Special Topics in Environmental Management

Ruling: California’s Cap-and-Trade Auction Not a Tax

California’s program to reduce greenhouse gas (GHG) emissions from major stationary sources withstood a legal challenge from industry when the 3rd Appellate District, a state Court of Appeal, ruled that auctions allowed by the cap-and-trade provision of the program do not constitute an unauthorized tax.

In a 2-to-1 opinion, the majority found that in the 2006 Global Warming Solutions Act (Assembly Bill (AB) 32), the California Legislature gave the California Air Resources Board (CARB) broad discretion to design a credit distribution system, which did not exclude use of an auction. Also, said the majority, for a number of reasons, the auction simply does not fit the definition of a tax.

$4.4 Million in Revenue

AB 32 requires that covered entities, which include manufacturers, natural gas and fuel suppliers, and electric utilities, must reduce their GHGs to 1990 levels by 2020. AB 32 also provided the CARB with the authority to promulgate regulations to implement the program. In 2012, CARB responded to this obligation by issuing its cap-and-trade compliance program. Under the program, each covered facility must surrender GHG allowances equal to its emissions compliance obligations for a relevant compliance period. CARB distributes some of these allowances for free. However, if a facility’s emissions exceed the free allocation, additional allowances must be obtained either through CARB’s quarterly auctions or on a secondary market where allowances are sold or traded without Board control.

The auction has been lucrative. Since the program’s inception, the state has collected more than $4.4 billion. This revenue has been invested into measures that reduce GHG emissions. A significant portion of these investments are intended to benefit disadvantaged communities.

What the Legislation Said

With the support of state industries, the California Chamber of Commerce made two assertions:

  • The auction sales exceed the legislature’s delegation of authority to CARB to design a market-based emissions reduction system.
  • The revenue generated by the auction sales amounts to a tax that violates the state’s required two-thirds supermajority vote by the legislature. (AB 32 passed by a simple majority vote of both legislative houses.)

These allegations were dismissed by a trial judge. The plaintiffs subsequently appealed.

Purchasing an Item of Value

The majority agreed with the trial judge and stated that:

  • In AB 32, the state legislature gave broad discretion to CARB to design a distribution system, and, said the majority, “a system including the auction of some allowances did not exceed the scope of legislative delegation.” Furthermore, the legislature later ratified the auction system by specifying how to use the proceeds derived therefrom.
  • The auction sales do not equate to a tax. The hallmarks of a tax are (1) that it is compulsory; and (2) that the payer receives nothing of particular value for payment of the tax; that is, the payor receives nothing of specific value for the tax itself.

“Contrary to plaintiffs’ view, the purchase of allowances is a voluntary decision driven by business judgments as to whether it is more beneficial to the company to make the purchase than to reduce emissions,” states the majority. “Reducing emissions reduces air pollution, and no entity has a vested right to pollute. Further, once purchased, either from the [CARB] or the secondary market, the allowances are valuable, tradable commodities, conferring on the holder the privilege to pollute. Indeed, speculators have bought allowances seeking to profit from their sale, and as one party puts it, taxes do not attract volunteers. These twin aspects of the auction system, voluntary participation and purchase of a specific thing of value, preclude a finding that the auction system has the hallmarks of a tax.”

In a statement, Mary D. Nichols, CARB’s chair, said the court’s decision “affirms the basic purpose and structure of the program—to deliver carbon reductions in a cost-effective and flexible manner.”

The ruling of the 3rd Appellate District is here.