Cap-And-Trade Program: Lawmakers Debate Cap-and-Trade and Hear Comments on Sinclair

In what was expected to be a run-of-the-mill informational legislative hearing on the budget, ideologies collided February 29 as lawmakers held a lively debate on the virtues of California's cap-and-trade program.

The purpose of the hearing held by Assembly Budget Subcommittee No. 3 on Resources and Transportation was to discuss cap-and-trade auctions and how the state is expected to utilize the revenue generated from the auctions.

As part of his 2012-13 state budget, Governor Jerry Brown assumes that the state will obtain $1 billion in cap-and-trade revenue, and he expects to use $500 million to offset existing general fund costs related to emissions reductions.

The California Air Resources Board (CARB) adopted cap-and-trade regulations in 2011 as part of its effort to implement AB 32, the 2006 Global Warming Solutions Act. AB 32 called for CARB to develop "market mechanisms" to reduce emissions to 1990 levels by 2020.

From the start of the hearing, members of the subcommittee offered differing philosophical perspectives on economics and cap-and-trade, in what Assemblyman Rich Gordon referred to as "good political discussion."

Assemblyman Brian Jones characterized cap-and-trade as an effort by the state to "create a market where essentially a market doesn't exist." He said the state hadn't gone as far as creating "command-and-control" regulations, which he said are often present in Marxist economic systems, but said that instead, through the creation of a new market via cap-and-trade, California was "setting up a socialist economic system."

Other committee members viewed cap-and-trade more favorably. Assemblyman Jared Huffman said cap-and-trade is a cost-effective alternative to heavy-handed "command-and-control" regulations. He recalled cap-and-trade being supported by members of the business community, because similar programs had been successful elsewhere.

Tiffany Roberts, the Legislative Analyst's Office (LAO) adviser on air quality and climate-change issues, told the committee that the LAO believes revenue derived from cap-and-trade would fall under the Sinclair court decision, rather than the constitutional provisions created by Proposition 26, because cap-and-trade was authorized by a state statute before Proposition 26 took effect.

In Sinclair Paint Company v. State Board of Equalization, the California Supreme Court ruled that there are key differences between taxes and fees. The case involved fees authorized by 1991's AB 2038, which imposed a specific fee on manufacturers of lead-based products, with a detailed funding plan for mitigating childhood lead poisoning.

Recent LAO research has opined that a legitimate use of cap-and-trade revenue under Sinclair includes supplementing existing environmental-related program expenditures with cap-and-trade revenue, as the governor has proposed. The LAO believes that mitigation can be viewed broadly, and that nexus can be established with a wide array of climate change programs.

Others believe this interpretation is flawed, and would lead to legal challenges.

CARB established an advisory committee (the Economic Allocation and Advisory Committee, or EAAC), which did comment on how Sinclair might restrict using auction revenue. In a November 18, 2009 hearing, EAAC Chair Larry Goulder said that when making recommendations to CARB on how cap-and-trade revenue should be used, "I don't think we should be concerned with what the current legal restrictions are." He said that if legal problems exist, those problems can be remedied at a later date. (For a detailed explanation of EAAC's review of Sinclair, see the CalTaxletter of December 4, 2009.)

EAAC's final report, published March 2010, noted: "EAAC has formulated its policy recommendations without conducting detailed legal analysis under Sinclair, confident that the legal feasibility of these options as part of a future California cap-and-trade program will become clearer over time with further analysis by the ARB and its legal advisors, whether or not there are further actions by the Legislature or the courts relevant to the issue."

To date, no document has been published by CARB or the Legislature fully analyzing how Sinclair interacts with cap-and-trade.

CalTax Research Analyst Robert Gutierrez told the subcommittee that taxpayers are hoping the Legislature fully vets all legal questions associated with Sinclair to ensure that cap-and-trade is a successful and viable program. "We urge the committee to carefully examine cap-and-trade budget proposals as it relates to Sinclair," Mr. Gutierrez said. "Taxes and fees have clear definitions – fees must be reasonable and fees must have significant nexus to the fee-payer. We also know from past court decisions that fees cannot be imposed for the primary purpose of raising revenue."

After presentations by LAO, Department of Finance, and CARB staff, the subcommittee's members expressed frustration with CARB's leadership and direction.

Assemblyman Gordon, who chairs the subcommittee, said he was "extremely disappointed" that CARB Chair Mary Nichols was unable to attend the hearing. He added: "This hearing has been scheduled for some time and it is the first time for the Legislature to look at this program following some of the initial regulations you've established. I would appreciate it if you would take back to your agency my extreme disappointment that Ms. Nichols was unable to join us today. It would have been very appropriate for her to be here – I think the Legislature expected that, as well as the stakeholders."

Assemblyman Brian Jones went further, stating: "It is my perception since I've been elected and serving here for 14 months that CARB is a rogue agency. I want to reaffirm and state emphatically that CARB's authority derives from this Legislature. It doesn't derive on its own. Your commissioners are not elected by the public or the voters of this state. We are elected by the voters of this state. And this Legislature has given over to CARB some authority that I believe CARB has run away with, and I am only hopeful that my colleagues in this committee and the rest of this Legislature will also come to the same conclusion that I've come to and soon realize that the authority of CARB comes from this Legislature, and we will start to rein that in and protect the voters and the public interest in this state."

Assemblyman Huffman disagreed, and said the Legislature has provided oversight to CARB and been involved in the implementation of AB 32. He said his colleague was using "soapbox moments" in an informational hearing, and added, "We should check ideology in at the door."

During the public testimony portion of the hearing, a number of individuals from the business community and various environmental groups presented their concerns with the governor's budget proposal.

Dorothy Rothrock, vice president of the California Manufacturers and Technology Association, said CARB's decision to use an auction for allowances, and not to allocate them freely, will be incredibly costly for businesses. "Companies are going to have up to 25 or even 50 percent [of the allowances] they need to operate withheld," she said. "There is no cost-effective or technologically feasible way for those companies to reduce emissions in order to avoid that cost – even CARB will admit that. So, this acts like a tax on those companies."

CalChamber said AB 32 does not provide for a revenue-raising auction. Marc Burgat, the chamber's vice president of government relations, said: "It's a little awkward to be talking about how we are going to spend the revenues from this when we question whether those revenues can be raised at all."

March 2, 2012
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