California is the incubator for US environmental regulation. Its clean air, water, and energy standards invariably presage similar efforts nationwide. California’s eco-friendly culture deserves tremendous credit for this, but it’s the state’s strong economy and colossal buying power that silence critics who argue green laws are bad for business.

Which makes the drama surrounding the Golden State’s cap and trade system quite interesting. On one hand, the system works beautifully. In its first two years, it has systematically cut greenhouse gas emissions. But cap and trade was supposed to generate millions of dollars for clean air projects. It did, until recently. As clean air revenues dwindled, political support for the program eroded, raising the question that underlies all environmental regulation: Is clean ____ worth the economic hit? Because California’s laws are so weird, a minefield of legal caveats clouds the answer. Last week, Governor Jerry Brown initiated what amounts to a last-ditch effort to save the system.

First, a refresher on cap and trade. California limits the volume of emissions allowed during a given year, and sells permits to power plants and others for the privilege of emitting some fraction of that volume. Since California launched the program in in 2014, the federal Environmental Protection Agency adopted the Clean Power Plan requiring all states to devise emission reduction plans. If the Clean Power Plan survives legal challenges (and a Trump presidency, should that happen), many states will look to California when designing their own systems.

Ironically, you can blame environmentalists for the threat to the California’s system. “When the law enabling cap and trade was being argued over, the whole progressive left-of-the-left were pretty suspicious of carbon trading,” says Michael Wara, an expert in energy and climate at Stanford Law. So the law’s authors offered a compromise: the state Legislature would reevaluate cap and trade in 2020. It didn’t seem like a big gamble at the time. After all, this is California.

But, it isn’t that simple. Although Californians love the environment, they hate taxes. State law (Proposition 13) makes it impossible to adopt new ones without a two-thirds majority of the Legislature. “Environmental law makers have historically gotten around this by defining money taken from polluters as fees, and saying this is money that goes into special funds used to clean up harm caused by emissions,” says Wara. But a law (Proposition 26, for those keeping score) passed in 2010 expanded the definition of tax in a way that essentially includes cap and trade. So even if the bill reauthorizing cap and trade does pass, cap and trade itself will be illegal under this new interpretation of state law. And, given that cap and trade always has been dicey among hard leftists and pro-business politicians alike, achieving a two-thirds “supermajority” for the reauthorization is nearly impossible.

But if cap and trade is safe until 2020, why is everyone so worried right now? Economics. The system places positive pressure on energy companies to invest in things like solar and wind. If cap and trade isn’t around, it makes financial sense to continue burning fossil fuels. Given that even modest renewable energy projects take years to get going, these companies must know now whether to invest. “In terms of power planning, it is like this debate is happening at 11:59 pm on December 31, 2019,” says Wara.

The ultra-irony is this: If cap and trade were still generating revenue, it might get that supermajority. But power companies aren’t buying emissions credits because they aren’t sure the Legislature will keep cap and trade going.

And the snake isn’t just eating its tail, it’s defecating down its own throat. Regardless of whether cap and trade survives, California must still lower its emissions. The Air Resources Board would have to use more primitive regulatory tools, such as requiring smoke stack filters. But those regulations provide no direct incentive for power companies to innovate, say, by building solar farms or developing large-scale battery storage. That means these top-down regulations aren’t just bad for business, they are a horribly inefficient way of curbing emissions.

The energy uncertainty principle

What does this have to do with national policies? That depends in some part on the next president. “This idea of California as a sure model has become a much less compelling argument than it was eight years ago,” says Severin Borenstein, an economist at UC Berkeley. In 2008, Obama and McCain believed the US should take action to fight climate change. Trump versus Clinton is binary. If Trump wins, whatever California decides about cap and trade fades to noise against his vows to abandon the Clean Power Plan, the Paris Agreement, and eight years of goodwill between the federal government and scientific community.

If Clinton wins, California probably still matters. Assuming the Clean Power Plan survives its legal challenges, every US state will be left to come up with a plan for curbing emissions. And those plans must pass political and economic muster. So, they’ll be scrutinizing California’s system for merits and flaws.

In California, the shakiness of cap and trade is manifesting itself economically. Just 9 percent of permits sold in the last auction, creating a budgetary shortfall for clean air projects statewide. “This is politically important, because that money is the grease that lubricates agreements in constituencies that support cap and trade,” says Wara.

Ware says this is an opportunity for California to take the lead in reframing how lawmakers negotiate emissions regulations. The cap and trade model sets revenue aside only for clean air projects. He thinks legislators could use that revenue to entice businesses to do the right thing—by reducing corporate income tax, or capital gains tax, for instance. California has proven it can cut emissions. Its next lesson for America is how to make climate regulations benefit everyone.


If Clinton Wins, American Can Look to California for Cutting Carbon