent sale. See infra note 107.

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Part I discusses the general features and likely distributive effects of a carbon cap-and-trade program. In the long run, consumers will bear most of the program’s costs as the prices of carbon-intensive goods and services increase.17 Nevertheless, after the program is adopted, some firms may suffer transition losses as increased costs reduce their profits.18 Additionally, the government can alter the program’s distributive effects through its control over permits.19 For example, the government could give permits to firms to avoid price increases or to compensate firms for transition losses. If, as seems likely, the government gives permits away, the resulting distributive effects will depend largely on whether the recipient firms are subject to rate regulation. State regulators will likely require that rate-regulated firms use any permits that that they receive to benefit their customers, e.g., by keeping prices low.20 Permits allocated to unregulated firms, however, generally will benefit those firms’ shareholders, not their customers and not consumers.21 Unregulated firms that are required to surrender permits will increase prices to reflect the opportunity cost of using permits in the production process. This means that unregulated firms will increase prices even if they receive permits for free because surrendering permits entails giving up the potential revenue that could be earned from selling them.22 In short, giving permits to unregulated firms generally will not protect consumers.23 Parts II and III consider the appropriate tax treatment of permits given to unregulated firms.24 Part II argues that because the permits will be valuable and easy to sell and will generally benefit shareholders, unregulated firms that receive permits for free have economic income that should be taxed.25 Part II also addresses and rejects the argument that free permits should not be taxed because they will merely compensate firms for transition losses.26 Although cap-andtrade may cause transition losses, free allocation of permits may overcompensate at least some firms, causing them to be better off than if cap-and-trade were not adopted.27 As 17. Cong. Budget Office, Shifting the Cost Burden of a Carbon Cap-andTrade Program 10 (2003) [hereinafter Shifting the Cost Burden]. 18. Id. 19. Id. at 3–4. 20. See infra note 190 and Part IV. 21. By “unregulated,” I mean that that the firms are not subject to rate regulation. 22. See, e.g., Cong. Budget Office, Trade-Offs in Allocating Allowances for CO2 Emissions 5 (2007) [hereinafter Trade-Offs]; Viard, supra note 4, at 616–17. 23. For a caveat to this analysis, see infra note 180. 24. These would include, e.g., the permits that the Waxman-Markey bill gives to merchant coal generators (i.e., unregulated coal-fired power plants) and to oil refineries. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. §§ 783(c), 787 (2009). 25. For a definition of economic income, see infra note 114. 26. For a discussion of this argument, see Joint Comm. on Taxation, Climate Change Legislation: Tax Considerations 9–10 (2009) [hereinafter Joint Comm. on Taxation]. The Joint Committee’s report notes that the IRS may have created a tax exclusion for free sulfur dioxide permits because it did not believe that cap-and-trade produced a net accession to wealth. 27. E.g., Dallas Burtraw & Karen Palmer, Compensation Rules for Climate Policy in the Electricity Sector, 27 J. Pol’y Analysis & Mgmt. 819 (2008) (noting that

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a result, the case for a tax exclusion for free permits is not especially strong. Moreover, because a tax exclusion entails a tax basis of zero, it may produce a significant lock-in effect that causes firms to refuse to sell their permits in order to avoid paying tax on the resulting gain.28 This lock-in effect may increase the overall cost of the cap-and-trade program.29 Additionally, Part III argues that firms should be taxed even if it turns out that the permits that they receive serve only to compensate them for transition losses. Ideally, the government would not use free permits to compensate firms because doing so will invite wasteful lobbying and may result in overcompensation.30 Compensating transition losses also effectively rewards firms that have failed to anticipate climate change legislation and to take steps to reduce their carbon emissions.31 This may discourage firms from anticipating future changes in the law, particularly new environmental regulations, which might result in excessive investment in technologies that are harmful to the environment.32 In short, compensating firms is a bad idea in principle and should be avoided. But if the government chooses to give permits away, then taxing the permits when received will at least reduce the net amount of any compensation. This is desirable because it moves us toward the optimal amount of compensation, i.e., zero. Part IV examines the appropriate tax treatment of permits given to local distribution companies (“LDCs”), which are rate-regulated firms that distribute electricity and natural gas to residential, commercial, and industrial users.33 The Waxman-Markey bill allocates a substantial share of permits to LDCs ostensibly for the benefit of consumers.34 Because LDCs are rate-regulated firms, state regulators will require that they use any permits that they receive to benefit their customers, e.g., by selling the permits to finance rebates. As a result, LDCs arguably will not have economic income from receiving permits.35 Nevertheless, Part IV argues that LDCs should be taxed on any permits that they receive. The rationale is as follows.

28. 29. 30. 31.

32. 33. 34. 35.

“free allocation of allowances . . . may overcompensate producers for their loss in value”); Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. See Ethan Yale, Taxing Cap-and-Trade Environmental Regulation, 37 J. Legal Stud. 535, 547 (2008) [hereinafter Yale I]. Id. at 543. See Burtraw & Palmer, supra note 27, at 836–43 (explaining that allocating permits to compensate electricity generators could lead to overcompensation of many firms). Cf. Louis Kaplow, Transition Policy: A Conceptual Framework, 13 J. Contemp. Legal Issues 161, 181 (2003) [hereinafter Kaplow I] (noting that when the government bans a product without compensating transition losses “the anticipation of transition losses . . . will efficiently discourage . . . investment ex ante”). See Daniel Shaviro, When Rules Change 84–85 (2000) [hereinafter When Rules Change]. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. §§ 783(b), 784 (2009). See id. See Joint Comm. on Taxation, supra note 26, at 9. The view that LDCs will not have economic income is debatable. For further discussion of this point, see infra note 333.

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Giving permits to LDCs is bad policy.36 If LDCs use their permits to provide rebates, the rebates may reduce the incentive to conserve electricity and natural gas and may produce windfalls for the shareholders of the LDCs’ commercial and industrial customers.37 There are more efficient and effective ways for the government to relieve the burden that cap-andtrade imposes on consumers. For example, the government could simply auction permits and send rebates directly to consumers.38 As a consequence, it would be better if LDCs received no permits. But if they do receive permits, then taxing the permits will reduce their net cost to the government and their net value to LDCs. This may be beneficial because it will reduce the amount of any rebates, thereby increasing the incentive to conserve and limiting windfalls to shareholders. It will also increase the amount of revenue available to the government for use in reducing the deficit, cutting taxes, or increasing spending on other programs.39

The General Features and Distributive Effects of a Carbon Cap-and-Trade Program

This Part explains how a carbon cap-and-trade program will likely work and its distributive effects. Section A contains an overview of the program’s general features. Section B describes how the costs that firms incur will be distributed among shareholders, workers, and consumers. Section C discusses how the government can use its control over permits to alter the program’s distributive effects. Section D briefly explains how free permits will affect the value of firms that receive them.

General Features

A carbon cap-and-trade program40 will have two primary features—the emissions cap and emissions permits.41 The emissions cap limits the annual aggregate carbon emissions

36. E.g., Chad Stone & Hannah Shaw, Ctr. on Budget and Policy Priorities, Senate Can Strengthen Climate Legislation by Reducing Corporate Welfare and Boosting True Consumer Relief 1–2 (2009); Chad Stone, Ctr. on Budget and Policy Priorities, Holding Down Increases in Utility Bills Is a Flawed Way to Protect Consumers While Fighting Global Warming 1 (2009) [hereinafter Stone, Holding Down Increases]; Hearing Before the Sen. Comm. on Energy and Natural Resources on the Costs and Benefits for Energy Consumers and Energy Prices Associated with the Allocation of Greenhouse Gas Emissions Allowances, 111th Cong. (2009) (statement of Chad Stone); see also Hearing Before the Sen. Comm. on Energy and Natural Resources on the Costs and Benefits for Energy Consumers and Energy Prices Associated with the Allocation of Greenhouse Gas Emissions Allowances, 111th Cong. (2009) (statement of Gilbert Metcalf ) [hereinafter Statement of Gilbert Metcalf ]; Viard, supra note 4, at 619–20. 37. E.g., Stone, Holding Down Increases, supra note 36, at 4–5; Viard, supra note 4, at 619. 38. Stone, Holding Down Increases, supra note 36, at 1, 7. 39. Whether this outcome is beneficial depends on whether the government would use the additional revenue in a way that is preferable to giving it to LDCs. 40. The cap-and-trade program created by the Waxman-Markey bill incorporates many of the features described in this Section. 41. Emissions permits are sometimes referred to as “allowances,” but this Article uses the shorter term “permits” instead.

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of covered firms42 to a specified amount usually expressed in tons of emissions.43 The program will likely be phased in so that the cap decreases over time.44 The government will distribute a quantity of permits corresponding to the cap.45 One permit confers the right to emit one ton of carbon.46 In other words, a covered firm must surrender a permit for each ton of carbon that it emits during the year.47 Following the initial distribution of permits, firms (and others who wish to do so) can buy and sell permits on the secondary market.48 Firms that own more permits than they are required to surrender can save the excess permits for use in a future year, a feature known as “banking.”49 Analysts anticipate that firms will reduce emissions by more than necessary in the early years of the program so that they can bank permits for use in future years, when the permits will become more expensive as the result of a more stringent cap.50 So in the program’s early years, banking will increase the demand for permits, thereby increasing their price.51 It will have the opposite effect in later years, i.e., it will increase permit supply and decrease permit price.52 Analysts anticipate that firms will bank permits until the expected annual appreciation in permit price provides the firms with a return on banked permits equal to the return on comparable investments.53 The purpose of cap-and-trade is to reduce carbon emissions to the capped level at the lowest possible social cost.54 The program creates flexibility in reducing emissions by allowing firms to take advantage of the fact that the cost of emissions abatement varies across firms and across time.55 For example, if Firm A can reduce emissions at a lower cost than Firm B, instead of requiring that both firms reduce emissions, the program allows A to reduce its emissions and to sell its excess permits to B. This lowers the overall cost of reducing emissions. In theory, cap-and-trade will allocate emissions abatement to the cheapest sources first.56 Firms that find it cheaper to

42. Where it might otherwise be unclear, I use the term “covered firms” to refer to firms that the program requires to surrender permits. 43. Cong. Budget Office, An Evaluation of Cap-and-Trade Programs for Reducing U.S. Carbon Emissions 5 (2001) [hereinafter Evaluation of Cap-and-Trade Programs]; Robert N. Stavins, A Meaningful U.S. Cap-andTrade System to Address Climate Change, 32 Harv. Envtl. L. Rev. 293, 298 (2008) [hereinafter Stavins I]. 44. The cap-and-trade program created by the Waxman-Markey bill is phased in gradually. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 721(e) (2009). 45. See Stavins I, supra note 43, at 298. 46. See Evaluation of Cap-and-Trade Programs, supra note 43, at 5. 47. Id. 48. Id. 49. The Waxman-Markey bill permits banking. H.R. 2454 § 725(a). 50. See, e.g., Cost Estimate, supra note 5, at 15. 51. Id. 52. Id. 53. Id. 54. See Stavins I, supra note 43, at 298; Harvey S. Rosen & Ted Gayer, Public Finance 86–94 (8th ed. 2008). 55. See Stavins I, supra note 43, at 329–330; Rosen & Gayer, supra note 54, at 94; N. Gregory Mankiw, Principles of Microeconomics 216 (4th ed. 2007). The flexibility that a cap-and-trade program allows in reducing emissions is the program’s chief advantage over traditional command-and-control environmental regulation. See Rosen & Gayer, supra note 54, at 94–95. 56. See Stavins I, supra note 43, at 298; Mankiw, supra note 55, at 216.

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reduce emissions than to purchase permits will abate.57 Conversely, firms that find it cheaper to purchase permits than to reduce emissions will purchase permits.58 If the market for permits is efficient, the cost of a permit should equal the marginal cost of reducing emissions by one ton.59 The reason is that each firm that has a marginal abatement cost that is lower than the permit price will abate (selling any excess permits that it holds) until its marginal abatement cost increases to equal the price of a permit.60 Conversely, each firm that has a marginal abatement cost that is higher than the permit price will buy permits until its marginal abatement cost decreases to equal the price of a permit.61 As a result of this process, the permit price will equal the marginal cost of abatement.62

Distribution of the Burden of Costs Imposed on Firms

A cap-and-trade program will impose substantial costs on firms, e.g., permit costs and abatement costs.63 Ultimately, the extent to which these costs reduce profits will depend on whether firms can shift them to employees (by reducing wages) and to consumers (by raising prices).64 To understand why, consider a program that requires fossil-fuel suppliers to surrender permits to cover the potential carbon emissions in the fuels that they sell.65 To preserve profits, the suppliers will attempt to shift their permit costs to employees (by reducing wages) and customers (by raising fuel prices).66 As a result, firms that use fossil fuels, e.g., electricity companies, will pay higher fuel prices. These firms will also incur abatement costs, e.g., the additional costs of generating electricity using alternatives to fossil fuels. Fossil-fuel users will attempt to shift these additional costs to their employees and customers. Ultimately, market interactions will determine how prices (including wages) adjust in response to cap-and-trade, which in turn will determine how shareholders, workers, and consumers share the burden of cap-and-trade’s costs.67 57. 58. 59. 60. 61. 62. 63. 64. 65.

66. 67.

See Stavins I, supra note 43, at 298. Id. See Yale I, supra note 28, at 536–37; Rosen & Gayer, supra note 54, at 86–90. See Rosen & Gayer, supra note 54, at 89–90. See id. See id. Abatement costs include any cost that firms incur to reduce emissions. An example would include the increased cost of producing electricity using renewable energy sources instead of using cheaper fossil fuels. See, e.g., Stavins I, supra note 43, at 304–05; Shifting the Cost Burden, supra note 17, at 2–3. The point of regulation in a cap-and-trade program can be upstream or downstream. Stavins I, supra note 43, at 309. An upstream program requires fossilfuel suppliers to surrender permits to cover potential emissions from burning fossil fuels. Id. A downstream program, on the other hand, requires fossil-fuel users to surrender permits. Id. at 309 n.73. In general, the distributive effects of a cap-and-trade program do not depend on the point of regulation. Id. at 310. In an upstream program, suppliers will raise the price of fossil fuels to reflect permit costs. Id. In a downstream program, fossil fuel users will have to pay permit costs directly. Id. Either way, the program makes using fossil fuels more expensive, which will affect both suppliers and users. Id. See Stavins I, supra note 43, at 304–05; Shifting the Cost Burden, supra note 17, at 2–3. See Stavins I, supra note 43, at 304–05.

Economists expect that in the long run, consumers will absorb most of cap-and-trade’s costs in the form of higher prices.68 Over time, firms that experience reduced returns on their investments in carbon-intensive assets will redirect capital toward more lucrative projects, e.g., renewable energy.69 During the transition to a cap-and-trade program, however, firms, and by extension their shareholders, in industries dependent on fossil fuels, particularly coal, may see their investments decline in value.70 The costs of cap-and-trade may impose transition losses on firms in two ways.71 First, to the extent that a firm cannot shift its additional costs to others, it will lose profit on the goods that it sells.72 Second, if a firm shifts costs to customers, the resulting price increase may reduce sales and eliminate profits from those sales.73

Distributive Effects of Permit Allocation

We have seen that price changes will determine how the costs that cap-and-trade imposes on firms are distributed among shareholders, workers, and consumers. The government can, however, dramatically alter these distributive effects through its control over permits.74 Because the government will create fewer permits than covered firms wish to surrender, permits will acquire a scarcity value.75 The government can capture this value by auctioning permits, in which case its use of auction revenue will substantially determine the program’s overall distributive effects.76 For example, Congress can use auction revenue to

68. See Shifting the Cost Burden, supra note 17, at 10. 69. See id. 70. Id. Similarly, workers in affected industries may lose their jobs or experience wage cuts. See id. at 3, 14. 71. Id. at 3. 72. Id. 73. Id. Economists expect that the industries most likely to experience transition losses are fossil-fuel suppliers, particularly coal companies, electricity generators, oil refineries, and certain energy-intensive industries. See, e.g., A. Lans Bovenberg & Lawrence H. Goulder, Neutralizing the Adverse Industry Impacts of CO2 Abatement Policies: What Does It Cost?, in Behavioral and Distributional Effects of Environmental Policy 45, 66–67 (Carlo Carraro & Gilbert E. Metcalf eds., 2001). 74. See Shifting the Cost Burden, supra note 17, at 3–4. Although the government can use auction revenue or free permits to compensate shareholders, workers, and consumers, it cannot fully compensate everyone. See id. at 4. The reason is that the program’s gross costs (i.e., its costs ignoring any environmental benefits) will exceed the value of the permits. Id. It may seem that cap-andtrade’s most significant cost will be the cost of permits. But in reality, permit costs are not real social costs. See Robert N. Stavins, A U.S. Cap-and-Trade System to Address Global Climate Change 12 (Brookings Inst., Discussion Paper No. 2007–13, 2007). When a firm purchases a permit, it merely transfers income to the seller (e.g., the government or another firm). See id. The loss to the buyer is exactly offset by revenue to the seller. Some of the program’s costs, however, will not involve income transfers. See Shifting the Cost Burden, supra note 17, at 2–4. The program will impose real social costs. Id. It will divert resources to produce goods in a way that reduces carbon emissions and avoids cheap fossil fuels. Id. It will also require consumers to reduce consumption of carbon-intensive goods (e.g., driving). See id. Unlike permit costs, these costs represent real resource costs and welfare losses that will not be recovered elsewhere in the economy. Id. at 3. As a result, when these costs are added to permit costs, the aggregate costs of the program will exceed permit value, making full compensation impossible. Id. at 4. 75. See Shifting the Cost Burden, supra note 17, at 3. 76. Id. at 3–4.

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compensate consumers for price increases or to cut income and payroll taxes.77 Alternatively, the government can give permits away for free. In prior cap-and-trade programs, including the acid rain program, the government gave away permits to covered firms to relieve the regulatory burden imposed upon them.78 Moreover, it seems likely that the government will give away at least some permits if it adopts a carbon cap-and-trade program.79 It may seem that free permits will benefit consumers because firms that receive them will not be forced to increase prices to cover permit costs. Nevertheless, this intuition is incorrect.80 The reason is that covered firms will likely increase prices to reflect the opportunity cost of using free permits in the production process (i.e., the forgone opportunity to sell any permits that are surrendered).81 Paradoxically, firms are likely to charge their customers for using permits for which the firms themselves do not pay. Since firms will not forgo price increases simply because they received their permits for free, free permits generally will benefit the shareholders of recipient firms, not consumers. This analysis, however, does not apply to LDCs.82 State regulators will likely require LDCs to use any permits that they receive to benefit their customers, not their shareholders.83

Second, as already mentioned, covered firms will pass on a substantial portion of their costs to customers by raising prices88 and will even raise prices to reflect the opportunity cost of using permits that they received for free. This may cause some firms to end up in a better position with the capand-trade program in place than without it.89

The IRS has issued administrative guidance addressing the taxation of sulfur dioxide permits distributed for free as part of the acid rain cap-and-trade program.90 Under Revenue Ruling 92-16, firms are not taxed when they receive free sulfur dioxide permits, and as a result, the permits have a tax cost basis of zero.91 Under Revenue Procedure 92-91, a firm that surrenders a permit for compliance purposes takes a tax deduction equal to the firm’s basis in the permit.92 Because free permits have no basis, their surrender generates no deduction. Moreover, a firm that sells permits that it received for free generally will have taxable gain equal to the sales proceeds.93 Unfortunately, Revenue Ruling 92-16 does not provide a rationale for the tax exclusion that it creates.94 One possibility is that the IRS concluded that free permits merely compensate covered firms for transition losses so that on net, cap-and-trade does not make those firms better off even if they receive free permits.95 Sections D and E of this Part address this argument. A second possible explanation is that the IRS was concerned that a secondary market for sulfur dioxide permits would not develop.96 This concern may have arisen because

Free Permits and Firm Value

It may seem that cap-and-trade will necessarily decrease the value of covered firms even if those firms receive free permits.84 Nevertheless, as explained in detail in Part II, free permits may actually increase the value of a covered firm relative to its value prior to adoption of the program. Briefly stated, this can happen for two reasons. First, some firms likely to be covered by the program own low-carbon assets that will increase in value because cap-andtrade will increase the price of the products those assets produce without a proportionate increase in costs.85 For example, many electricity companies own nuclear and hydroelectric facilities in addition to fossil-fuel fired power plants.86 The nuclear and hydroelectric facilities will benefit from cap-andtrade because the program will increase electricity prices, but these facilities will not incur substantial costs.87

77. See id. at 4. 78. See Dinan & Rogers, supra note 7, at 201. 79. The Waxman-Markey bill gives away a large portion of permits to firms. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 782 (2009). 80. E.g., Trade-Offs, supra note 22, at 5; see also Viard, supra note 4, at 616–17. 81. E.g., Trade-Offs, supra note 22, at 5; see also Viard, supra note 4, at 616–17. For further discussion of this point, see infra Part II.E. 82. For an additional exception, see infra note 180. 83. See infra Part IV. 84. This Section discusses cap-and-trade’s effects on unregulated firms. State regulators will likely adjust the prices of rate-regulated firms to ensure that cap-andtrade has little if any effect on their value. 85. See Stavins I, supra note 43, at 305; Burtraw & Palmer, supra note 27, at 826– 27; Dallas Burtraw et al., The Effect on Asset Values of the Allocation of Carbon Dioxide Emissions Allowances, Electricity J., June 2002, at 51, 56–57. 86. See Burtraw et al., supra note 85, at 56. 87. Id. at 56–57.

II. Permits Allocated to Unregulated Firms This Part argues that the government should require unregulated firms receiving permits to include those permits in income for tax purposes. Section A provides background by describing the tax exclusion that currently applies to free sulfur dioxide permits. Section B briefly discusses the tax policy objective of capital income neutrality and how a tax imposed on economic income furthers that objective. Section C explains that a tax exclusion for free permits creates a non-neutral tax preference that may be both inefficient and unfair. Sections D and E address and reject the argument that an exclusion for free permits is justifiable on the grounds that free permits will simply compensate firms for transition losses.

88. 89. 90. 91. 92. 93. 94. 95. 96.

The Tax Exclusion for Free Sulfur Dioxide Permits

E.g., Shifting the Cost Burden, supra note 17, at 10. E.g., Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. Rev. Rul. 92-16, 1992-1 C.B. 15; Rev. Proc. 92-91, 1992-2 C.B. 503. See Rev. Rul. 92-16, 1992-1 C.B. 15–16. See Rev. Proc. 92-91, 1992-2 C.B. 503–04. In certain circumstances, the surrender of a permit may be treated as a nondeductible capital expenditure, e.g., if surrender is treated as a production cost of inventory under I.R.C. § 263A. See id. Rev. Rul. 92-16, 1992-1 C.B. 15–16. See Joint Comm. on Taxation, supra note 26, at 9 (discussing possible reasons for the IRS’s decision to exclude permits from income). See id.

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the acid rain program was the government’s first significant experience with cap-and-trade, and the program applies to a limited number of firms, mostly electricity companies that own coal-fired power plants.97 Without an active secondary market, sulfur dioxide permits would have been difficult to value for tax purposes, and firms might have had trouble selling the permits to raise cash to pay the tax.98 These administrative concerns, however, should not preclude taxing free carbon permits. A carbon cap-and-trade program will likely cover numerous firms from a number of industries.99 Additionally, the value of carbon permits will far exceed the value of sulfur dioxide permits,100 and analysts expect that carbon permits will be traded on an active secondary market.101 So taxing carbon permits should not create insurmountable valuation and liquidity problems.102 Although taxing free carbon permits will be feasible, it would conflict with the IRS’s apparent reluctance to tax government grants of licenses and similar rights.103 Nevertheless, this reluctance is likely based in large part on the same administrative concerns that may explain the tax exclusion for free sulfur dioxide permits.104 Most government grants of noncash property would be difficult to tax, either because the property is hard to value or cannot easily be sold to pay the tax. As already discussed, these administrative concerns should not arise with respect to carbon permits.105 Before considering why the government should not extend the tax exclusion for sulfur dioxide permits to carbon permits, it is important to recognize what is at stake. If a firm receives permits and surrenders those permits in the year of receipt, it generally will not matter whether the permits are included in or excluded from income for tax purposes. As we have seen, excluded permits produce no income upon receipt, which means they have no tax basis and produce no tax deduction when surrendered.106 In effect, the tax system simply ignores the permits. On the other hand, if firms had 97. See id. at 9–10. 98. See id. at 10. 99. The Congressional Budget Office estimates that the Waxman-Markey bill would cover 7,400 facilities in various economic sectors, including electricity generators, refineries, natural gas distributors, and certain carbon-intensive industries. Cost Estimate, supra note 5, at 4–5. This estimate includes facilities covered by a separate, smaller cap-and-trade program regulating hydrofluorocarbons. Id. at 5–7. 100. The Congressional Budget Office estimates that if the Waxman-Markey bill is enacted, the permits eligible to be traded on the secondary market in 2012 will exceed $60 billion in value. Id. at 11. Note that this estimate includes the value of permits issued as part of the separate cap-and-trade program regulating hydrofluorocarbons. Id. 101. E.g., id. 102. See id. (“Within such a large and liquid market, allowances could be easily and immediately traded for cash.”). 103. See, e.g., Rev. Rul. 67-135, 1967-1 C.B. 20; I.R.S. Gen. Couns. Mem. 39,606 (Feb. 27, 1987). For example, Revenue Ruling 67-135 involved leases of oil and gas rights on federal lands administered by the Bureau of Land Management. Rev. Rul. 67-135, 1967-1 C.B. 20–21. The Bureau leased the lands without competitive bidding. Id. The IRS held that a taxpayer who obtained a lease did not have income even if the rent under the lease was below market (so that the lease itself had value). Id. 104. See Joint Comm. on Taxation, supra note 26, at 10. 105. According to the Congressional Budget Office, “the free distribution of allowances by the federal government [under the cap–and–trade program created by the Waxman-Markey bill] would be essentially equivalent to the distribution of cash grants.” Cost Estimate, supra note 5, at 11. 106. Rev. Rul. 92-16, 1992-1 C.B. 15; Rev. Proc. 92-91, 1992-2 C.B. 503.

to include the value of free permits in income, the permits would have a tax cost basis equal to their value at the time of receipt.107 Additionally, surrendering the permits would generate a tax deduction equal to their basis.108 As a result, if a firm were to surrender its permits in the year it received them, surrender of the permits would result in a deduction that fully offset any income from receiving the permits.109 This would produce the same result as if the permits were simply excluded from income. If, however, a firm banks its permits,110 it matters a great deal whether the permits are included in or excluded from income. Excluding the permits defers tax, e.g., until the permits are sold.111 Including the permits would mean that the firm must pay tax in the year of receipt. (Because the firm would take a tax basis in the permits equal to the amount included in income, the permits would not be taxed twice.112) As a result, the benefit of the tax exclusion is deferral. Deferring tax is similar to receiving an interest-free loan from the government.113 The firm gets to invest the deferred amount until the tax is due.

107. When a taxpayer includes the receipt of noncash property in income, generally the property has a tax basis equal to the amount included in income, i.e., its tax cost basis. Boris I. Bittker et al., Federal Income Taxation of Individuals ¶ 29.02[5] (3d ed. 2002); Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts ¶ 41.2.5 (3d ed. 1999); see also I.R.C. § 302(d) (2006) (basis of property received as a result of a dividend); Treas. Reg. § 1.61–2(d)(2)(i) (as amended in 2003) (basis of property received as compensation for services). 108. Rev. Proc. 92-91, 1992-2 C.B. 504. The analysis in the text assumes that, as is the case for sulfur dioxide permits, the surrender of a carbon permit will result in a deduction equal to the permit’s basis. This seems likely. See Joint Comm. on Taxation, supra note 26, at 7, 12–14 (considering the possibilities for taxing permits). 109. As discussed supra note 92, in certain circumstances, the surrender of a permit may be treated as a nondeductible capital expenditure. In that case, surrender of the permit would not immediately result in a deduction that fully offset the income from receiving the permit. Similarly, if the cap-and-trade program allows firms to surrender permits in a year following the year in which emissions occur, it is possible that a firm using the accrual method would be entitled to a deduction in the year the emissions occurred and not in the year the permits are surrendered. See Joint Comm. on Taxation, supra note 26, at 13 n.30. If this were the case and a firm received permits and surrendered those permits to cover emissions in the prior year, the firm could have income from the permits that would not be offset by a deduction (because the firm would have already taken the deduction in the prior year when emissions occurred). 110. The Congressional Budget Office expects that firms would bank a significant number of permits if Waxman-Markey were enacted. Cost Estimate, supra note 5, at 16 (“CBO estimates that by 2019, covered entities would undertake significantly more mitigation than necessary to meet their annual emission caps, banking about 2 billion mtCO2e of allowances.”). 111. See Rev. Rul. 92-16, 1992-1 C.B. 15; Rev. Proc. 92-91, 1992-2 C.B. 503. 112. More specifically, a firm that includes permits in income will receive a subsequent tax benefit either in the form of a deduction (if it surrenders the permits) or tax-free basis recovery (if it sells the permits). A firm that excludes its permits will not receive this benefit. For the excluding firm, however, the trade-off is worth it. As explained in the text, taxpayers generally prefer to defer tax. So a firm would generally prefer to exclude free permits from income rather than include the permits in income in exchange for a subsequent deduction or basis recovery. 113. Graetz & Schenck, supra note 14, at 297.

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Capital Income Neutrality and a Tax on Economic Income

This Part argues that free permits should be taxed if they constitute economic income.114 To that end, this Section briefly explains that a tax on economic income is appealing because it produces capital income neutrality.115 Many tax scholars support the idea of capital income neutrality, which exists in a tax system that imposes the same tax burden on all capital income.116 A tax that is neutral in this sense does not distort the choice among particular investments.117 For example, a tax that exempts income from certain investments but not others is not neutral because it may alter investment decisions. Conversely, a tax on economic income is neutral (assuming that it taxes all types of capital income at the same rate)118 because it extends to all capital income and does not favor particular investments.119 Thus, if we are going to have an income tax, preserving neutrality provides support for using economic income as the tax base (at least when measuring and taxing economic income does not raise significant administrative concerns).120 Capital income neutrality is desirable because it is generally thought to produce an efficient allocation of capital.121 114. Because many of the firms affected by cap-and-trade will likely be corporations subject to the corporate income tax, economic income in this context means corporate economic income, which has been defined as “the algebraic sum of (1) distributions to investors, less advances from investors, and (2) the change in value of [the corporation’s] net worth during the income period.” Leon Gabinet & Ronald J. Coffey, The Implications of the Economic Concept of Income for Corporation-Shareholder Income Tax Systems, 27 Case W. Res. L. Rev. 895, 915 (1977); see also Ethan Yale, When Are Capitalization Exceptions Justified?, 57 Tax L. Rev. 549, 552–53 (2004) [hereinafter Yale II]. This definition of corporate income is based on the Haig-Simons definition of personal income, according to which personal income is consumption plus changes in net worth during the period. Gabinet & Coffey, supra, at 915. Commentators have adapted the Haig-Simons definition of income to fit corporations by dropping the consumption component, retaining the accretion component, and adjusting for distributions to and receipts from investors. 115. Capital income is the income from savings. 116. See, e.g., When Rules Change, supra note 32, at 93–94; Yale II, supra note 114, at 551–52; David A. Weisbach, Measurement and Tax Depreciation Policy: The Case of Short-Term Intangibles, 33 J. Legal Stud. 199, 208–09 (2004); Joel Slemrod & Jon Bakija, Taxing Ourselves 131–34, 216–18 (4th ed. 2008). 117. Yale II, supra note 114, at 551–52. 118. Note, however, that capital income neutrality does not require that capital income and wages be taxed at the same rate. Yale II, supra note 114, at 557. 119. See, e.g., Slemrod & Bakija, supra note 116, at 31 (“A system that taxes some forms of income and does not tax others creates incentives for taxpayers to alter their actions so that they earn (or appear to earn) less of the kind of income that gets counted and more of the kind that does not.”). Even if an income tax exhibits capital income neutrality, the tax will not be neutral with respect to all decisions. By reducing the return to labor and saving, an income tax distorts the decisions to work and save. See generally Jonathan Gruber, Public Finance and Public Policy 611–60 (2d ed. 2007). As a result, some tax scholars advocate replacing the income tax with a consumption tax, which would be neutral with respect to the decision to save. See, e.g., Slemrod & Bakija, supra note 116, at 212–13 (reviewing the arguments in favor of a consumption tax). Nonetheless, if we are going to have an income tax, even consumption tax advocates might favor a broad-based tax that imposes a low rate on all capital income to a tax that imposes a higher rate on income from some investments while exempting income from others. 120. Taxing certain types of economic income, e.g., unrealized appreciation or imputed income from owner-occupied housing, might create administrative problems. 121. E.g., Yale II, supra note 114, at 551; Calvin H. Johnson, Soft Money Investing under the Income Tax, 1989 U. Ill. L. Rev. 1019, 1038 (1989). In theory, in

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Investors direct capital into investments that have the highest expected aftertax returns. So if the government imposes different tax burdens on different types of investments, e.g., by exempting income from certain investments while taxing income from others, then capital may flow into the investments that have the highest expected aftertax returns even if those investments do not have the highest expected pretax returns.122 In other words, capital will not be put to its most productive use. But if the government imposes the same tax burden on all investments, investors will in effect decide among investments based upon their expected pretax returns, which should generally maximize social welfare.123 In addition to being efficient, neutrality is also fair because it avoids windfalls to investors who happen to invest in tax-favored assets.124 If Congress reduces the relative tax burden imposed on a particular asset, e.g., by exempting income from the asset from tax, then investors will begin buying that asset. The increase in demand will increase the asset’s price, thereby reducing its expected rate of return.125 If capital markets were perfect and only top bracket taxpayers purchased the tax-favored asset, its price would continue to increase until its expected rate of return came in line with the expected aftertax rate of return of top bracket taxpayers on similar taxable investments.126 Once this happened, investors would no longer receive a tax advantage from investing in the tax-exempt asset.127 Instead, the tax preference would be capitalized into the asset’s price.128

certain circumstances deviating from neutrality may enhance efficiency. E.g., Slemrod & Bakija, supra note 116, at 131–34. For example, tax preferences may encourage activities that produce positive externalities. Id. at 132–33. Nonetheless, properly identifying appropriate deviations from neutrality is difficult. Id. at 132; Weisbach, supra note 116, at 208–09 (“Optimal tax theories may indicate that some deviation from neutrality is desirable, but the size of the adjustments tends to be sufficiently small and of uncertain direction, and the benefits sufficiently minimal, that most economists assume that neutrality is best.”). Moreover, once we abandon the neutrality norm, Congress may find it more difficult to resist the temptation to enact tax preferences that benefit special interests, even if those tax preferences have no principled justification. Slemrod & Bakija, supra note 116, at 218; When Rules Change, supra note 32, at 94–95. Thus, a strong argument exists for neutrality as a guiding principle with the caveat that exceptions may be appropriate in some instances. 122. E.g., Johnson, supra note 121, at 1038; Bittker & Lokken, supra note 107, ¶ 3.3.3. 123. E.g., Johnson, supra note 121, at 1038. Because it distorts the decisions to work and save, an income tax imposes an efficiency cost even if it does not distort the choice among particular investments. Nevertheless, the idea is that (at least in practice) other things equal, an income tax that imposes the same tax burden on all investments is likely to have a lower efficiency cost than an income tax that favors certain investments and penalizes others. 124. E.g., Johnson, supra note 121, at 1036–38; Yale II, supra note 114, at 552; see also Bittker & Lokken, supra note 107, ¶ 3.3.3 (discussing the circumstances under which a tax preference leads to a windfall); Marvin A. Chirelstein, Federal Income Taxation 431–32 (11th ed. 2009) (same). 125. E.g., Bittker & Lokken, supra note 107, ¶¶ 3.3.3., 3.3.4; Chirelstein, supra note 124, at 429–31; Johnson, supra note 121, at 1036–38; Yale II, supra note 114, at 551–52. 126. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 429–31; Johnson, supra note 121, at 1036–38; Yale II, supra note 114, at 551–52. 127. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 429–31. 128. See, e.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 429–31; Johnson, supra note 121, at 1037; Yale II, supra note 114, at 551–52.

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In reality, however, tax preferences are not always fully capitalized into the price of tax-favored assets.129 Investors often fail to reallocate funds until the aftertax rates of return on similar investments equalize.130 This can produce inequities because taxpayers who happen to invest in tax-favored assets face a lower tax burden and receive a higher aftertax rate of return than taxpayers who invest in similar tax-penalized assets.131 Additionally, to the extent that capitalization does not eliminate the advantage of tax preferences to investors, investors who invest in tax-favored assets effectively receive a windfall from the government without any obvious benefit to society.132 To illustrate, consider what would happen if the government created a special tax exemption for the interest on bonds issued by XYZ Corporation (“XYZ”).133 Assume that XYZ will issue a bond that pays $100 in interest annually in perpetuity. Assume further that similar taxable bonds offer a pretax rate of return of 10% and that all investors pay tax at a flat rate of 50%. Given these assumptions, the aftertax rate of return on taxable bonds is 5%. If XYZ’s bond were not exempt from tax, we would expect it to sell for $1,000. At that price, the bond’s aftertax rate of return would equal 5%, which is the aftertax rate of return available on similar bonds. Because of the tax exemption, however, investors will bid up the price of XYZ’s bond. If capital markets were perfect, the price of the XYZ bond would double to $2,000.134 At that price, the bond would yield 5%, so investors would be indifferent between it and similar taxable bonds. If this were to happen, an investor who bought the bond would in effect not benefit from the tax exemption because the bond’s price would have increased sufficiently to ensure that the investor received only the normal 5% return. In other words, the value of the tax exemption would be capitalized into the price of the bond.135 129. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 431–32; Yale II, supra note 114, at 551–52; Johnson, supra note 121, at 1036–38. 130. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 431–32; Yale II, supra note 114, at 551–52; Johnson, supra note 121, at 1036–38. 131. See, e.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 431–32; Johnson, supra note 121, at 1036–38; Yale II, supra note 114, at 551–52. 132. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 431–32; Johnson, supra note 121, at 1036–38; see also Boris I. Bittker, Equity, Efficiency, and Income Tax Theory: Do Misallocations Drive Out Inequities?, 16 San Diego L. Rev. 735, 743–44 (1979). 133. The example in the text is based on examples found in Bittker & Lokken, supra note 107, ¶ 3.3.3 and Chirelstein, supra note 124, at 427–32. 134. This conclusion assumes that investors expect that the government will not change the tax rate or repeal the tax exemption. It also assumes that creation of the tax exemption for XYZ’s bonds has no effect on the pretax return on other bonds. 135. See, e.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 430–31. If the tax exemption is fully capitalized, XYZ receives the entire benefit. To see why, recognize that without the exemption, XYZ could have borrowed $2,000 only if it had paid $200 in interest annually. In that case, the investor receiving the $200 in interest would have kept $100 and paid the remaining $100 to the government as tax. Because of the tax exemption, however, the government loses $100 in revenue, and XYZ can borrow $2,000 while paying only $100 in annual interest, not $200. Thus, the exemption is a subsidy provided by the government to XYZ, with no benefit to the investor. See, e.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 427–32.

But if we make the example more realistic by assuming that, for whatever reason, the tax exemption is not fully capitalized,136 the result changes significantly. For example, if the price of the XYZ bond increases to $1,500, not $2,000, then an investor who purchases the bond will earn an aftertax return of 6.7%, not 5%. In effect, the government provides the investor with what amounts to a windfall,137 which arguably is unfair because the government receives nothing in exchange.138 Put differently, why should an investor who happens to invest in a tax-favored asset such as the XYZ bond earn a higher aftertax return than an investor who invests in a similar tax-penalized asset?139 In sum, capital income neutrality has broad support because a neutral tax does not distort investment choices. Generally, neutrality is both fair and efficient. A tax imposed on economic income is neutral because it extends to all capital income. This suggests that as a tax policy matter, firms should be taxed when they receive free carbon permits if those permits constitute economic income.

The Tax Exclusion for Free Permits as a NonNeutral Tax Preference

Emissions permits are valuable assets, so a firm that receives them for free has economic income and arguably should have to include the permits in income for tax purposes. This Section will show that a tax exclusion for free permits creates a tax preference that deviates from neutrality. This tax preference may interfere with environmental policy140 and is potentially unfair. The next Section will consider whether, despite these concerns, a tax preference for free permits can be justified. As discussed in the previous Section, tax preferences can distort investors’ behavior, and a number of commentators have pointed out that the tax exclusion for sulfur dioxide permits may do just that.141 In particular, one commentator has used the Cary Brown theorem to show that the tax exclusion creates an incentive to bank free permits and that this incentive may increase the overall social cost of cap-and-trade.142 According to the theorem, under certain conditions, permitting a taxpayer to expense an investment (i.e., to deduct its cost immediately) is equivalent to requiring capitalization but exempting the income generated by the investment 136. One reason this could happen is that in reality, as opposed to the example, investors purchasing tax-exempt bonds may face different marginal tax rates. Thus, tax-exempt bonds may be priced to appeal to taxpayers who are not in the top tax bracket. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 427–32. 137. E.g., Bittker & Lokken, supra note 107, ¶ 3.3.3; Chirelstein, supra note 124, at 430–31. 138. See Johnson, supra note 121, at 1038. 139. See Yale II, supra note 114, at 552. 140. See Yale I, supra note 28, at 543; Jonathan R. Nash, Taxes and the Success of Non-Tax Market-Based Environmental Regulatory Regimes, in Critical Issues in Environmental Taxation 735, 749 (Nathalie J. Chalifour et al. eds., 2008). 141. See, e.g., Yale I, supra note 28, at 535, 543; Nash, supra note 140, at 749. 142. Yale I, supra note 28, at 543. Yale does not address the topic of this Article, i.e., whether the government ought to tax free permits. Instead, he accepts a tax exclusion for free permits as given and explains the ramifications for environmental policy.

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from tax.143 The tax exclusion for free permits is similar to expensing.144 More precisely, excluding permits is similar to including them in income and then expensing the amount included.145 Because an exclusion is similar to expensing, if a firm banks excluded permits, any subsequent appreciation in their value is effectively exempt from tax.146 To illustrate, assume that absent cap-and-trade, Firms A and B would each emit one ton of carbon and have $100 of net earnings during year 1. Assume for simplicity that each firm pays tax at a flat rate of 40%. The government adopts cap-and-trade and at the end of year 1, each firm receives a free permit worth $100. Assume that for tax purposes, the firms can exclude permits from income so that each firm has a tax basis of zero in the permit that it receives. Assume that A surrenders its permit to cover its year 1 emissions. Because it excluded the permit from income, A receives no tax deduction for surrendering the permit, and it pays $40 in tax on its $100 of net earnings. Assume that at the end of year 1, A invests its aftertax income of $60. A then sells its investment at the end of year 2 after the investment appreciates in value by 10%. Table 1 illustrates the results for A. It shows that at the end of year 2 A has $63.60 in cash after paying taxes.

Table 1: Effect of Tax Exclusion for Free Permits

1. Yr. 1 taxable income

Firm A

Firm B

$100

2. Yr. 1 tax

$40

3. Yr. 1 investment

$60

$100

4. Yr. 2 pretax sale proceeds

$66

$110

5. Yr. 2 pretax appreciation 6. Yr. 2 tax 7. Yr. 2 aftertax cash (line 4 minus line 6)

$10

$2.40

$44

$63.60

$66

Now turn your attention to Firm B. Assume that instead of surrendering its permit in year 1, B banks its free permit and chooses to abate its emissions at a cost of $100. (Recall from Part I that if the market for permits is efficient, the marginal cost of abatement should equal the cost of a permit. Thus, a permit price of $100 implies a marginal abatement cost of $100.) Assuming that B’s abatement costs are deductible,147 the deduction offsets B’s net earnings of $100 and reduces the firm’s taxable income to zero. So B pays no tax in year 1. 143. E. Cary Brown, Business-Income Taxation and Investment Incentives, in Income, Employment and Public Policy: Essays in Honor of Alvin H. Hansen 300–416 (Lloyd A. Metzler et al. eds., 1948). For a discussion of the Cary Brown theorem and the conditions under which equivalence holds, see Graetz & Schenck, supra note 14, at 298–301. 144. Yale I, supra note 28, at 544–45. 145. Id. 146. Id. at 544–47. 147. B’s abatement costs would be deductible business expenses unless they constitute capital expenditures. See I.R.C. §§ 162, 263 (2006).

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If permits appreciate at a rate of 10% (i.e., the same rate as the investment that A purchased), the permit that B banked will be worth $110 at the end of year 2. If it sells the permit, B will have a gain of $110. (Because B excluded the permit from income, it has a tax basis of zero.) Table 1 shows that after paying tax on its gain, B is left with $66. Line 7 of Table 1 shows that B has $2.40 more cash than A at the end of year 2. The Cary Brown theorem explains this result. The tax exclusion for free permits has the same effect as including the permits in income and then expensing them, and expensing provides a benefit similar to exempting subsequent appreciation from tax.148 In order to receive the benefit of this exemption, a firm receiving free permits must bank those permits. Because A did not bank its permit, it does not receive the benefit of the exemption. B, on the other hand, banked its permit. Thus, B ends up in the same position in which it would have been if the following had occurred: (1) it included the permit in income, producing $100 of taxable income; (2) it paid tax of $40 on that income; (3) it invested the aftertax income of $60 in an asset that appreciated in value by $6 (i.e., 10%) during year 2; and (4) it did not pay tax on the resulting appreciation. Why does banking produce this result? Abating emissions and banking the free permit allows B to defer payment of $40 in tax on $100 of income. The tax is deferred for one year from year 1 to year 2. Because of deferral, B receives what amounts to an interest-free loan from the government of $40. In effect, B invests the loan proceeds at an aftertax rate of return of 6% for a profit of $2.40. At the end of year 2, B is better off than A by this amount because A did not receive the interest-free loan. Instead, A had to pay $40 in tax on its $100 of net earnings in year 1. This analysis shows that an exclusion for free permits creates a tax preference for banking those permits.149 A and B are identical except for the fact that A surrendered its permit while B reduced emissions and banked its permit. Because B banked its permit, the firm pays $40 less in tax in year 1 than does A. This tax preference for banking would not exist if firms had to include free permits in income. Another way to explain why a tax exclusion for free permits favors banking is the lock-in effect.150 If free permits have no tax basis, a firm that sells them will pay tax on the full amount of the sales proceeds. Zero basis effectively transforms the income tax into an excise tax on the sale of permits. Banking permits allows firms to defer the tax. Thus, firms have an incentive to lock in their investment in free permits and to refrain from selling those permits to other firms. By creating an incentive to bank permits, the tax exclusion for free permits may increase the cost of cap-and-trade.151 If the exclusion encourages firms to bank permits, the current price of permits may rise relative to their future price. Given that the price of permits reflects the marginal cost of abatement, “[t]ax rules will warp the relative costs of abatement in 148. Yale I, supra note 28, at 544–47. 149. See id. at 546–48. 150. Id. at 547. 151. Id. at 543.

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present and future periods, causing the present cost of abatement to increase relative to future costs.”152 The effect on permit price of the tax exclusion for free permits is similar to the effect on the price of the XYZ bond of the tax exemption discussed in the example in the previous Section. The tax exclusion for free permits effectively exempts from tax any appreciation in the value of those permits if the permits are banked.153 So the tax exclusion may encourage firms to bank permits, which could cause the price of permits to rise so that the tax exemption becomes capitalized into permit price.154 If the tax exemption becomes fully capitalized into permit price, firms will no longer have a tax incentive to continue banking permits. On the other hand, if capitalization is less than complete, the price of permits will not increase enough to eliminate the tax advantage of banking. (This might happen, e.g., if holders of zero-basis permits do not dominate the market.) In that case, firms that receive and bank free permits may receive a windfall because the aftertax return on the banked permits may be higher than the aftertax return on similar investment opportunities.155 In sum, a tax exclusion for free permits creates a tax preference for banking those permits. If tax-induced banking increases the permit price, the overall cost of cap-and-trade may increase. By contrast, if the tax preference for banking is not fully capitalized in permit price, firms that receive and bank free permits may experience a windfall. The next Section considers whether this potential windfall is justifiable.

A Tax Exclusion as Rough Justice

Despite the fact that the free receipt of valuable permits produces economic income, recipient firms may argue that a tax exclusion provides a certain rough justice. The argument proceeds as follows. The adoption of a cap-and-trade program may cause some of the assets of certain firms to decline in value.156 (These transition losses may occur, e.g., if a firm is expected to incur costs that it cannot pass on to its customers.)157 If the income tax were imposed on economic income, firms could immediately deduct transition losses, and this deduction would at least partially offset any income resulting from free permits. The problem is that under the actual income tax (as opposed to a tax imposed on economic income) firms cannot immediately deduct transition losses because of the realization requirement.158 As a result, any 152. Id. 153. See id. at 543–48. 154. Id. at 547–48. 155. Arguably, the tax exclusion for free permits will create a windfall for firms even if the resulting tax exemption for subsequent appreciation is fully capitalized into permit price. As discussed infra Part II.E, the receipt of free permits by firms may itself constitute a windfall. To the extent that capitalization of the tax exemption makes permits more valuable, it increases the amount of this windfall. 156. See, e.g., Shifting the Cost Burden, supra note 17, at 3; Burtraw & Palmer, supra note 27, at 825–28. 157. Shifting the Cost Burden, supra note 17, at 3. 158. As a result of the realization requirement, unrealized gains and losses generally are not recognized for tax purposes until the occurrence of a realization event, e.g., a sale. E.g., J. Martin Burke & Michael K. Friel, Taxation of Individual Income 28 (8th ed. 2007); see also I.R.C. § 1001 (2006); Treas. Reg. § 1.1001–1(a) (as amended in 2007).

potential windfall resulting from a tax exclusion for free permits is arguably justified as a mechanism to mitigate the overtaxation that results from the inability to immediately deduct unrealized transition losses.159 Stated differently, if a firm’s transition losses equal or exceed the value of the permits it receives, then on net, the firm has no economic income as a result of cap-and-trade. Instead, the free permits effectively compensate the firm for losses it would otherwise sustain. This rough justice argument, however, suffers from two significant flaws. The first flaw is somewhat technical but still worth noting. Even if free permits merely compensate firms for transition losses, a tax exclusion that results in the permits having zero tax basis does not seem appropriate. If permits constitute compensation then they are analogous to a property damage award and arguably should be treated as a recovery of capital, or more precisely, a recovery for injury to capital.160 The tax consequences of treating free permits as a recovery of capital would mimic the consequences of including the permits in income and simultaneously deducting any losses on the firm’s other assets, except that the deduction would be limited to the lesser of the value of the permits or the tax basis of the other assets. In other words, receipt of the permits would effectively be tax-free to the extent of the firm’s tax basis in its other (non-permit) assets.161 The permits themselves would take a basis equal to their value, and the firm would reduce the basis of its other assets by the value of the permits (but not below zero).162 To illustrate, assume that Firm X owns assets that are worth $1,000 immediately before the government unexpectedly adopts a carbon cap-and-trade program in which X is a covered firm.163 Assume that if the government auctioned all permits, the value of X’s assets would drop to $900 because X’s additional costs (including permit costs) would reduce the firm’s expected profits. This could occur if investors expected that X would be unable to pass on all of its additional costs to its customers. Assume that instead of auctioning all permits, the government gives X, at no charge, permits worth $100. X receives the permits in the year the government adopts the program.164

159. The firms would be “overtaxed” in the sense that the realization requirement causes their taxable income to exceed their economic income. 160. See Raytheon Prod. Corp. v. Comm’r, 144 F.2d 110, 113–14 (1st Cir. 1944) (stating that a damage award is treated as a tax-free recovery of capital to the extent of the taxpayer’s basis in the damaged property); State Fish Corp. v. Comm’r, 48 T.C. 465, 472–73 (1967) (same); Sager Glove Corp. v. Comm’r, 36 T.C. 1173, 1180 (1961) (same). 161. See, e.g., Raytheon Prod. Corp., 144 F.2d at 113–14; State Fish Corp., 48 T.C. at 472–73; Sager Glove Corp., 36 T.C. at 1180. 162. See I.R.C. § 1016(a) (2006); Inaja Land Co., Ltd. v. Comm’r, 9 T.C. 727, 735–36 (1947); Rev. Rul. 70-510, 1970-2 C.B. 159 (holding that amounts received for granting a perpetual easement to flood the taxpayer’s property reduced the basis of the property). 163. Assuming that the program is adopted by surprise avoids the complication of a gradual decline in the value of X’s assets that would likely occur as the estimated probability of cap-and-trade’s adoption increased. 164. Instead of receiving all of its permits in the year the program is adopted, a firm might receive a stream of permits over several years. Receipt of a stream of permits complicates the analysis without materially altering the conclusion, so for simplicity, I assume immediate lump-sum receipt.

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Because the government gives X permits worth $100, adoption of the program has no effect on the firm’s aggregate value. The firm’s old assets, i.e., the assets it owned prior to adoption of the program, are now worth only $900. (To understand why, imagine that after receiving the permits, X sold its old assets but kept the permits. The buyer would not pay more than $900 for the old assets because after it purchased the assets, the buyer would still have to buy permits to cover emissions.) The permits the firm receives, however, are worth $100. So the firm’s aggregate value remains $1,000. In this example, the free permits are just sufficient to compensate the firm for the transition losses it sustains on its old assets. On net, the firm has no economic income or loss, so in a tax imposed on economic income, adoption of the program would have no net effect on taxable income. This does not mean, however, that for tax purposes, X should exclude the permits and give them a tax basis of zero, as it would if the tax exclusion in Revenue Ruling 92-16 applied.165 Instead, in theory at least, X should be taxed as follows. Since the permits are valuable property, X should include them in income and give them a tax basis of $100. Conversely, because the firm’s old assets have declined in value by $100, the firm should deduct this loss immediately. Assuming that prior to the adoption of the program, the firm’s old assets had an aggregate tax basis of $1,000 (i.e., their value at that time), the loss deduction would reduce the aggregate tax basis of the old assets to $900 (i.e., their value after adoption of the program).166 The result is that the income from the permits and the deduction for the loss on the old assets offset one another, producing no net effect on taxable income. Of course, instead of including the permits in income and allowing an offsetting deduction, the same outcome could be achieved by treating the receipt of the permits as a recovery of capital that reduces the basis of the old assets. In effect, X simply needs to transfer $100 of basis from its old assets to the permits. As this example makes clear, an analogy between free permits and a property damage award does not provide support for the tax exclusion created by Revenue Ruling 92-16. The tax consequences of treating free permits similar to a property damage award would generally be similar to including the permits in income and simultaneously deducting an offsetting loss on the recipient firm’s other assets. By contrast, Revenue Ruling 92-16 effectively requires that for tax purposes, firms simply ignore permits that they receive for free, at least until those permits are sold.167 These two approaches differ because the former approach results in permits that have a tax basis equal to their value at the time of receipt, whereas the latter results in permits that have no tax basis. This difference is important because, as the previous Section demonstrated, taxpayers have an incentive to bank permits that have no basis, and tax-induced banking may increase the overall cost of cap-and-trade. This tax preference for banking, however, would not arise if free permits were treated as a 165. Rev. Rul. 92-16, 1992-1 C.B. 15. 166. See I.R.C. § 1016(a) (2006). 167. Rev. Rul. 92-16, 1992-1 C.B. 15.

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recovery of capital and took a basis equal to their fair market value. The second flaw with the rough justice argument is more fundamental. The argument rests substantially on the claim that free permits merely compensate firms for transition losses. Returning to the example, if cap-and-trade had not caused X’s old assets to decline in value, then the free permits would have increased the value of the firm from $1,000 to $1,100. In other words, the permits would have triggered $100 of economic income with no offsetting loss. In that case, no reason would exist not to tax the permits upon receipt. The next Section argues that the claim that free permits will merely compensate firms for transition losses is questionable.

Windfalls Resulting from Free Permits

This Section shows that free permits may do more than just compensate firms for transition losses. The permits can actually increase the value of recipient firms relative to their value prior to adoption of cap-and-trade.168 As a result, the argument for not taxing the permits upon receipt is difficult to sustain. Subsection 1 describes in general terms how a cap-andtrade program with free permits can make firms better off than they would be if the program did not exist. Subsection 2 focuses specifically on firms in the electricity generation industry and explains how a cap-and-trade program will likely affect the value of those firms. I focus on the electricity generation industry because its members will be responsible for a large share of emissions abatement169 and, as a result, will be among the candidates for free permits.170 Subsection 3 explains that because the government may allocate permits for any reason it wants, there is no assurance that permits will simply provide compensation. As a result, the government should tax free permits upon receipt. Subsection 4 argues that firms should be required to include free permits in income despite the fact that doing so creates some potential for overtaxation in certain instances.

Covered Firms Generally

A seemingly intuitive argument can be made that a cap-andtrade program cannot increase the value of covered firms even if those firms receive free permits.171 This argument proceeds as follows. Cap-and-trade places a new regulatory burden on covered firms, i.e., the requirement that the firms surrender permits to cover emissions. Free permits reduce this burden, but only partially. Because firms will not receive all of the permits they wish to surrender, they will still incur 168. Burtraw & Palmer, supra note 27, at 819 (noting that “free allocation of allowances . . . may overcompensate producers for their loss in value”). 169. Id. at 823. 170. The Waxman-Markey bill allocates permits to certain coal-fired power plants. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 783(c) (2009). 171. This argument is similar to an argument that was used to justify the tax exclusion for free sulfur dioxide permits. See Letter from George B. Javaras and Donald E. Rocap, Kirkland & Ellis, to Glenn A. Carrington, Internal Revenue Service (Sept. 18, 1992), reprinted in 208 Tax Notes 46 (1992).

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substantial costs, including the cost of purchasing additional permits. Granted, the government could increase the program’s regulatory burden by auctioning permits. But its failure to do so does not put covered firms in a better position than they were in before the program existed. A grant by the government of limited pollution rights in place of previously unlimited pollution rights does not make covered firms better off.172 In other words, free permits make covered firms better off than if they had to purchase permits at auction. But free permits do not make the firms better off than they were before they were required to surrender permits in the first place. The problem with this argument is that it assumes that because a cap-and-trade program limits the rights of covered firms it must also reduce their value. This assumption is incorrect. For example, a program in which the government auctioned all permits would limit the rights of covered firms and impose significant costs, but it would not necessarily reduce the value of all of those firms.173 The reason is that many firms will be able to raise prices and pass on a substantial portion of their costs to their customers. Additionally, many firms that own carbon-intensive assets also own low-carbon assets that will actually increase in value when the government adopts cap-and-trade.174 This will happen because the program will increase prices of the goods produced using those assets without imposing a proportionate increase in costs.175 Given that the value of all covered firms would not necessarily decline even if the government auctioned all permits, a substantial risk exists that giving permits away will overcompensate many firms for any transition losses that they do in fact incur.176 It may seem that free permits should benefit consumers, not firms, because firms that receive permits for free will not be forced to raise prices. This view, however, is inaccurate. Even if firms receive permits for free, using permits in the production process involves an opportunity cost.177 A firm that uses its permits forgoes the revenue from selling them. Firms make pricing decisions based on opportunity costs.178 In general, firms will increase prices to reflect the opportunity cost of using permits even if the firms received those permits for free.179 As a result, free permits generally will benefit 172. See id. 173. See Stavins I, supra note 43, at 305; Burtraw & Palmer, supra note 27, at 826– 27; Burtraw et al., supra note 85, at 56–57. 174. See Stavins I, supra note 43, at 305; Burtraw et al., supra note 85, at 56–57. 175. See Stavins I, supra note 43, at 305; Burtraw et al., supra note 85, at 56–57. 176. Burtraw & Palmer, supra note 27, at 822 (“The award of free allowances to producers is a blunt instrument for compensation [that] tends to reward winners as well as losers.”). 177. Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. 178. Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. 179. See, e.g., Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. Indeed, these price increases will further the purpose of cap-and-trade by giving consumers an incentive to reduce consumption of carbon-intensive goods. Viard, supra note 4, at 619–20. Note that prices will not necessarily increase to reflect the full cost of permits, whether those costs represent explicit costs or opportunity costs. See, e.g., id. at 616–17. In other words, firms will not be able to raise prices enough to pass on all permit costs to consumers. This does not, however, alter the conclusion in the text that free allocation of permits generally will not stop firms from raising prices and will therefore benefit shareholders, not consumers. For a discussion of why some electricity generators may

the firms that receive them (or more precisely, the shareholders of those firms) and not consumers.180 This partly explains why allocating permits for free can significantly overcompensate covered firms for any transition losses. If the government auctions permits, in effect, money flows from consumers to the government, which captures permit value. This results from a three-step process: (1) money flows from consumers (who pay higher prices); (2) to covered firms (which purchase permits); and (3) then to the Treasury. But if the government gives permits away for free, the third step is omitted. In other words, firms capture permit value because they charge their customers for permits that they themselves receive for free.181 As a result, free permits can produce windfalls for the firms that receive them.182 not be able to pass on all of their permit costs to their customers, see infra Part II.E.2. 180. Trade-Offs, supra note 22, at 5; Viard, supra note 4, at 616–17. The analysis in the text assumes that permits are given to firms based on historical measures over which the firms have no control, e.g., historical emissions. If that is the case, then permit allocations will not affect production decisions and will not result in lower prices but will instead increase profits. See, e.g., Stavins I, supra note 43, at 317 n.96, 319–20. It is possible, however, that the government will update allocations periodically based on output. For example, the Waxman-Markey bill includes output-based updating for some allocations. See, e.g., American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 783(c) (2009) (using output-based updating for allocations to merchant coal generators). Outputbased updating transforms allocations into a production subsidy, which may dampen the price increases that would otherwise result from cap-and-trade. Evaluation of Cap-and-Trade Programs, supra note 43, at 12–15; Stavins I, supra note 43, at 317 n.96. In that case, shareholders and consumers will likely share the benefits of freely allocated permits. Evaluation of Cap-andTrade Programs, supra note 43, at 12–15; Stavins I, supra note 43, at 320 n.102. But even if consumers receive some benefit, output-based updating is problematic. If the government uses free permits to keep prices of certain goods and services artificially low, it will reduce the incentive to conserve. See, e.g., Evaluation of Cap-and-Trade Programs, supra note 43, at 12–15; Stavins I, supra note 43, at 317 n.96; Viard, supra note 4, at 619–20. As a result, emissions abatement will shift from the subsidized sectors of the economy to unsubsidized sectors where it may be more expensive. E.g., Viard, supra note 4, at 619–20. The net result may be an inefficient subsidy that increases the overall cost of cap-and-trade. Id. Consumers will save money on subsidized goods but as a result, may spend even more money on unsubsidized goods. Id. In short, the use of output-based updating to benefit consumers is likely to prove counterproductive. So if the government ultimately uses free permits in this way, it may be best to tax those permits in order to reduce the amount of the inefficient subsidy. Output-based updating creates problems similar to those created by the allocation of permits to LDCs. For a more complete discussion of these problems, see infra Part IV. There is one caveat to this analysis. Output-based updating may be beneficial for allocations to “trade-vulnerable” industries (although this is controversial). See infra note 328. 181. Another way of describing why firms benefit from free permits is as follows. By forcing firms to limit production of carbon-intensive goods, cap-and-trade effectively organizes firms into a cartel, which increases prices and creates the potential for economic rents. Bovenberg & Goulder, supra note 73, at 48–49, 56–60; Lawrence H. Goulder, Mitigating the Adverse Impacts of CO2 Abatement Policies on Energy-Intensive Industries 2 (Res. for the Future, Working Paper No. 02–22, 2002). The potential rents are reflected in permit value. If the government auctions permits, it transforms the potential rents into revenue. If the government gives away permits, it allows firms to retain the rents. 182. Yet another way to think about this is to recognize that a cap-and-trade program in which permits are auctioned is similar to a carbon tax, the burden of which falls primarily on consumers because it increases the prices of carbonintensive goods and services. See Viard, supra note 4, at 613–17. But a cap-andtrade program with free permits for covered firms is similar to a carbon tax in which the government allows firms to keep the tax revenue. See id. Hence the conclusion that free permits can make firms substantially better off than they would be if the cap-and-trade program did not exist.

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Empirical evidence from the European Union (“EU”) supports this conclusion.183 The EU has a carbon cap-andtrade program in which most permits are given away for free to covered firms.184 Economists have concluded that many firms have likely reaped windfalls precisely because the firms have raised prices despite the fact that they do not have to pay for most of their permits.185

Firms in the Electricity Generation Industry

To better illustrate how a carbon cap-and-trade program with free permits may increase the value of covered firms, this Subsection explains the likely effects of the program on the electricity generation industry. This industry is responsible for 40% of carbon emissions, and analysts estimate that it could account for 70% of emissions reduction under a carbon cap-and-trade program.186 Cap-and-trade will impose significant costs on many power plants, so members of the industry will likely lobby for free permits.187 As we will see, a substantial risk exists that any allocation scheme will overcompensate many firms for their potential transition losses.188 This Subsection focuses specifically on what I will refer to as unregulated generators,189 which are firms that sell electricity on competitive markets and that, unlike rate-regulated utilities,190 are not subject to rate regulation.191 The effects of cap-and-trade on the value of unregulated generators will be ambiguous.192 If the government wishes to compensate these firms for transition losses, it will be difficult to estimate those losses (if any) and to determine the appropriate amount of compensation.193 To illustrate why, consider a cap-and-trade program in which electricity generators are covered firms. Market forces 183. See Jos Sijm et al., CO2 Cost Pass Through and Windfall Profits in the Power Sector, 6 Climate Pol’y 49, 67 (2006); Trade–Offs, supra note 22, at 5. 184. Sijm et al., supra note 183, at 49. 185. See id. at 49, 67; Trade-Offs, supra note 22, at 5. 186. Burtraw & Palmer, supra note 27, at 823. 187. As previously noted, the Waxman-Markey bill allocates free permits to certain coal-fired power plants. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 783(c) (2009). 188. Burtraw & Palmer, supra note 27, at 826–28; see also Burtraw et al., supra note 85, at 56–57 (noting that some utilities may profit from cap-and-trade even if permits are auctioned). 189. The Waxman-Markey bill allocates permits to merchant coal generators, which are unregulated generators. See H.R. 2454 § 783(c). 190. I focus on unregulated generators because rate-setting bodies will likely adjust the rates of rate-regulated utilities so that the utilities recover any additional costs and do not suffer significant transition losses. Burtraw & Palmer, supra note 27, at 824. So the government has no reason to use free permits to compensate rate-regulated utilities. As discussed infra Part IV, the Waxman-Markey bill does give free permits to LDCs, the rates of which are regulated, but the bill requires LDCs to use the permits to benefit their customers. H.R. 2454 § 783(b). 191. For a description of unregulated generators, see Energy Info. Admin., U.S. Dep’t of Energy, The Changing Structure of the Electric Power Industry 2000: An Update 21–24 (2000) [hereinafter Electric Power Industry 2000]; Paul L. Joskow, The Difficult Transition to Competitive Electricity Markets in the United States, in Electricity Deregulation: Choices and Challenges 31, 44–49 (James M. Griffin & Steven L. Puller eds., 2005). 192. Burtraw & Palmer, supra note 27, at 826–27; see also Burtraw et al., supra note 85, at 56–57 (noting that cap-and-trade may increase the revenues of some utilities by more than it increases costs). 193. See Burtraw & Palmer, supra note 27, at 821–45 (discussing the difficulties in estimating losses at the firm level).

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will determine the effects of the program on firms that sell power in competitive markets. In competitive wholesale markets, prices generally are set based on generators’ offers, which are accepted in order from the lowest to highest until demand is met.194 The market clearing price is the price of the marginal generator, i.e., the highest offer sufficient to satisfy demand.195 All generators receive the market clearing price, even if they submitted lower offers.196 Because the marginal generator sets the price of electricity, prices in competitive markets depend on the marginal generator’s operating costs.197 This means that prices generally will increase to reflect any costs that cap-and-trade imposes on the marginal generator, including any permit costs.198 Because of this, the effects of cap-and-trade on other generation facilities will largely depend on whether their additional costs per unit of electricity generated are more or less than those of the marginal generator.199 If they are more, the additional costs will cut into profits and reduce the value of the facility.200 If they are less, the facility may increase in value because electricity prices will increase by more than any additional costs.201 This raises an important question: which facilities are the marginal generators in the various markets for electricity? The answer varies from market to market and depends on the time of day and year, but very often, the marginal generator in a particular market is a power plant fueled by natural gas.202 A few details about the electricity industry will assist in explaining why. Electricity cannot be stored, so it must be generated and consumed at virtually the same time.203 Also, demand varies throughout each day and throughout the year.204 As a result, some generation capacity sits idle during off-peak hours (e.g., nighttime).205 Because of their high capital costs and for technical reasons, some power plants (e.g., many nuclear and coal-fired power plants) operate at long-intervals or almost constantly.206 These baseload plants operate during both peak and off-peak hours.207 Other power plants (e.g., many gas-fired power plants) are brought online 194. See Susan F. Tierney et al., Uniform-Pricing Versus Pay-as-Bid in Wholesale Electricity Markets 1–2, 7–8 (2008). 195. See id. 196. See id. 197. Burtraw & Palmer, supra note 27, at 824. 198. See id.; Anne E. Smith et al., Implications of Trading Implementation Design for Equity-Efficiency Trade-Offs in Carbon Permit Allocations 4 n.4 (Charles River Assocs., Discussion Paper, 2002). Sijm, Neuhoff, and Chen, however, discuss several reasons why the price of electricity might not increase sufficiently to fully reflect the permit costs of the marginal generator. Sijm et al., supra note 183, at 51–52. 199. See Burtraw & Palmer, supra note 27, at 829; Smith et al., supra note 198, at 4 n.4. 200. See Burtraw & Palmer, supra note 27, at 829; Smith et al., supra note 198, at 4 n.4. 201. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56–57. 202. See Burtraw et al., supra note 85, at 56; Burtraw & Palmer, supra note 27, at 829; Smith et al., supra note 198, at 4 n.4. 203. Joskow, supra note 191, at 40. 204. Id. 205. Id. 206. See Electric Power Industry 2000, supra note 191, at 9–10 (noting that baseload plants usually operate continuously). 207. See id.

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to meet peak demand.208 The nuclear and coal-fired baseload plants often have lower operating costs (primarily because of lower fuel costs) than the peakload gas-fired power plants.209 This means that in competitive markets, a gas-fired power plant is often the marginal generator that sets the price of electricity (at least during peak hours).210 Because gas-fired power plants often set the price in competitive markets, economists expect that many of these facilities will be able to shift a substantial portion of their additional costs to their customers.211 This means that in many cases, cap-and-trade’s effects on the profits of coal-fired power plants and other generation facilities will depend on whether those facilities’ costs per unit of electricity generated increase by more or less than the costs of gas-fired power plants.212 On the one hand, natural gas emits about half as much carbon as coal per unit of electricity generated.213 This means that if a gas-fired power plant is the marginal generator in a particular market, prices will likely increase enough to allow coal-fired power plants to recover roughly half of their additional costs.214 On the other hand, low-carbon facilities, e.g., nuclear, hydroelectric, and wind facilities, will have no or low additional costs.215 These facilities will experience windfalls as the price of the electricity they produce rises much faster than their costs.216 In general, economists expect that a cap-and-trade program in which permits are auctioned would have the following effects on values at the facility level.217 Many coal-fired power plants would likely decline in value as increased costs cut into profits.218 Low-carbon facilities would likely substantially increase in value.219 To the extent that they serve as the marginal generators in their respective markets, the effects on gas-fired power plants generally would likely be less dramatic than the effects on other types of facilities.220 While the effects on facility values are of interest, what matters for purposes of this Article are the effects of capand-trade on values at the firm level. Firms, not facilities, 208. See id. 209. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56. 210. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56; Smith et al., supra note 198, at 4 n.4. 211. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56; Smith et al., supra note 198, at 4 n.4. 212. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56; Smith et al., supra note 198, at 4 n.4; Sijm et al., supra note 183, at 52–53. 213. Energy Info. Admin., U.S. Dep’t. of Energy, Emissions of Greenhouse Gases in the United States 2000, at 140 (2001); Smith et al., supra note 198, at 4 n.4. 214. Smith et al., supra note 198, at 4 n.4. 215. See Burtraw et al., supra note 85, at 56. 216. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 56. 217. By facility level, I mean at the generation facility or power plant level, as opposed to at the firm level. 218. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 55; Smith et al., supra note 198, at 4 n.4. 219. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 55; Smith et al., supra note 198, at 4 n.4. 220. See Burtraw & Palmer, supra note 27, at 829; Burtraw et al., supra note 85, at 55; Smith et al., supra note 198, at 4 n.4.

serve as taxable units. The argument that free permits should be excluded from income for tax purposes is substantially weakened unless cap-and-trade imposes transition losses at the firm level. Cap-and-trade’s potential effect on firm values can be difficult to determine because many firms own a portfolio of generation facilities.221 As we have seen, some facilities will increase in value and others will decrease in value. The net effect on a particular firm will depend on its energy generation portfolio. In a study that estimates cap-and-trade’s effects on facility and firm values (assuming that the government auctions all permits) researchers concluded that because many firms have diversified energy generation portfolios, net losses at the firm level could be substantially less than gross losses at the facility level.222 Some firms may actually increase in value.223 This research substantially weakens any argument that free permits will merely compensate firms for transition losses. Given that some firms will increase in value even if permits are auctioned, a significant possibility exists that free permits will overcompensate at least some firms and increase their value above what it would be if the government did not adopt cap-and-trade.224

The Government’s Motives in Allocating Permits and the Procedure for Determining Transition Losses

The fact that free permits can increase the value of firms weakens the argument against taxing the permits upon receipt. Free permits are not similar to an award for property damage because we have no guarantee that the permits will simply restore the taxpayer to the position it was in prior to the adoption of cap-and-trade. This point is particularly forceful when you consider that in allocating permits, the government may have mixed motives. It may allocate permits to compensate for transition losses, but it also may allocate permits for any number of other reasons, including the desire to placate powerful interest groups.225 In this respect, con221. See Burtraw & Palmer, supra note 27, at 826–27. 222. Id. at 825–27. 223. Id.; see also Stavins I, supra note 43, at 305. 224. The Waxman-Markey bill contains a provision that allows the Administrator of the Environmental Protection Agency, in consultation with the Federal Energy Regulatory Commission, to adjust permit allocations to merchant coal generators if the Administrator makes an affirmative finding that those generators are receiving windfall profits. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 783(c)(5) (2009). It is not clear, however, how the Administrator will make such a finding and whether the provision will be vigorously enforced. Given the delicate political balance that the bill’s complex allocation scheme achieves and the influence of the special interest groups involved, the Administrator may be reluctant to tamper with permit allocations. Cf. Peter Behr, Power Industry Infighting Heats Up Over Climate Legislation, ClimateWire, July 16, 2009, available at http://www.nytimes. com/cwire/2009/07/16/16climatewire–power–industry–infighting–heats– up–over–clim–38477.html (“Some industry experts said that the Federal Energy Regulatory Commission could, in theory, intervene if [generators] were taking unfair advantage of the allotment program. But such an effort could run into the complex ownership arrangements that the [generators] have for their various coal, nuclear and renewable generation resources, they added.”). 225. See, e.g., Broder, supra note 3, at A20 (discussing the manner in which free permits were used to secure passage of the Waxman-Markey bill).

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trast free permits with a property damage award that results from litigation in which the defendant has a strong incentive to ensure that the award is not excessive. Even if the government’s motives were pure, determining which firms will suffer losses and the amount of those losses will be difficult. For example, a good faith attempt to determine losses at the firm level in the electricity generation industry might require that the government painstakingly net gains at some facilities against losses at others.226 Moreover, the researchers who have attempted to estimate firmlevel losses note that the estimates are not precise and depend on numerous variables.227 For example, delays in implementing the cap-and-trade program (or slowly phasing it in) could substantially reduce transition losses.228 Delays will give firms time to realize the value of existing carbon-intensive assets and to adjust their investments accordingly.229 Because estimating losses is so difficult, it seems unlikely that the government will be able to accurately target allocations only to those firms that might lose value.230 Overcompensation seems especially likely given the fact that the allocation scheme will result from a highly politicized process in which numerous interest groups vie for billions of dollars worth of permits.231 During this process, firms have a significant incentive to exaggerate potential losses and understate potential gains.232

The Potential for Overtaxation

This Section has described in detail the very real possibility that free permits may make at least some recipient firms better off than they would be if the government did not adopt climate change legislation. On the basis of this analysis, I conclude that free permits should be taxed upon receipt.233 Nevertheless, I acknowledge that some firms receiving free permits would otherwise suffer transition losses so that at 226. See Burtraw & Palmer, supra note 27, at 837. 227. Id. at 821–22. 228. Id. at 820–21. 229. Id. 230. Id. at 823 (“[C]onsiderations regarding the difficulty of targeting compensation to its intended recipients . . . might move policy makers away from free allocation.”). 231. Cf. Paul L. Joskow & Richard Schmalensee, The Political Economy of MarketBased Environmental Policy: The U.S. Acid Rain Program, 41 J. L. & Econ. 37, 38 (1998) (“Because emissions permits are valuable and decisions about their distribution are made by political institutions, these decisions are likely to be highly politicized, reflecting rent-seeking behavior and interest group politics.”). 232. See Burtraw & Palmer, supra note 27, at 819 (“Strong incentives exist for parties to argue for an ever-increasing share of emissions allowances through free allocation.”). 233. If the government taxes free carbon permits, a technical issue will arise in the event that a firm receives permits in a year prior to the year in which the permits can be surrendered for compliance purposes. It is possible that the terms of a permit may specify that it cannot be used until a later year. The issue is whether the firm should include the permits in income upon receipt or defer recognizing income until the year the permits are eligible for surrender. See Joint Comm. on Taxation, supra note 26, at 7–8. In principle, the former is preferable. The only reason to defer income recognition is the liquidity problem that might arise if a firm owes tax because income inclusion occurs in a year prior to the year in which the firm takes a tax deduction for surrendering the permits. See id. This, however, should not be a significant problem if, as expected, firms find it easy to sell the permits even though the permits cannot be used until a later year. Id.

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least some portion of the permits that they receive can be viewed as providing compensation. Because the realization requirement prevents immediate deduction of transition losses, requiring that these firms include free permits in income may cause them to be overtaxed. This prospect, however, does not convince me to support a tax exclusion similar to the one created by Revenue Ruling 92-16. Four reasons support my position. First, a strong case can be made in support of a conclusive presumption that firms receiving free permits would not have otherwise suffered transition losses. The realization requirement exists largely because of the difficulty of quantifying unrealized changes in asset values.234 Unrealized transition losses resulting from the adoption of cap-and-trade are no different. As this Section has made clear, even in the absence of free permits, the effects of climate change legislation on firm values would be ambiguous. Some firms would be better off and others worse off. Identifying the firms that will suffer transition losses and quantifying those losses will be difficult. Additionally, it is not clear that the government will use free permits solely to compensate transition losses. Thus, there is no reason not to include free permits in income and apply the realization requirement to disallow the deduction of any unrealized losses. This approach may result in overtaxation in some cases, but the realization requirement frequently results in overtaxation.235 Moreover, any overtaxation may be easier to accept once we consider that cap-and-trade will cause some firms to enjoy unrealized gains so that those firms will effectively be undertaxed. Second, if the problem is that the realization requirement prevents firms from immediately deducting unrealized transition losses, then a tax exclusion that results in free permits having no tax basis is a woefully underinclusive remedy. The exclusion generally will benefit only those firms that receive permits. If a firm suffers transition losses but receives no permits, it will receive no benefit from the exclusion. It is not apparent why a firm that suffers transition losses and receives free permits should receive a tax benefit that is unavailable to a similar firm that receives no free permits. Third, as already discussed, a tax exclusion may lead to tax-induced banking of permits. This in turn may increase the overall cost of cap-and-trade and impede the objectives of environmental policy. Finally, a case can be made for taxing free permits even if those permits merely compensate firms for transition losses. The next Part develops this argument.

234. E.g., Burke & Friel, supra note 158, at 29. 235. The realization requirement can result in overtaxation because by deferring the recognition of unrealized losses, the requirement may increase the present value of a taxpayer’s tax liability. This type of overtaxation is the opposite of the undertaxation that results when the tax on unrealized gains is deferred until realization. For a discussion of the benefits of tax deferral, see supra text accompanying note 113.

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III. Free Permits and Transition Policy This Part argues that taxing permits used to compensate transition losses furthers the objectives of transition policy.236 It makes the case that while compensation may be necessary to secure passage of climate change legislation, it is otherwise undesirable. As a result, the government should, to the extent politically feasible, minimize the amount of compensation. One way to do that is by taxing firms when they receive permits for free. In other words, if the government uses permits to compensate transition losses, then a 100% excise tax imposed upon the receipt of those permits arguably is ideal. A 100% excise tax would produce a result similar to providing no compensation, and providing no compensation would be the best policy if it were politically feasible. Given that an excise tax is not likely, imposing the income tax (which may be possible) is the next best alternative. To illustrate, assume that a particular firm is subject to tax at a rate of 35% and that the firm’s assets decrease in value by $100 when the government adopts cap-and-trade. Ideally (i.e., in a tax on economic income), the government would allow the firm to deduct the $100 loss on its tax return. But the government would not give the firm permits to compensate it for its aftertax loss of $65. Consequently, if the firm does in fact receive permits, taxing those permits is desirable because it reduces the net amount of compensation. This argument is based on the recognition that receiving free permits is tantamount to receiving a cash grant. If the grant itself is bad policy, then taxing the grant reduces its net cost to the government and may therefore be good policy. In recent years, law and economics scholars have developed a consequentialist framework for analyzing transition policy.237 This Part applies that framework to argue against compensating firms for losses stemming from climate change legislation. Section A makes the prima facie case against compensation.238 Section B discusses some potential objections to the noncompensation argument.

The Argument Against Compensating Firms

Changes in the law, i.e., legal transitions, often adversely affect the value of long-term investments, which creates losers.239 Among other things, transition policy addresses

236. For a definition of transition policy, see infra text accompanying note 240. 237. See generally Kaplow I, supra note 31; Louis Kaplow, An Economic Analysis of Legal Transitions, 99 Harv. L. Rev. 509 (1986) [hereinafter Kaplow II]; When Rules Change, supra note 32; Daniel Shaviro, When Rules Change Revisited, 13 J. Contemp. Legal Issues 279 (2003) [hereinafter When Rules Change Revisited]. Some of the ideas that Kaplow and Shaviro develop originated in Michael J. Graetz, Legal Transitions: The Case for Retroactivity in Income Tax Revision, 126 U. Pa. L. Rev. 47 (1977). 238. Daniel Shaviro has argued against giving away permits to firms when the government adopts cap-and-trade programs to control pollution. When Rules Change, supra note 32, at 84–86; When Rules Change Revisited, supra note 237, at 287–88. My argument is largely consistent with Shaviro’s general points, although I discuss a number of issues that Shaviro does not specifically address. 239. Kaplow II, supra note 237, at 511.

whether the government should compensate the losers for their losses.240 Traditionally, commentators advocated compensation or other transition relief241 on the grounds that investors had reasonably relied on current law in making their investment decisions.242 More recently, scholars have challenged this reliance argument.243 Given that the law changes frequently, investors arguably cannot reasonably rely on the status quo.244 Moreover, the government could always negate the reasonableness of reliance by announcing that all laws are subject to change.245 Additionally, investors appear to have no stronger a normative claim to compensation for transition losses than for other types of losses, which typically go uncompensated.246 These criticisms have eroded some of the traditional support for the reliance argument. Recent literature instead focuses on the consequentialist framework for evaluating transition policy,247 which examines the economic and political consequences of transition relief.248 Subsections 1 and 2 use the general conclusions of the consequentialist analysis to argue that the government should not give away permits to compensate firms that suffer losses as a result of cap-and-trade. Subsection 3 offers an additional argument against compensation, namely that it may cause cap-and-trade to be less efficient and equitable by reducing money available for tax cuts and consumer rebates.

Compensation as an Unnecessary and Inefﬁcient Form of Risk Mitigation

The possibility of legal change imposes a risk upon investors and part of the appeal of compensation is that it mitigates this risk.249 Nonetheless, the consequentialist framework 240. Id.; Barbara H. Fried, Ex Ante/Ex Post, 13 J. Contemp. Legal Issues 123, 123 (2003). Legal transitions can also enhance the value of investments. For example, as discussed in Part II, climate change legislation may increase the value of low-carbon assets. Where legal transitions create transition gains, transition policy addresses whether the government should tax away those gains. Kaplow II, supra note 237, at 552–55 (discussing the appropriate treatment of transition gains). As a practical matter, transition losses tend to receive more attention than transition gains if for no other reason than the fact that “losers cry for compensation while winners never cry for taxation.” Id. at 555. The treatment of transition gains is outside the scope of this Article. 241. Transition relief can take various forms, including compensation, grandfathering, delayed implementation, and phase-ins. See When Rules Change, supra note 32, at 216–26 (discussing the various types of transition relief ); Kaplow I, supra note 31, at 187 (same). Whatever its form, transition relief reduces or eliminates transition losses. The analysis in the text focuses on compensation because free emissions permits are effectively equivalent to cash and serve as a type of compensation. 242. Kaplow II, supra note 237, at 522 (discussing and rejecting the reliance argument). 243. See, e.g., Kaplow II, supra note 237, at 522–27; When Rules Change, supra note 32, at 19; Graetz, supra note 237, at 74–79. 244. Kaplow II, supra note 237, at 522; When Rules Change, supra note 32, at 19. 245. Kaplow II, supra note 237, at 522–23. 246. See id. at 523–24 (stating that arguments in favor of reliance often ignore the fact that losses frequently occur for reasons other than government action); Graetz, supra note 237, at 78. 247. See Kyle D. Logue, Legal Transitions, Rational Expectations, and Legal Progress, 13 J. Contemp. Legal Issues 211, 225 (2003) (noting that the consequentialist framework “has come to dominate legal scholarship on transition issues”). 248. See generally the sources cited supra note 237. 249. Kaplow II, supra note 237, at 527–28.

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demonstrates that the risk mitigation function of compensation is often unnecessary and inefficient.250 One of the key insights underlying the consequentialist framework is that from the investor’s perspective, the risk of transition losses is similar to other types of risk.251 A loss is a loss whether it stems from a change in the law, a change in demand for a product, or any other type of market risk. Because we generally regard it is a bad idea for the government to protect investors from market risk, it follows that the government generally should not protect investors from the risk of transition losses unless some good reason can be offered to distinguish the latter from the former.252 Once we recognize the similarity between the risk of transition losses and market risk, the case in favor of compensation is considerably weakened.253 Generally, it is undesirable to use compensation to mitigate the risk of transition losses for the same reason it is undesirable to use compensation to mitigate market risk.254 Investors frequently can mitigate both types of risk on their own (e.g., by purchasing insurance or, more importantly for purposes of this Article, through diversification). Moreover, private risk mitigation mechanisms tend to be more efficient than government-provided compensation.255 Compensation creates inefficient incentives by permitting investors to ignore potential losses,256 which may lead to wasteful overinvestment.257 Additionally, compensation may impose significant administrative costs.258 It requires that the government determine losses ex post when “[p]otential recipients have strong incentives to argue for high valuations.”259 Diversified stock ownership, on the

250. Id. at 526–50; When Rules Change, supra note 32, at 33–42. 251. Kaplow I, supra note 31, at 177; Kaplow II, supra note 237, at 535–36. 252. Kaplow II, supra note 237, at 551 (“[A] general policy of government-provided mitigation [of the risk of transition losses] is inefficient for precisely the same reasons that general government relief for market risks would be inefficient.”); Fried, supra note 240, at 159 (“We do not routinely protect investors against market risk, presumably for what we regard as good reasons. If we are going to single out that portion of market risk that is created by change in government policy, we presumably need some good reason to do so-e.g., considerations of political economy-that distinguishes this case from all others.”). 253. Kaplow I, supra note 31, at 177–80; Kaplow II, supra note 237, at 535–36. 254. Kaplow I, supra note 31, at 177–80; Kaplow II, supra note 237, at 535–36. 255. Kaplow II, supra note 237, at 527–28; When Rules Change, supra note 32, at 42. 256. See Kaplow II, supra note 237, at 538–42. Private risk mitigation mechanisms may also create inefficient incentives. For example, insurance creates the risk of moral hazard. Insureds have a reduced incentive to take steps to avoid covered losses. Similarly, diversification may result in poor incentives. Diversified stock ownership generally entails the separation of management and control, and managers may not have sufficient incentives to account for potential losses that will be borne by shareholders and not the managers themselves. Nevertheless, the market has developed methods of balancing the tradeoff between spreading risk through insurance and diversification and maintaining incentives. Id. at 536–41. Insurance policies frequently provide for co-insurance, deductibles, and premiums that vary with risk, id. at 537–41, and shareholders may be able to monitor managers’ behavior and structure compensation to provide managers with appropriate incentives. 257. Id. at 529 (“The efficient level of investment is that induced when investors bear all real costs and benefits of their decisions. Therefore, the encouragement resulting from the assurance that compensation or other protection will be provided in the event of change results in overinvestment.”). By shifting the burden of transition losses from investors to taxpayers, compensation creates a negative externality. Id. at 531. 258. Id. at 547. 259. Id.

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other hand, avoids this problem because any losses are spread automatically.260 Climate change legislation illustrates the manner in which compensation creates inefficient incentives. If firms expect that they will receive compensation for transition losses when climate change legislation is adopted, they have little incentive to avoid investments in carbon-intensive assets, e.g., investments in coal-fired power plants.261 On the other hand, if firms do not expect compensation, they have an incentive to account for the possibility of transition losses and refrain from overinvestment in carbon-intensive assets.262 Moreover, compensation is an unnecessary and costly way to mitigate the risk of losses resulting from cap-and-trade. Many of the potentially affected firms are public companies whose ownership is dispersed among diversified investors. Diversification will automatically spread transition losses. Compensation, on the other hand, would require that the government make some attempt to determine which firms will suffer losses and the amount of those losses. As we have already seen, ascertaining losses will not be an easy task. Moreover, firms have an incentive to exaggerate their losses, which is likely to result in overcompensation in many cases and in substantial resources wasted on lobbying for free permits.263

Extending the Scope of Future Laws through Anticipation

A second key insight underlying the consequentialist framework is that compensation limits the scope of future laws.264 As we have seen, compensation removes the incentive to anticipate changes in the law. Contrast this with a policy of not providing compensation, which encourages anticipation to avoid transition losses. Anticipation effectively extends the scope of a future law because those who anticipate it will take it into account prior to enactment.265 In other words, the future law will begin to influence behavior even before it is adopted.266 As a result, anticipation will often be desirable where new laws result in progress and improvement.267 Climate change legislation provides an excellent example of how compensation limits the scope of a new law. If firms anticipate that the legislation will include compensation, they have little incentive to alter their investments to take it into account. The legislation will reduce carbon emissions only after it is officially enacted. But if firms do not expect com260. Id. 261. See When Rules Change, supra note 32, at 84–86; When Rules Change Revisited, supra note 237, at 287–88. 262. See When Rules Change, supra note 32, at 84–86; When Rules Change Revisited, supra note 237, at 287–88. 263. When Rules Change, supra note 32, at 85; see also Joskow & Schmalensee, supra note 231, at 38. 264. See When Rules Change, supra note 32, at 26, 47–49; Kaplow I, supra note 31, at 191; Kaplow II, supra note 237, at 572–74. 265. See Kaplow I, supra note 31, at 191; Kaplow II, supra note 237, at 572–74; When Rules Change, supra note 32, at 26, 47–49. 266. See Kaplow I, supra note 31, at 191; Kaplow II, supra note 237, at 572–74; When Rules Change, supra note 32, at 26, 47–49. 267. Kaplow I, supra note 31, at 191; see Kaplow II, supra note 237, at 572–74; When Rules Change, supra note 32, at 26, 47–49.

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pensation, they will take the legislation into account prior to enactment, e.g., by reducing their investments in carbonintensive assets.268 This has the effect of expanding the legislation’s scope and reducing carbon emissions even before the government puts cap-and-trade in place. And assuming that carbon emissions are harmful,269 expanding the legislation’s scope generally will be beneficial.270

Compensation Versus Tax Cuts and Consumer Rebates

Another reason to oppose compensation for losses resulting from cap-and-trade is that it reduces revenue available for tax cuts and consumer rebates. By diverting revenue from tax cuts, compensation may make cap-and-trade less efficient. Because it will increase prices, cap-and-trade reduces the real value of income, and in this sense, it is similar to a tax on earnings.271 As a result, it may alter the incentive to work and create an excess burden that increases the overall cost of the program.272 If the government auctions permits, it can use permit value to cut existing distortionary taxes, e.g., income and payroll taxes. Cutting taxes will at least partially offset the program’s efficiency costs.273 Additionally, by diverting revenue from consumer rebates, compensation (which generally will benefit shareholders who, as a group, have higher than average incomes) may make cap-and-trade less equitable. In sum, while giving away permits reduces auction revenue available for tax cuts and consumer rebates, taxing firms when they receive free permits will offset this effect to some extent.

Potential Objections to the Noncompensation Argument

The previous Section argued that the government should not use free permits to compensate firms for transition losses. This Section addresses eight potential objections to the noncompensation argument. Several of these objections relate to the effects of compensation on investors. Others are based on the claim that compensation may have positive effects on government behavior. The Section concludes that despite these potential objections, the case against providing compensation when climate change legislation is adopted remains strong. This Section also discusses two caveats to the 268. See Kaplow II, supra note 237, at 530 n.56; When Rules Change, supra note 32, at 26, 84–86; When Rules Change Revisited, supra note 237, at 287–88. 269. The argument that carbon emissions contribute to global warming has considerable support among scientists worldwide. See, e.g., Elisabeth Rosenthal & Andrew C. Revkin, Science Panel Says Global Warming is ‘Unequivocal’, N.Y. Times, Feb. 3, 2007, at A1. 270. When Rules Change, supra note 32, at 26, 84–86; When Rules Change Revisited, supra note 237, at 287–88. Shaviro discusses some caveats to this analysis, which I address infra Part III.B. 271. Rosen & Gayer, supra note 54, at 341–42 (citing Ian W.H. Parry and Wallace E. Oates, Policy Analysis in a Second-Best World, 19 J. Pol’y Analysis & Mgmt. 603 (2000)); Shifting the Cost Burden, supra note 17, at 16–17. 272. Rosen & Gayer, supra note 54, at 341–42; Shifting the Cost Burden, supra note 17, at 16–17. 273. Rosen & Gayer, supra note 54, at 341–42; Shifting the Cost Burden, supra note 17, at 16–17.

argument that the government should tax permits used to compensate firms.

Too Late for Anticipation

As we have seen, the case against compensation is based in part on anticipation. Compensation takes away the incentive for investors to anticipate adoption of climate change legislation, which may lead to wasteful overinvestment in carbon-intensive assets and may discourage firms from reducing carbon emissions before the legislation is adopted.274 Thus, part of the objective of removing the prospect of compensation is to alter incentives prior to adoption of the legislation. Of course, now that legislation is receiving serious consideration, any attempt to alter incentives may not have much effect.275 At this point, past investments in carbon-intensive assets are already sunk costs. It may be too late to affect pre-enactment behavior by threatening to withhold compensation.276 This fact, however, does not completely undermine the anticipation-based argument against compensation. If the government compensates firms for losses sustained upon adoption of climate change legislation, firms may be more likely to expect compensation in the event the government adopts cap-and-trade programs or pollution taxes intended to regulate pollutants other than greenhouse gases.277 This expectation of compensation could discourage firms from altering their behavior in anticipation of future pollution control legislation.278 Conversely, if the government refuses to provide compensation when it adopts climate change legislation, that act may contribute to the development of a norm of noncompensation that will encourage anticipation of future cap-and-trade programs and pollution taxes.279 Such a norm would create desirable incentives going forward.

The Possibility of Bad Laws

The argument against compensation rests in part on the objective of extending the scope of future laws. Not providing compensation has this effect because it encourages firms to anticipate future laws and modify their behavior to conform with those laws even before enactment. This response will be beneficial if new laws tend to improve upon the sta274. See When Rules Change, supra note 32, at 84–86; When Rules Change Revisited, supra note 237, at 287–88. 275. Cf. Kaplow II, supra note 237, at 557–58 (noting that the benefits of anticipation will be realized only if the policy of noncompensation is known before a reform is adopted). 276. Cf. id. (noting that this problem arises whenever a policy of noncompensation is not known in advance). 277. Cf. id. (noting that if the government does not consistently follow a policy of noncompensation, the policy will lose credibility). 278. Cf. When Rules Change, supra note 32, at 84–86 (noting that giving permits away as part of the acid rain cap-and-trade program likely created the expectation that permits will be given away if and when the government adopts a carbon cap-and-trade program). 279. See When Rules Change, supra note 32, at 84–85 (arguing that if the government had not given away permits when it adopted the acid rain cap-and-trade program, then it would have established a precedent that might have encouraged firms to anticipate future cap-and-trade programs and pollution taxes).

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tus quo.280 But if new laws frequently are harmful, extending their scope will usually be ill advised.281 For example, if investors anticipate that the government will ban a particular product without compensating firms that produce that product, firms will be less likely to invest in the product in the first place, and its supply will decrease even before the ban is enacted.282 Anticipation will effectively expand the scope of the ban. As a policy matter, this is desirable if the ban is appropriate, but it is not necessarily desirable if banning the product is a mistake.283 If the government does not provide compensation when it adopts climate change legislation, the likely effect will be to expand the scope of future cap-and-trade programs and pollution taxes through anticipation.284 The question that arises is whether this outcome is desirable. The answer largely depends on whether in enacting cap-and-trade programs and pollution taxes the government’s objective is to achieve the optimal level of pollution or to maximize revenues (e.g., through permit auctions).285 If the government has the former objective, anticipation generally will be beneficial. But if the government has the latter objective, it may set the quantity of pollution permits below the optimal level or the amount of pollution taxes above the optimal level, in which case anticipation of new environmental laws may result in excessive pollution abatement.286 So which of these possibilities is more likely? It seems improbable that the government generally will pursue a policy of excessive pollution abatement using pollution permits or pollution taxes.287 This is currently not a common practice.288 Moreover, the firms that would be harmed by this type of policy are often members of well-organized and politically influential special interest groups that are in a good position to defend themselves.289 An additional point is worth noting. Even if new laws are often harmful, the anticipation-based argument against compensation does not fall apart completely.290 If the government is determined to enact a law, even if the law itself is harmful, it may still be beneficial for those who will be affected to anticipate enactment.291 For example, if the government is determined to enact a pollution tax that would render a particular type of facility worthless, it may be efficient if firms that are considering investing in that type of facility take the 280. See Kaplow I, supra note 31, at 191; Kaplow II, supra note 237, at 572–74; When Rules Change, supra note 32, at 26, 47–49. 281. Kaplow I, supra note 31, at 191; see Kaplow II, supra note 237, at 572–74; When Rules Change, supra note 32, at 26, 47–49. 282. Kaplow I, supra note 31, at 191. 283. Id. 284. See When Rules Change, supra note 32, at 84–86; When Rules Change Revisited, supra note 237, at 287–88. 285. See When Rules Change, supra note 32, at 85. 286. See id. 287. Id. 288. Id. 289. Id.; cf. Bovenberg & Goulder, supra note 73, at 46 n.1 (noting that firms that are adversely affected by climate change legislation will have a strong incentive to take political action since the stakes are high). 290. See When Rules Change, supra note 32, at 49; Kaplow II, supra note 237, at 572. 291. See When Rules Change, supra note 32, at 49; Kaplow II, supra note 237, at 572.

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tax into account, regardless of whether the tax is good or bad. But if firms expect to receive compensation when the tax is adopted, they have little incentive to account for the tax in their investment decisions, which may result in wasteful overinvestment.

Irrationality and the Potential Unavailability of Private Risk Mitigation Mechanisms

The argument that compensation is often unnecessary as a risk mitigation device assumes that private actors are rational, appreciate the risk of transition losses, and mitigate that risk if they so desire.292 It further assumes the availability of private mechanisms for mitigating transition risk, e.g., insurance.293 In reality, these assumptions may be false in some cases. Research in behavioral economics and finance suggests that we suffer from numerous cognitive biases that may prevent us from accurately perceiving certain risks.294 In particular, we may fail to appreciate low-probability risks.295 Additionally, market failures, e.g., adverse selection problems, may cause insurance to be unavailable to those who would like to purchase it.296 If people are not rational or if private mechanisms for mitigating risk are unavailable,297 then government compensation of transition losses may be warranted.298 This argument for compensation, however, is not very persuasive when it comes to compensating transition losses resulting from climate change legislation. Climate change is a well-known threat299 and firms have had years to anticipate 292. When Rules Change, supra note 32, at 19–25; Kaplow II, supra note 237, at 548. 293. When Rules Change, supra note 32, at 40–42; Kaplow II, supra note 237, at 536–50. 294. When Rules Change, supra note 32, at 19–25; see also Kaplow II, supra note 237, at 548–50. 295. When Rules Change, supra note 32, at 40; Kaplow II, supra note 237, at 548–50. 296. Kaplow II, supra note 237, at 536–50; When Rules Change, supra note 32, at 40–42. 297. To illustrate the problems that these two conditions create, consider the tax deduction for home mortgage interest. If the government repealed the deduction, home values would likely fall. If homeowners anticipate the possibility of repeal without transition relief they may wish to mitigate this risk. Two problems arise. On the one hand, homeowners may fail to fully appreciate the risk (e.g., because the probability of repeal is so low that they simply ignore it). See Logue, supra note 247, at 225. On the other hand, even if homeowners do perceive the risk, there may be little they can do about it. Insurance companies may refuse to insure the risk because, e.g., insurance might remove the incentive that homeowners have to oppose repeal. See Kaplow II, supra note 237, at 605; Christopher T. Wonnell, The Noncompensation Thesis and Its Critics: A Review of This Symposium’s Challenges to the Argument for Not Compensating Victims of Legal Transitions, 13 J. Contemp. Legal Issues 293, 303 (2003). Moreover, the investment in the home is not easily diversifiable. See When Rules Change, supra note 32, at 41. 298. Kaplow II, supra note 237, at 536–50; When Rules Change, supra note 32, at 40–42; Logue, supra note 247, at 225–26. Even if private actors are irrational or private mechanisms for mitigating risk are unavailable, compulsory insurance may be preferable to ex post compensation. Kaplow II, supra note 237, at 549. Unlike compensation, a mandatory insurance program may be able to maintain appropriate incentives through the use of premiums. Id. 299. The debate over climate change has received enormous attention for over two decades. See, e.g., Philip Shabecoff, Global Warming Has Begun, Expert Tells Senate, N.Y. Times, June, 24, 1988, at A1 (discussing the congressional testimony of Dr. James Hansen of NASA regarding the warming effects of greenhouse gases).

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and prepare for legislation that regulates carbon emissions.300 Climate change legislation is not the sort of low-probability risk that potentially affected firms are likely to have ignored or failed to appreciate.301 Additionally, many firms that a cap-and-trade program might harm are public companies with numerous shareholders. Diversification can spread various kinds of risks, including low-probability risks of which a particular investor is not aware and risks against which a particular firm cannot insure.302 The possibility of diversification may make the risk-mitigation function of government compensation largely unnecessary even if investors are sometimes irrational.303

Fairness and the Distributive Effects of Cap-and-Trade

The benefits of mitigating climate change will be shared broadly by both the general public and by future generations. Although consumers will bear most of cap-and-trade’s cost, the burden on consumers will be diffuse and may be partially or completely offset by the environmental benefits that consumers will enjoy.304 On the other hand, certain firms will sustain large losses.305 These firms might argue that the government should compensate them so that the burden of the program is more evenly distributed among the program’s beneficiaries. In other words, firms might argue that it is only fair that the government compensate them for the losses they sustain as a result of a program that will benefit society generally.306 Although fairness can be an elusive concept, a number of considerations undercut the argument that compensation is fair in this instance. First, the purpose of cap-and-trade is to force covered firms and their customers to bear the full cost of carbon emissions. Up to this point, firms have imposed these costs on others. A (perhaps controversial) argument exists that the firms responsible for carbon emissions should

300. See, e.g., William K. Stevens, Meeting Reaches Accord to Reduce Greenhouse Gases, N.Y. Times, Dec. 11, 1997, at A1 (discussing the Kyoto Protocol, under which a number of countries agreed to reduce greenhouse gas emissions). 301. Cf. Kaplow II, supra note 237, at 549 (arguing that misperception of risk is of less concern when the entity subject to risk is a firm that has sophisticated managers as opposed to an individual dealing with personal risk); Duke Energy Co., 2004 Summary Annual Report 4–5 (2004) (announcing the company’s intention to “shape public policy” with respect to climate change in order to “advance the interests of [its] investors and customers”). 302. See Kaplow II, supra note 237, at 600–01. For example, because some firms in the electricity industry will increase in value if and when the government adopts a cap-and-trade program, investors have the opportunity to significantly reduce their net transition losses simply by holding a portfolio of diversified stocks within the electricity sector. See Burtraw & Palmer, supra note 27, at 827–28. Diversification outside the electricity sector would further mitigate transition risk. 303. Kaplow has pointed out that when diversification is possible, compensation often will be unnecessary to mitigate risk even if investors fail to appreciate the risk or if insurance is unavailable. Kaplow I, supra note 31, at 178 n.30. 304. See Bovenberg & Goulder, supra note 73, at 46 n.1. 305. Id. at 45-46. 306. The argument that fairness requires that the government broadly distribute the burden of transition losses is a familiar one. Kaplow II, supra note 237, at 576–77.

be left with any transition losses resulting from a program that responds to their own harmful activity.307 Second, the argument that the government should use compensation as a device for distributing the burden of transition losses ignores the fact that investors can mitigate the risk of those losses through diversification.308 Although firms may suffer concentrated losses, investors’ losses generally will be diffuse as long as those investors own diversified portfolios. If losses are diffuse, fairness concerns become less significant.309 Additionally, to the extent that particular investors suffer concentrated losses because they have chosen not to diversify, compensation largely loses its appeal. The failure to diversify constitutes either a deliberate gamble310 or poor investment strategy. If the former is true, i.e., if an investor has in effect bet against climate change legislation, then no normative claim to compensation exists. After all, “[n]o principle of ethics requires that Monte Carlo produce only winners.”311 If the latter is true, the problem may suggest a need for investor education programs, but it would not appear to warrant government compensation of losses. Incompetent investors lose money every day for a variety of reasons, and the government does not compensate those losses. Why should the government treat losses resulting from climate change legislation any differently? Finally, the distributive effects of providing compensation to firms may lead some to conclude that doing so would be unfair. As discussed in Part II, free permits generally will result in a transfer of wealth from consumers to shareholders. In general, shareholders have above-average incomes.312 So assuming that the shareholders of firms receiving free permits are characteristic of shareholders generally, free permits will largely benefit individuals with above-average incomes.313

307. N. Gregory Mankiw, Smart Taxes: An Open Invitation to Join the Pigou Club, 35 E. Econ. J. 14, 18 (2009); cf. E. J. Mishan, The Post-War Literature on Externalities: An Interpretative Essay, 9 J. Econ. Literature 1, 25 (1971) (“[I]t may be argued [that] the freedom to operate noisy vehicles, or pollutive plant, does incidentally damage the welfare of others, while the freedom desired by members of the public to live in clean and quiet surroundings does not, of itself, reduce the welfare of others. If such arguments can be sustained, there is a case . . . for making polluters legally liable.”). 308. Cf. Kaplow II, supra note 237, at 536 n.74 (explaining that the financial markets have the ability to spread risk almost as broadly and perhaps even more broadly than the government). 309. Cf. Kaplow I, supra note 31, at 171 (arguing that the question of how transition losses ought to be distributed is best viewed from an ex ante perspective and treated as a problem involving the imposition of risk). 310. Cf. When Rules Change, supra note 32, at 18, 34–35 (arguing that anyone who invests in a firm subject to the risk of transition losses is implicitly betting against an adverse change in the law unaccompanied by compensation); J. Mark Ramseyer & Minoru Nakazato, Tax Transitions and the Protection Racket: A Reply to Professors Graetz and Kaplow, 75 Va. L. Rev. 1155, 1159–60 (1989) (discussing the idea that if prices of investments are discounted ex ante to reflect the risk of transition losses, then purchasing those investments involves a gamble and investors cannot argue ex post that the government’s failure to relieve transition losses is unfair). 311. Ramseyer & Nakazato, supra note 310, at 1160. 312. See Ian W.H. Parry, Are Emissions Permits Regressive?, 47 J. Env’t. Econ. & Mgmt. 364, 375 (2004). 313. Id. at 364–79.

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Political Feasibility

Giving permits to firms may be politically expedient. Regardless of the merits of the approach, the reality is that free permits will reduce opposition to cap-and-trade by industries that might otherwise use their disproportionate political influence to prevent its adoption.314 Note that any argument for using permits to gain the support of special interests is not based on compensation’s intrinsic merits. In fact, a firm that wants permits need not demonstrate a loss at all. The firm merely has to show that it has sufficient power to warrant a payoff. In any event, if the only rationale for compensation is that it will facilitate desirable legislation, then the government should (to the extent politically feasible) minimize the cost of giving permits away. Taxing firms when they receive free permits will reduce the government’s overall cost.315

Compensation as an Instrument for Improving Government Decision Making

In some contexts, compensation may improve government decision making. For example, the requirement that the government compensate landowners for takings of property may be justified at least in part by the notion that compensation forces the administrators of agencies that engage in takings to internalize the costs imposed by their decisions—costs that these administrators might otherwise ignore.316 Although this argument may be persuasive with respect to takings, it has less force when applied to climate change legislation. Takings generally involve action by administrative agencies.317 Because agencies are subject to a budget constraint imposed by the legislature, administrators may be more likely to give weight to direct outlays that appear on an agency’s budget than to any off-budget costs imposed by an agency’s actions.318 Climate change legislation, on the other hand, will be enacted by Congress, which is subject to a different set of political forces. Many of the benefits of climate change legislation will be diffuse (i.e., enjoyed by the general public and future generations), but part of the costs will be concentrated in particular industries.319 Under these circumstances, the public choice theory of interest group politics suggests that industry groups are more likely to organize and lobby in opposition to the legislation than the general public is likely to organize and lobby in favor of it.320 If this is correct, lobbying efforts may cause Congress to assign too much weight to the concentrated costs incurred by industry relative 314. See, e.g., Stavins I, supra note 43, at 351–52; cf. Kaplow II, supra note 237, at 571–72 (discussing considerations that arise when the government uses transition relief to secure enactment of a law). 315. For example, if a firm pays tax at a rate of 35% and if the receipt of permits is taxable, then giving the firm a permit worth $100 will impose a net cost on the government of only $65. 316. When Rules Change, supra note 32, at 78–79. 317. Id. at 78. 318. Id. (citing William A. Fischel, Regulatory Takings: Law, Economics, and Politics 207 (1995)). 319. Bovenberg & Goulder, supra note 73, at 45–46. 320. See id. at 2 n.1. Lobbying efforts by environmental groups and by industry groups that will benefit from climate change legislation, e.g., firms that specialize in renewable energy, may offset this effect to some extent.

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to the diffuse benefits enjoyed by the public. Thus, in this instance, it does not appear that compensating firms will be necessary to ensure that Congress will take their potential losses into account. In fact, as we have seen, some proponents of climate change legislation favor giving permits away precisely because they believe doing so is necessary to overcome the disproportionate political influence of certain industry groups.

Compensation as a Restraint on Government Action

A related but more general argument in favor of compensation is that mandatory compensation may restrain government action in certain cases.321 As a result, it may appeal to those who believe that changes in the law are often detrimental and should be avoided or who fear that the government is prone to single out particular individuals or groups for punishment.322 The restraint argument may justify a compensation requirement in certain contexts, e.g., where a law applies narrowly to a particular individual or small group that has little political power. But in other contexts, restraining government through mandatory compensation may be undesirable.323 Any benefits of doing so have to be balanced against the costs that compensation imposes (1) by taking away the incentive of private actors to anticipate new laws;324 (2) by requiring that the government establish procedures for determining the correct amount of compensation;325 (3) by giving private actors an incentive to waste resources lobbying for an ever larger piece of the pie; and (4) by creating the potential for overcompensation of groups that have disproportionate political influence. These concerns are especially significant when a law affects a large number of private actors (as opposed to an individual or a small group) in ways that are not easy to quantify, as would be the case for climate change legislation.326

Free Permits as Compensation for Overtaxation

As discussed in Part II, some firms may be overtaxed in the year the government adopts climate change legislation because they will suffer unrealized transition losses that they cannot immediately deduct for tax purposes. Should the

321. Kaplow II, supra note 237, at 575; Richard A. Epstein, Beware of Legal Transitions: A Presumptive Vote for the Reliance Interest, 13 J. Contemp. Legal Issues 69, 71–72 (2003). 322. Kaplow II, supra note 237, at 575–76; Epstein, supra note 321, at 71–77. 323. See Kaplow II, supra note 237, at 575–76. 324. See id. at 567 (arguing that the benefits of using compensation to prevent government decision makers from undervaluing the costs imposed by their actions must “be balanced against its adverse incentive effects”). 325. See id. at 547 (discussing the administrative costs of compensation). 326. Richard Epstein, who favors the use of transition relief as a restraint on certain types of government actions, has noted that compensation may in many cases prove untenable for generally applicable laws that affect a large number of private actors. Epstein, supra note 321, at 75–76.

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government use free permits to compensate firms for this overtaxation? I believe that the answer is no. First, it is important to keep in mind that although transition losses are not deductible immediately, they may ultimately be deducted either upon realization or through depreciation. This mitigates (but does not eliminate) any overtaxation. Second, given that overtaxation (as well as undertaxation) is an inevitable consequence of our realization-based income tax, it is not clear why compensation should be awarded in this particular circumstance. Third, as emphasized throughout this Article, quantifying a particular firm’s transition losses, if any, will be a difficult task. Quantifying the amount of any overtaxation resulting from the inability to immediately deduct those losses would be even more difficult. Under these circumstances, any attempt to provide compensation invites firms to waste resources lobbying for permits. To summarize, using free permits to compensate firms for transition losses is arguably bad transition policy. The government should avoid compensation altogether. But if that proves impossible, taxing the permits when received will at least reduce the government’s net cost and is therefore desirable.327

If the government uses permits to provide subsidies for the public’s benefit, whether these permits should be taxed arguably depends on, among other things, the optimal amount of the subsidy. After all, taxation simply reduces the net subsidy. This might be desirable if the pretax subsidy is either too large or otherwise ill advised, but it might be undesirable if the pretax subsidy is either optimal or too small. Although this argument may have some merit, a strong case exists that all permits should be taxed upon receipt, regardless of the motive for allocation. It seems likely that the government will adopt only one rule applicable to all permits and will not tax some permits while exempting others from tax. Given this constraint, the better rule is to tax all permits. As already discussed, taxing permits may have the desirable effect of limiting the amount of compensation provided to firms. Additionally, for political reasons, Congress may attempt to disguise as a program that benefits the public a program that amounts to little more than a grant of government funds to a politically influential industry. In any event, if Congress determines that in certain cases, taxation reduces the pretax subsidy for a particular program below the optimal amount it can always increase the subsidy by making cash grants, assuming that doing so is politically feasible.

IV.

Two Caveats

This Subsection briefly discusses two caveats to the argument that the government should tax permits used to compensate firms. The first caveat is that the argument assumes that Congress will not defeat the purpose of taxation by simply increasing the initial permit allocation to account for the tax or by giving any tax revenue back to the firms that pay the tax, e.g., via a cash grant. This assumption seems plausible for two reasons. First, aggregate permit value is finite, which limits Congress’s ability to increase permit allocations to account for any tax on permits. Second, although permit allocations and cash grants are similar, the public may more readily perceive cash grants as “corporate welfare.” So Congress may be less inclined to hand out cash than it is to hand out permits. If so, then taxing permits may effectively cap the amount available for compensating firms. The second caveat arises from the fact that in addition to giving permits away to compensate firms, the government may use permits to provide subsidies that ostensibly will benefit the public at large. The Waxman-Markey bill, for example, allocates permits to certain firms to subsidize the development of low-carbon assets.328 327. As discussed supra note 7, the government is not limited to giving permits to covered firms. Because they can be sold, the government could use permits to compensate firms that will suffer transition losses even if those firms themselves are not required to surrender permits. My proposal to tax permits would apply even if the recipient is not a covered firm. Whether or not the recipient firm is a covered firm, we have no assurance that permits will merely compensate it for transition losses. Regardless, the government should not use permits to compensate firms, but if it makes the mistake of doing so, taxing the permits when received reduces the cost. 328. See American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. §§ 782(f ), (i) (2009). The bill also allocates permits to “trade-vulnerable industries” to prevent domestic firms in those industries from losing market share to foreign firms not burdened by cap-and-trade and to prevent domestic

Permits Given to Local Distribution Companies

The Waxman-Markey bill allocates a substantial portion of permits to LDCs, which are rate-regulated firms that distribute electricity and natural gas to residential, commercial, and industrial users.329 LDCs own the wires and pipes through which electricity and natural gas flow to retail customers, and they are regulated even in states that have deregulated other parts of the utility sector.330 Waxman-Markey requires state regulators to ensure that LDCs use the permits that they receive to benefit their customers.331 The bill does not, however, clearly spell out exactly what that means. Since LDCs themselves generally will not need permits (because they have no emissions), one possibility is that they might sell their permits to finance customer rebates.332

firms from moving offshore to avoid the costs imposed by cap-and-trade. See id. § 782(e). In theory, this provision could produce environmental benefits if it avoids the relocation of carbon-intensive industries to countries that do not regulate emissions. Nevertheless, for the reasons given in the text, I favor taxing permits used for this purpose. 329. Id. §§ 783(b), 784. 330. Nat’l Ass’n of Regulatory Util. Comm’rs, FAQ: Consumer Benefits of Free CO2 Allowances for Utilities (2009) [hereinafter Consumer Benefits], available at http://www.naruc.org/Publications/FAQ1_Consumer_Benefits.pdf. 331. H.R. 2454 §§ 783(b)(5), 784(c). 332. Hearing Before the Sen. Fin. Comm. on Auctioning under Cap-and-Trade, 111th Cong., May 7, 2009 (statement of Douglas Elmendorf, Director of the Congressional Budget Office) [hereinafter Statement of Douglas Elmendorf ]; Stone, Holding Down Increases, supra note 36, at 3; Consumer Benefits, supra note 330. Note, however, that Waxman-Markey requires certain natural gas LDCs to surrender permits. H.R. 2454 §§ 700(13)(J), 722(b)(8). Additionally, some electricity LDCs are part of regulated, vertically integrated utilities that generate electricity, and the utilities would be required to surrender permits. Consumer Benefits, supra note 330.

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The ostensible rationale for giving permits to LDCs is to reduce the burden that cap-and-trade imposes upon consumers. Although this is a worthwhile objective, providing consumer relief by giving permits to LDCs may prove both inefficient and inequitable.335 There are better ways to provide relief to consumers, e.g., by auctioning permits and using the auction proceeds to fund rebates sent directly by the government.336 At least three serious objections can be raised to giving permits to LDCs. First, it may cause the overall cost of capand-trade to increase.337 If LDCs use the permits to keep utility bills low, e.g., by providing rebates, this will weaken the price signal and impair the incentive to conserve electricity and natural gas.338 This in turn will reduce emissions abatement in the electricity and natural gas sectors and shift it to other sectors of the economy where it may be more expensive.339 As a result, overall abatement costs may increase.340 Consumers will save on their utility bills, but those savings may be more than offset by increases in the prices of gasoline and other carbon-intensive goods.341 The Waxman-Markey bill attempts to avoid this problem by stating that if LDCs provide rebates, they must provide “rebates with regard to the fixed portion of the ratepayers’ bills or as a fixed credit or rebate,” and they cannot “provide

to any ratepayer a rebate that is based solely on the quantity” of electricity or natural gas delivered to that ratepayer.342 The apparent purpose of this restriction is to ensure that rebates are provided as a lump sum that does not vary solely with consumption. In other words, the rebate may lower the overall utility bill, but it will not affect the price paid per unit of electricity or natural gas consumed. If the rebates are fixed so that they do not vary based on electricity use, then in theory they will not affect the price signal or the incentive to conserve. The problem with this approach is that it assumes that users of electricity and natural gas are fully informed and rational and that they will respond to changes in variable costs. That assumption may be true for commercial and industrial users that monitor their utility bills closely. But it seems less likely for consumers, who may respond only to changes in their overall bill.343 If LDCs structure rebates so that consumers experience little or no change in their overall bill, they may be unlikely to conserve. Second, giving permits to LDCs may benefit the shareholders of the LDCs’ commercial and industrial customers rather than consumers.344 The Waxman-Markey bill requires that LDCs distribute the benefits of any permits they receive among their “ratepayer classes ratably based on . . . deliveries to each class.”345 This means that if LDCs use permits to provide rebates, over 60% of those rebates will go to commercial and industrial customers, not consumers.346 Moreover, if, as the bill requires, the rebates are fixed and do not affect variable costs, then it is likely that the businesses receiving them will not pass on the rebates to their customers in the form of reduced prices for goods and services.347 The reason is that businesses make pricing decisions based on variable costs, not fixed costs.348 Fixed rebates do not affect variable costs, so they will not affect prices.349 Instead, the rebates will increase profits and result in a windfall to shareholders.350 This problem could perhaps be corrected if LDCs

333. See Joint Comm. on Taxation, supra note 26, at 9 (“A reasonable argument for the lack of any accession to wealth could exist in the case of an entity with a regulated rate of return, such as a utility, that is required to pass through to its customers the benefits of any freely allocated allowances.”) The argument that LDCs have no economic income is apparently based on the view that while LDCs are receiving valuable permits, they also have an offsetting obligation to pass through permit value to their customers. So the LDCs function as a conduit through which money passes from the government to the LDCs’ customers. This view is debatable and whether LDCs have economic income may depend on the precise rules governing the use of permits by LDCs, which, as already mentioned, are not made clear by the Waxman-Markey bill. In any event, I take no position on the issue and base my proposal for taxation on the alternate grounds discussed in the text. 334. See infra text accompanying notes 335–56. 335. See Stone & Shaw, supra note 36, at 5–10; Stone, Holding Down Increases, supra note 36, at 3–6; Statement of Gilbert Metcalf, supra note 36; Viard, supra note 4, at 619–20. 336. E.g., Stone, Holding Down Increases, supra note 36, at 1, 7. 337. E.g., id. at 4–6; Statement of Gilbert Metcalf, supra note 36; Statement of Douglas Elmendorf, supra note 332; see also Viard, supra note 4, at 619–20. 338. E.g., Stone, Holding Down Increases, supra note 36, at 4–6; Statement of Douglas Elmendorf, supra note 332; see also Viard, supra note 4, at 619–20. 339. E.g., Stone, Holding Down Increases, supra note 36, at 4–6; Statement of Douglas Elmendorf, supra note 332; see also Viard, supra note 4, at 619–20. 340. E.g., Stone, Holding Down Increases, supra note 36, at 4–6; Statement of Douglas Elmendorf, supra note 332; see also Viard, supra note 4, at 619–20. 341. E.g., Stone, Holding Down Increases, supra note 36, at 6–11; Statement of Douglas Elmendorf, supra note 332; see also Viard, supra note 4, at 619–20.

342. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. §§ 783(b)(5)(B)(i), 784(c)(2) (2009). 343. Stone, Holding Down Increases, supra note 36, at 4 n.4 (noting that the ability of fixed rebates to preserve the price signal “is largely blunted if consumers look only at the bottom line of their bill, where they would not experience the ‘sticker shock’ that could prompt changes in behavior”); Statement of Gilbert Metcalf, supra note 36 (“If the value of the permits allocated to LDCs is returned to customers on their monthly bill it is quite likely that many consumers will misperceive this as a reduction in the price of consuming electricity and natural gas.”). This problem may be somewhat mitigated if rebates are given annually instead of monthly. The Waxman-Markey bill, however, is not clear as to how any rebate program should be administered. 344. Cong. Budget Office, The Estimated Costs to Households From the Cap-and-Trade Provisions of H.R. 2454, at 5–6, 12 (2009) [hereinafter Estimated Costs to Households]; Stone & Shaw, supra note 36, at 5–7. 345. H.R. 2454 §§ 783(b)(5)(C), 784(c)(3). 346. Stone & Shaw, supra note 36, at 6; see also Estimated Costs to Households, supra note 344, at 5. 347. Estimated Costs to Households, supra note 344, at 5–6, 12; Stone & Shaw, supra note 36, at 6–7. 348. Estimated Costs to Households, supra note 344, at 5–6, 12; Stone & Shaw, supra note 36, at 6–7. 349. Estimated Costs to Households, supra note 344, at 5–6, 12; Stone & Shaw, supra note 36, at 6–7. 350. See Estimated Costs to Households, supra note 344, at 5–6, 12; Stone & Shaw, supra note 36, at 6–7. The Waxman-Markey bill contains language that could be interpreted as allowing LDCs to give rebates to their industrial customers that vary based on electricity use. See H.R. 2454 § 783(b)(5)(D). This interpretation is open to question, but if rebates to industrial customers

If LDCs are required to use their permits to benefit customers, then receipt of the permits arguably will not produce economic income for the LDCs.333 Nonetheless, this Part argues that a compelling case exists for taxing LDCs when they receive free permits. The problem is that giving permits to LDCs is itself bad policy.334 Taxing the permits is desirable because it will reduce the net value of the permits to the LDCs and their net cost to the government.

Problems with Giving Permits to LDCs

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were allowed to structure their rebates to businesses so that the rebates reduced the cost of electricity and natural gas. But that would create another problem that we have already examined, i.e., it would weaken the price signal and reduce the incentive to conserve.351 The obvious (but perhaps politically infeasible) solution to this dilemma is to cut out the LDCs altogether and to instead have the government auction permits and send rebates directly to consumers. Since rebate checks and utility bills would come in separate envelopes, this approach would reduce the burden on consumers but also preserve the price signal and avoid the problems associated with tying the rebates to utility bills.352 Third, despite the fact that LDCs are regulated, they may find ways to use permits to increase their profits.353 It is possible that LDCs will use permits for purposes other than rebates, e.g., to fund energy efficiency programs.354 These energy efficiency programs may be beneficial in some cases, but as one commentator has noted, “the quality of state utility regulation is uneven across the country.”355 Thus, absent clear guidelines from the federal government, LDCs may be able to use permits to finance programs that ostensibly benefit consumers but that actually benefit shareholders.356

Taxing Permits Given to LDCs

Because giving permits to LDCs is itself bad policy, the government should avoid it. But that may be impossible for political reasons. In that case, taxing the permits may be the next best alternative. Taxing the permits will reduce the net permit value available for rebates. This is beneficial to the extent that the rebates would undermine the incentive to conserve electricity and natural gas and to the extent that the rebates would ultimately go to the shareholders of the LDCs’ commercial and industrial customers. Assuming, as I propose, that LDCs should pay tax on any free permits they receive, the remaining question is the timing of the tax. Should the permits be taxed upon receipt or when they are sold? If LDCs generally sell permits in the year of receipt, the timing issue will be relatively unimportant. But if the LDCs are permitted to bank permits, then postponing taxation until the time of sale increases the value of the permits to the LDCs and may ultimately increase the amounts rebated to customers. (This will occur because tax deferral reduces the present value of the tax owed on the permits.) Increasing the amount of the rebates is undesirable for the same reasons that giving permits to LDCs is undesirable. Moreover, postponing taxation until the time of sale could can vary with use, the rebates will undermine the incentive to conserve. Stone & Shaw, supra note 36, at 7 n.8. 351. Stone & Shaw, supra note 36, at 9–10 (noting that allocating permits to LDCs will either result in “corporate welfare” or reduce the incentive to conserve). 352. See id. at 10. 353. Stone, Holding Down Increases, supra note 36, at 4 n.4. 354. The Waxman-Markey bill requires that natural gas LDCs use at least onethird of the permits that they receive for energy efficiency programs. American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 784(c)(5) (2009). 355. Stone, Holding Down Increases, supra note 36, at 4 n.4. 356. Id.

create the problems associated with zero basis discussed in Part II. Thus, a strong argument exists for taxing at the time of receipt any permits given to LDCs.

Conclusion This Article has argued that if, as seems likely, the government gives away carbon permits, it should tax firms on those permits when the permits are received. The government should tax permits given to unregulated firms for three reasons. First, there is no guarantee that the permits will merely compensate for transition losses. They may in fact make recipient firms better off than they would be if cap-and-trade were not adopted. Second, applying a tax exclusion similar to the one that currently applies to free sulfur dioxide permits will create a tax preference for banking permits that is potentially inefficient and unfair. Third, taxing free permits furthers the objectives of transition policy by reducing the net cost of giving permits away. Minimizing the cost of free permits is desirable because it would be preferable if the government auctioned permits instead of using them to compensate firms for transition losses. The government should also tax permits given to LDCs. Taxing the permits when received will reduce their net cost to the government and their net value to the LDCs. This is beneficial because it will reduce the net amount of rebates the LDCs can offer their customers, which will in turn increase the incentive to conserve electricity and natural gas and reduce the windfall to the shareholders of the LDCs’ commercial and industrial customers.

Seems Like Old Times For Environmental Law: The Supreme Court’s Conservative Turn In 2008–09 Peter Manus* Introduction During the 2008–09 Term, the Supreme Court issued five decidedly unfavorable decisions in the environmental area. The Court invoked a variety of doctrines, among them constitutional standing,1 Chevron deference,2 and the standards of review for preliminary injunctions.3 These doctrines impacted a range of major federal environmental statutes, including the National Environmental Policy Act (“NEPA”),4 the Clean Water Act (“CWA”),5 and the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA” or “Superfund”).6 Five Justices— Chief Justice Roberts and Justices Scalia, Kennedy, Thomas, and Alito—voted against the environmental protection interests in all five cases.7 This bloc of conservative Justices * Professor of Law, New England School of Law. J.D., 1987, Cornell Law School, B.A., 1980, Dartmouth College. 1.

4. 5. 6. 7.

See generally Summers v. Earth Island Inst., 129 S. Ct. 1142 (2009) (holding that plaintiff environmental organizations lacked standing to challenge a new U.S. Forest Service policy allowing salvage timber sales from national forests to proceed without public input). See Entergy, Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498 (2009) (holding that the Clean Water Act allowed the use of cost-benefit analysis in setting performance-based standards for water discharges from existing cooling water intake structures); Burlington N. & Santa Fe Ry. Co. v. United States, 129 S. Ct. 1870 (2009) (holding that arranger liability under the Comprehensive Environmental Response, Compensation, and Liability Act required the government to show that the defendant intended to dispose of hazardous substances); Coeur Alaska, Inc. v. Se. Alaska Conservation Council, 129 S. Ct. 2458 (2009) (holding that the Clean Water Act authorized discharges of fill into waters of the United States without triggering performance standards requiring a permit for new discharges of pollutants). See Winter v. Natural Res. Def. Council, Inc., 129 S. Ct. 365, 381–82 (2008) (lifting a preliminary injunction that required the U.S. Navy to adhere to mitigation measures designed to protect marine mammals while the Navy continued to conduct sonar training exercises). National Environmental Policy Act, 42 U.S.C. §§ 4321–4370f (2006). Federal Water Pollution Control Act, 33 U.S.C. §§ 1251–1387 (2006). Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. §§ 9601–9675 (2006). See Winter, 129 S. Ct. at 369 (Roberts, C.J., joined by Scalia, Kennedy, Thomas & Alito, JJ. delivered the opinion of the Court); Summers v. Earth Island Inst., 129 S. Ct. 1142, 1146 (2009) (Scalia, J., joined by Roberts, C.J., and Kennedy, Thomas & Alito, JJ., delivered the opinion of the Court, and Ken-

was joined by Justices Stevens, Souter, and Breyer, each in at least one case, leaving only Justice Ginsburg to favor the environmental protection interests in all five cases.8 In one case, Justice Ginsburg published a solitary dissent.9 It was not a good year at the nation’s high court for environmental protection advocates. In addition, the fact that these five decisions followed the landmark environmental victory in Massachusetts v. EPA10 carries some foreboding implications for environmental protection advocates. It appears not only that Massachusetts v. EPA may be the last pro–environment decision to emerge from the current Supreme Court, but the 2008–09 Term also makes clear that fundamental questions over whether and how environmental injuries may be redressed by the judicial branch are far from resolved. For example, a majority of the Court’s current nedy, J., concurred); Entergy, 129 S. Ct. at 1501 (Scalia, J., joined by Roberts, C.J., and Kennedy, Thomas & Alito, JJ., delivered the opinion of the Court); Burlington N., 129 S. Ct. at 1873–74 (Stevens, J., joined by Roberts, C.J., and Scalia, Kennedy, Souter, Thomas, Breyer & Alito, JJ., delivered the opinion of the Court); Coeur Alaska, 129 S. Ct. at 2462 (Kennedy, J., joined by Roberts, C.J., and Thomas, Breyer & Alito, JJ., delivered the opinion of the Court, which Scalia, J., joined in part). 8. See Winter, 129 S. Ct. at 382, 386 (Breyer, J., joined in part by Stevens, J., concurring on the issue of vacating the preliminary injunction imposed by the district court against the Navy to the extent that the Navy challenged it); id. at 387 (Ginsburg, J., joined by Souter, J., dissenting); Summers, 129 S. Ct. at 1153 (Breyer, J., joined by Stevens, Souter & Ginsburg, JJ., dissenting); Entergy, 129 S. Ct. at 1512 (Breyer, J., concurring on the issue of whether the CWA’s language allows the comparison of costs and benefits when calculating the performance standards under review, but dissenting from the holding); id. at 1516 (Stevens, J., joined by Souter & Ginsburg, JJ., dissenting); Burlington N., 129 S. Ct. at 1884 (Ginsburg, J., dissenting); Coeur Alaska, 129 S. Ct. at 2477 (Breyer, J., concurring); id. at 2480 (Ginsburg, J., joined by Stevens & Souter, JJ., dissenting). 9. See Burlington N., 129 S. Ct. at 1884. 10. Massachusetts v. EPA, 549 U.S. 497, 498 (2007) (holding that the Commonwealth of Massachusetts had standing to sue EPA for its decision against regulating greenhouse gas emission under the CAA). Justice Stevens wrote the majority opinion, joined by Justices Kennedy, Souter, Breyer and Ginsburg. Id. at 502. Chief Justice Roberts dissented on the issue of standing, joined by Justices Scalia, Thomas, and Alito. Id. at 535. Justice Scalia dissented on the issue of standing and on the question of whether the CAA authorized EPA to regulate mobile source emissions due to their contribution to global warming. Id. at 549.

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Justices appear energized to reinvigorate debate over how and when an individual or organization may frame an environmental harm as a justiciable claim.11 The more recently appointed conservative Justices have joined their seasoned colleagues in questioning the value of earth’s species, the public’s interest in exercising stewardship over natural resources, and the possibility that any branch of government or private group might obtain judicial assistance in their efforts to protect the environment.12 This Article analyzes the five Supreme Court environmental cases from the 2008–09 Term collectively, individually, and from a historical context. Part I discusses each case in sequence, focusing on the logic, language, and impact of the decisions.13 Through this examination, Part I offers observations about the contradictions and consistencies among the cases as well as indications about the majority’s overall perspective on environmental law and the judiciary’s role in that field. Part II considers each of the 2008–09 Term decisions in its broader historical context and discusses their significant commonalities with high-profile environmental cases from past decades.14 Ultimately, this Article aims to offer a sense of the tenacity and openness with which the ideologically conservative majority of the Supreme Court seeks to minimize the reach and effect of environmental law.

Five Environmental Cases, Five Environmental Losses

The Supreme Court enjoys near-total discretion in selecting cases to hear each Term, which means that any Term’s decisions can deliver messages about the personal beliefs and politics of the Justices.15 The variety of motivations that underlie the Court’s acceptance or denial of certiorari on any given 11. See, e.g., Summers, 129 S. Ct. at 1148–51. 12. See Winter, 129 S. Ct. at 377–78 (questioning the value of protecting marine species through properly conducted environmental impact review). Hostility to species protection may also be perceived in decisions such as Lujan v. Defenders of Wildlife, 504 U.S. 555, 567 (1992) (rejecting arguments that a party might have a sufficient interest in endangered species to bear a cognizable injury when endangered species or their habitats are threatened). Summers, 129 S. Ct. at 1147, questions whether a citizen may bear an interest in public land preservation, which echoes Lujan v. National Wildlife Federation, 497 U.S. 871 (1990) (refusing to recognize that a citizen might bear an interest in public land preservation except where the citizen has particular plans to hike). The standing issue addressed in Summers built on principles established in one of the Supreme Court’s earliest significant environmental decisions in the modern environmental regulatory era, Sierra Club v. Morton, 405 U.S. 727 (1972). In Morton, the majority denied standing on the basis of an inadequate claim of injury-in-fact where the Sierra Club, a longstanding environmental organization whose members regularly used the federal lands in jeopardy, challenged the U.S. Department of Interior for its failure to prevent the development. See id. at 741. 13. See infra Part I. 14. See infra Part II. 15. See generally Margaret Meriwether Cordray & Richard Cordray, The Philosophy of Certiorari: Jurisprudential Considerations in Supreme Court Case Selection, 82 Wash. U. L. Q. 389, 389 (2004) (discussing the Supreme Court’s plenary authority over case selection and the massive influence that the Justices’ choices have on U.S. politics and society).

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case should not be underestimated.16 Nevertheless, when the Court issues five environmental losses in such rapid succession as the Supreme Court did this past Term, it can be stated fairly that the five Justices who joined the majority’s holding in all five cases have invited speculation about their proclivities and prejudices in the environmental arena. This Part introduces the five cases, both in broad terms and in terms of their logic, style and internal consistency. It offers primary impressions of the decisions and thoughts on the Justices’ motivations in deciding each case.

Winter Chill—Launching the Term with a Blow to NEPA

Winter v. Natural Resources Defense Council, Inc.17 earns a place among the Supreme Court’s opinions that reveal hostility among its conservative members toward environmental protection. The case centered on whether and how a court might exercise equitable powers to respond to the U.S. Navy’s inattention to NEPA as the Navy conducted sonar training exercises in waters inhabited by marine mammals.18 Nowhere in his majority opinion did Chief Justice Roberts comment upon the Navy obtaining permission from the Council on Environmental Quality (“CEQ”) to violate the preliminary injunction issued by the district court and approved by the Ninth Circuit Court of Appeals, despite the separation of powers problems this creates, supposedly a prime concern of the conservative bench.19 Indeed, nowhere did the majority opinion express even a passing concern that the Navy’s attempt to avoid NEPA’s Environmental Impact Statement (“EIS”) requirement subverted a longstanding mandate that agencies fully consider the potential detrimental environmental consequences of their activities before implementing those activities.20 Perhaps more telling, the Court’s decision 16. See id. (identifying a variety of administrative, ideological, and personal motivations that influence various Justices in their decisions on which cases to accept before the Court). 17. Winter, 129 S. Ct. at 365. 18. Id. at 374–75. The Navy had appealed the Ninth Circuit’s affirmation of the district court’s denial of the Navy’s motion to vacate the district court’s injunction. The Navy argued that an executive branch determination that the Navy faced emergency circumstances allowing it to implement alternative arrangements to full NEPA compliance overrode the mitigation measures that had been imposed under the district court’s injunction. See id. at 373–74, 388–89 (Ginsburg, J., dissenting). 19. See generally id. at 370–82. The CEQ is an executive branch advisory board. Chief Justice Roberts presented the Navy’s tactic in turning to the CEQ in neutral terms. See id. at 373–74. In contrast, Justice Ginsburg detailed the Navy’s tactics to avoid a full-fledged NEPA review. See id. at 390-91 (Ginsburg, J., dissenting). After pointing out that the district court review had been far more thorough than the CEQ’s “hasty decision on a one-sided record,” Justice Ginsburg concluded this section of her dissent with the observation, “If the Navy sought to avoid its NEPA obligations, its remedy lay in the Legislative Branch. The Navy’s alternative course-rapid, self-serving resort to an office in the White House—is surely not what Congress had in mind when it instructed agencies to comply with NEPA ‘to the fullest extent possible.’” Id. at 391. 20. See id. at 387. It was left to Justice Ginsburg’s dissent to point out the obvious, “If the Navy had completed the EIS before taking action, as NEPA instructs, the parties and the public could have benefited from the environmental

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is based primarily upon the barely examined but staunchly asserted presumption that the public’s interest in having the Navy conduct sonar training exercises off the coast of California without interruption overwhelmingly outweighed the survival and comfort of countless marine species.21 Underscoring the activism of the Court’s opinion is the Court’s conclusory assertion, which flew in the face of the thorough analysis by the district court that the Navy did not need to observe certain mitigation measures as it continued its training exercises.22 The Court dismissed the lower courts’ analyses of the Navy’s ability to continue its training exercises while adhering to temporary mitigation measures designed to protect the marine species.23 Although the Navy itself had agreed to four of the mitigation measures imposed by the district court, the majority swept aside those measures in deciding that the lower courts had inappropriately imposed a preliminary injunction.24 In these ways, the majority presented itself consciously and overtly as determined to exercise its equitable discretion to favor national security interests over protection of marine species.25

The Winter Opinion

As noted above, the ultimate issue in Winter was weighing the public’s interest in allowing the Navy to use mid-frequency active sonar during training exercises in the waters off southern California without interruption against the public’s interest in protecting the multiple marine species inhabiting those waters from death or injury.26 This highly

21.

22.

23. 24. 25.

26.

analysis—and the Navy’s training could have proceeded without interruption. Instead, the Navy acted first, and thus thwarted the very purpose an EIS is intended to serve.” Id.; see also William S. Eubanks II, Damage Done? The Status of NEPA after Winter v. NRDC and Answers to Lingering Questions Left Open by the Court, 33 Vt. L. Rev. 649, 649 (2009) (“[T]he majority ultimately viewed Winter more as a national security case and less as a substantive environmental case since its analysis focused predominantly on potential hardships to the Navy under the facts.”). The majority stated its unsupported presumption three times. See Winter, 129 S. Ct. at 376 (“[E]ven if plaintiffs have shown irreparable injury from the Navy’s training exercises, any such injury is outweighed by the public interest and the Navy’s interest in effective, realistic training of its sailors.”); id. at 378 (“The public interest in conducting training exercises with active sonar under realistic conditions plainly outweighs the interests advanced by the plaintiffs. . . . In this case . . . the proper determination of where the public interest lies does not strike us as a close question.”); id. at 382 (“We do not discount the importance of plaintiffs’ ecological, scientific, and recreational interests in marine mammals. Those interests, however, are plainly outweighed by the Navy’s need to conduct realistic training exercises to ensure that it is able to neutralize the threat posed by enemy submarines.”). See id. at 388–89 (Ginsburg, J., dissenting) (detailing the efforts of both lower courts to thoroughly understand the Navy’s activities in order to craft mitigation measures that would allow the Navy to both continue its training and comply with NEPA). Id. at 377 (“In this case, the [d]istrict [c]ourt and the Ninth Circuit significantly understated the burden the preliminary injunction would impose on the Navy’s ability to conduct realistic training exercises.”). See id. at 381 n.5 (rejecting Justice Breyer’s argument that the Court should leave intact the mitigation measures that the Navy admitted it could tolerate). See id. at 382 (“We do not discount the importance of plaintiffs’ ecological, scientific, and recreational interests in marine mammals. Those interests, however, are plainly outweighed by the Navy’s need to conduct realistic training exercises to ensure that it is able to neutralize the threat posed by enemy submarines.”). Id. at 376–82. The Court first identified the Navy’s interest as the uninterrupted continuation of its then-current training exercises, but it readily broadened that interest to include the safety of the U.S. fleet and national security. See id.

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subjective comparison of two dissimilar public interests arose out of the majority’s predominant focus on the final element of the preliminary injunction analysis, which requires a court to grant an injunction only when doing so would be in the public interest.27 Although the majority opinion places much emphasis on this public interest element in its deliberation, it never actually explains why the public’s interest in the Navy’s uninhibited sonar training trumps the public’s interest in protecting marine species.28 Indeed, the majority opinion never discusses the concept of public interest itself, and, perhaps more tellingly, the Court never precisely articulates the public interest that the environmental organizations hoped to vindicate.29 The majority nonetheless assures readers that it, unlike either lower court, gave the public interest issue “proper consideration.”30 In contrast, the Court readily defines the public interest advanced by the Navy in its broadest, simplest terms: national security.31 If the Court’s cursory comparison of national security and species protection is accepted, then the public interest in allowing the U.S. armed forces to conduct training exercises for the purpose of wartime preparedness trumps any public interest in environmental protection to such a degree that Navy training exercises must be conducted uninterrupted and uninhibited by any conditions designed to protect the environment. By foregoing any meaningful discussion on this issue, the majority opinion presents the prioritization of national defense over environmental stewardship as self-evident.32 Apparently, no definition of the environmental interest or even of the concept of public interest was warranted because the disparity was so massive and obvious.

27.

28.

29. 30. 31. 32.

at 378 (“[F]orcing the Navy to deploy an inadequately trained antisubmarine force jeopardizes the safety of the fleet. . . . [T]he President—the Commander in Chief—has determined that training with active sonar is ‘essential to national security.’”). See id. at 378. The Court identifies the four elements of a litigant’s argument for a preliminary injunction as the need to “establish that he is likely to succeed on the merits, that he is likely to suffer irreparable harm in the absence of preliminary relief, that the balance of equities tips in his favor, and that an injunction is in the public interest.” Id. at 374. In its analysis, the Court merges the final two elements. See id. at 378 (“[W]e conclude that the balance of equities and consideration of the overall public interest in this case tips strongly in favor of the Navy.”). Throughout its discussion, the Court uses conclusory or opinionated language to state its view. See, e.g., id. at 378 (arguing that the Navy’s interest “plainly outweighs” the environmental interests); id. (“The proper determination of where the public interest lies does not strike us as a close question.”); id. at 382 (arguing that the plaintiffs’ interests are “plainly outweighed” by the Navy’s interests). See id. at 376 (“A proper consideration of [the balance of equities and public interests] alone requires denial of the requested injunctive relief.”). See id. at 378 (“[T]he [d]istrict [c]ourt addressed these considerations in only a cursory fashion.”); id. at 379 (“The lower courts did not give sufficient weight to the views of several top Navy officers.”). See, e.g., id. at 378 (“‘President [Bush]—the Commander in Chief—has determined that trainng with active sonar is ‘essential to national security.’” (quoting Pet. App. 232a)). Id. at 378 (“The public interest in conducting training exercises with active sonar under realistic conditions plainly outweighs the interests advanced by the plaintiffs.”); id. at 382 (describing the plaintiffs’ interests as “plainly outweighed” by the Navy’s interests).

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THE SUPREME COURT’S CONSERVATIVE TURN

Winter’s Impact

Paradoxically, the conclusion in Winter that national security interests trump environmental protection interests actually may comfort those who count environmental stewardship as a basic moral responsibility and a core public interest. After all, few interests can be imagined that would presumptively prevail over all others as readily as that of a nation’s security and, as a corollary to that, the physical safety of its armed forces.33 The language of the Winter majority opinion, however, suggests that environmental protection interests would not carry significant weight in the majority’s eyes under circumstances less dramatic than those present in this case. First, the majority opinion tends to characterize the environmentalists and their interests as frivolous.34 Jean-Michel Cousteau, the explorer, prolific writer, and founder of the Ocean Futures Society, is identified as “an environmental enthusiast and filmmaker.”35 The scant identification of environmental interests included references to whale-watchers and photographers.36 The majority characterizes the environmental interests three times as “recreational,” and four times the majority describes the plaintiff’s desire to merely “observe” animals.37 These subtle verbal jabs take on more significance when the deciding issue for the majority is a highly subjective prioritization of public interests.38 The majority’s fourteen paragraph discussion on the urgency of military training compared to only two sentences acknowledging the “seriousness” of the environmental interests at stake is also striking.39 Perhaps the opinion is crafted in this way to emphasize the contrast between the two public interests at stake. The Navy’s interests may be unassailably weightier than those of the environmentalists, but the Court could have better supported its conclusion by offering a dispassionate, equivalent consideration of each. More troubling than the opinion’s scant references to the environmental interests at stake is the Court’s open-mindedness in considering claims advanced by the Navy that are similar to claims rejected by the Court when advanced by

33. See id. at 382. Indeed, at one point the Court points out that the ultimate dispute in the case is not whether the Navy may be enjoined from harming the marine species inhabiting southern California waters, but only whether the Navy needed to prepare an EIS studying the issue. Id. at 381. 34. See id. at 377–78. 35. Id. at 371. 36. Id. at 377. 37. See id. at 375, 377, 378, 382. The Court does admit that environmental interests also include scientific and ecological interests, but the Court never elaborates on these interests or even explains them. 38. The majority opinion begins and ends by quoting Presidents George Washington and Theodore Roosevelt, which might be interpreted as an attempt by the majority to inspire patriotic sentiments. See id. at 370 (quoting George Washington’s first annual address to Congress with the words “‘[T]o be prepared for war is one of the most effectual means of preserving peace.’”); id. at 382 (quoting Theodore Roosevelt’s 1907 address to Congress with the words “‘[T] he only way in which a navy can ever be made efficient is by practice at sea, under all the conditions which would have to be met if war existed.’”). 39. Id. at 377 ([The Navy’s] interests must be weighed against the possible harm to the ecological, scientific, and recreational interests that are legitimately before this Court.”). Id. at 382 (“We do not discount the importance of plaintiffs’ ecological, scientific, and recreational interests in marine mammals.”).

environmental protection advocates in this and other cases.40 For example, the Court accepted without examining the Navy’s arguments relating to concreteness and imminence.41 The Navy claimed that its uninterrupted sonar training was necessary and urgent due to the threat of attack by enemy submarines.42 The majority never questioned the imminence of submarine attacks by enemy nations; nor did the majority question the relative increase of the threat to national security presented by a slower training regime or one conducted in a less populated marine habitat.43 Indeed, at one point in the opinion the majority evokes a melodramatic tone about the perils that threaten U.S. national security in the form of submarine attacks, noting that an injunction against Navy sonar training could force the Navy to seek the injunction’s dissolution, but “[b]y then it may be too late.”44 This relaxed examination of the threat to national security sharply contrasts the Court’s strict examination of concreteness and imminence arguments that have been advanced by environmental petitioners over the years.45 The Navy effectively argued that the particular type of training exercise under dispute was of tremendous importance to naval security because all naval training is part of an integrated whole; an ineffective sonar training program conducted off the coast of California in 2008 could degrade other elements of naval warfare preparedness.46 Although the Court could reasonably accept this argument at face value, its doing so reinforces the majority’s bias against environmental protection interests. Theories about the potential for environmental harms, including those presented in the Winter case and in others, have been routinely met with skepticism by the Winter majority Justices.47 This skepticism concerning potential harms to species resembles conservative Jus40. See infra notes 61–63 and accompanying text (discussing the requirement that both specific times and places where a plaintiff will encounter injury in context of standing for environmental plaintiffs). 41. See Winter, 129 S. Ct. at 377–78. 42. See id. at 370 (“Antisubmarine warfare is currently the Pacific Fleet’s top warfighting priority. Modern diesel-electric submarines pose a significant threat to Navy vessels. . . . Potential adversaries of the United States possess at least 300 of these submarines.”); id. at 378 (“[F]orcing the Navy to deploy an inadequately trained antisubmarine force jeopardizes the safety of the fleet.”); id. at 380-81 (“Unlike the Ninth Circuit, we do not think the Navy is required to wait until the injunction ‘actually result[s] in an inability to train . . . sufficient naval force for the national defense’ before seeking its dissolution. By then it may be too late.”); id. at 382 (“[The environmental interests] are plainly outweighed by the Navy’s need to conduct realistic training exercises to ensure that it is able to neutralize the threat posed by enemy submarines.”). 43. See id. 44. Id. at 381. 45. For evidence of the Court majority’s approach when an environmentalist must establish imminence, see, e.g., discussion relating to Summers, infra notes 57– 63 and accompanying text (requiring specificity about both times and places where a plaintiff will encounter injury). 46. See Winter, 129 S. Ct. at 377 (quoting a declaration by Admiral Gary Roughead, Chief of Naval Operations, who stated, “‘It is important to stress the ship crews in all dimensions of warfare simultaneously. If one of these training elements were impacted—for example, if effective sonar training were not possible—the training value of the other elements would also be degraded.’”). 47. In Winter, the majority several times questions the validity of claims that sonar training may be linked to marine mammal injuries. See id. at 371 (stressing the lack of proof that mass strandings of marine mammals may be linked to the use of active sonar); id. at 378 (minimizing the plaintiffs’ interests by casting them as vague and unquantifiable “the most serious possible injury would be harm to an unknown number of the marine mammals.”).

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tices’ skepticism about the interdependent nature of earth’s environment.48 In the end, Winter is a study in judicial activism. The majority offers unproven conclusions as undeniable truth. Winter may be dismissed as unremarkable when placed among the Court’s long line of anti-NEPA decisions. In the context of the 2008–09 Term, however, the decision is an ominous harbinger of the decisions to come.

Blistering Summers—Reasserting the Hostility Toward Environmental Standing

Following on the heels of Winter, Summers v. Earth Island Institute49 stands as a second judicial blow to the principle that government decisionmaking should include regularized, publicly accessible consideration of environmental impacts.50 The case arose out of a U.S. Forest Service decision to exempt certain public lands projects from notice and comment.51 NEPA was implicated because the Forest Service’s rationale for the exemptions was that these projects had already been categorically exempted from the EIS process, and the Forest Service reasoned that such projects could be safely presumed to have too minor an impact on the environment to warrant individualized public process.52 The Court majority could have used Summers as a second opportunity to air its skepticism about the value of environmental impact review, but did not. Instead, Summers provided Justice Scalia an opportunity to revive his arguments against environmental standing, which may have seemed a worthwhile, if not urgent, pursuit by the conservative mem-

48. See, e.g., Lujan v. Defenders of Wildlife, 504 U.S. 555–56 (1992) (Scalia, J.) (“[R]espondents propose a series of novel standing theories. The first, inelegantly styled ‘ecosystem nexus,’ proposes that any person who uses any part of a ‘contiguous ecosystem’ adversely affected by a funded activity has standing even if the activity is located a great distance away . . . . Respondents’ other theories are called, alas, the ‘animal nexus’ approach, whereby anyone who has an interest in studying or seeing the endangered animals anywhere on the globe has standing; and the ‘vocational nexus’ approach, under which anyone with a professional interest in such animals can sue. Under these theories, anyone who goes to see Asian elephants in the Bronx Zoo, and anyone who is a keeper of Asian elephants in the Bronx Zoo, has standing to sue because the Director of the Agency for International Development (AID) did not consult with the Secretary regarding the AID-funded project in Sri Lanka. This is beyond all reason.”). 49. Summers v. Earth Island Inst., 129 S. Ct. 1142 (2009). 50. Both Winter and Summers were argued on October 8, 2008, with Winter issued on November 12, 2008 and Summers on March 3, 2009. See Winter, 129 S. Ct. at 365; Summers, 129 S. Ct. at 1142. 51. See Summers, 129 S. Ct. at 1147. The Forest Service is required to “establish a notice, comment, and appeal process for ‘proposed actions of the Forest Service concerning projects and activities implementing land and resource management plans developed under the Forest and Rangeland Renewable Resources Planning Act of 1974.’” Forest Service Decisionmaking and Appeals Reform, Pub. L. No. 102–381, § 322, 106 Stat. 1419 (1993). The regulations allowing certain Forest Services activities to be categorically excluded from the public process are codified at 36 C.F.R. §§ 215.4(a), 215.12(f ) (2009). The new regulations under dispute identify particular fire rehabilitation and salvage timber sale activities as categorically excused from public process. Notice of Final National Environmental Policy Act Implementing Procedures, 68 Fed. Reg. 33,824 (June 5, 2003) (Forest Service Handbook 1909.15, ch. 30, § 31.2(11)); Notice of Final Interim Directive, 68 Fed. Reg. 44,607 (Forest Service Handbook 1909.15, ch. 30, § 31.2(13)). 52. See Summers, 129 S. Ct. at 1147.

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bers of the Court in the wake of Massachusetts v. EPA.53 The Court held that the Earth Island Institute lacked standing because the Institute’s members’ plans to hike in the federal lands scheduled for timber sales were insufficiently specific.54

The Summers Opinion

Justice Scalia asserted that the member-hikers’ affidavits were insufficiently specific because they allowed for conjecture about whether and when they might hike on a tract of federal land that was about to be subjected to a salvage timber sale.55 The consequence of Justice Scalia’s opinion was that the hikers’ opportunity to participate in notice and comment under the new Forest Service policy was stripped away.56 Justice Scalia justifies his decision to reject the hikers’ affidavits primarily on two bases—Court precedents and the Court’s constitutional obligation to limit itself to cases or controversies.57 The tone of the opinion is doctrinaire, as if Justice Scalia considers it irresponsible for the dissenting Justices to break with precedents and escape the constitutional limits of judicial authority by admitting factual probabilities into the calculus of what constitutes a concrete or imminent injury.58 Following a pattern he established in past cases, Justice Scalia pounces on any non-specificity in an affiant’s statement and rejects out of hand the overwhelming likelihood that a longstanding organization’s numerous members will continue to behave as they had before.59 In so doing, Justice Scalia revives his previously established signature theme—that public interest advocates must monitor environmental agencies infraction by infraction rather than programmatically.60 In his dissent, Justice Breyer disagrees with the majority over the level of temporal and geographical specificity 53. Chief Justice Roberts authored the dissent that addressed standing in Massachusetts v. EPA, 549 U.S. 497, 535–48 (2007). 54. See Summers, 129 S. Ct. at 1150–51 (criticizing the Institute’s members’ affidavit for its lack of specificity). 55. Id. The majority faults the hikers generally for neglecting to identify particular timber sales that would impede the affiant’s specific plans to enjoy the National Forests. Where the affidavit did refer to a specific series of Forest Service plans for a particular national forest, the majority faulted it for failing to assert a definite intention to visit the location. 56. See id. at 1151. 57. See id. at 1149–52 (stressing that the Court’s stern reading of affidavits submitted by individuals seeking injunctions against the government is in keeping with precedents); id. at 1148 (framing the analysis by opening with references to the Court’s obligation to maintain the proper balance of powers by confining itself to cases or controversies). 58. See, e.g., id. at 1151 (accusing the dissent of attempting to make “a mockery of our prior cases”); id. at 1152 (defending the practice of requiring individual parties to allege particular injuries by concluding that the requirement “has never been dispensed with in light of statistical probabilities”); id. (pointing to a court’s inherent obligation to assure itself that standing exists before concluding that “[w]hile it is certainly possible—perhaps even likely—that one individual will meet all of [the standing] criteria, that speculation does not suffice”). 59. See, e.g., id. at 1151 (“‘Such ‘some day’ intentions—without any description of concrete plans, or indeed any specification of when the someday will be—do not support a finding of the ‘actual or imminent’ injury that our cases require.’”)(quoting Lujan v. Defenders of Wildlife, 504 U.S. 555, 564 (1992)). 60. See Lujan v. Nat’l Wildlife Fed’n, 497 U.S. 871 (1990). Interestingly, the Summers majority never cites National Wildlife Federation, the case that is most factually analogous, and the case in which Justice Scalia first and most clearly warned environmentalists that the Court could not be used by public interest advocates to attain programmatic relief. Id. at 894.

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required of a plaintiff attempting to establish standing.61 Responding to the majority’s predominant focus on the imminency requirement, the dissent points out that the proper question in the context of a standing analysis is whether the plaintiff has established that he is vulnerable to a realistic threat of future harm.62 Thus, the dissent argues, the focus should be less on the temporal element of imminence and more on whether the claimed future threat is conjectural.63 Related to this, the dissent highlights that, in an evaluation of a claim of imminent harm, the claimant’s statements about past actions are pertinent, as they may establish a pattern of behavior to support claims about future behavior.64 The majority dismisses these statements about past harms as completely immaterial.65 Addressing the majority’s asserted reliance on precedent, the dissent reminds the majority that the Court had recently accepted state petitioners’ standing in Massachusetts v. EPA, where the harm arising out of the federal government’s inaction might not occur for decades.66 The hiker’s affidavit analyzed by the Summers majority, the dissent insists, presents adequate specificity for standing.67 “To know, virtually for certain, that snow will fall in New England this winter is not to know the name of each particular town where it is bound to arrive,”68 Justice Breyer observes. Throughout his opinion, Justice Breyer’s tone is chiding, argumentative, and in some places even indignant, as where he notes that “a threat of future harm may be realistic even where the plaintiff cannot specify precise times, dates, and GPS coordinates.”69 Justice Breyer challenges the majority with question after question, as if to suggest disbelief that logic underlies the majority’s dogged adherence to such a narrow construction of standing.70 The dissent underscores that 61. See Summers, 129 S. Ct. at 1156 (Breyer, J., dissenting) (“[A] threat of future harm may be realistic even where the plaintiff cannot specify precise times, dates, and GPS coordinates.”). 62. Id. at 1155–56 (arguing that the question of imminence in the context of a standing analysis is meant to focus courts on “where, as here, a plaintiff has already been subject to the injury it wishes to challenge, the Court has asked whether there is a realistic likelihood that the challenged future conduct will, in fact, recur and harm the plaintiff.”). 63. Id. at 1155 (explaining that the proper application of imminence in a standing analysis is “to emphasize that the harm in question—the harm that was not ‘imminent’—was merely ‘conjectural’ or ‘hypothetical’ or otherwise speculative”). 64. See id. at 1156. 65. See id. Without considering the possibility that statements about past actions are offered to establish a pattern of behavior, the majority rejects those statements as immaterial. See id. at 1150. 66. See id. at 1156 (finding standing where the plaintiff state admitted that the injuries it would suffer due to global warming are indistinct in scope and timing). 67. See id. at 1157–58 (addressing the affidavit in the context of the affidavit of the plaintiff whose claim settled, the statement of the Forest Service, and the standing determination in Massachusetts v. EPA, 549 U.S. 497 (2007)). 68. Summers, 129 S. Ct. at 1157. 69. Id. at 1156; see also id. at 1154 (Breyer, J., closes the opening paragraph of his dissent, which summarizes the majority position, with the observation that “[n]othing in the record or the law justifies this counterintuitive conclusion.”). 70. See id. at 1155 (“How can the majority credibly claim that salvage-timber sales, and similar projects, are unlikely to harm the asserted interests of the members of these environmental groups?”); id. at 1156 (“How could the Court impose a stricter criterion [on imminence than it did in Los Angeles v. Lyons, 461 U.S. 95 (1983)]?”); id. at 1157 (“Why describe this perfectly sensible response to the settlement of some of the Complaint’s claims [that is, the submission of additional affidavits after the individual claims of one member were settled] as

the Summers majority is far less humble in its references to judicial duty and precedents than it is selective in both its choice of facts and reliance on previous case law.71 Justice Breyer concludes his dissent with the observation that “[m] any years ago the Ninth Circuit warned that a court should not ‘be blind to what must be necessarily known to every intelligent person.’”72 Granting that the majority Justices are indeed intelligent, it is fair to conclude that Summers is the work of a result-oriented Court.

Summers’ Impact

As a standing decision, Summers adds nothing to the view of constitutional standing expressed in a string of prior cases, most notably the pair authored by Justice Scalia in the early 1990s. Lujan v. National Wildlife Federation and Lujan v. Defenders of Wildlife together stand for the general proposition that the case or controversy requirement of the U.S. Constitution’s Article III places severe constraints on both the scope of injury that an environmental plaintiff may claim to have suffered and the factual circumstances under which an imminent injury will be judicially cognizable.73 The level of particularization that the majority demanded in the plaintiff’s affidavit under review in Summers reflects the same level of scrutiny exhibited in these prior environmental standing cases.74 As the Court’s environmental standing decision following environmental plaintiffs’ success in Massachusetts v. EPA, Summers sends a message to environmental plaintiffs that they should not expect similar success in standing claims in the future. Apparently, the level of scrutiny and the selective reading that Justice Scalia applies to environmental plaintiffs’ affidavits is as appealing to the current majority of the Court as it was to the conservative majority of the early 1990s.75 The current majority has regrouped to render the recent victory in Massachusetts v. EPA an exception to the longstanding Court view that environmental organizations

71. 72. 73.

74.

75.

a ‘retroactiv[e]’ attempt to ‘me[e]t the challenge to their standing at the time of judgment’?”). See id. at 1157 (identifying details in the surviving affidavit that support a finding that it is adequately concrete to establish standing). Id. at 1158 (quoting In re Wo Lee, 26 F. 471, 475 (1886)). See Lujan v. Nat’l Wildlife Fed’n, 497 U.S. 871 (1990) (holding that hikermembers failed to allege with adequate specificity that a federal program to encourage mining, oil and gas leases on federal lands threatened their recreational and aesthetic interests in those lands); Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992) (holding that member-animal observers’ affidavits failed to allege with adequate specificity that their plans to travel overseas to observe certain endangered species would be detrimentally impacted by a federal decision to exempt U.S. funding of construction projects on foreign soil from a statutory consultation requirement designed to protect endangered species and their habitats). Indeed, Justice Scalia worries that the dissent’s approach “would make a mockery of our prior cases, which have required plaintiff-organizations to make specific allegations establishing that at least one identified member had suffered or would suffer harm.” Summers, 129 S. Ct. at 1151. See Nat’l Wildlife Fed’n, 497 U.S. at 874. In 1990, of the current Justices who presided over Summers, only Justices Scalia, Kennedy, and Stevens were members of the Court. By 1992, Justices Souter and Thomas had joined the Court. See Defenders of Wildlife, 504 U.S. at 556–57. Thus, Chief Justice Roberts and Justice Alito are the “new” members of the conservative majority in environmental standing decisions.

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presumptively lack standing because their members’ harms are insufficiently imminent and concrete.76

Riverkeeper Adrift—Reading Cost-Beneﬁt Analysis into the Clean Water Act

Entergy Corp. v. Riverkeeper, Inc. introduced the trio of statutory interpretation cases that complete the string of losses suffered by environmental protection advocates in the 2008–09 Term.77 These cases all deal with issues of judicial deference; their differences and commonalities suggest a propensity among the majority of Justices to defer to federal environmental agencies selectively. In Burlington Northern & Santa Fe Railway Co. v. United States, eight Justices joined the majority and the opinion was authored by Justice Stevens,78 a Justice who cannot fairly be accused of bias against environmental plaintiffs.79 This suggests that the three cases warrant individual evaluation. Entergy involved a dispute over the performance standards for certain cooling water intake structures.80 Under the CWA, these standards must incorporate “the best technology available for minimizing adverse environmental impact” (“Best Technology Available” or “BTA”).81 Riverkeeper claimed that Environmental Protection Agency (“EPA”) had developed its BTA standards through cost-benefit analysis, and that the CWA does not permit cost-benefit analysis under the BTA standard, even though the CWA does allow cost-benefit analysis under the BTA.82 The Second Circuit agreed, and remanded the case to EPA with instructions to explain how its standard was not the product of a cost-benefit analysis.83 The Supreme Court reversed, concluding that the CWA gave EPA the discretion to develop BTA standards through costbenefit analysis.84 76. Environmental plaintiffs may also have misperceived Friends of the Earth, Inc. v. Laidlaw Environmental Services, Inc., 528 U.S. 167 (2000) as evidence that a majority of the Court had come to more readily find standing in environmental cases. 77. See Entergy Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498 (2009). 78. Burlington N. & Santa Fe Ry. Co. v. United States, 129 S. Ct. 1870, 1873–74 (2009). Justice Stevens was joined by Chief Justice Roberts and Justices Scalia, Kennedy, Souter, Thomas, Breyer, & Alito; Justice Ginsburg filed a dissent. 79. Justice Stevens wrote the majority opinion in Massachusetts v. EPA, 549 U.S. 497 (2007) (holding Massachusetts had standing to bring suit based on alleged injury due to global warming and rejecting the contention that the state did not have the authority to regulate greenhouse gas emissions from mobile sources). 80. See Entergy, 129 S. Ct. at 1502–05 (detailing the history of the regulations). 81. See 33 U.S.C. § 1326(b) (2006) (“Any standard established pursuant to § 1311 of this title [the CWA section mandating that all effluent discharges comply with the Act] or § 1316 of this title [the CWA section addressing thermal discharges] and applicable to a point source shall require that the location, design, construction, and capacity of cooling water intake structures reflect the best technology available for minimizing adverse environmental impact.”). 82. Entergy, 129 S. Ct. at 1505. Congress created the BPT standard for discharging facilities already in existence at the time that the CWA was originally introduced, reasoning that these facilities could not absorb the substantial financial burden associated with the more ambitious technologies required for new facilities. See id. at 1519 (Stevens, J., dissenting) (discussing the reasoning behind the BPT standard and stating that the CWA’s scheme imposes a system under which standards move away from this “temporary and exceptional” standard). 83. See Riverkeeper, Inc. v. EPA, 475 F.3d 83, 114 (2d Cir. 2007). 84. See Entergy, 129 S. Ct. at 1510 (citing Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984)). The majority opinion, however,

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The Entergy Opinion

Writing for the majority, Justice Scalia offered only a murky notion of what cost-benefit analysis entails85 and failed to acknowledge the widely known problems its application can cause in environmental standard setting.86 Cost-benefit analysis appears barely distinguishable in Justice Scalia’s majority opinion from other analyses through which cost may influence environmental standard-setting.87 Likewise, the majority purported to discern no significant difference between standards in the CWA that make economics a central consideration and those that prioritize pollution control.88 This oversight led the majority to reject any implication from the BTA provision’s silence on cost-benefit analysis that Congress did not intend cost-benefit analysis to be used with the BTA standard.89 A fundamental distinction between the majority and dissenting opinions in Entergy is their method of applying the Chevron doctrine;90 each opinion is logically sound but reaches opposite conclusions. Justice Scalia’s majority opinion launches its statutory analysis with a summary of EPA’s interpretation of the BTA standard, followed by the assertion that “[the EPA’s] view governs if it is a reasonable interpretation of the statute—not necessarily the only possible interpretation.”91 From this starting point, the majority opinion predominantly defends and justifies EPA’s preferred statutory reading.92 In contrast, Justice Stevens’ dissent begins with a discussion of cost-benefit analysis as a lens through which to analyze the CWA, and concludes that the statute is clear on its face, thus obviating any need for the dissent to consider whether EPA’s interpretation of the BTA provision is reasonable.93 In a footnote, the dissent takes the majority to task for skipping Chevron’s first step and simply applying Chevron deference.94 The majority responds, also in a footnote, that an agency interpretation that contradicts the letter of a statute cannot survive the second step of a Chevron analysis

85. 86. 87.

88. 89. 90. 91. 92. 93. 94.

acknowledges that it collapses the two-step Chevron analysis into a single step. See Entergy, 129 S. Ct. at 1505 n.4. See id. at 1509. In contrast, see Justice Stevens’ dissent, id. at 1516 (reviewing the dangers of environmental harms or benefits being monetized). Id. at 1509-10 (reviewing various settings in which EPA includes costs in its calculus and considers the benefits derived from technologies bearing various costs, ultimately concluding that Riverkeeper having acknowledged in its brief that the CWA would not require billions of dollars to be spent to save one fish is tantamount to Riverkeeper conceding that the CWA authorizes cost-benefit analysis generally). Id. at 1507 (expressing doubt about the assertion that certain CWA tests preclude cost-benefit analysis). See id. at 1506–08 (reviewing standards and denying that the BTA test must conform). It may be that Justice Scalia used Chevron deference to avoid the technical complexities of the CWA’s varying standards. See Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984). See Entergy, 129 S. Ct. at 1505 (citing Chevron, 467 U.S. at 843–44). See id. at 1506–10. Id. at 1516–22 (concluding that, under Chevron, the agency’s past practices are “irrelevant”); id. at 1521 n.13. Id. at 1518 n.5 (finding it “puzzling” that the majority sets forth the second step of Chevron at the outset of its opinion).

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because such an interpretation would be unreasonable.95 To take the majority’s rationale to its logical conclusion would allow courts to skip straight to Chevron’s second step. The majority opinion touches on a number of statutory terms so that a Court-led reading of the BTA provision may almost be pieced together from various paragraphs in the opinion.96 For example, the Court presents dictionary definitions and a comparative analysis of how certain words are used in various CWA provisions.97 The Court’s focus throughout this brief exercise, however, is on finding fault with the Second Circuit’s or Riverkeeper’s reading of the statute’s terms.98 By merging the two steps of its analysis, the majority opinion is able to discern ambiguity in every element of the BTA provision. The Court also limits its analysis of the BTA standard by resisting contextual analysis and ignoring legislative history.99 When the Court broadens its scope of analysis to encompass additional CWA standards, it declines to accept that the statute is designed to move cost considerations out of the core calculus of standard-setting for facilities other than those to which the BPT standard applies.100 Further, the Court refuses to accept that BTA is even part of the dynamic movement among the statutory standards through which costconsideration was intended to be marginalized over time.101 While it is true that the statute’s various standards may baffle the novice, and it is also true that cooling water intake structures do not fit readily into a hierarchy of polluting sources that includes old and new point sources as well as nontoxic and toxic discharges, the Supreme Court is not a novice at reading statutes and the legislative history of the CWA could have helped the Court crack any supposed code.102 By conflating Chevron’s two steps and ignoring the statute’s legislative history, the Court avoids acknowledging that the dissent’s legislative history analysis offers strong support for its reading of the statute.103 Repeatedly finding very 95. Id. at 1505 n.4 (invoking the idea that through a step-two analysis in which an agency’s statutory interpretation is determined to have been unreasonable, a court will discover whether a step-one analysis is necessary). 96. Id. at 1505–06 (focusing on the terms “best” and “minimizing”). 97. Id. at 1506 (referencing Webster’s New International Dictionary to find the meaning of “best” to be ambiguous, and various sections of the CWA to agree with EPA that “minimizing adverse environmental impacts” does not prioritize environmental impacts over cost). 98. Id. at 1505–06 (accepting the plausibility of both parties’ arguments, and thus concluding that the agency reading is “not ambiguously preclude[d]”). 99. Id. at 1506–09 (launching the discussion with a lament—“alas”—at the supposed complexity of Riverkeeper’s contextual analysis). 100. Id. at 1507 (denying that the Act precludes cost-benefit analysis under all but the BPT standard). 101. Id. at 1507–08. 102. Cf. Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984). See, e.g., Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 467 (2001) (concluding that the CAA provision under dispute precluded cost from factoring into air quality standards). The Entergy dissent points to Whitman as an analogous case in which the Court understood that a statutory provision’s silence on cost evidences a congressional intent to bar cost-benefit analysis. Entergy, 129 S. Ct. at 1517–18. The Entergy majority attempts to minimize Whitman, noting that the case “stands for the rather unremarkable proposition that sometimes statutory silence, when viewed in context, is best interpreted as limiting agency discretion.” Id. at 1508. 103. Both the Entergy dissent and concurrence conclude that the CWA legislative history verifies that Congress intended that cost play a central role in standard setting only under the BPT standard. Id. at 1512–14 (Breyer, J., concurring); id. at 1519–20 (Stevens, J., dissenting). Justice Breyer, however, concludes that

little that is definite or instructive about the CWA,104 the opinion concludes weakly that agency discretion to use costbenefit analysis under the BTA standard is acceptable.105

Entergy’s Impact

The Entergy decision carries several implications beyond its impact on BTA under the CWA. First, the system and language of standard-setting under the CWA is not unique to that statute. The Clean Air Act (“CAA”), for example, also tasks EPA with setting various performance standards, some allowing a relaxed, cost-sensitive standard, and others requiring diminished emissions at greater expense.106 Entergy may be read as inviting a more confused, conservative reading of the various standards in such environmental statutes. Second, and perhaps more significantly, the Entergy majority took the concept of Chevron deference to a new level, as Justice Scalia bypassed the first step of the analysis, instead skipping directly to a discussion of whether EPA’s reading of the BTA standard constituted a permissible construct of the statute.107 As a response to the dissent’s protest at this maneuver, Justice Scalia offered no more than a footnote explaining that an agency interpretation of a statute that is not reasonable could not possibly comport with its clear meaning, so that the two steps of Chevron may be conflated without compromising the doctrine.108 It is difficult to believe that Justice Scalia intended for other courts to emulate his condensed version of the Chevron test, as he has made a point of defending the Chevron test on grounds of its clarity.109

Superfund Railroaded—Robbing CERCLA of Cleanup Liability

Burlington Northern invites comparison with Entergy in that both cases involved challenges to an agency’s interpretation of a federal statute under its jurisdiction.110 Contrasting nothing in the legislative history precludes EPA’s use of cost-benefit analysis when setting BTA. Id. at 1514. Justice Breyer also concludes that EPA’s process for determining BTA does not constitute a cost-benefit analysis of the nature that would be appropriate for setting BPT. Id. at 1514–15. 104. See id. at 1506, 1508. 105. See id. at 1510 (concluding that “the EPA permissibly relied on cost-benefit analysis in setting the national performance standards and in providing for cost-benefit variances from those standards as part of the Phase II regulations”). 106. See, e.g., Whitman, 531 U.S. at 471 (discussing the CAA by identifying standards set forth in CAA § 109, 42 U.S.C. § 7409 (2006) as disallowing cost consideration). 107. Entergy, 129 S. Ct. at 1505 (launching the analysis section of the opinion with a description of EPA’s position and the observation that “[t]hat view governs if it is a reasonable interpretation of the statute-not necessarily the only possible interpretation, nor even the interpretation deemed most reasonable by the courts” and citing to Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843–44 (1984)). 108. Entergy, 129 S. Ct. at 1505 n.4 (noting that “surely if Congress had directly spoken to an issue then any agency interpretation contradicting what Congress has said would be unreasonable”). 109. See United States v. Mead, 533 U.S. 218, 240 (2001). (Scalia, J., dissenting) (criticizing the majority opinion for applying the Skidmore standard instead of the more deferential Chevron standard)). 110. See Burlington N. & Santa Fe Ry. Co. v. United States, 129 S. Ct. 1870 (2009). Unlike Entergy, Burlington Northern does not involve an agency constructing a statute through a gap-filling mechanism such as regulations, and thus Burlington Northern does not invoke the Chevron doctrine. Burlington N., 129 S.

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Entergy markedly, however, the Burlington Northern majority gave no deference to the agency’s argument or past interpretations.111 Burlington Northern also contrasted Entergy in that the Court construed the CERCLA provision under dispute in Burlington Northern narrowly,112 while it found much leeway in the CWA standard under consideration in Entergy.113 A third notable distinction between the cases is that Justice Stevens authored the dissent in Entergy,114 but authored the majority opinion in Burlington Northern.115 Indeed, as an initial impression it may appear that the only consistency between the two cases is that in both of them the environmental petitioners lost.

The Burlington Northern Opinion

Just as in Entergy, the majority opinion in Burlington Northern presents a statutory discussion that is selective in its analysis, which could lead to the conclusion that the Court was oriented toward a preferred result.116 The primary issue was whether Shell was liable under CERCLA for having arranged a chemical transfer operation in which chemicals were spilled.117 CERCLA applies a system of strict liability applicable to parties who arrange for disposal of hazardous substances that later necessitate remediation.118 To find that Shell falls outside the scope of arranger liability, the majority ignored the statutory definition of “disposal,” which it did without explanation after acknowledging the problem that the inclusion of the terms “spilling” and “leaking” in the definition presented for Shell’s argument on the degree of intent required for a party to have arranged for disposal of hazardous substances.119 In this way, the opinion lays its emphasis on a narrow reading of the term “arranged” to determine that Congress could not have intended for a party centrally involved in the handling of hazardous substances at a site to be liable for the cleanup of those substances at that site.120 Ct. at 1877 (framing the issue as one of statutory analysis based on an agency finding of liability, as opposed to agency standard-setting). 111. See id. at 1878–82. 112. See id. at 1878–80. 113. See Entergy, 129 S. Ct. at 1505–10. 114. See id. at 1516. 115. See Burlington N., 129 S. Ct. at 1874. 116. See supra notes 82–89 and accompanying text for discussion of the Court’s seeming naivety about cost-benefit analysis and also about Congress’ intent when using terms like “practicable” and “available” in the CWA. 117. See Burlington N., 129 S. Ct. at 1874–75. 118. Comprehensive Environmental Response, Compensation, and Liability Act, § 107(a)(2)(3), 42 U.S.C. § 9607 (a)(2)(3) (2006). 119. See Burlington N., 129 S. Ct. at 1879–80 (acknowledging the Government’s argument about how the inclusion of unintentional acts such as “spilling” in the definition of “disposal” opens up the definition of “arranged for” to include unintended but foreseen spills occurring during activities arranged by the party, then simply insisting that Shell needed to have “taken intentional steps” to spill the hazardous substances to qualify as an arranger). 120. See id. at 1880 (concluding that “Shell’s mere knowledge” about the spills “is insufficient grounds for concluding that Shell ‘arranged for’ the disposal of [hazardous substances] within the meaning of [CERCLA] § 9607(a)(3)”). The case also addresses the issue of whether the district court’s apportionment of liability is supported by the statute, concluding that it is. Id. at 1880–84. Because this Article primarily focuses on issues where commonalities and distinctions among the five 2008–09 Supreme Court environmental opinions are readily apparent, this Article does not address the apportionment issue in Burlington Northern.

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The Stevens opinion acknowledges its reading of CERCLA turns a blind eye to the statutory definition of “disposal.”121 This selective reading of CERCLA is further underscored in Justice Ginsburg’s dissent.122 Justice Ginsburg concludes that control over an operation that inevitably will cause hazardous substance spills, coupled with knowledge of those spills, constitutes arranging for such spills.123 Although Justice Ginsburg admits that she considered the case a close one,124 she alone adopts a reading that accommodates all the implicated statutory terminology. In addition to ignoring statutory language to reach its decision, the Burlington Northern majority opinion needed to ignore a primary principle of CERCLA’s liability scheme, which is that liability for hazardous substance cleanup should be borne by those who control and profit from the use of hazardous substances.125 Although never stated expressly in CERCLA’s text, the statute’s goal of prioritizing cleanup over fault-finding is made clear from a number of its provisions. First, CERCLA imposes strict, joint and several liability upon the parties listed in § 107 of the Act.126 These parties are listed without reference to fault, and the affirmative defenses provided describe only several unlikely circumstances under which such parties may escape liability.127 When CERCLA expressly limits liability, as it does for certain lenders, trustees, and other so-called innocent landowners, the statute specifies in great detail the requirements for a party to avail itself of such liability protection.128 In keeping with CERCLA’s broad strict-liability provision, the statute also creates a means through which liable parties may participate in contribution actions so as to allocate cleanup cost more fairly among the various contributors to a Superfund site.129 All of these features of CERCLA attest to both the statute’s intent for all parties involved in the hazardous substance industry to participate in cleanup of pollution occurring through the operation of that industry and its intent to prioritize cleanup over fault-finding. 121. Id. at 1879–80. 122. See id. at 1884–85 n.1 (Ginsburg, J., dissenting). 123. See id. at 1885 (stressing that Shell changed its method of delivery to a process that “directly and routinely” caused the spills, because it was more “economically advantageous” than its previous mode of delivery, which had ensured against spillage). 124. See id. at 1884. 125. See id. at 1885 (identifying “CERCLA’s objective—to place the cost of remediation on persons whose activities contributed to the contamination rather than on the tax-paying public”). 126. CERCLA § 107(a), 42 U.S.C. § 9607(a) (2006), assigns liability, without regard to fault, to parties who bear the following statuses in connection with a site requiring cleanup: owner, operator, party who arranged for disposal of hazardous substances at the site, and party who transported hazardous substances to the site. Such parties are deemed “potentially liable parties” under the Act, and they may be compelled to fund response actions at the site prior to and as a separate matter from the determination of their liability. 127. CERCLA § 107(b), 42 U.S.C. § 9607(b) (2006), allows parties to assert the affirmative defenses that the contamination of the site with which they are connected was an act of God, an act of war, or an act of a third party with whom they have no contractual relationship. 128. See CERCLA § 101(20)(E), 42 U.S.C. § 9601(20)(E) (2006) (excluding lenders who do not participate in site management from ownership status); CERCLA §§ 107(b)(3), 107(n), 42 U.S.C. §§ 9607(b)(3), 9607(n) (addressing the innocent landowner defense and establishing limits on fiduciary liability). 129. CERCLA § 113, 42 U.S.C. § 9613(f ) (2006), addresses the contribution action.

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An interpretation of arranger liability that allows a company to escape liability when the company controlled, handled, and profited from commerce in hazardous substances over many years during which spills occurred is simply not in keeping with the statute’s goals. Indeed, the majority’s emphasis on the fact that Shell took steps to reduce the spillage its arrangements caused at the transfer site appears to disregard the statute’s strict liability scheme.130

provisions harmoniously.135 Second, Burlington Northern is the only environmental case of the 2008–09 Term in which the Supreme Court’s reading of a statutory provision led to a conclusion contrary to that argued by the implementing agency.136 This observation is meaningful because Burlington Northern is the only case in the Term where the government favored a statutory reading that would produce a more environmentally benign outcome.

Burlington Northern’s Impact

Burlington Northern resembles Entergy in more than their holdings against environmental petitioners. The two decisions present similar styles of argumentation. Most significantly, neither majority was inclined to base its decision on the overriding principle underlying each of the statutes. CERCLA’s underlying principle is that private parties that profit from the production, handling, and use of hazardous substances should bear the costs of remediation when those substances pollute.131 The dissenters acknowledged this, and thus were guided by more than dictionary definitions and so-called ordinary meanings in their reading of the liability provisions.132 To the dissent, arranging should be loosely construed to encompass parties who devise and control the method for handling a hazardous substance through which inevitable spills occur over a long period.133 The majority preferred to focus almost exclusively on the plain meaning of the word “arranged,” as if the most important consideration of how the term is read in CERCLA is that it should be consistent with the term’s use when discussing the planning of a party or the placing of flowers in a vase.134 Because it is difficult to accept that the majority was unaware of CERCLA’s aim to cast liability widely so as to include all who participate in the hazardous substance industry, it appears that the Court meant to send a message through Burlington Northern that it finds the broad liability scheme unpalatable. Thus, Burlington Northern is similar to Entergy in that the Court reads a statutory term so as to undermine the spirit of the statute. The Northern Burlington decision strikes a more ominous chord than its predecessor, however, in two ways. First, eight of the nine Justices joined the Northern Burlington majority despite Justice Ginsburg’s dissent, which both reminded the majority of Congress’ intent in creating CERCLA liability and also read the liability and definitional 130. Burlington N., 129 S. Ct. at 1880 (concluding that Shell’s “mere knowledge” of the spills cannot serve as grounds to conclude that it arranged for such spills). 131. See Burlington N., 129 S. Ct. at 1885 (identifying CERCLA’s primary objective as placing “the cost of remediation on persons whose activities contributed to the contamination rather than on the taxpaying public”). 132. See id. 133. See id. (pointing out that Shell found it “economically advantageous, in lieu of shipping in drums, to require” bulk shipments and storage, and also that Shell’s “control rein” over the delivery and transfer process rightly cast Shell as an arranger). 134. See id. at 1879–80 (introducing the “ordinary meaning” approach and then concluding that to qualify as an arranger Shell needed to have entered the transaction with Brown & Bryant with the intent that the pesticide be discarded during transfer).

Iced in Alaska—Carving a Hole in the Clean Water Act

Coeur Alaska is the final of the five environmental decisions emerging from the 2008–09 Term, and is the decision that may contribute the most to a perception that the Court’s majority is hostile to environmental protection interests.137 The case asked whether the U.S. Army Corps of Engineers (“Army Corps”) was authorized to issue a fill permit allowing Coeur Alaska to dump slurry wastes into a navigable lake when a CWA regulation expressly prohibits the discharge of process wastes from the type of mine that Coeur Alaska operated.138 The Court concluded that the CWA did not require the EPA to subject the Army Corps permit program to effluent discharge limitations, and that discharges qualifying for an Army Corps fill permit were not subject to discharge bans that would otherwise be imposed under the CWA .139

The Coeur Alaska Opinion

Justice Kennedy’s opinion begins with a scant examination of the statutory phrase that the government claimed was key to understanding the relationship between § 402 of the CWA,140 the provision that creates the statute’s core pollution discharge permit program, and § 404 of the CWA, the provision that authorizes the Army Corps fill discharge permit program.141 The opinion admits that the Southeast Alaska Conservation Council (“SEACC”) offered a cognizable interpretation of the interplay between these programs, but instead follows the agencies’ preferred interpretation.142 135. See id. at 1885 n.1 (citing the definition of “disposal” and including “spilling” and “leaking”). 136. Compare id. at 1879–80, with Entergy, Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498, 1510 (2009) (conforming to EPA reading of the CWA), and Coeur Alaska, Inc. v. Se. Alaska Conservation Council, 129 S. Ct. 2458, 2478 (2009) (conforming to EPA and Army Corps of Engineers reading of CWA). 137. Coeur Alaska, 129 S. Ct. at 2458. 138. Id. at 2463. The opinion explains that the lake in question, Lower Slate Lake, is twenty-three acres in size and is thus small, but it constitutes a navigable water and thus falls under CWA jurisdiction. Coeur Alaska planned to dump 4.5 million tons of debris into the lake, raising its bed to its current surface level, with the result that the surface of the lake would spread to sixty acres, requiring a dam at its downstream shore that would render it an isolated water body. Id. at 2464. 139. Id. at 2475–77 (concluding that EPA’s practice of barring application of the § 306 standards from discharges qualifying as fill under the § 404 program warrants deference). 140. 33 U.S.C. § 1342 (2006). 141. 33 U.S.C. § 1344 (2006). 142. See Coeur Alaska, 129 S. Ct. at 2467–68 (acknowledging SEACC’s assertion that the agency reading of § 402 is grammatically incorrect, but rejecting the SEACC’s alternative reading in favor of the government position that the

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While conceding that the Chevron standard is inapplicable,143 the Court adopts agency deference as its guide to understanding the CWA, and the remainder of its discussion does little more than verify that the agency position finds adequate support in the CWA and the agencies’ own regulations.144 To the question of whether the new source performance standards authorized under § 306 of the CWA may bar discharges otherwise qualifying for a § 404 fill permit, the majority considers the applicability of the Chevron doctrine.145 Although both the statute and the agency standards are silent on the question of whether the new source performance program’s regulatory bans on designated industry discharges prohibit those industries from obtaining a fill permit, the majority appears inclined to favor an interpretation of those silences under which Congress and EPA failed to address the applicability of § 306 of the CWA to discharges qualifying as fill because both legislators and regulators presumed that the fact that § 404 of the CWA fill permits would not be subject to new source performance standards under § 306 is so obvious that it need not be expressed in the statute.146 Nevertheless, the majority concedes that neither statute nor regulations unambiguously resolve how § 306 and § 404 may be reconciled, so the Court resorts to applying a deferential reading of an EPA memorandum addressing the topic.147 The remainder of the majority opinion lauds the EPA memorandum and, primarily on this basis, concludes that fill permits are available for new sources of the type of wastes at issue even though such wastes are expressly banned under the EPA’s § 306 regulations.148 It is left to Justice Ginsburg’s dissent to consider the supposedly incompatible programs in light of the structure, core

commands, and priorities of the CWA.149 Unlike the majority opinion, the dissent launches its analysis with a review of the CWA’s key programs through which Congress charged the EPA with meeting the statute’s principal goal of restoring and maintaining the integrity of U.S. waters.150 These key programs included both the § 402 permitting system and the new source performance standards developed under § 306.151 This overview of the CWA and its pertinent history presages Justice Ginsburg’s main point, which is that a reviewing court’s statutory analysis of so-called clashing CWA programs cannot properly turn on the supposed ambiguity or silences of select provisions before courts take refuge in non-regulatory agency statements.152 Indeed, after providing her brief review of the priorities expressed in the CWA, Justice Ginsburg easily concludes that the outcome desired by both agency and industry in the case appears to contradict the clear intent of the statute and the longstanding regulations.153 Her opinion begins its analysis of §§ 306 and 404 with the goal of harmonizing those sections with the statute as a whole.154 Guided by the statute’s overriding principles, Justice Ginsburg offers a reading that is true to the statutory language and consistent with the overall statutory structure.155 After all, § 306 states its proscription against new discharges of wastewater from frothfiltration processes as being universally applicable.156 Section 404’s authorization of the Army Corps to issue fill permits, on the other hand, contains no such assertion of universality.157 Thus, under a straightforward reading of the statute, discharges banned under § 306 are not eligible to apply for permits under § 404.158

phrase in question is meant to shield all discharges qualifying as fill under § 404 from the § 402 discharge program). 143. See id. at 2469–70 (“We look first to the agency regulations, which are entitled to deference if they resolve the ambiguity in a reasonable manner. But the regulations, too, are ambiguous, so we next turn to the agencies’ subsequent interpretation of those regulations.”). 144. See id. at 2468–69 (framing the analysis as one under which the applicability of § 404 precludes the applicability of § 402). 145. Id. at 2469. 146. See id. at 2471 (concluding that § 404 omitting to protect the permit holder from suit alleging a violation of § 306, while § 404 does protect the permit holder from suit under other CWA programs, demonstrates that Congress never conceived of § 306 as applying where § 404 applied, rather than concluding that the omission means that Congress did not intend to protect fill permit holders from suit for breaching § 306); see also id. at 2472–73 (reaching a similar conclusion about the silence on § 306 in the EPA guidelines for § 404). 147. See id. at 2472–77 (citing United States v. Mead Corp., 533 U.S. 218 (2001)); Auer v. Robbins, 519 U.S. 452 (1997) (noting the general proposition that agency interpretations issued in forms other than rulemaking are entitled to deference if not plainly erroneous). Justice Scalia, in a concurrence, takes exception to this element of the majority opinion, arguing that the various non-Chevron tests that the courts have spawned after Mead actually amount to applications of Chevron, and concludes by asserting that, “I favor overruling Mead. Failing that, I am pleased to join an opinion that effectively ignores it.” Id. at 2480 (Scalia, J., concurring). 148. See id. at 2473–74 (lauding the EPA interpretation because (1) it confines the § 404 exemption from § 306 to closed bodies of water; (2) it does not exempt incidental filling effects; (3) it reminds readers that, in administering the § 404 program, the Army Corps must determine that fill discharges are in the public’s interest; (4) toxic pollutants are not included in the § 306 exemption; and (5) the Court finds EPA’s reasoning sensible and consistent with the EPA’s regulatory scheme).

149. See id. at 2480-81 (framing the discussion in terms of the original intent of the CWA and its core command to ban discharges of pollution to waters of the United States except under EPA permit). 150. See Coeur Alaska, 129 S. Ct. at 2480–82 (identifying the key means through which Congress planned for the CWA to reduce water pollution, including the presumption that discharges of pollution to waters of the United States are prohibited, the development of technology-based, pollution-control standards, increasingly strict limitations on effluent discharges from identified categories of dischargers, and the heightened requirements applicable to new discharge sources). 151. Coeur Alaska, 129 S. Ct. at 2482 (identifying the § 402 program, dubbed the National Pollution Discharge Elimination System, as the “lynchpin” of the Act). 152. See id. at 2483–84. 153. Id. at 2482 (noting that Coeur Alaska’s claim to a § 404 permit “carries weighty implications”). 154. See id. (opining that “[n]o part of the statutory scheme, in my view, calls into question the governance of EPA’s performance standard”). 155. Id. at 2482–83 (noting that the text of CWA § 306 contains the word “any” in three places, and the regulations contain the words “there shall be no discharge,” while the text of § 404 simply states that the Army Corps “may” issue fill permits). CWA § 404(a), 33 U.S.C. § 1344(a) (2006) (the Army Corps “may issue permits” for the discharge of “dredged or fill material”). 156. See CWA § 306(e), 33 U.S.C. § 1316(e) (2006) (“[I]t shall be unlawful for any owner or operator of any new source to operate such source in violation of any standard of performance applicable to such source.”). See also 40 C.F.R. § 440.104(b)(1) (2009) (“[T]here shall be no discharge of process wastewater to navigable waters from mills that use the froth-flotation process . . . .”). 157. CWA § 404(a), 33 U.S.C. § 1344(a) (2006) (stating that the Army Corps “may issue permits . . . for the discharge of dredged or fill material . . .”). 158. Coeur Alaska, 129 S. Ct. at 2482–83 (explaining how this reading comports with the CWA’s structure and objectives).

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Coeur Alaska’s Impact

The Coeur Alaska decision’s impact on the administration of the CWA is obvious. Unless Congress or EPA exercises legislative or administrative means to reassert the priorities of the Act, the fill permit program may ignore the discharge elimination program to the detriment of U.S. waters. As a decision based primarily on the Court’s reading of one or two statutory provisions, Coeur Alaska underscores some of the tactics of the conservative Justices. As in Entergy, for example, the Coeur Alaska majority appeared determined to discern no overriding principle in the CWA that would warrant a reading of two seemingly contradictory provisions to favor pollution control.159 As in Burlington Northern, the majority’s reading of the statute’s language is selective, so that certain words must simply be ignored for the Court to reach its conclusion.160 And, as with the two prior cases, the Coeur Alaska dissent makes clear that the majority’s reading both undermines the statute’s core principle and necessitates ignoring some of the statute’s language.161 Perhaps the most significant impact of the Coeur Alaska decision is the openness with which the majority expresses its personal views on environmental protection laws. Justice Kennedy expresses concern that the environmental petitioners’ reading of the CWA would inhibit would-be industrial dischargers from obtaining fill permits.162 The majority also relies heavily on a memorandum produced by EPA.163

II.

Echoes from Past Supreme Court Environmental Opinions

Accusations of bias in the Supreme Court’s 2008–09 Term environmental law decisions may be tempered when each case is placed in historical context. For example, Winter joins an unbroken history of Supreme Court NEPA-losses for environmental protection advocates.164 Similarly, as a standing case, Summers revisits a long-time Achilles’ heel of environmental petitioners, with the majority adding little to the opinions denying standing that emerged from the Court 159. See supra notes 141–43 and accompanying text; Coeur Alaska, 129 S. Ct. at 2475. 160. See supra notes 135–37 and accompanying text. 161. See Coeur Alaska, 129 S. Ct. at 2483; Entergy, Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498, 1517–18 (2009); Burlington N. & Santa Fe Ry. Co. v. United States, 129 S. Ct. 1870, 1885 (2009). 162. See Coeur Alaska, 129 S. Ct. at 2469 (noting the “dischargers would face a more difficult problem” under the challengers’ reading of the statute). 163. See Memorandum from Diane Regas, Director, Office of Wetlands, Oceans and Watershed at EPA, to Randy Smith, Director, Office of Water, Region X, at EPA, Clean Water Act Regulation of Mine Tailings 1, 1 n.1 (May 17, 2004), available at http://www.vnf.com/assets/attachments/EPAs_2004_Regas_Memo.pdf (introducing the memo by stating that it is generally applicable to mines, but responds to proposed “discharges of mine tailings from the proposed Kensington Mine.”). The memorandum clearly responds specifically to the issue at dispute in Coeur Alaska. See id.; see also Coeur Alaska, 129 S. Ct. at 2473–74 (discussing the EPA 2004 memorandum). 164. See Jason J. Czarnezki, Revisiting the Tense Relationship Between the U.S. Supreme Court, Administrative Procedure, and the National Environmental Policy Act, 25 Stan. Envtl. L.J. 3, 10 n.43 (2006) (noting that as of 2006, environmental petitioners had lost in all fifteen of the NEPA cases the Court had decided in its history).

through the 1990s.165 The three remaining 2008–09 environmental cases all turn on the level of deference the Court gives an agency in interpreting its statutory directives.166 As such, they might be viewed as doing little more than confirming that these principles of statutory interpretation do not constrain the Court’s activist agenda.167 In sum, the five environmental cases of the Court’s 2008–09 Term may offer few surprises when considered in the context of certain trends and prior opinions. Nevertheless, the five cases do present several unprecedented disappointments. Perhaps the most significant is that the Summers standing decision follows the landmark Massachusetts v. EPA decision, in which Court held that evidence of the link between shoreline attrition and global warming allowed the Commonwealth of Massachusetts to maintain its claim against EPA for EPA’s decision against regulating carbon dioxide emissions under the CAA.168 Massachusetts v. EPA stood as a stunning break from the nearly unbroken line of environmental standing losses coming out of the Supreme Court over the decades.169 Adding to the environmental community’s optimism over Massachusetts v. EPA was the Supreme Court’s environmental standing decision preceding it in Friends of the Earth v. Laidlaw Environmental Services, another environmental petitioners’ victory that appeared to signal a change in the Court’s comfort with environmental litigation.170 This year, the Court dispelled any such signal.

165. See supra notes 74–76. For examples of past standing decisions echoed by Summers v. Earth Island Institute, 129 S. Ct. 1142 (2009), see Lujan v. Nat’l Wildlife Fed’n, 497 U.S. 871, 879, 898 (1990) (denying standing for environmental petitioners seeking to challenge a government program encouraging mining, oil and gas leases in federal lands); see also Lujan v. Defenders of Wildlife, 504 U.S. 555, 558–59, 562 (1992) (denying standing to environmental petitioners challenging a U.S. Department of Interior decision exempting federal actions impacting endangered species overseas from the Endangered Species Act consultation requirement); Steel Co. v. Citizens for a Better Env’t, 523 U.S. 83, 86–88, 105 (1998) (denying standing where the defendant steel manufacturer complied with the statute at issue just prior to the time petitioners filed suit). 166. See supra notes 78–79, 91–96, 109–13. 167. See Jason J. Czarnezki, An Empirical Investigation of Judicial Decisionmaking, Statutory Interpretation, and the Chevron Doctrine in Environmental Law, 79 U. Colo. L. Rev. 767, 793, 798 (2008) (concluding that “[t]he data provide very limited evidence that Chevron step one is used strategically to achieve [the judges’] desired policy preferences [in environmental cases]”). 168. See Massachusetts v. EPA, 549 U.S. 497, 505 n.6 (2007); see also CAA § 202, 42 U.S.C. § 7521 (2006) (requiring EPA to regulate emissions from mobile sources that contribute to air pollution and endanger public health and welfare). 169. See, e.g., Jeffrey Rosen, Supreme Court, Inc., N.Y. Times Mag., Mar. 16, 2008, 38, at 74 (“On rare occasions, the Roberts Court has held that the Bush administration’s deregulatory efforts circumvent the will of Congress—like the 5–4 decision [of 2007] holding that the Environmental Protection Agency acted capriciously when it adopted a rule that said it had no legal authority to regulate greenhouse gases.”); Jonathan H. Adler, Business, the Environment, and the Roberts Court: A Preliminary Assessment, 49 Santa Clara L. Rev. 943, 954 (2009) (“Insofar as [three Roberts Court opinions identified as ’significant business wins’] are ‘pro-business,’ they are all quite modest. Solid base hits, to be sure, but not home runs. Their significance pales in comparison to Massachusetts v. EPA, by far the most significant environmental decision decided by the Roberts Court thus far.”) (footnote omitted). 170. See Friends of the Earth, Inc. v. Laidlaw Envtl. Servs., Inc., 528 U.S. 167, 181–83 (2000) (finding standing where defendant’s noncompliance with its CWA discharge permit prevented members of an environmental organization from recreational use of a river, despite a district court’s finding that the defendant’s noncompliance had not resulted in any “demonstrable proof of harm” to the receiving waters).

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This section identifies historically significant precedents that may help place the 2008–09 Supreme Court environmental decisions in context.

Winter and the Evisceration of NEPA

As a case about the Navy’s NEPA responsibilities, Winter is reminiscent of Weinberger v. Catholic Action of Hawaii/ Peace Education Project, which the Court decided in 1981.171 In Catholic Action, Justice Rehnquist wrote for the Court, affirming that NEPA applies to all government actions that present a significant threat to the environment, regardless of the special circumstances under which the nation’s armed forces may operate.172 Justice Rehnquist acknowledged that national security might require that an EIS produced by a branch of the armed forces be unavailable for public review.173 Nevertheless, he explained, even where all the benefits of NEPA may not be realized, some of them will be realized when the armed forces adhere to the EIS requirement.174 Those conducting the environmental review will be able to assess, and even choose among, the relative environmental impacts identified under alternative scenarios for meeting their goals, as will other government officials reviewing the EIS, such as the President.175 In considering separately the dual functions of NEPA— agency guidance and public disclosure—and concluding that each serves an important function, the Catholic Action opinion contrasts sharply with Winter. In Winter, the majority discounts NEPA’s agency guidance function, interpreting the EIS requirement as procedural and presuming that the content of an EIS may be readily ignored once the agency completes it.176 Indeed, the contrast between the two cases underscores how the judicial view of NEPA changed from the statute’s early days when NEPA was characterized as “action-forcing” rather than merely procedural.177 In that light, Winter also stands as a reminder of the landmark 1989 case, Robertson v. Methow Valley Citizens Council, in which the Court stressed the procedural and non-coercive

171. See Weinberger v. Catholic Action of Haw./Peace Educ. Project, 454 U.S. 139 (1981) (overturning appellate court requirement that the Navy produce a hypothetical EIS where national security interests prevented the Navy from publishing an EIS on the possible storage of nuclear weapons in a weapons storage facility being constructed at a Naval base in Hawaii). 172. See id. at 146 (stating that if the Navy proposed to store nuclear weapons at the site in question, it would be required under NEPA and Department of Defense Regulations to prepare an EIS). 173. See id. at 143, 146 (discussing the “twin aims” of NEPA, the first being “to inject environmental considerations into the federal agency’s decision making process by requiring the agency to prepare an EIS,” and the second being “to inform the public that the agency has considered environmental concerns in its decision making process”). 174. See id. (finding that the two goals of the EIS process, decision making and disclosure, are “not [necessarily] coextensive”). 175. See id. at 142. 176. See Winter v. Natural Res. Def. Council, Inc., 129 S. Ct. 365, 376 (2008) (stressing that NEPA “impose only a procedural requirements”). 177. Compare id., with Catholic Action, 454 U.S. at 148 (Blackmun, J., concurring) (defining NEPA as “action-forcing” and emphasizing that a key goal of NEPA is to aid the federal government in planning actions and making decisions that are sensitive to environmental impacts).

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nature of NEPA.178 Robertson explored the issue of whether non-environmental considerations allow agency actors to reject the most environmentally benign options emerging from the NEPA process.179 The Winter majority uses Robertson for the simple proposition that NEPA mandates no action, and that therefore the EIS process cannot outweigh Navy training as a matter of public concern.180 Another historically significant NEPA case involving the Navy is the 1982 decision Weinberger v. Romero-Barcelo.181 In Romero-Barcelo, the Court addressed a district court injunction against the Navy for discharging ordnance into U.S. waters without a CWA permit.182 The Supreme Court concluded that neither the CWA nor the district court’s equitable discretion required an injunction because it appeared that a CWA permit was likely to be issued eventually.183 In allowing deference to the Navy to overshadow respect for environmental agency process, Romero-Barcelo certainly presages Winter. Romero-Barcelo differs from Winter significantly, however, because by finding that the Navy likely would receive the required CWA discharge permit, the Romero-Barcelo Court satisfied itself that the purposes of the CWA permit program would not be thwarted by allowing the Navy to continue its practices as it went through the permit process.184 In addition, the Navy’s practice of discharging munitions into the ocean is not a typical practice to which the CWA permit program would apply.185 In contrast, the Winter decision thwarted one of the core purposes of NEPA when it denied injunctive relief.186 The Winter Court’s suggestion that the EIS would have no impact on the Navy’s actual behavior appears to provide an apparent justification for the decision.187 These cases may indicate that Winter should be relegated to a special class of regulatory exemptions for armed forces operations. However, Winter also bears some similarities to the 2004 decision, Department of Transportation v. Public Citizen.188 In that case, Justice Thomas’ majority opinion found that an agency performing a NEPA analysis did not 178. Robertson v. Methow Valley Citizens Council, 490 U.S. 332, 350 (1989) (“The sweeping policy goals announced in § 101 of NEPA are thus realized through a set of ‘action-forcing’ procedures that require that agencies take a ‘hard look’ at environmental consequences,’ and that provide for broad dissemination of relevant environmental information. Although these procedures are almost certain to affect the agency’s substantive decision, it is now well settled that NEPA itself does not mandate particular results, but simply prescribes the necessary process.”) (citation omitted). 179. Id. (“If the adverse environmental effects of the proposed action are adequately identified and evaluated, the agency is not constrained by NEPA from deciding that other values outweigh the environmental costs.”). 180. Winter, 129 S. Ct. at 376. 181. Weinberger v. Romero-Barcelo, 456 U.S. 305 (1982). 182. Id. at 306–07. 183. Id. at 320. 184. Id. ( “The [d]istrict [c]ourt did not face a situation in which a permit would very likely not issue, and the requirements and objectives of the statute could therefore not be vindicated if discharges were permitted to continue.”). 185. See id. at 309. 186. See Winter v. Natural Res. Def. Council, Inc., 129 S. Ct. 365, 390 (2008) (Ginsburg, J., dissenting) (“The Navy’s publication of its EIS in this case, scheduled to occur after the fourteen exercises are completed, defeats NEPA’s informational and participatory purposes.”). 187. See supra note 20; see also Winter, 129 S. Ct. at 381 (“Given that the ultimate legal claim is that the Navy must prepare an EIS, not that it must cease sonar training, there is no basis for enjoining such training.”). 188. Dep’t of Transp. v. Pub. Citizen, 541 U.S. 752 (2004).

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have to consider environmental impacts of its non-discretionary actions.189 That is, in its EIS an agency need only consider environmental impacts that it has the authority to diminish or avoid.190 In so finding, Public Citizen undermined an important function of the EIS, which is to document the government’s impacts on the environment, rather than merely to aid government actors in their efforts to minimize the environmental impacts directly under their control.191 By limiting the scope of the EIS to discretionary agency decisions, Public Citizen is a decision by the current conservative Court majority that undermines one of NEPA’s key functions. Similarly, the Winter decision, by casting the Navy’s sonar training program as imperative to the nation’s security and thus nondiscretionary, followed the trend set in Public Citizen. In this way, Winter represents another example of the majority’s negative perspective on NEPA. Winter, however, goes further than Public Citizen. By casting military training as a perennially urgent matter of public concern that may be neither questioned nor impeded, Winter may set precedent for a permanent exemption from the EIS requirement for military exercises.192 It remains to be seen whether Winter will be interpreted so broadly. Judging from the energy with which the current Court has applied itself to environmental cases this year, it appears quite possible that an opportunity to apply Winter in this manner may arise sooner rather than later.

Summers and the Revival of the Environmental Standing Game

In its revival of environmental standing gamesmanship from the 1990s, Summers does more than simply put a fresh date on stale arguments. By not discussing the two major environmental standing cases of the early 2000s, Friends of the Earth v. Laidlaw and Massachusetts v. EPA, Summers makes clear that these two decisions did not permanently change environmental standing doctrine. In Laidlaw, the Court determined that a reasonable apprehension of pollution that causes a petitioner to abandon recreational pursuits can constitute an injury in fact even where data indicates that the pollution did not exist.193 The 189. See id. at 770. The Court determined that because the Federal Motor Carrier Safety Administration had no discretion on the issue of whether to issue regulations pertaining to trucks that would be entered the United States from Mexico upon the President’s lifting of a moratorium on Mexican trucks entering the United States, the agency did not have to address the increased pollution that the trucks would emit into U.S. air. See id. (addressing the discretion issue). 190. See id. at 768. According to the Court, the nondiscretionary nature of the agency action made it impossible for an EIS to either aid the agency in planning its actions or inform the public of the agency’s decision making process so that the public can “provide input as necessary to the agency making the relevant decisions.” See id. 191. See Winter, 129 S. Ct. at 389–90 (Ginsberg, J., dissenting) (noting the “larger informational role” of the EIS). 192. See id. at 370, 376, 381 (stressing the Navy’s use of sonar training program for decades). 193. Friends of the Earth, Inc. v. Laidlaw Envtl. Servs., Inc., 528 U.S. 167, 183–84 (2000). Laidlaw exceeded the discharge limits allowed under its CWA permit for mercury and other toxic materials. Id. at 176. The case is primarily a decision on mootness, in which the Court reverses the appellate court by finding

Laidlaw petitioners had abandoned their recreational use of a river when the defendant discharged pollutants in the river in excess of those allowed under its CWA permit.194 The lower court found, however, that in spite of the illegal discharges, the river remained safe for recreational purposes.195 This fact prompted some Justices to question whether the petitioners’ claim satisfied the causation element of standing.196 In an argument that one could term the “flip side” of the usual argument favored by the conservative branch of the Court (that the courts may only recognize an environmental injury linked to some injury suffered personally by a petitioner), Justice Scalia argued that no environmental petitioner’s personal injury, including the present abandonment of recreational pursuits, may be recognized without being linked to some actual injury to the environment.197 The majority, in an opinion authored by Justice Ginsburg, concluded that the petitioners’ abandonment of the river had been reasonable under the circumstances and, thus, constituted an injury-in-fact.198 Laidlaw is an unusual case in that it focuses on a link in the causation chain—the petitioners’ interpretation of a set of circumstances—usually not present in a standing analysis.199 Accordingly, it is a case with limited direct precedential value. The peculiar facts of Laidlaw also made it a case that seemed likely to be an environmental loss at the Supreme Court level. The outcome thus suggested a level of openmindedness toward environmental claims that indicated a shift on the Court in its general acceptance of environmental protection advocates. Similarly, Massachusetts v. EPA was not destined to be a broadly applicable precedent.200 The fourteen petitionerstates asked the Court to find standing based on the impacts of global warming suffered by them in their proprietary that a defendant’s compliance with law that removes the petitioner’s injury after the petitioner has filed suit does not render the complaint moot, particularly where the defendant could conceivably resume its injurious behavior. Id. at 190 (“[A] defendant claiming that its voluntary compliance moots a case bears the formidable burden of showing that it is absolutely clear the allegedly wrongful behavior could not reasonably be expected to recur.”). As a preliminary matter, the case addresses standing, and there it determines that a petitioner’s burden is to allege injury to himself and that this requirement does not change where the case involves an allegation of harm to the environment. Id. at 181. 194. Id. at 181–83 (discussing various affiants’ abandonment of the river due to concerns about the illegal discharges of mercury and other toxins). 195. Id. at 181. 196. Id. at 198 (Scalia, J., dissenting, joined by Thomas, J.). 197. Id. at 199 (Scalia, J., dissenting) (arguing that “a lack of a demonstrable harm to the environment will translate, as it plainly does here, into a lack of demonstrable harm to citizen petitioners”). 198. See id. at 183–84 (explaining where the defendant’s illegal discharges reasonably caused the petitioner to avoid using the receiving waters, the petitioner met the injury-in-fact requirement); see also id. at 184–85 (“[W]e see nothing ‘improbable’ about the proposition that a company’s continuous and pervasive illegal discharges of pollutants into a river would cause nearby residents to curtail their recreational use of that waterway and would subject them to other economic and aesthetic harms. The proposition is entirely reasonable . . . and that is enough for injury-in-fact.”). 199. Id. at 180 (citing Lujan v. Defenders of Wildlife, 540 U.S. 555, 560-61 (1992)). 200. Massachusetts v. EPA, 549 U.S. 497, 518 (2007) (limiting its analysis to that of a state’s capacity to achieve standing: “It is of considerable relevance that the party seeking review here is a sovereign State and not, as it was in Lujan [v. Defenders of Wildlife], a private individual.”); see also id. at 522 (“Because the Commonwealth ‘owns a substantial portion of the state’s coastal property,’ it has alleged a particularized injury in its capacity as a landowner.”).

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relationship with state lands and also based on their quasisovereign capacity as representatives of their citizens, whose privately owned property suffered negative impacts.201 For the causation element of standing, the petitioner-states pointed to EPA’s refusal to regulate greenhouse gas emissions from mobile sources under the CAA.202 The redressability element of standing, the petitioners argued, was satisfied because the Court’s proper reading of the CAA would result in EPA’s regulation of new motor vehicle emissions, thus slowing the pace of global warming and reducing the mounting impacts on state and private property.203 Reversing the D.C. Circuit Court of Appeals, the Supreme Court recognized standing despite a multitude of familiar arguments articulated in the several dissents, including Justice Scalia’s invocation of the doctrine of agency deference.204 Because the injuries of global warming transcend all national boundaries, making it presumptively an issue that defies the particularity of causation and injury usually required by the Court in environmental cases,205 the environmental-petitioners’ victory in Massachusetts v. EPA appeared to some to herald a sweeping reversal of the Court’s historical skepticism toward environmental petitioners.206 Thus, more than Laidlaw, the 2007 decision indicated a long-awaited acceptance by a majority of the Court that environmental issues could constitute the bases of cases or controversies. Summers negates the optimistic readings of Laidlaw and Massachusetts v. EPA. Justice Scalia’s triumphant revival of decades-old skepticism toward environmental standing underscores the fact that these two previous cases do not establish that a majority of Justices may be relied upon to favor standing in environmental cases.207 It remains to be seen whether the two cases indicate that environmental standing issues will enjoy a more even-handed reception by the Court, or whether the two are simply aberrations from the more ingrained patterns of review in standing cases that were reestablished this year. Perhaps of even more historical interest is the reassertion of a notion first introduced in the landmark environmen201. See id. at 519–20 (citing the standing argument of Georgia v. Tennessee Copper Co., 206 U.S. 230, 237 (1907) to illuminate Massachusetts’ argument for standing on the basis of the state’s “well-founded desire to preserve its sovereign territory today”); see also id. at 519 (“That Massachusetts does in fact own a great deal of the ‘territory alleged to be affected’ only reinforces the conclusion that its stake in the outcome of this case is sufficiently concrete to warrant the exercise of federal judicial power.”). 202. Id. at 523–25 (determining that EPA’s refusal to regulate greenhouse gas emissions contributes to the global-warming related injuries to the Massachusetts coastline). 203. See id. at 525 (discussing that, although EPA’s regulation of mobile-source emissions would not reverse the harms experienced by the petitioners, it would reduce the risks of catastrophic harm to some extent). 204. See id. at 549 (Scalia, J., dissenting) (stressing that the CAA standard in question hinges on the EPA Administrator’s judgment, and then applying deference to the EPA’s preferred reading of the term “air pollutant”). 205. See id. at 521 (discussing injury with the observation that “[t]he harms associated with climate change are serious and well recognized”); id. at 522 (“That these climate-change risks are ‘widely shared’ does not minimize Massachusetts’ interest in the outcome of this litigation.”); id. (“These rising seas have already begun to swallow Massachusetts’ coastal land.”). The Court readily acknowledged both the harm and the injury. Id. 206. See, e.g., Robert E. Weinstock, The Lorax State: Parens Patriae and the Provisions of Public Good, 109 Colum. L. Rev. 798 (2009). 207. See supra notes 57-58 and accompanying text.

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tal standing case Sierra Club v. Morton.208 In his Summers dissent, Justice Breyer argued that the Court should recognize as both concrete and imminent the fact that a newly launched agency program presenting a widespread threat of salvage timber sales occurring without public process on federal lands will inevitably impact the concrete, particularized interests of a long-established environmental organization’s members who hike the nation’s federal lands.209 In so arguing, Justice Breyer revived the argument for organizational standing first expressed by Justice Blackmun in his Sierra Club v. Morton dissent.210 Justice Blackmun urged the Court to expand standing law in the environmental arena to allow organizational standing.211 As he explained, parallels existed in other areas of law, and the expansion could be controlled by utilizing existing vetting methods: I would permit an imaginative expansion of our traditional concepts of standing in order to enable an organization such as the Sierra Club, possessed, as it is, of pertinent, bona fide, and well-recognized attributes and purposes in the area of environment, to litigate environmental issues. This incursion upon tradition need not be very extensive. Certainly it should be no cause for alarm. It is no more progressive than was the decision in Data Processing [Service Organizations, Inc. v. Camp, 397 U.S. 150 (1970)] itself. It need only recognize the interest of one who has a provable, sincere, dedicated, and established status. We need not fear that Pandora’s box will be opened or that there will be no limit to the number of those who desire to participate in environmental litigation. The courts will exercise appropriate restraints just as they have exercised them in the past.212

Justice Breyer’s presentation of similar ideas three decades later, also in dissent, serves as evidence that the Supreme Court has failed to recognize environmental impacts and their consequential injuries to humankind.

Entergy and the Legacy of Chevron

The Court’s application of the Chevron doctrine in Entergy compromised the environmental protection purpose of the CAA. A similar result occurred in the Chevron case itself. The dispute in Chevron centered on how aggressively the CAA required EPA to force industry to transition to cleaner pollution control systems.213 The Act requires less up-to-date technology for older facilities than it does for new facilities, and provides EPA discretion to determine when a facility modification triggers the new source performance standards.214 The 208. Sierra Club v. Morton, 405 U.S. 727, 741 (1972) (denying standing where the petitioner had not established that either the organization or a member had suffered a personal, direct injury). 209. See supra notes 61–72 and accompanying text. 210. Sierra Club, 405 U.S. at 755 (Blackmun, J., dissenting). 211. See generally id. at 755–60 (Blackmun J., dissenting). 212. Id. at 757–58 (Blackmun, J., dissenting). 213. See Chevron, U.S.A., Inc. v. Natural Res. Def. Council, 467 U.S. 837, 840 (1984). 214. Clean Air Act § 111, 42 U.S.C. § 7411 (2006). The substantive question before the Court was whether the CAA authorized the EPA to promulgate regulations which allowed states to treat all pollution sources within an industrial plant as if they were encased in a “bubble.” This would allow a pollution source

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Court deferred to EPA’s view on this issue, which reduced the number of plant modifications subject to the stringent new source emission standards.215 In upholding the EPA’s interpretation of the CAA, the Court slowed the movement from old to new pollution control technologies, thereby undermining the Act’s environmental protection purpose.216 Similar to Chevron with the CAA, the issue in Entergy was how much control EPA may exercise over the pace of the movement from older to newer pollution control technologies under the CWA.217 As in Chevron, the dispute in Entergy arose when EPA arguably employed an overly cost-conscious and less environmentally effective approach to industrial transition to cleaner technology.218 And, like the Chevron majority, the Entergy majority deferred to EPA’s interpretation of when and how aggressively the environmental statute in question required industry to move from cost-conscious to more technologically advanced pollution controls.219 The Court in Chevron was faced with an ambiguous statutory term, the word “source,” which is neither a term of art in the CAA nor a term whose interpretation in one case would be likely to impact how other environmental statutes are read.220 Contrasting this, the Entergy majority was faced with statutory language that is far more precise and the standard under examination is analogous to those in other statutes.221 The Court’s decision on whether a performance standard calling for the “best technology available” allows cost-benefit analysis could impact more than water discharge standards.222 Perhaps of even greater significance, the Entergy majority declined223 to engage in Chevron’s step-one analysis.224 The to maintain the status of existing source even where it underwent modifications and thus would be classified as a new source without the protection of the bubble. See Chevron, 467 U.S. at 840. 215. Id. at 866 (“When a challenge to an agency construction of a statutory provision, fairly conceptualized, really centers on the wisdom of the agency’s policy . . . the challenge must fail. In such a case, federal judges—who have no constituency—have a duty to respect legitimate policy choices made by those who do. The responsibilities for assessing the wisdom of such policy choices and resolving the struggle between competing views of the public interest are not judicial ones.”). 216. See id. at 851 (“Congress sought to accommodate the conflict between the economic interest in permitting capital improvements to continue and the environmental interest in improving air quality.”). 217. See Entergy Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498, 1505 (2009). 218. See id. at 1505. 219. Id. 220. See Chevron, 467 U.S. at 862 (“We know full well that this language is not dispositive.”). 221. See e.g., Wendy E. Wagner, Congress, Science and Environmental Policy, 1999 U. Ill. L. Rev. 181, 203 (1999) (arguing that best technology standards in the CAA and CWA illustrate similar Congressional goals); Ryan J. Rasmussen, Major D’oh: OIRA’s Influence Over the EPA’s Regulatory Decision Making in Riverkeeper Inc., v. EPA, Note, 18 Vill. Envtl. L.J. 357, 371–72 (2008) (comparing “best technology available” to similar statutory provisions). 222. See, e.g., 42 U.S.C § 7412(i)(6) (2006) (specifying “best available control technology” within the CAA). 223. See Entergy, 129 S. Ct. at 1505 n.4; see also id. at 1518 n.5 (Stevens, J., dissenting). 224. See Chevron, 467 U.S. at 842–43 (“When a court reviews an agency’s construction of the statute which it administers, it is confronted with two questions. First, always, is the question of whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines Congress has not directly addressed the precise question at issue, the court does not

Entergy majority moves directly to a deferential determination of whether the agency’s interpretation is within the bounds of reason, which virtually assures that the agency’s action will stand.225 The Court’s indifference to the Act’s overall pattern of moving dischargers through phases of ever-improving technology and its lack of consideration for the problems posed by cost-benefit analysis in the environmental arena supports an inference that the Entergy majority wants to limit the reach of federal environmental laws. Another application of Chevron that bears comparison with Entergy is the 2001 decision Whitman v. American Trucking Ass’ns, Inc.226 Although the case may be best known for its discussion of the non-delegation doctrine, the bulk of the analysis involves statutory interpretation. Interestingly, and in contrast to the findings of the Entergy majority, Justice Scalia’s opinion for the American Trucking majority denies that cost considerations may be imputed into a statutory standard that is silent on the cost issue.227 It is unclear whether this radical shift is due to the language of the CAA provision under consideration in American Trucking or because the majority was more intent on rejecting the non-delegation argument than on injecting cost-benefit analysis into the CAA. Justice Scalia offers some clear language, however, indicating that he understands that including cost considerations in standard-setting alters the process radically.228 His opinion also includes an observation about whether cost should readily be imputed into a standard that does not include it expressly, an observation which was quoted back at the conservative Justices in two of the 2008–09 dissents229: “Congress, we have held, does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions- it does not, one might say, hide elephants in mouseholes.”230 Before concluding that Entergy represents a reversal for a Justice once sensitive to the issues inherent in environmental standard-setting, it should be noted that American Trucking ends by rejecting EPA’s interpretation of the statute in the case, even under the deferential Chevron standard.231

simply impose its own construction of the statute, as would be necessary in the absence of an administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency’s answer is based on a permissible construction of the statute.”). 225. See id. at 1505 n.4 (asserting that the step-two analysis would find any agency interpretation of an unambiguous term unreasonable under Chevron). 226. Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457 (2001). 227. Id. at 467 (“We have . . . refused to find implicit in ambiguous sections of the CAA an authorization to consider costs that has elsewhere, and so often, been expressly granted.”). 228. See id. at 469 (“That factor [cost] is both so indirectly related to public health and so full of potential for canceling the conclusions drawn from direct health effects that it would surely have been expressly mentioned . . . had Congress meant it to be considered.”). 229. Entergy, 129 S. Ct. at 1517; Coeur Alaska, Inc. v. Se. Alaska Conservation Council, 129 S. Ct. 2458, 2484 (2009). 230. Entergy, 129 S. Ct. at 1517; Coeur Alaska, 129 S. Ct. at 484. 231. Whitman, 531 U.S. at 481 (“We conclude . . . that the agency’s interpretation goes beyond the limits of what is ambiguous and contradicts what in our view is quite clear. We therefore hold the implementation policy unlawful.”).

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Burlington Northern and the Backlash against CERCLA

Traditionally, courts have read CERCLA to impose a strict liability scheme applicable to a broad set of parties playing any part in the industries whose activities led to the need for an environmental remediation effort at a Superfund site.232 Issues such as divisibility of harm and contribution were routinely cleared from the question of liability, even where judges acknowledged that the statute pushed aside fairness and fault in favor of its intended result, which is that a large pool of parties be involved in the remediation effort.233 These statutory goals are reflected in the Burlington Northern dissent when Justice Ginsburg identifies CERCLA’s objective as “to place the cost of remediation on persons whose activities contributed to the contamination rather than on the taxpaying public.”234 In a relatively recent high profile case, the Supreme Court signaled that its patience with the statute had grown thin.235 In Cooper Industries, Inc. v. Aviall Services, Inc., Justice Thomas wrote the majority opinion in a case that applied a Chevron step-one analysis to the contribution section of CERCLA.236 Justice Thomas’ succinct fourteen page opinion addresses the issue of whether a private party who voluntarily incurred CERCLA cleanup response costs (under threat of suit) has a statutory cause of action for cost recovery against other contributors to the site.237 The Court read § 113(f)(1) narrowly to conclude that the statute provides that a party may avail itself of § 113 only where a civil action has been filed against it.238 That is, in order to avail themselves of § 113, parties who contributed hazardous substances to a site must resist cooperating in the cleanup until the government files suit, thus opposing the statute’s goal of encouraging cleanup.239 Justice Thomas never finds it necessary to acknowledge that the Court’s reading of the statute opposes its goals; his view is that the language of § 113 is so clear that the Court need not consider the purpose of CERCLA.240 Referenced in the Cooper Industries opinion is the 1994 Supreme Court CERCLA decision Key Tronic Corp. v. United States.241 That case centered on whether Key Tronic could recover attorney’s fees from the U.S. Air Force where the federal government had deemed both parties liable in connection with a Superfund cleanup.242 The Court’s primary focus, 232. See, e.g., U.S. v. Monsanto, 858 F.2d 160, 167 (4th Cir. 1988) (agreeing with “the overwhelming body of precedent” that CERCLA is a strict liability scheme imposing liability broadly to parties). 233. See id. at 172. 234. Burlington N. & Sante Fe Ry. Co. v. United States, 129 S. Ct. 1870, 1885 (2009). 235. Cooper Indus., Inc. v. Aviall Servs., Inc., 543 U.S. 157, 161 (2004). 236. Id. 237. Id. at 160–61. 238. Id. at 166. 239. See id. 240. See id. at 167 (“Each side insists that the purposes of CERCLA bolsters its reading of § 113(f )(1). Given the clear meaning of the text, there is no need to resolve this dispute or to consult the purpose of CERCLA at all.”). 241. Key Tronic Corp. v. United States, 511 U.S. 809 (1994). 242. Id. at 811 (identifying the issue as whether attorney’s fees are “necessary costs of response” under CERCLA § 107(a)(4)(B), 42 U.S.C. § 9607(a)(4)(B) (2006)).

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thus, was on whether the statute should be read to include various attorney expenses as response costs.243 CERCLA uses the term “response” broadly to cover various actions invoked by the necessity to clean up Superfund sites; the Court concluded that the term does encompass certain lawyer-related expenses but not those related exclusively to litigation.244 In the course of its opinion, the Court acknowledged the breadth of CERCLA’s liability provision.245 The decision may be used as a precedent favoring the acknowledgement of CERCLA as a statutory tool to encourage cleanup and prioritize it over allocation of liability. Perhaps the most interesting aspect of the case for purposes of the present analysis is Justice Scalia’s dissent, in which he argued in favor of reading the statute to allow the recovery of attorneys’ fees in the context of both private and government-led cleanup situations.246 The focus of Justice Scalia’s argument was on the statutory language that he claimed authorizes private parties to recover attorneys’ fees in contribution actions, and in so arguing he accused the Court of requiring a “password” or “magic phrase” for such authorization, rather than simply reading the explicit language of the statute logically.247 In Key Tronic, Justice Scalia thus demonstrated his suspicion about reading into statutory silences, a suspicion notable in his Entergy opinion, where he refused to read a ban on cost-benefit analysis into the CWA BTA provision’s silence on the issue.248 Indeed, Justice Scalia’s Key Tronic dissent reinforces his preference for reading language closely and without reference to the broader goals of the environmental statute in which the language appears.249 In the end, Burlington Northern follows Cooper Industries as another example of the Court’s impatience with CERCLA. The fact that eight Justices joined the majority opinion indicates that the decision is less a statement on the Court’s environment protection biases than it is on the statute.250

Coeur Alaska and the Further Evisceration of the Clean Water Act

In his Coeur Alaska concurrence, Justice Scalia complained about the majority’s reference to the Mead standard in con243. See Key Tronic, 511 U.S. at 814–19. 244. See id. at 819–20 (finding that litigation-related fees in connection with a government-initiated cleanup are not recoverable, but that legal work to identify additional liable parties may be recoverable because they are conducted in pursuit of the cleanup and not in pursuit of litigation). 245. Id. at 814 (“As its name implies, CERCLA is a comprehensive statute that grants the President broad power to command government agencies and private parties to clean up hazardous waste sites. . . . [Government-led cleanups] typically require private parties to incur substantial costs in removing hazardous wastes and responding to hazardous conditions.”). 246. Id. at 821–22 (Scalia, J., dissenting) (arguing for a broader reading of the term “enforcement activities” to encompass attorney fees because “[o]bviously, attorney’s fees will constitute the major portion of those enforcement costs”); see also id. at 823–24 (refusing to accept that Congress meant to bar attorney’s fees from being recovered under one type of CERCLA cost recovery action by explicitly authorizing attorney fee recovery under another type of cost recovery action). 247. Id. at 823. 248. See id. at 821–24. 249. See id. 250. See Burlington N. & Sante Fe Ry. Co. v. United States, 129 S. Ct. 1870 (2009).

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THE SUPREME COURT’S CONSERVATIVE TURN

nection with its discussion of an EPA memorandum that addressed the interplay between the CWA provisions and regulations at dispute in the case.251 Justice Scalia’s point was that the majority appeared to invent a new brand of deference, neither applying Mead’s “Skidmore” deference nor Chevron’s two-step analysis, yet giving the agencies the same level of deference accorded under Chevron.252 Putting aside the deference standard question, Justice Scalia’s concurrence underscored the high regard that Justice Kennedy’s opinion accorded EPA’s internal words and logic, which seems barely differentiable from that which would be enjoyed by publically vetted regulations. The majority gave five rationales for its confidence in the EPA memorandum, but in essence the majority took solace in the EPA’s limiting the scope of its conclusion that fill permitting is not subject to the pollution discharge program to closed bodies of water.253 The memo explains that EPA maintains pollution control authority over discharges from the so-called closed water bodies into surrounding waters.254 Inherent in the Court’s finding that this practice is reasonable is the notion that closed bodies of water are somehow less integral to the system of U.S. waters than those that have a surface connection with other water bodies. This notion creeps uncomfortably close to the plurality view in the notorious 2006 decision, Rapanos v. United States.255 The Rapanos plurality presages the 2008–09 majorities in a number of ways, including its presentation of the case facts in an almost-litigious fashion, with the landowner who illegally filled his wetlands portrayed as the victim of an overzealous federal government.256 Federal regulators are described as “enlightened despots.”257 The disgust with which the opinion discusses the efforts of the Army Corps to protect wetlands is particularly striking when compared with the majority’s pro-Army Corps opinion in Coeur Alaska.258 In Rapanos, the Court describes the “immense expansion of federal regula251. See Coeur Alaska, Inc. v. Se. Alaska Conservation Council, 129 S. Ct. 2458, 2479 (2009) (Scalia, J., concurring) (noting that the Court is adding another type of deference, applicable to agency positions that clarify ambiguous statutes and regulations, that is identical to Chevron deference but does not call itself that). 252. See id. at 2479–80 (Justice Scalia noting that “if we must not call that practice Chevron deference, then we have to rechristen the rose”). 253. Id. at 2473–74 (determining that the memorandum’s prioritization of fill permitting over pollution discharge regulatory bans (1) preserves a role for EPA’s performance standard; (2) does not allow dischargers to evade the performance standards; (3) preserves the Army Corps’ authority to determine whether a discharge is in the public interest; (4) does not apply to toxic pollutants; and (5) reconciles the three statutory provisions and the regulations implementing them). 254. Id. at 2473 (observing, as the first reason that the Court identifies to explain its deference to the EPA memorandum, that it “confines the Memorandum’s scope to closed bodies of water. . . . [While] the EPA’s performance standard retains an important role in regulating the discharge [from such closed bodies] into surrounding waters”). 255. Rapanos v. United States, 547 U.S. 715 (2006). 256. Compare id. at 719–21 (discussing “[t]he burden of federal regulation on those who would deposit fill material in locations denominated ‘waters of the United States’” as “not trivial”), with id. at 788 (Stevens, J., dissenting) (pointing out that the landowner “filled large areas of wetlands without permits, despite being on full notice of the Corps’ regulatory requirements” and noting that “[b] ecause the plurality gives short shrift to the facts of this case . . . I shall discuss them at some length”). 257. Id. at 721. 258. See Coeur Alaska, 129 S. Ct. at 2472–77.

tion of land use that has occurred under the Clean Water Act” and even identifies “half of Alaska” as part of the area of “swampy land” over which the Corps has asserted jurisdiction in its three-decade power-grab.259 Indeed, the Rapanos plurality is written as if the Justices would prefer reading the term “navigable waters” in the CWA literally, and thus limit regulation of wetlands to those that abut such waters.260 Casting its statutory analysis as a Chevron review, the Court concludes that the Army Corps’ interpretation of CWA jurisdiction is impermissible.261 As the Rapanos dissent points out, the plurality’s approach to the statute and agency’s interpretation appears far more aggressive than Chevron would have it be.262 One might presume that the Court producing the Rapanos plurality would be bent on limiting CWA jurisdiction to the regulation of pollution discharges to flowing waters, with perhaps an equal desire to limit severely the regulatory protection of wetlands, but Coeur Alaska proves that presumption incorrect. In Coeur Alaska, the majority justifies it decision, in part, by twice referencing the fact that, if the Army Corps is not allowed to sacrifice the lake in question, it would instead sacrifice a wetland,263 thus appearing as if the conservative Justices now revere the wetlands that they declined to protect in Rapanos.264 To be fair, it must be noted that Justice Kennedy, the author of Coeur Alaska, concurred in Rapanos, at least in part on the basis of his disagreement with the plurality’s denigration of wetlands.265 Justice Kennedy rejected the plurality’s simplistic argument for surface contiguity as the test for CWA jurisdiction, arguing instead for a case-by-case analysis of wetlands to determine their hydrological connection to traditional waters of the United States.266 In addition to containing echoes of Rapanos that indicate a result-oriented approach to environmental cases on the part of the conservative members of the Court, the Coeur Alaska majority opinion echoes two of the opinions issued earlier in the 2008–09 Term. It echoes Entergy in that the Court is highly deferential toward an environmentally unfriendly agency reading of the CWA.267 As in Entergy, the Court relies far more on agency interpretations of the statutory provision under dispute than it does on its own reading of 259. See Rapanos, 547 U.S. at 722. 260. See id. at 724–25 (discussing United States v. Riverside Bayview Homes, Inc., 474 U.S. 121 (1985)); id. at 731 (admitting that the term “navigable waters” was not intended to be read literally, but insisting that “the qualifier ‘navigable’ is not devoid of significance”). 261. Id. at 739–42 (defining CWA jurisdiction to not include intermittent waterways or wetlands not abutting navigable waters). 262. See id. at 805–06 (pointing out that “the proper question is not how the plurality would define ‘adjacent,’ but whether the Corps’ definition is reasonable,” then going on to explain how the Corps’ definition warrants deference). 263. Coeur Alaska, 129 S. Ct. at 2465, 2478. 264. See Rapanos, 547 U.S. at 742 (finding only those wetlands with a connection to other bodies of water protected under the CWA). 265. Id. at 761 (arguing against the plurality’s description of wetlands as “moist patches of earth”). 266. Id. at 782 (asserting that the Army Corps “must establish a significant nexus on a case-by-case basis when it seeks to regulate wetlands based on adjacency to nonnavigable tributaries”). 267. Compare Coeur Alaska, 129 S. Ct. at 2473, with Entergy, Corp. v. Riverkeeper, Inc., 129 S. Ct. 1498, 1505 (2009).

the provisions.268 The Court also follows both Entergy and Burlington Northern by neglecting to consider the core thrust of the statute when conflicting interpretations of individual provisions are at issue.269 In all three cases, it is left to the dissent to remind the Justices that environmental laws strive, first and foremost, to meet environmental goals.270

Conclusion

would say unfairly—encountered since the beginning of the modern environmental era. In one of his final opinions, the late Justice Blackmun professed “difficulty imagining this Court applying its rigid principles of geographic formalism anywhere outside the context of environmental claims.”274 This observation, penned nearly two decades ago, would have been a fitting close to the dissent in any one of the Court’s environmental opinions from the 2008–2009 Term.

“Conservatives finally got their Court” 271

It is a tricky proposition to accuse a group of Justices of sharing a social agenda or political ideology that motivates the group to select and decide cases in a result-oriented manner. After all, such an accusation can be dismissed quite readily as having been motivated by the very politics that the Justices are accused of attempting to undermine. In an article responding to the “pro-business” reputation of the Roberts Court, for example, Professor Jonathan Adler characterizes eight of the Court’s sixteen environmental cases decided between 2006 and early 2009 as having yielded pro-business outcomes.272 In addition, Professor Adler makes the valid point that Massachusetts v. EPA, one of the pro-environment decisions emerging from the Roberts Court, has thus far eclipsed any of its fellow Roberts Court environmental decisions in significance.273 Thus, Court defenders may scoff at the idea that a single Term’s cases can reveal anything of significance about either particular Justices or a collective agenda that some of them may share. But regardless of patterns among decisions and their comparative significances, individual opinions can reveal the predispositions and even the prejudices of those who write and join them. In that light, the five decisions discussed in this Article indicate that the majority of the Supreme Court remains uncomfortable with the idea of environmental values as the subject of a case or controversy. The analysis also indicates that at least some of these Justices are willing to stretch both law and logic to ensure that environmental petitioners continue to encounter the difficulties in accessing the courts that they have traditionally—and some

268. See supra at notes 77–105 and accompanying text. 269. See supra at notes 77–105 and accompanying text. 270. See Rapanos, 547 U.S. at 799, 804; Entergy, 129 S. Ct. at 1518–21; see Burlington N., 129 S. Ct. at 1885. 271. See Erwin Chemerinsky, Turning Sharply to the Right, 10 Green Bag 423, 423 (2007). The article surveys recent cases to illustrate the pro-business cohesiveness of the Court’s conservative bloc. Professor Chemerinsky’s observations focused on abortion, school desegregation, speech, taxpayer standing, criminal appeals, and a variety of cases protecting business interests. In fact, the only environmental case he cites is Massachusetts v. EPA, which he includes as a rare exception to the string of conservative victories. 272. Adler, supra note 169, at 954–55. The article predates the Court’s decisions in Burlington Northern & Santa Fe Railway Co. v. United States 129 S. Ct. 1870 (2009) and Coeur Alaska, Inc. v. Southeast Alaska Conservation Council, 129 S. Ct. 2458 (2009). 273. Adler, supra note 169, at 954-55.

274. Lujan v. Defenders of Wildlife, 504 U.S. 555, 595 (1992) (Blackmun, J., dissenting).

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“Carbon Cowboys”: How to Rein in Deceptive Sellers in the Carbon Offset Market Trevor Salter* “If I was the financial adviser to the Mafia, I would advise them to get into carbon trading.” Bryan Leyland, Economic Panel Chairman, New Zealand Climate Science Coalition1 “GAO, through its purchase of offsets, found that the information [regarding carbon offsets] provided to consumers by retailers offered limited assurance of credibility.” U.S. Government Accountability Office2

Introduction Carbon offsets3 are often touted as important tools in the campaign to slow global climate change,4 but they are sold in

* J.D. expected 2010, The George Washington University Law School; B.A. 2006, Brigham Young University. Much love and thanks to my wife, Kristin, and to my boys, Liam and Eamon, for making this, and everything else, possible. The title is taken from Fiona Harvey, Beware the Carbon Offsetting Cowboys, Fin. Times, Apr. 25, 2007. 1. 2. 3.

Posting of Nick Loris to The Foundry Blog, http://blog.heritage .org/2009/09/22/today’s-calamity-carbon-offsets-do-not-offset-the-economicpain-of-cap–and-trade/ (Sept. 22, 2009, 14:57 EST). U.S. Gov’t Accountability Office, Pub. No. GAO–08–1048, Carbon Offsets (2008) [hereinafter GAO Report]. As used in this Note, “carbon offset” refers to a reduction in any greenhouse gas (“GHG”), not just CO2. Other naturally occurring GHGs include methane (CH4) and nitrous oxide (N20). Id. at 1 n.1. The market for renewable energy certificates (“RECs”) is very similar to the market for carbon offsets. See Fed. Trade Comm’n (“FTC”), Guides for the Use of Environmental Marketing Claims; Carbon Offsets and Renewable Energy Certificates; Public Workshop, 72 Fed. Reg. 66,094, 66,095 (Nov. 27, 2007) (to be codified at 16 C.F.R. pt. 260) [hereinafter FTC Workshop Announcement]. Although this Note only discusses offsets, the principles and legal remedies discussed apply to both markets. RECs are sold at a premium to the market price of electricity to interested consumers, and proceeds from REC sales are used by the power company to develop or operate renewable energy projects (solar, wind, etc.) or purchase renewable energy from other providers. See id. REC purchases often give consumers cause to characterize their electricity consumption as deriving from renewable sources. See id. See, e.g., Dan Carson, Appalachian Power Co., Carbon Offsets (Aug. 27, 2008), available at http://www.greenpeace.org/ raw/content/international/press/reports/aep-internal-document-on-carbo.pdf (“Climate change is a global phenomenon such that GHG reductions made anywhere on earth will be functionally equivalent to those made locally [through offsets].”); Ben Elgin, Another Inconvenient Truth, Bus. Week, Mar. 26, 2007, at 96 (“A growing number of organizations, corporations, cities, and individuals are seeking to protect the climate [by purchasing carbon offsets] . . . .”).

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a “‘wild West’, buyer-beware marketplace.”5 Consumers do not buy a tangible item when they purchase a carbon offset.6 Ordinarily, the only thing consumers can hold and examine is a piece of paper stating that the proceeds from their purchase will reduce greenhouse gases (“GHG”) in the atmosphere by a certain number of tons.7 Consumers often do not know whether their purchase actually reduces GHGs.8 Consumers’ lack of information about an offset’s validity gives unscrupulous sellers opportunities to unintentionally mislead, or even intentionally deceive, consumers about the true GHG reduction benefit of offsets.9 For example, most offset consumers probably do not expect that their money can help a company profit from extracting oil,10 or that a company can use offset proceeds to avoid liability for a polluting landfill.11 Consumers would also likely be surprised to learn that they can pay full price for an offset that actually reduced GHGs by as little as half the amount the seller advertised.12 Yet consumers in the United States can unwittingly pay for oil extraction and liability avoidance and still not receive the benefit for which they paid in today’s carbon offset market. Government agencies do not adequately protect consumers. They do not formally regulate the offset market,13 although sellers who mislead or defraud consumers may be 5. 6. 7.

8. 9.

10. 11. 12. 13.

Katherine Hamilton et al., Ecosystem Marketplace, State of the Voluntary Carbon Market 2007: Picking Up Steam 31 (2007), available at http://www.carbon.sref.info/an-example/market-news. See FTC Workshop Announcement, supra note 4, at 66,096. Offset sellers often provide “certificates” after consumers purchase an offset. For an example of a certificate, see Climate Care, Example Certificate, http:// www.jpmorganclimatecare.com /media/documents/pdf/Example%20Certificate.pdf (last visited Mar. 3, 2010). See FTC Workshop Announcement, supra note 4, at 66,096. See id. For simplicity, this Note uses the term “seller” broadly to include retailers, wholesalers or brokers, and developers or operators of GHG reduction projects from which offsets are derived. See generally Hamilton et al., supra note 6, at 21–22 (discussing retailers, wholesalers, brokers, and developers as the four general categories of carbon offset market participants). Some companies and individuals perform multiple roles in the market (e.g. retailer, wholesaler, and operator). Id. at 22 (“numerous [survey] respondents operate at several levels in the value chain . . .”). See infra text accompanying notes 109–11. See infra text accompanying notes 112–14. See infra text accompanying note 101. GAO Report, supra note 3, at 9. The Environmental Protection Agency (“EPA”) and the U.S. Forest Service provide “technical assistance” to carbon offset project developers. Id.

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liable under state consumer protection laws or state fraud common law.14 The Federal Trade Commission (“FTC”) may also prosecute deceptive sellers under § 5 of the FTC Act prohibiting “unfair and deceptive acts and practices.”15 However, these legal remedies are ill-adapted to the unique features of the carbon offset market and allow deceptive sellers to escape liability.16 Cap-and-trade legislation passed in the House and proposed in the Senate recognize the problems of carbon offsets and propose mechanisms to limit the potential for fraud in the offset market.17 These bills would transform what is currently a voluntary offset market into a mandatory market; entities would purchase offsets as part of their compliance obligations.18 Yet there are two problems with the proposed legislation that make it likely that the carbon offset market will continue to have credibility issues. First, the proposed legislation probably will not be enacted.19 Key legislators agree that even if alternative legislation is enacted, it will likely be more modest and focus on job creation and energy efficiency.20 14. Id. at 7. For simplicity, this Note uses “mislead” or “deceive” when discussing how offset sellers can take advantage of consumers. This Note uses “fraud” only when discussing common law fraud claims, where a seller’s intent is a required element. See infra Part III.A. and accompanying notes. In contrast to fraud, misleading and deceptive advertising does not require proving the seller’s intent. See FTC v. Algoma Lumber Co., 291 U.S. 67, 81 (1934) (holding that the FTC could hold a company liable for unfair and deceptive practices even though the company’s misrepresentations were innocently made). 15. 15 U.S.C. § 45(a) (2006). 16. Despite several investigative reports detailing situations where consumers were deceived about the efficacy of the carbon offset they purchased, the absence of any public actions either undertaken by a private party or by a government agency against an offset seller may suggest that current legal remedies are inadequate. For examples of investigative reports, see Elgin, supra note 5; Harvey, supra note 1. 17. “Cap-and-trade” refers to a program where Congress sets a nationwide limit on emissions (the “cap”), and auctions or allocates emission permits amongst regulated entities. These entities can then buy or sell allowances, or hold their allowances for credit against the next compliance period. See Robert R. Nordhaus & Kyle W. Danish, Assessing the Options for Designing a Mandatory U.S. Greenhouse Gas Reduction Program, 32 B.C. Envtl. Aff. L. Rev. 97, 120 (2005). The primary Senate cap-and-trade bill is the Clean Energy Jobs and American Power Act, S. 1733, 111th Cong. (2009), introduced by Senators Kerry and Boxer on September 30, 2009. Carbon offset purchases are discussed in § 731 (“Part D”). The House passed the American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. (2009) on June 26, 2009. The provisions relating to carbon offsets are substantially similar to those in the Senate bill and are discussed at § 731. Both bills would require the EPA to issue standardized methodologies and maintain a central registry to help ensure that offsets represent real reductions in GHGs. See S. 1733 § 732(b)–(d); H.R. 2454 § 732(b)–(d). States have also begun forming regional cap-and-trade bodies, which may have a role in offset regulation. See, e.g., Tseming Yang, The Problem of Maintaining Emission “Caps” in Carbon Trading Programs Without Federal Government Involvement, 17 Fordham Envtl. L. Rev. 271, 282–86 (2006) (discussing the Northeast Regional Greenhouse Gas Initiative). 18. This Note’s analysis and recommendations are equally applicable to a mandatory offset market should Congress and the President enact cap-and-trade legislation. Allowing offset purchases as a compliance mechanism could dramatically increase the size and value of the offset market, which reinforces policy makers’ need to understand the unique problems of the offset market. See generally Stockholm Env’t Inst., CORE: Mandatory versus Voluntary Markets, http:// www.co2offsetresearch.org/ policy/MandatoryVsVoluntary.html (last visited Mar. 3, 2010) (noting that demand increases in offset markets where purchases are made in response to regulation). 19. See John M. Broder & Clifford Krauss, Advocates of Climate Bill Scale Down Their Goals, N.Y. Times, Jan. 26, 2010, at A4. See also Cap-and-Trade’s Last Hurrah, Economist, Mar. 20-26, 2010, at 32 (discussing that the likelihood of passing cap-and-trade legislation has “faded badly”). 20. See Broder & Krauss, supra note 20, at A4.

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Second, even a comprehensive cap-and-trade bill will not immediately make all offsets credible. Policy makers should learn from the European Union, which does regulate the offset market. Regulators in the European Union continue to experience problems ensuring carbon offset credibility and deceptive sellers can continue to escape liability.21 The two epigraphs at the beginning of this Note—the first from a voluble climate change and carbon offset skeptic, the second from the comparatively more neutral and staid U.S. Government Accountability Office (“GAO”)—illustrate the feelings and problems engendered by the relatively new market for carbon offsets. By many accounts across the market participant spectrum, “carbon cowboys . . . looking to make a quick buck” are riding into the legal void created by a lack of regulation and a lack of well-suited legal remedies.22 This Note proposes both a short-term and a long-term solution to close the legal void and rein in the “carbon cowboys.” In the short term, the FTC and courts should use the threepart test articulated in Cliffdale Associates, Inc. (“Cliffdale”)23 and adopted by the Ninth Circuit in FTC v. Pantron I, Corp. (“Pantron”).24 Applying the Cliffdale test is preferable in the short-term because the FTC and courts can immediately use the test to deter the worst potential abuses in the carbon offset market. Yet the Cliffdale test insufficiently protects both consumers and sellers in the long-term. In the long-term the Commodity Futures Trading Commission (“CFTC”) should require carbon offset sellers to register their offsets.25 The CFTC should enforce registration misrepresentations just as it enforces other registration statement misrepresentations.26 CFTC registration is the preferred solution because registration benefits consumers and sellers by increasing the transparency and credibility of the carbon offset market over the long -term.27 Part I of this Note reviews the state of the carbon offset market in the United States. Part II focuses on the features of carbon offsets and the offset market that make the potential for consumer deception uniquely problematic. Part III reviews the problems of currently applicable legal theories under which deceptive offset sellers are potentially liable. Part IV discusses the Cliffdale test as the short-term solution. Part V details CFTC registration requirements for carbon offsets as the preferred, long-term solution.

21. See U.S. Gov’t Accountability Office, Pub. No. GAO–09–151, International Climate Change Programs 7–8 (2008) [hereinafter GAO Report on International Climate Change Programs] (discussing lessons learned from the European Emissions Trading Scheme). 22. Harvey, supra note 1. 23. See Cliffdale Assocs., Inc., 103 F.T.C. 110, 164–66 (1984). 24. See FTC v. Pantron I, Corp., 33 F.3d 1088, 1095–96 (9th Cir. 1994). 25. 17 C.F.R. § 40.2 (2009) (contains the CFTC’s minimum registration requirements). 26. 7 U.S.C. § 15 (2006) (discussing the CFTC’s enforcement authority). 27. See GAO Report, supra note 3, at 28 (“[A] standardized offset registration process would foster transparency . . . . Because there is no single registry and because of a lack of communication among existing registries, it is difficult for consumers to determine the quality of the offsets they purchase.”).

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CARBON COWBOYS

The Carbon Offset Market In The United States

Carbon offsets are “measurable reduction[s] of greenhouse gas emissions from an activity or project in one location that [are] used to compensate for emissions occurring elsewhere.”28 For example, if an individual wants to reduce his or her net GHG emissions into the atmosphere from the individual’s driving, the individual might purchase an offset from an online retailer. The retailer promises the individual that the retailer will use the proceeds to fund or operate a project, such as a methane capture operation at a landfill, which will reduce the landfill’s methane emissions in an amount corresponding to the individual’s vehicle emissions.29 Individuals and corporations increasingly signal responsible action toward mitigating man-made climate change through purchasing carbon offsets.30 These purchases are voluntary because the United States has not yet created a mandatory carbon market similar to the European Union’s Emissions Trading Scheme.31 However, the problems and solutions discussed are applicable to both voluntary and mandatory markets. There are some strident critics of carbon offsets, particularly within the environmental community, who equate carbon offset sales with the sale of indulgences; they absolve consumers of their environmental sins.32 Nevertheless, popular culture lauds carbon offset consumers. At the 2007 Academy Awards, each celebrity presenter and award recipient was given a glass statue representing 100,000 pounds of GHGs reduced through the purchase of an offset sold by Terrapass, an online retailer.33 TerraPass estimated 100,000 pounds to be the yearly GHG emissions from living a celebrity lifestyle.34 Similarly, former Vice President Al Gore hosted a “Green Inaugural Ball” following President Obama’s inauguration where the Ball’s “carbon footprint,” an estimate of GHG emissions produced from organizing and holding the Ball, was offset through the purchase of “high-quality offsets.”35 Although celebrity-purchased offsets often receive the most publicity in the media, individual consumer-purchased carbon offsets actually account for only five percent 28. 29. 30. 31. 32.

33. 34. 35.

GAO Report, supra note 3, at 1. See FTC Workshop Announcement, supra note 4, at 66,095. Elgin, supra note 5. See GAO Report on International Climate Change Programs, supra note 22, at 3 n.6. Andrew C. Revkin, Op-Ed., Carbon-neutral is Hip, But is it Green?, N.Y. Times, Apr. 29, 2007, § 4, at 14 (“‘The worst of the carbon-offset programs resemble the Catholic Church’s sale of indulgences back before the Reformation,’ said Denis Hayes, the president of Bullitt Foundation, an environmental grant-making group . . . ‘This whole game is badly in need of a modern Martin Luther.’”). Elgin, supra note 5. Id. Press Release, The Corporate Soc. Responsibility Newswire, 2009 Green Inaugural Ball Selects NativeEnergy As Sole Carbon Offset Provider (Jan. 17, 2009) (on file with The George Washington Journal of Energy and Environmental Law (“JEEL”)). Whether a particular offset is “high quality” is a determination made by a third-party expert consultant or organization. Cf. Trexler Climate + Energy Servs., Inc., A Consumers’ Guide to Retail Offset Providers 10 (2006), available at http://www.cleanair-coolplanet.org/ConsumersGuidetoCarbon Offsets.pdf (ranking offset projects from “highest quality” to “low quality”).

of annual carbon offset purchases by volume as of 2007.36 In contrast, businesses purchase eighty percent of carbon offsets by volume.37 Some companies, such as Dell, HSBC, and Barclays, created plans to go entirely “carbon neutral,” whereby GHG emissions generated by the company’s activities are offset through offset purchases.38 Offsets are derived from projects that reduce GHGs. There are two general types of projects. One type reduces GHG emissions at the source by using offset proceeds to pay for energy efficiency improvements or renewable energy projects (thirteen percent of U.S. offset projects).39 A second type of offset project captures and “sequesters” GHGs before or after entering the atmosphere.40 Common examples of capture projects include capturing methane emitted by mines, landfills, or agricultural operations and burning it to produce less potent CO2 (forty-nine percent of projects),41 planting trees that absorb CO2 from the atmosphere or using “no till” agriculture that reduces CO2-generating plant decomposition (seventeen percent of projects), and sequestering CO2 in geologic formations, usually underground (nineteen percent of projects).42 The carbon offset market is growing rapidly. As of 2007, “over 600 organizations develop, market, or sell carbon offsets in the United States,” which offset about 10.2 million tons of GHGs.43 From 2004 to 2007, offset projects increased 125% (from 93 to 211), representing a 66% increase in GHG reductions (from 6.2 million tons to 10.2 million tons).44 Offsets sell for an average of approximately $6 per ton of GHG,45 which in total makes the market worth approximately $100 million according to some estimates.46 The offset market, like most other markets, has been negatively affected by the recent economic recession. Prices have fallen by one or two dollars per ton.47 However, some experts predict the market’s

36. Hamilton et al., supra note 6, at 50. This statistic reflects purchases outside the United States as well (sixty-eight percent of those surveyed were U.S. consumers, and thirty-one percent were European or Canadian consumers). 37. Id. Governments purchased twelve percent and NGOs purchased two percent of carbon offsets by volume. Id. The U.S. House of Representatives, Office of the Chief Administrative Officer, is an example of a government consumer. The Officer purchased 30,000 tons worth of offsets as part of the “Green the Capitol” initiative. GAO Report, supra note 3, at 23. 38. Harvey, supra note 1; Press Release, Dell, Dell is First Major Computer Company to go Carbon Neutral (Sept. 26, 2007) (on file with JEEL). 39. GAO Report, supra note 3, at 12. 40. Id. 41. Id. at 14. Methane is a greenhouse gas that is twenty-three times more potent than carbon dioxide. Once “flared,” or burned off, methane degrades into much less potent carbon dioxide. Elgin, supra note 5, at 97. 42. GAO Report, supra note 3, at 12–15. The remaining offset purchases go towards renewable energy projects (six percent) and an undefined “other” category (one percent). Id. at 15. 43. Id. at 9. Although 10.2 million tons is a large figure, EPA estimates that the United States has been emitting approximately seven billion tons of GHGs per year since 2000. Id. at 13. 44. Id. 45. Hamilton et al., supra note 6, at 32. This figure was calculated by averaging the price of offsets sold by retailers, brokers, wholesalers, and project developers. 46. Elgin, supra note 5. 47. See Envtl. Leader, Carbon Offset Prices Fall, Buyers Focus On Quality (2009), http://www.environmentalleader.com/2009/02/16/ carbon-offset-prices-fall-buyers-focus-on-quality/.

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overall value will increase to approximately $4 billion, especially if Congress passes cap-and-trade legislation.48 Despite the promising signs of future growth in the carbon offset market, the market suffers from significant questions about its credibility.49 In a study conducted in response to Congressional concerns about the offset market’s credibility, the GAO purchased offsets from thirty-three retailers and found that “only [nine] provided information related to the use of quality assurance mechanisms, including verification and monitoring.”50 At best, “[a] majority” of retailers “provide[d] further information on their Web sites that was not directly related to [GAO’s] transactions.”51 The GAO concluded that it rarely obtained sufficient information to understand what it was purchasing, “and other consumers may face similar challenges with their transactions.”52 Institutional consumers can respond to these market credibility concerns by expending time and money ensuring the quality of their purchased offsets, sometimes even hiring major accounting firms like KPMG.53 Yet even with the additional effort, quality carbon offsets may still be hard to find. For example, Barclays only found enough “quality” credits to offset forty percent of its GHG emissions.54 Individual consumers may have particular difficulty ensuring offset credibility because they might lack the means to conduct extensive independent verification. These consumers can rely to a certain extent on offset certification programs created by offset sellers and third party monitoring groups.55 However, offset retailers do not widely use third party certification programs.56 Offset sellers who do use certification programs may confuse more than help consumers because each program employs different assumptions and methodologies to define a “high quality” offset.57 Beyond the problems for individual consumers, the offset market’s credibility issues are also problems for the collective public. Many offset consumers, especially institutional consumers, perhaps unsurprisingly state that public relations benefits are a major reason for purchasing offsets.58 When an institutional consumer’s primary motivation is favorable press, both the consumer and the seller benefit from misrepresenting the actual amount of GHG reductions result48. See John Goff, Carbon Trading, CFO Magazine, Jan. 1, 2008, at 42 (“[O] bservers talk about a $4 billion carbon [offset] trading market once federal caps are approved.”). 49. See, e.g., GAO Report, supra note 3, at 7–9; Todd Wynn, Cascade Policy Inst., Money for Nothing: The Illusion of Carbon Offsets 5–8 (2009), available at http://www.cascadepolicy.org/pdf/env/Climate_Trust_Audit_ 021009.pdf; Elgin, supra note 5. 50. GAO Report, supra note 3, at 8. 51. Id. 52. Id. 53. See Harvey, supra note 1. 54. Id. 55. Cf. Trexler Climate + Energy Servs., Inc., supra note 36, at 15–20 (profiling the “top” offset providers, including their internal and third party certification and verification programs). 56. Id. at 12. 57. See generally Hamilton et al., supra note 6, at 37–41 (summarizing the array of certification programs and their different goals, standards, and methodologies). The proliferation of these certification programs suggests a market-created indictment of the market’s credibility. 58. See id. at 50–51.

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ing from a purchased offset.59 If a seller asserts that a project reduces 100 tons of GHGs per year, but in reality the figure is closer to fifty tons, both sides benefit. The seller benefits because the seller can put more offsets on the market. The institutional consumer benefits because it buys a piece of paper stating that the company reduced 100 tons of GHGs, not fifty. Although there are surely many companies that have more altruistic motives for purchasing offsets than the public relations appeal, the public is nevertheless misled into believing that more is being done to reduce net GHG levels than in reality.

II.

Four Problems With Carbon Offsets That Make Consumers Uniquely Susceptible To Deceptive Advertising

In addition to problems with the carbon offset market as a whole, carbon offsets in particular have four major problems that make offset sales particularly susceptible to deceptive advertising.60 First, it is difficult to verify that the actual amount of GHGs reduced by a project matches the advertised amount (the “verification problem”).61 Second, it is difficult to determine whether the project that generates GHG reductions produces additional GHG reductions that were not possible without financing from carbon offset sales (the “additionality problem”).62 Third, carbon offset sellers can sell the same offset twice to different consumers (the “double-counting problem”).63 Fourth, there is no guarantee that the offset leads to permanent or even moderately long-term GHG reductions (the “permanence problem”).64 Each of these problems shares a common cause: unlike other commodities, carbon offsets are not tangible.65 Consumers cannot handle the product to ensure that it is unique and meets their expectations. Indeed, carbon offsets may be more analogous to buying equity shares in a project. Yet unlike selling equity on a stock market where sales are regulated by Securities and Exchange Commission (“SEC”) securities rules,66 there is no regulation or government oversight to directly deter fraud or misrepresentation in the carbon offset market.67

59. Cf. Elgin, supra note 5 (describing GHG reductions claims that lacked evidentiary support). 60. See GAO Report, supra note 3, at 2 (“[Credible carbon offsets] must be additional, quantifiable, real, and permanent.”). This Note uses slightly different terminology. 61. See id. at 25–32; FTC Workshop Announcement, supra note 4, at 66,096–97; Wynn, supra note 50, at 5–8. 62. See GAO Report, supra note 3, at 25–32; FTC Workshop Announcement, supra note 4, at 66,096–97; Wynn, supra note 50, at 5–7. 63. FTC Workshop Announcement, supra note 4, at 66,096 64. Wynn, supra note 50, at 7. 65. FTC Workshop Announcement, supra note 4, at 66,096 (“As a result [of offsets being intangible commodities], the potential for deception is greater than with more tangible products for which consumers more easily can confirm most advertising claims.”). 66. See, e.g., 17 C.F.R. § 240.10b–5 (2009) (prohibits untrue statements or omissions of material facts in connection with the purchase or sale of any security). 67. See GAO Report, supra note 3, at 9.

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This Part reviews each problem in turn, with particular attention paid to the problems of verification and additionality.

When Is “A Ton A Ton?”The Problem Of Verifying That An Offset Results In The Advertised GHG Reduction

Offset sellers typically advertise the amount of GHGs reduced by a purchased offset. For example, Expedia, an airline ticket purchasing website, offers travelers the opportunity to pay $6 to offset 1,000 pounds of GHGs emitted from their airplane.68 Expedia partners with TerraPass and transmits offset sale proceeds to the online offset retailer.69 TerraPass in turn may use the proceeds to finance the construction or maintenance of a GHG-reducing project, such as a project that captures methane emitted by landfills or dairy farms.70 The 1,000 pounds figure is TerraPass’s calculation of the number of GHGs produced by an individual flying crosscountry.71 The problem with this figure is that it is very difficult to measure both the GHG emissions of an activity (here, cross-country air travel)72 and the GHG reductions produced by a project (here, the amount of methane captured at a landfill or dairy farm).73 The difficulty of measuring GHG reductions makes it hard to verify sellers’ claims, which concerns the FTC, among others, that consumers are not “getting what they [paid] for” because “there is [a] real possibility of fraud in this market.”74

The problem of measuring GHG emissions from an activity

GHG emission “calculators” commonly found on the internet measure GHG emissions from various activities, but their credibility is doubtful.75 Unlike traditional calculators, 68. Barbara De Lollis, Can You Be Green by Buying Offsets?, USA Today, Mar. 2, 2007, at 1B; see also Expedia, Reducing Your Carbon Footprint, http://www. expedia.com/daily/sustainable_travel/going_green/carbon_footprint.asp (last visited Mar. 3, 2010). 69. See De Lollis, supra note 69. 70. TerraPass, TerraPass Carbon Offset Project Types, http://www.terrapass.com/ projects/categories.html (last visited Mar. 3, 2010). 71. See De Lollis, supra note 69. 72. See Christian N. Jardine, Oxford Univ. Envtl. Change Inst., Calculating the Carbon Dioxide Emissions of Flights 2 (2009), available at http:// www.eci.ox.ac.uk/research/energy/downloads/jardine09-carboninflights.pdf (discussing airline GHG emission calculation problems). 73. See S.M. McGinn et al., An Approach for Measuring Methane Emissions from Whole Farms, 35 J. Envtl. Quality 14 (2006), available at http://jeq.scijournals.org/cgi/reprint/35/1/14 (select “Begin manual download”) (discussing the difficulty of measuring farm animal methane emissions); Brian Palmer, Measuring the National Carbon Footprint, Slate, Nov. 19, 2008, http://www.slate. com/id/2205011/ (discussing the difficulty of measuring landfill and farm animal methane emissions). Cf. Richard L. Ottinger et al., Pace Univ. Ctr. for Envtl. Legal Studies, Environmental Costs of Electricity 165–69 (1990) (discussing the difficulty of measuring forest sequestration projects). 74. Christopher Joyce, Carbon Offsets: Government Warns of Fraud Risk, National Public Radio, Jan. 3, 2008, www.npr.org/templates/story/story. php?storyId=17814838 (quoting Jim Kohm, the head of FTC’s enforcement division). 75. See Michael P. Vandenbergh & Anne C. Steinemann, The Carbon–Neutral Individual, 82 N.Y.U. L. Rev. 1673, 1736 (2007); Tim De Chant, On Trail of Elusive Carbon Footprint, Chi. Trib., Aug. 10, 2008, at 1. In addition to the

carbon calculators can yield very different results when one enters identical inputs.76 For example, internet offset retailer Native Energy’s carbon calculator assumes that a household emits approximately twelve tons of CO2 annually,77 but Conservation International’s calculator assumes that a household emits only five tons of CO2 annually.78 This discrepancy implicates a conflict of interest problem for offset retailers like Native Energy and TerraPass who provide carbon calculators on their websites: the retailers may have incentives to inflate GHG emission assumptions to sell more offsets.79 For air travel, an Oxford University study found that calculators can vary by more than 225% when estimating an individual’s share of CO2 emissions from a transatlantic flight (1.53 vs. 3.48 tons of CO2).80 This air travel emission discrepancy also results from different assumptions, including the plane type (older models are half as fuel efficient as newer models), how long CO2 emitted by the plane remains in the air, and how seats and cargo are distributed in the plane.81 The cost difference resulting from these varying calculations may not trouble some consumers. The average retail price of a carbon offset is $8 per ton,82 which, when comparing Conservation International’s calculator to Native Energy’s calculator, results in a price differential of $40–$96 to offset household CO2 emissions and $12–$28 to offset an individual’s contribution to a transatlantic flight’s CO2 emissions. An institutional consumer, however, has more concern because it must purchase many more offsets than an individual.83 Individual and institutional consumers alike are most vulnerable to deceptive sellers when a seller combines a high estimate of GHG emissions with a high price per ton to offset those emissions. For example, the retail price of carbon offsets extends as high as $25 per ton,84 so an offset retailer could sell a household emission offset for as much as $300 ($25 x 12 tons of CO2)—more than twice the average price of $120 for a comparable offset.85 Despite such a high price, a deceptive seller can rely on the fact that price competition is only “starting to appear” in the offset market because consumers have a difficult time comparing the quality of off-

76. 77. 78. 79. 80. 81. 82. 83. 84. 85.

offset calculations discussed infra text accompanying notes 78–80, calculators can be found at carbonfund.org, terrapass.com, nature.org, and stopglobal warming.org. See Vandenbergh & Steinemann, supra note 76, at 1736. NativeEnergy, Lifestyle Calculator, http://www.nativeenergy.com/pages/lifestyle_calculator/464.php (select “Want to offset from US averages?”) (last visited Mar. 3, 2010). Conservation Int’l, Our Methodology, http://www. conservation .org/act/ live_green/carboncalc/pages/methodology.aspx (last visited Mar. 3, 2010). See Vandenbergh & Steinemann, supra note 76, at 1737. See Jardine, supra note 73, at 2. Silverjet, a “carbon-neutral” trans-Atlantic carrier, claims that a passenger only generates 1.2 tons of CO2. See Revkin, supra note 33. See Jardine, supra note 73, at 3–4. See Hamilton et al., supra note 6, at 32. This fact explains Barclays and HSBC banks going to great lengths to ensure the quality of the offsets they purchased. See Harvey, supra note 1. Mark C. Trexler & Laura H. Kosloff, Selling Carbon Neutrality, 26 Envtl. F. 34, 35 (2006), available at http://www.nativeenergy. com/filebin/pdf/Trexler%20Retail_Offsets_EnvForum_Final11.pd. Id. at 36.

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sets.86 Who is to say that the $360 offset is not the proverbial “Cadillac” of carbon offsets? With each offset seller using its own assumptions and calculator to determine offset price, and with consumers unable to compare offsets because they are intangible, consumers have little to rely on beyond a seller’s representations.87

The problem of measuring GHG reductions from a project

Two measurements must be taken to determine the GHG reductions from a carbon offset project.88 The first measurement is a baseline estimate of the net GHG emissions resulting from a location.89 For example, a baseline estimate determines the methane emitted by a landfill or farm, or the current CO2 reductions from a forest.90 The second measurement estimates the GHG reductions of the project.91 For example, a GHG reduction estimate determines how much a methane capture and flare device will reduce GHGs emitted by a landfill, or how much additional CO2 is captured from the air and sequestered into planted trees.92 The difference between the GHG reduction estimate and the baseline estimate provides the basis for a project developer’s claim of environmental benefit. Measuring the baseline and reduction estimates are scientifically complex and require a number of assumptions.93 Offset sellers can freely choose among varying assumptions and measurement methodologies, although some are more scientifically reputable than others.94 Methodology differences allow deceptive sellers opportunities to choose a favorable methodology and set of assumptions to inflate an estimate, thereby “increasing the quantity of offsets” that the seller can market from a given project.95 Deceptive sellers can also choose the most favorable estimates of GHG reductions. GHG reduction measurement accuracy varies by type of project, although statistics are scarce.96 Methane capture projects built at mines and land86. Mark C. Trexler et al., Ecosystem Marketplace, Going Carbon Neutral: How the Retail Carbon Offsets Market Can Further Global Warming Mitigation Goals 4 (2006). 87. As discussed supra, text accompanying notes 56–58, third party verification and certification programs do not adequately inform consumer choices because these programs also use differing standards and assumptions. See Trexler Climate + Energy Servs., Inc., supra note 36, at 15–16; Hamilton et al., supra note 6, at 37–39. 88. See Ottinger et al., supra note 74, at 171 (discussing measurements taken in a forest sequestration project). 89. Id. 90. Id. 91. Id. 92. Id. at 165–71. 93. Id. at 165–71, 176 (reviewing varying assumptions in competing GHG reduction estimates from a forest sequestration project). 94. See GAO Report, supra note 3, at 27–28. 95. Letter from Elliot Burg, Assistant Attorney Gen., Vt. Attorney Gen.’s Office, & David A. Zonana, Deputy Attorney Gen., Cal. Attorney Gen.’s Office, to the Office of the Sec’y, Fed. Trade Comm’n 3 (Jan. 25, 2008) [hereinafter AG Letter], available at http://ag.ca.gov/cms_attachments/press/pdfs/ n1520_carbon_offset_letter.pdf. 96. See GAO Report, supra note 3, at 28 (discussing what project types are the most and least credible); Trexler Climate + Energy Servs., Inc., supra note 36, at 10 (ranking quality of offsets by project type).

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fills are the most accurate and most industry studies state that methane capture projects reduce by seventy-five percent the amount of methane that would have entered the atmosphere without methane capture equipment.97 Although lacking comparative statistics, some animal scientists expressed “considerable uncertainty” with farm methane capture projects because the variability of conditions found on different farms makes it difficult to devise uniform tests.98 Forestation projects are notoriously difficult to measure, and GHG reduction estimates can vary by as much as fifty percent.99 There are two practical consequences for consumers resulting from the verification problem. First, consumers simply may not receive the advertised benefit. If an individual offsets his or her household emissions of eight tons of CO2, and the purchased offset is derived from a reforestation project, the individual’s payment may only actually realize four tons of CO2 reduction. If a consumer paid full price but only received half a cookie, half a television, or half a car, the consumer would justifiably be outraged and want to hold the seller responsible. This problem exponentially increases for institutional consumers. The second consequence for consumers from the verification problem is that because not all offsets are estimated using the same standards and assumptions, offsets are not “fungible.”100 An offset sold by one seller is not credibly equal to an offset sold by another seller.101 Proverbially stated, offset consumers often compare apples to oranges when they consider which offset to purchase. Carbon offsets’ lack of fungibility makes it “difficult for consumers to understand what they purchase . . . [because] it is difficult for consumers to determine the quality of the offsets they purchase.”102 The corollary of lack of fungibility is that it makes for an inefficient carbon offset market.103

“Icing on the Cake”:The Problem of Additionality

To be “additional,” a carbon offset must finance a project that reduces GHGs in addition to what would normally take place in a business-as-usual scenario (i.e. without proceeds from offset sales).104 The GAO succinctly stated the rationale for ensuring the additionality of GHG-reducing projects: “[O]nly offsets that are additional to business-as-usual activities result in new environmental benefits.”105

97. See Raymond L. Huitric & Dung Kong, L.A. County Sanitation Dists., Measuring Landfill Gas Collection Efficiency Using Surface Methane Concentrations 1 (2007), available at www.climatechange.ca.gov/ events/2007-06-12_mac_meeting/public_comments/HuitricSWANA_06.pdf (stating that landfill methane collection has a seventy–five percent efficiency rate). 98. See McGinn et al., supra note 74, at 14. 99. See Ottinger et al., supra note 74, at 166. 100. GAO Report, supra note 3, at 28. 101. Id. 102. Id. 103. See id. 104. See Mark C. Trexler et al., A Statistically-Driven Approach to Offset-Based GHG Additionality Determinations: What Can We Learn?, 6 Sustainable Dev. L. & Pol’y 30, 31 (2006). 105. GAO Report, supra note 3, at 25.

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Deceptive offset project developers can take money from carbon offset consumers for activities the developer was going to do anyway.106 Blue Source, the self-proclaimed leader of carbon offset sales in North America,107 sells offsets to consumers derived from CO2 captured from industry emissions and injected into old oil wells, thereby forcing up residual crude oil.108 A Financial Times investigation revealed that Blue Source did not tell consumers that due to high oil prices at the time, this practice was profitable in itself, and consumers simply financed oil extraction that would have taken place anyway.109 Similarly, a BusinessWeek investigation showed that Waste Management, Inc. realized extra profits from carbon offset consumers for developing methane flares for the company’s landfill.110 Waste Management executives earlier committed to develop the project because state regulators were threatening action against the company for methane that was contaminating groundwater beneath the landfill.111 In effect, offset consumers unknowingly helped finance a project undertaken by the company to avoid civil liability for groundwater contamination. TerraPass marketed and sold the offsets on Waste Management’s behalf at the same time that it was selling offsets derived from six other projects.112 Five of those six project developers stated that financing from offsets had not played a significant role in deciding to undertake the GHG-reducing project.113 In the words of one project manager, offset financing is “just icing on the cake . . . [w]e would have done this project anyway.”114 Blue Source and Waste Management did nothing illegal. Moreover, some might argue that they had smart business strategies: get paid for something they were going to do anyway. However, selling offsets derived from a project that would have been undertaken even without the proceeds from purchased offsets is antithetical to the consensus definition of a carbon offset.115 Determining whether a project is additional is difficult because the determination requires assuming a counterfactual scenario—what would have happened without financing from the sale of carbon offsets?116 Similar to the verification 106. Cf. Trexler et al., supra note 105, at 31–32 (discussing the difficulty of setting standards for determining additionality). 107. Blue Source, About Blue Source At a Glance, http://www.ghgworks.com/2about.html (last visited Mar. 3, 2010). 108. Blue Source, Carbon Capture and Storage, http://www. ghgworks.com/3ccapture-storage.html (last visited Mar. 3, 2010). 109. Fiona Harvey & Stephen Fidler, Industry Caught in ‘Carbon Credit’ Smokescreen, Fin. Times, Apr. 26, 2007, at 1. 110. Elgin, supra note 5, at 98. 111. See id. at 97. 112. See id. at 98. 113. See id. 114. Id. 115. See, e.g., FTC Workshop Announcement, supra note 4, at 66,096–97; GAO Report, supra note 3, at 2–3 (summarizing the definition of carbon offset as given by market “stakeholders”). 116. Id. at 26 (“Determining additionality is inherently uncertain because, [sic] it may not be possible to know what would have happened in the future had the projects not been undertaken.”); see also Trexler et al., supra note 105, at 31 (“[I]t is impossible to definitively answer [the additionality question]. Even if we could read the minds of project developers, they themselves may not know what they would have done under different circumstances. It is not even a ‘hypothetical’ question, since a hypothesis can be empirically tested.”).

problem, a number of standards and methodologies are used for addressing the additionality problem.117 The varying and contradictory standards for addressing the additionality problem, together with the inherent uncertainty of making a determination based on a hypothetical assumption, makes additionality the single biggest problem facing the carbon market today.118

When One Person’s Offset is Also Another’s:The Problem of Double-Counting

Deceptive offset sellers can “double-count” offsets by selling the same offset to different consumers.119 For example, a project developer who plants a forest that absorbs 30,000 tons of GHGs from the atmosphere could sell thirty offsets, each representing 1,000 tons of GHGs, to a company. The developer could then sell the same thirty offsets to a different company. Because there is no central registry that ties offset sales with specific projects or consumers, and one purchasing company is unlikely to independently learn from the developer whether the developer sold the same offset to another company, the developer can easily commit fraud by a double sale.120

When an Offset Is Here Today and Gone Tomorrow:The Problem of Permanence

Consumers should justifiably expect that their purchased offsets will produce permanent, or at least long-term, GHG reductions. Yet the reality is that some carbon offset projects are neither permanent nor long-term. For example, the rock band Coldplay offset the GHG emissions resulting from one of its concert tours by financing 10,000 mango tree plantings in India.121 Over four years later, many of the mango saplings died due to inadequate attention and financing by the project developer.122 Permanence problems are not confined to forestation projects. Any number of problems, including human neglect or mechanical breakdown, can interrupt or limit GHG reductions at project sites. Yet barring physical inspection, consumers might have little assurance from sellers that offset purchases lead to permanent GHG reductions. The consumer’s interest and benefit from the offset sale continues well past the actual date of sale, and a seller fails to adequately protect consumer interest by failing to ensure that a project permanently reduces GHGs.123 117. See Trexler et al., supra note 105, at 33 (listing and quantitatively assessing different types of additionality tests). 118. See GAO Report, supra note 3, at 52 (ranking by market participants of additionality as the most serious problem affecting market credibility). 119. See, e.g., AG Letter, supra note 96, at 4; GAO Report, supra note 3, at 28. 120. See GAO Report, supra note 3, at 28. 121. See Amrit Dhillon & Toby Harnden, How Coldplay’s Green Hopes Died in the Arid Soil of India, The Sunday Tel. (London), Apr. 30, 2006, at 3. 122. Id. Trees planted through offset financing can also be destroyed through wildfires or insect infestation. 123. See AG Letter, supra note 96, at 7 (noting that consumer interests are best protected when an offset seller provides evidence, among other things, “that the projects or practices are actually carried out and are permanent”).

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The four problems discussed above are not exceptional when one considers that many markets present unique problems for market participants. Yet unlike most other markets, the unique problems in the carbon offset market are compounded because consumers lack adequate legal remedies to use against deceptive offset sellers.

III. Current Legal Remedies To Hold Deceptive Offset Sellers Liable This Part first discusses legal remedies that the FTC and state attorneys general would likely use against deceptive offset sellers.124 This Part then argues that these remedies are insufficient both because they are ill-suited to the unique problems posed by carbon offsets and because current legal remedies are not philosophically consistent with promoting consumer protection.

State Fraud Common Law is Not Well-Suited to Prosecute Deceptive Offset Sellers

State common law fraud claims can be based on actual or constructive fraud.125 Actual fraud requires proof that the offset seller knew that the advertised GHG reduction was not truthful and was intended to deceive the consumer.126 An actual fraud claim therefore would only be a viable option for a defrauded offset consumer in the rare case where an offset seller made some statement that clearly indicates the seller was aware that the offset was defective in some material respect. Consumers can prove constructive fraud only through proof that offset sellers knew they lacked a reasonable basis on which to make the advertised claim concerning the offset’s environmental benefits.127 As discussed below in connection with state and federal consumer protection laws,128 carbon offset sellers can easily escape liability under a “reasonable basis” standard because the scientific methodology underlying claims of offset benefits is inexact. Inexact science gives sellers cover for making claims on the furthest extreme of plausibility.129

124. The qualifier “likely” is necessary because an extensive review resulted in no known public cases where an offset seller was prosecuted for fraudulent or deceptive practices. This is perhaps understandable considering that the carbon offset market has only had an appreciable impact within the last three to four years, and as discussed in this Part, current legal remedies are ill-suited for prosecuting deceptive offset sellers. 125. See, e.g., Pinney & Topliff v. Chrysler Corp., 176 F. Supp. 801, 803 (S.D. Cal. 1959) (holding that “with actual or constructive fraud there must be a false representation or promise as to a material fact, knowledge of its falsity when made, or lack of reasonable ground to believe in its truth”). 126. See Restatement (Second) of Contracts § 162(1) cmt. a (1979); see also Restatement (Second) of Torts § 526 (1999). 127. Restatement (Second) of Contracts § 162(1)(c) (1979). 128. See infra Part III.B. and accompanying footnotes. 129. See text accompanying notes 137–38.

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State and Federal Consumer Protection Laws Are Insufﬁcient Remedies for Holding Deceptive Offset Sellers Liable

The FTC is the federal agency with jurisdiction over consumer protection, and although the FTC has not brought an action against an offset seller or issued rules governing offset advertising, FTC officials confirmed that the agency is beginning to direct its attention to potentially misleading offset advertising.130 The statute under which the FTC enforces environmental marketing claims, such as those relating to carbon offsets, is § 5 of the FTC Act, which prohibits “unfair and deceptive acts and practices.”131 Unlike state common law fraud claims, claimants under § 5 need not prove intent.132 The FTC has issued interpretive rules, called the “Green Guides,” to guide marketers of products who make environmental benefits claims.133 Under the Green Guides, products making claims of environmental benefits, such as an offset, must have a “reasonable basis substantiating the claim . . . [which] will often require competent and reliable scientific evidence . . . .”134 There are three problems, each closely related to the others, with the “reasonable basis in the science” standard articulated in the FTC’s Green Guides as applied to carbon offset marketing. First, as discussed above in relation to the verification problem, measuring GHG reductions from an offset project is an “inherently uncertain” scientific endeavor requiring a lot of assumptions.135 The deceptive offset seller can choose from a multitude of GHG measurement standards and assumptions to find the standard that calculates the most GHG reductions from the seller’s project.136 In other words, in the absence of a definitive standard, a seller could use the most favorable, though still plausible, assumptions and standards and still have a reasonable scientific basis. For example, an offset seller could assume that both all trees in a reforestation project would mature to contain high average wood densities (high wood density translates to more CO2 sequestered per tree), and all planted trees 130. See, e.g., FTC Workshop Announcement, supra note 4, at 66,094–97. The FTC already has a lead role on other environmental marketing activities, including claims regarding the degree that a product is “environmentally friendly,” the percentage of a product’s recyclable content, a product’s biodegradability, and the amount of waste a product generates. See 16 C.F.R. § 260.7 (2009). 131. 15 U.S.C. § 45(a) (2006). State consumer protection laws are generally substantively similar to FTC Act § 5, so the problems discussed concerning FTC § 5 apply equally to state equivalents. See, e.g., Cal. Bus. & Prof. Code § 17,200 (West 2008); N.Y. Gen. Bus. Law § 349 (West 2004). 132. Julian O. von Kalinowski et al., 1 Antitrust Laws and Trade Regulation § 5.04 (2d ed. 2005). 133. FTC Green Guides, 16 C.F.R. § 260 (2009). The FTC’s Green Guides are currently undergoing revision to account for, among other things, misleading claims about carbon offsets. The FTC stated that the revision should be completed in 2009. See Envtl. Leader, FTC Examines Green Building, New Green Guides ‘Definitely’ in 2009, July 16, 2008, http://www.environmental leader. com/2008/07/16/ftc-examines-green-building-new-green-guides-definitelyin-2009/. As of this Note’s publication, the FTC has not yet issued its Green Guides revision. 134. FTC Green Guides, 16 C.F.R. § 260.5 (2009). 135. See supra Part II.A. and accompanying notes. 136. See, e.g., Ottinger et al., supra note 74, at 165–71, 176; Trexler et al., supra note 105, at 33 (listing different additionality tests from which project developers can choose).

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would mature without loss to fire, pests, or human activity.137 Although many experts would consider these assumptions unlikely, they might still be plausible enough for a seller to claim that they have reasonable bases in the science.138 These two assumptions, together with assumptions leading to the lowest plausible estimate of current GHG reductions from the land to be reforested, maximize the GHG reductions a seller can claim from the reforestation project. The more GHG reductions a seller can claim, the more offsets a seller can market, which translates to the healthiest bottom line and the least consumer protection. The second and related problem with the reasonable basis in the science standard is that it is most effective in circumstances where there is a scientific consensus on the appropriate methodologies with which to evaluate environmental benefit claims. For example, the standard works well where marketers claim that plastic trash bags are biodegradable because the government can test whether the bags actually decompose;139 or where a marketer claims its coffee filters are chlorine-free because the government can examine the manufacturing process or test the filters and determine whether chlorine was used.140 In these cases there is a definitive answer: the bags either decompose or they do not; the filters either contain chlorine or they do not. In contrast, the government cannot conduct definitive tests for carbon offsets because every marketer calculates offset benefits using a variety of methodologies and assumptions, any one of which could be the most accurate (although some assumptions are more plausible than others).141 Determining offset additionality also requires a number of assumptions, with one market survey listing eight different tests that sellers use.142 The practical effect of all this uncertainty is that unscrupulous offset sellers can choose the most advantageous assumption, and then select the highest possible amount of GHG reduction that can be plausibly claimed.143 Yet the offset seller can still escape liability because the seller can technically, but accurately, state that the seller had a reasonable basis in the science. In the absence of consensus methodologies and assumptions, the seller’s only limitation is that the seller’s claims cannot be so extreme that no test or assumption would support the claim. The third and final problem with the reasonable basis in the science standard is that it is inconsistent with the con137. See Ottinger et al., supra note 74, at 166. 138. But cf. id. at 165–68. 139. Cf. N. Am. Plastics Corp., 118 F.T.C. 632, 633–34 (1994). 140. See, e.g., Mr. Coffee, Inc., 117 F.T.C. 156, 158 (1994); see also Alan Levy, Senior Scientist, Food & Drug Admin., Address at Carbon Offsets & Renewable Energy Certificates Workshop (Jan. 8, 2008) (“[C]laims [about biodegradability and recycled content] at least seem to be objectively verifiable based on science and product testing.”). 141. See, e.g., Ottinger et al., supra note 74, 165–76 (discussing varying assumptions in forest sequestration projects); see also Levy, supra note 141 (“Claims about offsetting one’s carbon footprint or carbon neutral by contrast [to claims about biodegradability and recycled content] are claims about the behavior of the product maker or service provider and can’t be evaluated by product testing.”). 142. See Trexler et al., supra note 105, at 33. 143. Cf. id. at 32 (describing “phantom reductions” as a product in part of what additionality test is chosen).

sumer-centric philosophy that should prevail in consumer protection law. The FTC Act’s “overriding purpose [is] . . . to protect the consumer from being misled.”144 The FTC recognized that the Green Guides, the FTC’s interpretive rules on environmental marketing claims,145 should focus on “the way in which consumers understand environmental claims and not necessarily the technical or scientific definition of various terms.”146 At the FTC’s workshop on the carbon offset market, FTC Chairwoman Deborah Majoras reaffirmed that deceptive advertising in the context of carbon offset markets should be evaluated by what would mislead the reasonable consumer.147 In contrast, the reasonable basis in the science standard does not focus on the consumer’s thoughts about an advertisement, but on the adequacy of the seller’s scientific methodology providing the basis for the advertisement.148 Thus, the consumer-centric focus of the FTC Act and the FTC’s intent in promulgating the Green Guides are in tension with the scientific, seller-centric focus of the FTC’s reasonable basis standard. As discussed above,149 a consumer’s money can lead to as little as fifty percent of the advertised GHG reduction, an occurrence which a consumer surely would not expect when buying the offset.150 But the seller would escape liability because the seller can point to reasonable assumptions underlying the estimate. New legal remedies are necessary when sellers are not required to deliver according to consumer expectations.

IV.

The Short-Term Solution:The Cliffdale “Likely To Mislead” Test

Courts should replace the reasonable basis in the science standard used in other environmental marketing cases with the likely to mislead test articulated in Cliffdale151 and adopted by the Ninth Circuit in Pantron.152 This test is preferable in the short-term because it provides a ready-made standard that can be “pulled off the shelf” to better protect consumers in the interim before the CFTC establishes formal regulations for the offset market.153

144. F.T.C. v. Pantron I Corp., 33 F.3d 1088, 1099 (1994) (quoting Nat’l Petroleum Refiners Ass’n v. F.T.C., 482 F.2d 672, 685 (D.C. Cir. 1973)) (internal quotations omitted). 145. See FTC Green Guides, 16 C.F.R. § 260 (2009). 146. FTC Workshop Announcement, supra note 4, at 66,096. 147. Deborah Majoras, Chairwoman, FTC, Opening Remarks at the FTC Public Workshop on the Carbon Offset Market 9 (Jan. 8, 2008) (“So for marketers the basic rule to remember is any material misrepresentation, omission or practice is deceptive if it’s likely to mislead consumers who are acting reasonably.”). 148. FTC Green Guides, 16 C.F.R. § 260.5 (2009) (“[Marketers can] rely upon a reasonable basis substantiating the claim . . . [which] will often require competent and reliable scientific evidence.”). 149. See Ottinger et al., supra note 74, at 166. 150. A major problem with the offset market is that there are few, if any, consumer surveys detailing what consumers expect from purchased offsets. See generally Levy, supra note 141, at 23–36 (discussing unanswered questions about consumer expectations in the offset market). 151. Cliffdale Assocs., Inc., 103 F.T.C. 110, 164 (1984). 152. F.T.C. v. Pantron I Corp., 33 F.3d 1088, 1095 (9th Cir. 1994). 153. See infra Part V.

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This Part first reviews the likely to mislead test articulated in Cliffdale and adopted by the Ninth Circuit in Pantron. This Part then discusses the advantages of applying the likely to mislead test in the offset market context, and then answers some of the potential problems of replacing the reasonable basis in the science standard.

The Likely to Mislead Test

In Cliffdale, the FTC held a manufacturer of a fuel efficiency device called the “Ball-matic” liable for deceptive advertising.154 The manufacturer argued that its fuel efficiency claim had a reasonable basis because the manufacturer conducted a “controlled, supervised test” that showed that cars installed with the Ball-matic improved their gas mileage between eight and forty percent.155 The manufacturer also produced customer testimonials as evidence that showed that the manufacturer had a reasonable basis to make its advertising claims.156 The FTC claimed that the manufacturer lacked a reasonable basis in the science and produced evidence of a fuel efficiency test, used both by the Environmental Protection Agency (“EPA”) and non-government experts, which showed that the fuel efficiency savings of the Ball-Matic were illusory.157 Experts also reviewed the methodology of the manufacturer’s test and concluded that it was not scientifically credible.158 Experts reached the conclusion that the manufacturer’s test was not credible because, unlike carbon offsets, there is a scientific consensus about how to test the extent to which a product increases a car’s fuel efficiency.159 Therefore, an FTC administrative law judge (“ALJ”) held that the manufacturer’s test was an insufficient basis for its fuel efficiency claim.160 The key point about Cliffdale is that in affirming the ALJ’s decision, the FTC gave scant attention to the “reasonable basis” inquiry and focused much more on whether a reasonable consumer would be misled by the manufacturer’s claim.161 Furthermore, the Commission’s test was not the reasonable basis test, but a new, “likely to mislead” test.162 This test holds that a practice is deceptive if: (1) “there is a representation, omission, or practice” that; (2) is likely to mislead a reasonable consumer; and (3) “the representation, omission, or practice is material.”163 The FTC then applied the three-part test to each discrete claim,164 and relegated the “reasonable basis” test to a two paragraph discussion at the conclusion of the opinion.165 154. Cliffdale, 103 F.T.C. at 162. 155. Id. at 138. 156. Id. at 137–38. 157. Id. at 138–41. 158. Id. at 143–44. 159. Id. 160. See id. at 148. 161. Compare id. at 173 (discussing reasonable basis test), with id. at 164–65 (discussing test for what would mislead a reasonable consumer). 162. Id. at 164. 163. Id. at 164–65. 164. See, e.g., id. at 164–70 (applying likely to mislead test to fuel efficiency claim). 165. Id. at 173 (“[The Commission] need go no further to conclude that respondents did not have a reasonable basis for their claims” because the Commission

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The Ninth Circuit explicitly adopted the Cliffdale likely to mislead test in Pantron.166 Pantron is a good example of a situation where, as in the case of deceptive offset sellers, an advertising claim could plausibly have a reasonable basis in the science, yet still be untrue and therefore mislead the reasonable consumer. In Pantron, the FTC alleged that Pantron used deceptive advertising when it claimed that its product, Helsinki Formula, promoted new hair growth for balding individuals.167 In response, Pantron entered testimony from eighteen users attesting to Helsinki Formula’s efficacy.168 Pantron also introduced into evidence a “consumer satisfaction survey” showing that seventy percent of customers were satisfied after six months, over half its orders came from repeat customers, and less than three percent of consumers “exercised their rights under the money back guarantee.”169 Finally, Pantron introduced testimony of three experts, two of whom conducted clinical studies substantiating Pantron’s claims about the Helskini Formula.170 The third rebutted the testimony of one of the FTC’s experts.171 The district court held that the FTC failed to carry its burden that Pantron actually deceived consumers because “there [was] no evidence in the record to support a contention that the Helsinki Formula is wholly ineffective . . . [and] studies and anecdotal evidence offered by Pantron supported the proposition that the compound works for some people some of the time.”172 Although the district court held that the FTC “marginally carried its burden of proof” that Pantron’s scientific claims were false,173 the district court nevertheless declined to order monetary damages because the FTC failed to prove that customers were actually deceived.174 On appeal, the Ninth Circuit agreed that the likely to mislead test” used in Cliffdale “set[s] forth the appropriate general principles for determining whether advertising is deceptive.”175 The court doubted the quality of Pantron’s studies,176 but it did not base its decision against Pantron on the superiority of the FTC’s studies over Pantron’s studies. Rather, the court held on alternative grounds that even if Pantron’s claims were technically true, the marketing was still misleading because the benefits of the product resulted from the placebo effect, not from the qualities of the Helalready found respondents liable under the likely to mislead test.). On appeal, the Ninth Circuit determined that the FTC had “clearly and expressly abandoned the reasonable basis theory.” F.T.C. v. Pantron I, Corp., 33 F.3d 1088, 1096 (9th Cir. 1994). The FTC appended a policy statement to the Cliffdale decision that effectively limited the applicable scope of the test to food, drug, cosmetic, and device advertisements. Cliffdale, 103 F.T.C. at 174 app. 166. Pantron, 33 F.3d at 1095. The bulk of the discussion in Pantron focuses on whether the company is liable under § 12 of the FTC Act. Section 12 governs deceptive advertising claims specifically, whereas § 5 governs “deceptive and unfair acts and practices” in general. Compare 15 U.S.C. § 55 (2006), with 15 U.S.C. § 45(a) (2006). 167. Pantron, 33 F.3d at 1091. 168. Id. at 1093. 169. Id. 170. Id. at 1093–94. 171. Id. 172. Id. at 1094 (emphasis added) (internal quotations omitted). 173. Id. 174. Id. 175. Id. at 1095. 176. See id. at 1097 nn.24–25 and accompanying text.

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sinki Formula.177 Stated differently, although Pantron could reasonably point to benefits of their product, the advertisement misled consumers because the benefit stemmed from the placebo effect, not from the product’s qualities. The Ninth Circuit then rejected the requirement that an advertisement not have a reasonable basis in the science, and held that the FTC “is not required to prove that a product is ‘wholly ineffective’ in order to carry its burden of showing that the seller’s representations of product efficacy are false.”178 The court reinforced that the proper analysis should not be the sufficiency of the advertisement’s scientific basis: “The question we must face, then, is not whether Pantron’s claims were ‘true’ in some abstract epistemological sense, nor even whether they could conceivably be described a ‘true’ in ordinary parlance.”179 In sum, the Pantron court illustrates how the likely to mislead standard is necessary in contexts where the manufacturer of a product can point to plausible evidence substantiating the product’s claims, yet still mislead consumers about the efficacy of a product. Read together, Cliffdale and Pantron stand for the proposition that courts should evaluate advertising claims from the perspective of what would “likely mislead the reasonable consumer.”180 In this evaluation, courts should give little, if any, attention to whether the seller has sufficient scientific evidence to support the claim.181 Rather, the proper analysis should be whether a reasonable consumer, in light of all the circumstances, would be deceived by the advertisement.182

Applying the Likely to Mislead Test to the Carbon Offset Market

The likely to mislead test would considerably strengthen the credibility of the carbon offset market. Under the likely to mislead test, an offset seller would be liable for advertisements that would likely mislead a reasonable consumer about a material aspect of the offset.183 A reviewing court may consider an offset seller’s scientific bases for the claim, but the court’s ultimate decisional focus should remain on a consumer’s expectations regarding the purchased offset.184 Adopting the likely to mislead test, however, should only be a short-term solution in the interim before the CFTC issues regulations requiring offset sellers to register their products. When thus viewed as an interim solution, the 177. See id. at 1097, 1101 (“The evidence before the district court made clear that there is no reason to believe that the Helsinki Formula is at all effective outside of its placebo effect. Accordingly, it was materially ‘misleading’ under Cliffdale for Pantron to represent that the Formula is effective in combating male pattern baldness.”). 178. Id. at 1100. 179. Id. at 1099–1100. 180. See id. at 1095; Cliffdale Assocs., Inc., 103 F.T.C. 110, 164–65. 181. See Pantron, 33 F.3d at 1099; Cf. Cliffdale, 103 F.T.C. at 173 (relegating the reasonable basis in the science test to a brief, two paragraph discussion). 182. See Pantron, 33 F.3d at 1095; Cliffdale, 103 F.T.C. at 164–65. 183. Cf. Pantron, 33 F.3d at 1095 (substantially adopting the likely to mislead test). An aspect of an offset advertisement is “materially” misleading “if [the aspect] is likely to affect the consumer’s conduct or decision.” Cliffdale, 103 F.T.C. at 175 app. 184. Cf. Cliffdale, 103 F.T.C. at 110 (establishing FTC policy on the likely to mislead test).

likely to mislead test has several advantages over the reasonable basis standard. First, the likely to mislead test frees judges from adjudicating very complex, and inherently uncertain questions concerning the veracity of offset claims. If the experts in the offset market cannot agree on the best assumptions and methodologies for measuring GHG reductions,185 or for determining whether a project is additional,186 then judges certainly cannot expect to do so. The likely to mislead test is therefore easier for courts to administer because it would avoid the “battle of the experts” problem that inevitably occurs when the question centers on the sufficiency of scientific evidence. Adopting the likely to mislead test also serves notice to deceptive offset sellers that they cannot rely on plausible, but still misleading claims to scientific support. Offset sellers will therefore have incentives to be more forthcoming in their representations of the benefits of offsets. For example, instead of categorically stating than an offset derived from a forest sequestration project will reduce GHGs by thirty tons, offset sellers would be on safer ground to state GHG reductions as a range, such as stating that an offset will reduce GHGs by fifteen to thirty tons.187 Stating a range of values is more accurate, given the uncertainty of the measurements, and therefore would be less likely to mislead the reasonable consumer about the benefit of the offset they are purchasing. Finally, and perhaps most importantly, the likely to mislead test harmonizes the consumer protection purpose of the FTC Act with the FTC’s enforcement guidance and courts’ decisional focus. The reasonable basis standard was a workable method of operationalizing the terms “deceptive” and “unfair” in the FTC Act in the context of tangible products that can be objectively tested.188 But the reasonable basis standard breaks down when applied to carbon offset sellers. Without a consensus on evaluation criteria with which to judge offsets, the best standard, and the standard most consistent with the FTC Act, is the reasonable consumer’s expectations.

The Beneﬁts of the Likely to Mislead Test Outweigh Any New Problems it May Create

A reasonable critique that one could offer of the likely to mislead standard is that it is too inexact and leaves sellers uncertain of how to avoid liability. Sellers had a safe harbor in the reasonable basis in the science test if their advertising claims were reasonably supported by scientific evidence. More specifically, sellers would not fear liability if they correctly utilized a methodology or assumption accepted by at least some other offset experts for accurately determining GHG reductions and additionality. 185. See AG Letter, supra note 96, at 3 (noting that there are “no common standards for qualifying emissions reductions”). 186. See Trexler et al., supra note 105, at 31–33 (discussing different tests for measuring additionality). 187. Cf. Ottinger et al., supra note 74, at 165–69 (discussing the difficulty of measuring forest sequestration projects). 188. Cf. Levy, supra note 141, at 23 (stating that it is easier to enforce deceptive and unfair practices when the product can be objectively tested).

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There are three responses to this critique. First, the likely to mislead standard is no more inexact than the reasonable person standard that judges have fairly applied in tort and other fields of law for over a century.189 Offset sellers need not look upon this change in law as a “hunting license” for a uniquely susceptible consumer to exploit; they need only fear liability for actions that would mislead a reasonable consumer under the circumstances. Second, § 5 of the FTC Act is not a citizen suit provision.190 Only the FTC is empowered to enforce the prohibition on deceptive advertising.191 The FTC would be restrained from dramatically increasing liability exposure in the offset market both because of resource constraints and because the FTC traditionally only prosecutes the most egregious cases in a given industry.192 Although some may term the FTC “the little agency that could,” it is still a “little agency” that “must move . . . from high tech issues like spyware and identity theft, to environmental trends like the marketing of carbon offsets, to public health crises like childhood obesity.”193 This wide mandate together with limited resources means that it is unlikely that the FTC can fundamentally change the incentive structure of the carbon offset market through the application of a broader legal test alone. The third consideration that makes dramatically increased liability exposure for offset sellers unlikely is that minimal changes by sellers in their advertising would forge a strong liability shield. If a seller only advertised a range of GHGs reduced by an offset, rather than an absolute value, the FTC would find it much harder to claim that the advertisement was misleading because a seller would state a low and high value of GHG reduction.194 Alternatively, a seller could disclose that actual GHG reduction may be materially less than advertised due to the difficulty of accurately measuring GHG reductions.195 189. See generally Oliver Wendell Holmes, The Common Law 51–58, 107–10, 146–50 (1881) (discussing the reasonable person standard in criminal and tort law). But see Robert B. Mison, Homophobia in Manslaughter: The Homosexual Advance as Insufficient Provocation, 80 Cal. L. Rev. 133, 159 (1992) (“The failure of the reasonable man to represent ‘the social reality in which it operates can create prejudicial and untenable results.’” (quoting Dolores A. Donovan & Stephanie M. Wildman, Is the Reasonable Man Obsolete? A Critical Perspective on Self-Defense and Provacation, 14 Loy. L.A. L. Rev. 435, 466 (1981))). 190. See 15 U.S.C. § 45(a)(2) (2006) (empowering the Commission to “prevent persons . . . from using . . . unfair or deceptive acts or practices in or affecting commerce”). 191. Note, “Corrective Advertising” Orders of the Federal Trade Commission, 85 Harv. L. Rev. 477, 477 (1971). 192. Indeed, a coalition of consumer protection groups recommended recently in an open letter to the incoming Obama administration that because the FTC has limited resources, citizens should be given power to enforce the FTC Act’s prohibition against “unfair and deceptive acts and practices.” See Consumer Action, Consumer Coalition Lists Goals for Obama’s FTC, Dec. 2008, http://www.consumer-action.org/coalition/articles/ consumer _coalition_lists_goals_for_obamas_ftc. 193. Lydia B. Parnes, Anticipating New Consumer Protection Challenges in the Food and Drug Marketplace, 63 Food & Drug L.J. 593, 594 (2008). Ms. Parnes made this statement at a food and drug law conference while she was Director of the FTC’s Bureau of Consumer Protection. Id. at 593. 194. Cf. Green Guides, 16 C.F.R. § 260.7(e) (2009) (providing examples where manufacturers are required to be more specific in their representations concerning recycled content in their products). 195. See supra Part II.A. A seller might respond that advertising a range or disclosing that the highest plausible value may not be accurate will negatively impact profits. Although this may be true, supra, many consumers buy offsets

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The ultimate problem with simply adopting the likely to mislead test as the single solution for both the short-term and the long-term is that it does not remedy the fundamental informational disadvantages suffered by consumers in the offset market. Consumers must still rely on the FTC to protect their interests, and as indicated above, the FTC is only likely to prosecute the most egregious violators of § 5’s prohibition against deceptive practices. To bring greater credibility and transparency to the carbon market, and thereby increase consumer participation and seller returns, the better solution involves affirmative disclosures by the seller of information that reduces consumers’ concerns about the four problems of carbon offsets.196

The Long-Term Solution:The CFTC Should Require the Registration of Offsets

The verification, additionality, double-counting, and permanence problems are really problems of consumers’ informational deficit. To close this deficit, the CFTC should require offset sellers to certify that their products are verifiable, additional, are not sold to multiple consumers, and continue to result in the advertised benefit after purchase. This reporting requirement goes marginally beyond what is required of other commodities197 and may be fairly termed a “reporting plus requirement,” but it is necessary to account for the unique nature of carbon offsets and the multiple means by which an offset seller can deceive a consumer. Once the registry is in place, responsibility for enforcing deceptive claims about carbon offsets would shift from the FTC to the CFTC. At bottom, the carbon offset market must comply with similar reporting requirements before it can enjoy credibility on par with traditional commodities and securities markets. This Part first discusses the advantages of CFTC oversight of the carbon offset market as a long-term solution to problems with the market’s credibility and transparency. Then this Part addresses possible critiques of registration.

Oversight by the CFTC Most Effectively Ensures the Long-Term Credibility and Transparency of the Carbon Offset Market

The CFTC recently signaled its willingness to oversee the carbon offset market.198 The CFTC has experience both in regulating the types of trades that would take place in the

for public relations reasons, and these consumers are still free to state the highest possible GHGs offset through their purchase. Moreover, increased market transparency could potentially bring in more consumers to compensate for revenues lost due to greater disclosure. 196. See supra Part II. 197. See 17 C.F.R. § 40.2 (2009) (CFTC’s registration requirements). 198. See generally Gary Gensler, Chairman, CFTC, Remarks at the International Emissions Trading Association 2009 Fall Symposium (Nov. 3, 2009), available at http://www.cftc.gov/ucm/ groups/public/@newsroom/documents/ speechandtestimony/opagensler-17.pdf.

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market and in preventing fraud based on selling commodities on paper that do not really exist.199 Specifically, the CFTC should require all offset sellers to register their offsets in a central registry and enforce any misrepresentations made on registration statements. The CFTC’s expertise does not extend to some of the scientifically complex questions such as determining whether an offset seller misrepresented an emission methodology, so the CFTC should partner with the EPA to establish acceptable methodologies that sellers may use.200 Both the Senate and the House cap-and-trade bills advocate establishing a national, mandatory carbon offset registry.201 Offset market participants usually recommend registries as important in preventing double-counting.202 Registries connect an offset with a consumer and project so that deceptive sellers cannot sell the same offset twice.203 Registries can also play important roles in verifying that offsets actually reduce GHGs to advertised levels and are additional.204 For example, carbon offset sellers in Europe, where offset registration in a single registry is required, reduced their GHG advertising claims by forty percent once registration was required.205 This suggests that offset sellers do not make exaggerated claims when they could be held liable by a government registrar for advertising misrepresentations. Registries can also promote stringent protocols for ensuring additionality, which prevents offsets with dubious additionality claims from reaching the market.206 A number of third party registries have been created by private companies and non-profits in response to the perception that the carbon offset market was not credible.207 However, these registries do not communicate with each other and employ different standards in evaluating offsets.208 Consumers are not necessarily any wiser after consulting them.209 The CFTC therefore should create a single registry to provide both a minimum standard for offset credibility and enforcement authority to deter deceptive sellers. Due to the 199. See id. at 4. 200. See id. at 3. Both the House and the Senate cap-and-trade bills contemplate that the EPA, with the assistance of an expert advisory board, will establish standard methodologies and assumptions that sellers may employ. See generally Clean Energy Jobs and American Power Act, S. 1733, 111th Cong. §§ 731–34 (2009); American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. §§ 731–34 (2009). 201. See S. 1733 § 724(d); H.R. 2454 § 732(d). 202. See GAO Report, supra note 3, at 28; Hamilton et al., supra note 6, at 44. 203. Hamilton et al., supra note 6, at 44 (explaining that registries “can keep track of credit ownership and eliminate ‘double-counting’”). 204. Cf. H.R. 2454 § 732(b) (discussing requirements for registered offsets); Andrew C. Schatz, Regulating Greenhouse Gases by Mandatory Information Disclosure, 26 Va. Envtl. L.J. 335, 337–47, 385–86 (discussing the benefits of mandatory information disclosure of pollutants and carbon offsets). 205. Anja Kollmuss & Benjamin Bowell, Tufts Climate Initiative, Voluntary Offsets For Air–Travel Carbon Emissions 11–12 (2006), available at http://sustainability. tufts.edu/downloads/TCI_Carbon_Offsets_Paper_ April-2-07.pdf. 206. See generally Hamilton et al., supra note 6, at 44–45 (discussing various third party registries, some of which implement additionality protocols). 207. See id. 208. See GAO Report, supra note 3, at 28; see also Trexler et al., supra note 105, at 33. 209. Cf. GAO Report, supra note 3, at 28 (explaining that, because of registry problems, “it is difficult for consumers to determine the quality of the offsets they purchase”).

unique nature of carbon offsets and the multiple avenues for deception, offset sellers should provide additional certifications intended to mitigate the potential verification, additionality, double-counting, and permanence problems. Therefore, in addition to complying with the modest registration requirements specified in CFTC Regulation 40.2,210 offset sellers should also certify that the offset is verifiable, additional, has not been sold to multiple consumers, and that the project continues to result in advertised GHG reductions. Each of these requirements will be dealt with in turn. To verify an offset, the seller should specify the methodology (or test) used to make the advertised claim of GHG reductions, together with an indication of the degree of accuracy that can be expected from the use of the seller’s methodology. This indication of accuracy could be made by specifying the range of GHG reduction that can be expected from the offset together with a confidence value of the statistic.211 The CFTC, in consultation with the EPA, should use its rule-making authority to set minimum standards and acceptable assumptions in making GHG estimates.212 To certify that an offset is additional, a seller should certify that the offset project would not have been undertaken but for the financing obtained from the sale of offset purchases. This will often require an offset retailer to communicate more fully with the project developer. Additionality certification would also mitigate problems like that seen in the Waste Management anecdote—where the retailer did not learn until BusinessWeek conducted its investigation that the project developer (Waste Management, Inc.) was receiving offset financing to fund a project meant to avoid state regulatory action against the company.213 Similar to verification, the CFTC in consultation with the EPA should specify by rulemaking permissible protocols for ensuring additionality.214 The CFTC should also require offset sellers to certify that an individual offset has not been sold to multiple consumers. This would mitigate the problem of double-counting and serve as an incentive for offset sellers to develop uniform accounting practices. Offset sellers’ obligations should not end on the issuance of the offset because consumers might reasonably expect con210. 17 C.F.R. § 40.2 (2009). This regulation requires “a copy of the product’s rules, including all rules related to its terms and conditions . . . [t]he intended listing date; and . . . certification by the registered entity that the product to be listed complies with the [CFTC] Act and regulations thereunder.” 211. For statistics with unknown population values, as is the case here where the true “population” of GHGs is unknown, it is standard to give the “confidence interval.” Valerie J. Easton & John H. McColl, Statistics Glossary, http://www. stats.gla.ac.uk/ steps/glossary/confidence_intervals.html (last visited Mar. 3, 2010). A confidence interval is a percentage of the degree of certainty that a statistician would find the true population level within the range given. Id. An example of a confidence interval in the context of GHG measurement would read as follows: “We can say with 95% certainty that the true level of GHGs reduced by the consumer’s offset will be between 10 and 15 tons.” 212. Establishing acceptable assumptions and standards is admittedly outside the CFTC’s expertise. Responsibility for setting minimum standards could either be delegated in legislation to a different expert agency or to an in-house scientific advisory panel, similar to that contemplated in House and Senate legislation. See Clean Energy Jobs and American Power Act, S. 1733, 111th Cong. § 731 (2009); American Clean Energy and Security Act of 2009, H.R. 2454, 111th Cong. § 731 (2009). 213. Elgin, supra note 5. 214. Additionality protocols may also be a scientific advisory panel.

JOURNAL OF ENERGY & ENVIRONMENTAL LAW

tinued GHG reductions from their purchased offset. Therefore, sellers should file supplementary annual or biannual statements certifying that the project continues to operate under the circumstances detailed in the initial registration statement.215 If the seller notifies the CFTC that a project is no longer resulting in the advertised GHG reductions, the CFTC should grant a reasonable cure period, not to extend beyond six months. If the seller fails to cure the problem within the time period, sellers would be required to refund a pro-rata amount to the consumer corresponding to the percentage difference between the amount of GHGs the project reduces at the present time and the amount of GHGs the project reduced at the time the consumer bought the offset from the seller. Requiring offset sellers to certify that a project continues to result in advertised GHG reductions mitigates the permanence problem and also allows for the application of improved technology or methodology that better calculates GHG reductions. Using new technologies or methodologies, offset sellers can substantiate or refine their advertising claims, which in turn would increase the credibility and transparency of the market. All seller parties to an offset sale—the project developer, the broker or wholesaler, and the retailer—should certify that part of the offset transaction that is within the party’s competency.216 All three parties would certify that the project is verifiable. The project developer should certify that the project is additional, or in other words, that the developer would not have undertaken the project but for carbon offset proceeds. The retailer and broker or wholesaler should certify that a discrete offset has not been sold to multiple consumers (or multiple retailers in the case of the broker or wholesaler). The project developer should certify on an annual or biannual basis for the life of the offset project that there has not been a change in circumstances with the project and the project continues to reduce GHGs by the advertised amount. Taking these steps would most effectively ensure the long-term credibility and transparency of the market. This is important not just in terms of the individual consumers, but also in terms of the public good. Regulating carbon offsets best protects the public’s expectations of the efforts being made toward reducing man-made contributions to global climate change. Scientists, policymakers, and citizens need to have accurate information before making decisions regarding climate change, and it would be difficult to have accurate information if the offset market was easily susceptible to fraud and deception.

215. Offset sellers would, of course, be able to include a term of performance in an offset sale. This term might state that the purchased offset will only lead to advertised GHG reductions for a specified period of time. In such cases, offset sellers would not be required to file supplementary statements beyond the term of the purchase. 216. As a corollary, one seller party should not be liable for the misrepresentations of another seller party unless the non-misrepresenting party knew or should have known of the misrepresentations. See Escott v. BarChris Constr. Corp., 283 F. Supp. 643 (S.D.N.Y. 1968).

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The Beneﬁts Of A Single Registry For The Carbon Market Outweigh The Potential Problems

Among those who agree that the federal government should establish a single offset registry, many believe that EPA should exercise primary oversight.217 However, the CFTC is better situated than the EPA to establish and provide oversight over an offset registry for two reasons. First, “[t]he CFTC’s mission is to protect market users and the public from fraud, manipulation, and abusive practices related to the sale of commodit[ies].”218 Carbon offsets are commodities that should be regulated by the CFTC because it is the institutional actor with the greatest experience in registering and providing oversight of commodities markets.219 Second, the CFTC currently exercises limited oversight of the carbon offset market through its monitoring of the Chicago Climate Exchange (“CCX”),220 so it has some experience with the unique problems posed by carbon offsets.221 To be sure, the EPA would have significant expert roles in determining acceptable offset methodologies and assumptions. EPA personnel would work with the CFTC to determine whether a seller followed the stated methodology. But the primary oversight authority should be the CFTC. The GAO reiterated two of the most common critiques from those opposed to the federal government adopting regulations for the carbon offset marketplace and implementing a uniform registry. First, “several stakeholders said that a single standard may not be desirable because it could stifle innovation and limit access to the market. . .”222 There is no question that requiring offset sellers to register their product would increase market barriers for some potential sellers. Offset sellers would have greater responsibilities to ensure an accurate test for additionality and communicate with project developers to ensure the developer would not undertake the project but for offset purchase proceeds. For offset sales that are not term-limited, a seller would have to retest the project for accuracy every year or two years. This often requires paying professionals, both scientific to ensure test accuracy and legal to ensure compliance with CFTC registration requirements. Some smaller offset sellers may also feel the need to buy liability insurance or reorganize into a business structure that affords limited liability. Tradeoffs are certainly implicated here, but it is important to remember that the current carbon offset market essentially 217. The House bill contemplates EPA as the primary offset regulator. See H.R. 2454 § 732. 218. CFTC, About the CFTC, http://cftc.gov/aboutthecftc/index.htm (last visited Mar. 3, 2010). 219. The CFTC has been regulating commodities since 1974. See id. 220. GAO Report, supra note 3, at 19. CCX is a voluntary carbon exchange market where offset sellers can register their offsets for trade. Id. at 5. According to the GAO, CCX operates with little formal oversight by the CFTC because market participants are experienced. Id. at 19. CCX members are all private businesses, public utilities, governments, or universities that are sufficiently sophisticated with enough resources to independently verify the quality of carbon offsets purchased. Chicago Climate Exchange, Members of CCX, http:// www.chicagoclimatex.com/ (select “member list”) (last visited Mar. 3, 2010). 221. The CFTC’s monitoring of carbon offsets in connection with the CCX is further recognition that offsets are commodities. 222. GAO Report, supra note 3, at 28.

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operates by caveat emptor.223 Caveat emptor has been discredited both as a market rationale and as a legal theory over the last half century.224 Caveat emptor was workable when seller and consumer were in equal bargaining positions, but courts and the markets realized that this assumption was no longer true.225 As discussed above, consumers are especially disadvantaged in the carbon offset market because offsets are intangible commodities that are not easily valued.226 Unless consumers are placed in a better informational position, the offset market will continue to lose both credibility and consumers.227 The burden of increased costs is often advanced to counter new regulatory efforts, particularly in environmental law.228 But the U.S. economy has shown a remarkable resilience in the face of new regulations.229 There is no reason to doubt that here too the market will adapt and flourish despite new regulations. The second critique the GAO repeated from market participants is that “the flexibility offered by multiple standards encourages the testing of new methodologies and emissions reduction technologies.”230 This critique that a single registry will stifle innovation also has some merit. With a higher barrier of entry, smaller firms which tend to be more innovative will have greater disincentives to enter the offset market. Innovation might also be adversely affected in terms of technology and methodology development. To be on safe ground, offset sellers might gravitate toward offset projects that can produce more certain measurements of GHG reductions. GHG reductions from methane capture and efficiency upgrade projects (respectively forty-nine percent and thirteen percent of offset projects by volume) tend to be easier to calculate than forestry and sequestration projects (respectively seventeen percent and nineteen percent of offset projects by volume).231 Therefore, reducing the field of potential GHGreducing projects could possibly stifle innovation in types of projects and types of measurement methodologies because there is less opportunity to experiment in unique contexts. Although regulation might dampen innovation, money spurs innovation. The greater market credibility that offset registration promises can attract more consumers and retain existing consumers. Moreover, the carbon offset market will only grow larger as government and private consumers pay 223. Hamilton et al., supra note 6, at 31. 224. See, e.g., Denise Binder, The Duty to Disclose Geologic Hazards in Real Estate Transactions, 1 Chap. L. Rev. 13 (1998). 225. Id. at 23. 226. See supra Part II (introductory paragraph). 227. Cf. Trexler Climate + Energy Servs., Inc., supra note 36, at 4–6 (“Contributing to the transparency of retail offset markets will hopefully contribute to their robust growth . . . .”). 228. See, e.g., Richard B. Stewart, Environmental Regulation and International Competitiveness, 102 Yale L.J. 2039, 2044 (1993). 229. One of the best examples is the cap-and-trade program for sulfates, which are the leading cause of acid rain. Power companies were required to lower their sulfate emissions, a decision much criticized at the time. But by many accounts, companies have adapted and even flourished by trading sulfate emission credits. See generally Joseph Goffman, Title IV of the Clean Air Act: Lessons for Success of the Acid Rain Emissions Trading Program, 14 Penn St. Envtl. L. Rev. 177 (2006). 230. GAO Report, supra note 3, at 28. 231. Id. at 13–15, 28.

an increasing amount of attention to how to mitigate manmade climate change. The market has grown 125% in three years, and with market value forecasts as high as $4 billion within another three years,232 there will be plenty of incentive to enter the market and innovate to attract consumers away from competitors.

Conclusion The retail carbon offset market has serious credibility questions due to the unique challenges carbon offsets pose to science and consumer awareness. In the short-term, the best solution is for the FTC Commission and courts to analyze offset advertising claims in terms of what is likely to mislead the consumer. In the long-term, the best solution is to register offsets with the CFTC so that the carbon offset market can benefit from the same relative transparency enjoyed by other commodities and securities markets. Adopting these proposals will both protect consumer interests and reward the majority of trustworthy offset sellers who would benefit from a market with greater credibility.

232. Elgin, supra note 5.