Introduction  In order to come up with any effective mechanismfor carbon dioxide (CO2) emissions in Indiana, it is first important to understand itsenergy sources, emissions, markets and consumption trends. Coal has been thebackbone of Indiana energy with more than 80% of Indiana’s electricity beinggenerated from coal-fired power plants: in 2015, the state ranked eighth in thecountry for coal production and third for coal consumption (EIA, 2017-b).

Thisavailability and usage of coal is one of the factors that has kept electricityprices relatively low in Indiana, attracting industry to the Midwestern state,which uses more energy than both the residential and commercial sectorscombined (Dillon & Slaper, 2015). Accordingly, in 2014, the vast majorityof state’s CO2 emissions were caused by electricity generation (66.9%) andindustry (27.8%) (DOE, 2014), and when observing emissions by end-use sector,electric power remained the leading source with industry and transportationbeing the next largest sources (EPA, 2014).Over the last few years, the state hasdiversified its energy portfolio due to environmental regulations on emissionsas well as dropping natural gas prices (Dillon & Slaper, 2015), but itsreliance on coal has caused it to have the eighth-highest carbon emissions inthe U.S. (EIA, 2017-b).

In order to address CO2 emissions, there arevarious policies that Indiana can implement: these may be market-based, such asa carbon tax or cap-and-trade, or command-and-control policies, which includeregulations and technology specifications. 2.                 The three options to cut emissions  Command-and-ControlBased on Indiana’s energy background,command-and-control policies would likely regulate power plants or possiblyenforce fuel standards. Regulations regarding power plants and fuel standardswould focus on reducing the carbon intensity of power generators andtransportation fuel, respectively, setting CO2 emissions reductionstargets to be achieved by a certain year. In general, command-and-controlpolicies are useful when addressing market failures, such as externalities inthe case of emissions, but can be inefficient in terms of which carbon usesthey target: mandates can reduce emissions from high-value uses of carbon whenpower plants and energy production are regulated (Lecture B12b, slide 15)while they should aim to reduce carbon use where willingness to pay is lowerand closer to the social cost of carbon, which has a central estimate of $36per ton (Lecture B14, slide 29).

For example, much emissions are caused bytransportation, which should be targeted because they include low-value uses likerecreational driving and idling. Additionally, command-and control approachescan be expensive and are less flexible than their market-based counterparts. Cap-and-Trade            Cap-and-trade could also assist the state in reducing emissionsfrom electricity generation and industry.

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The cap on emissions could be appliedto particular sectors or all companies with the latter option being morebeneficial but less politically feasible. In order to implement this system,the state would set a cap that limited its emissions to an ideal level;eventually, this would be where the social cost of carbon intersects thestate’s demand for carbon (Lecture B12b, slide 29), but the cap would likelydecrease over time to achieve this level. It would then issue permits inaccordance with the cap, auctioning or distributing them to emitters.

            Unlike some mandates, cap-and-trade passes on the correct pricesignal for carbon and therefore targets low-value uses of carbon (LectureB12b, slide 30). Furthermore, when permits are allocated, it grants companiesa valuable property right, which would create necessary political support, andif other areas implement similar programs, permits could potentially be tradedbetween states, further reducing low-value emissions (Lecture B12B, slide30). However, setting the cap is a challenging task, and allowing for too manyemissions, which is likely with the state’s conservative climate, fails tofully affect the targeted carbon uses and results in insignificant reductions.The policy is also likely to disadvantage state trade and impact low-incomehouseholds more severely (Lecture B12b, slide 24), and these issues wouldneed to be effectively addressed to improve political support. Lastly, althoughallocating permits would garner support, the right to pollute should ultimatelybelong to the state due to the resulting effects on society.

 Carbon Tax            A carbon tax could reduce state emissions by “targeting thecarbon content of fuel combustion and other processes of emitting carbon”(Lecture B12b, slide 18) and therefore raising the price of gasoline, naturalgas, coal, and electricity. The state would ideally set the tax equal to thesocial cost of carbon in order to reflect the negative externalities of carbonuse, but a rising tax could also be implemented to achieve emissions reductionsover time and gain political support. Like cap-and-trade, this approach passeson the correct price signal, changing the targeted carbon-emitting behaviors,but is considered the most efficient, least expensive way to reduce emissions(Lecture B12b, slide 23). Additionally, a carbon tax has the potential toraise a significant amount of revenue, depending on the state’s tax rate; basedon total retail sales in 2015, a tax of $25 per ton would result in about $1.25billion in revenues from electricity consumption alone (EIA, 2017-a).

Becauseenergy taxes are very difficult to evade, a carbon tax would also reduce totaltax evasion in the state as well as make the informal economy less appealing,helping diminish its size (Lecture B13, slide 25). However, the tax would bedifficult to implement due to opposition to emissions reductions in the state,and again, it is likely to disadvantage state manufacturing and place a largerburden on the poor, as it is regressive (Lecture B12b, slide 24). Lastly, thetax would also create deadweight loss, or a loss of economic efficiency.  3.

                 Lessons from other states with similar emissions cutting options  Command-and-ControlCommand-and-control policies at the federal andstate level could help guide the implementation of these regulations inIndiana. The Clean Power Plan, which was proposed in 2014, aims to reduce powerplant emissions 30% by 2030, using carbon intensity standards, and it allowsstates to achieve reductions with demand side energy efficiency, renewableportfolio standards or goals, or market-based greenhouse gas emissions programs(Lecture B22-1, slide 34). Similarly allowing power plants in the state toimplement a variety of emissions reduction methods could help increaseefficiency and garner political support.

The Plan’s benefits also largely relyon resulting health co-benefits (Lecture B22-1, slide 38), so it would bemore effective for the state to regulate these co-benefits separately throughmandates for filters and other measures that improve health. Additionally,under California’s Assembly Bill 32 (AB 32), the state uses fuel standards toreduce the carbon intensity of transportation fuel 10% by 2020, setting annualstandards for gasoline, diesel, and other replacement fuels that apply topetroleum and biofuel providers (California Air Resources Board, 2017). Suchstandards successfully target low-value uses of carbon, but the program has a highpotential for leakage, meaning the state could lose producers, jobs, and taxrevenues. Cap-and-TradeSeveral states have implemented cap-and-tradeprograms that offer insight. In addition to fuel standards, California’s AB 32also uses cap-and-trade: it auctions most available permits and enforces aprice floor of $10 per ton that grows 5% annually (Lecture B22-1, slide 25).

However, as previously mentioned, it has a problem with leakage; state trade isdisadvantaged, as companies must compete for permits, giving them incentive toproduce elsewhere. For this reason, virtually all permits have been given awayfor free – a practice that will continue until 2030 (Sexton & Sexton,2017). Nine states participate in another cap-and-trade program, the RegionalGreenhouse Gas Initiative (RGGI), which caps the emissions of fossil fuelplants with a capacity of 25 megawatts or more (Lecture B22-1, slide 9). Uponimplementation of RGGI, the price of permits immediately dropped to the pricefloor of $1.86, indicating that the cap was too high.

This has been a commonproblem with such programs, and like these states, Indiana should set a pricefloor to prevent prices from falling to $0 if cap revisions are necessary. Toaddress leakage issues, the state should also consider capping the emissions ofpower plants rather than all carbon-emitting companies, as power plants arealready heavily regulated and cannot move if taxed (Lecture B22-1, slide 10). Carbon TaxBoulder, Colorado, levies a carbon tax onelectricity consumption of residents and businesses in an effort to reduceoverall emissions 80% by 2050, using separate residential, commercial, andindustrial tax rates (City of Boulder, Colorado, 2017). Each of these tax ratesis much lower than the price increases we would observe under a carbon tax of$25 per ton, indicating that the tax is well below the social cost of carbon.This would likely be the case in Indiana as well due to the state’sconservative climate and existing opposition.

While a lower tax would fail toreduce emissions to the optimal level, Colorado’s tax demonstrates thatimprovements are still possible, as it avoided over 50,000 metric tons ofemissions between 2007 and 2015 despite population and economic growth (City ofBoulder, Colorado, 2017). Additionally, a lower tax would still allowhigh-value carbon uses to continue and would reduce the resulting deadweightloss.4.                 Impact of market-based policies on daily life: likely winners andlosersand if citizens can be cushioned against those effects (650 words) As mentioned above, Indiana’s dependence on coalis quite significant, and therefore, the impact of these market-based policieswill be greater in Indiana than states that have very low coal dependence.However, the costs of such policies are not evenly distributed for everyone.(CBO, 2013). Workers and investors in emission-intensive industries of Indianawould see the greatest decrease in demand for their products and hence wouldbear relatively large burdens when the economy adjusted to the tax. Thesepolicies will make both producing and using carbon-intensive products moreexpensive, also leading to an increase in the costs of electricity andtransportation that involve relatively copious amounts of CO2 emissions.

While thisrise in costs will incentivize manufacturers to produce in ways leading tofewer CO2 emissions, it isimportant to note that companies that areresponsible for collecting and paying the tax dollars do not necessarily bearthe entire burden of the carbon tax and can pass some of their burdens on tothe customers, smaller businesses and households. (Australian Department of theEnvironment, n.d.

)          Accordingto a study by NERA Economic Consulting and the National Association ofManufacturers (NAM), market policies will lead to residents of Indiana payingmore for natural gas, electricity, gasoline and other energy relatedcommodities. Basically, elevated costs of these important fuels will in someway or the other impact every person and business in Indiana.          Thesepolicies may adversely impact particularly manufacturers, which consumeone-third of our nation’s energy supply, and the low-income families strugglingto make ends meet with a national unemployment rate of approximately around 8percent.

Furthermore, many Indiana companies which compete for businessinternationally, will have a disadvantage as their foreign competitors will beoperating without having to bear similar costs. (NAM, n.d.)           Further focusing onlow-income households which spend a large portion of their incomes on energy(Lecture B12b, slide 23), it is possible to offset these negative impacts byusing the revenues generated from the policy. One way is to offer rebates tothe poor.

For example, under the cap anddividend system, public revenues raised from the sale of pollution credits isrebated to citizens or to consumers as a subsidy for increasing efficiency.Without accounting for how the revenuesfrom a market policy like tax would be used, such a policy would have anegative effect on the economy (CBO,2013)         One way toprotect the poor from becoming more impoverished, is a lump-sum rebate, butthis approach may not provide economic efficiency. Another way to distributethe revenues is through a tax swap. This means that the revenues may be used tofill gaps in distortionary taxes like corporate orindividual income tax rate cuts. This method may be economically moreefficient.  (Stone,2015)        There are similarconcerns with an aggressive cap-and-trade program. Under the auction approach,customers in Indiana will be paying much more due to coal’s higher emissions.One issue in Indiana is that a lack of economically viable technology requiredto capture carbon emissions on existing power plants which would make reducingemissions tough in the short run.

Indiana also currently doesn’t have afeasible solution to deal with the carbon once captured (Vectren Corporation,n.d.).

These are practical issues which need to be considered.        A cap-and-trade programmay soften this blow if it would initially provide for more free allowances.Initially providing a higher percentage of free allowances instead of auctionedallowances will give time for developing proven carbon capture technology overseveral years. In the meantime, utilities and customers could work togethertowards reducing emissions in that period by exploring alternatives likerenewable resources and encouraging energy efficiency initiatives. Theneventually over time, number of free allowances can be reduced gradually.

(Vectren Corporation, n.d.) However, there arecertain cons of free permits like the dirtiest firms may get rewarded, freepermits may create incentives for misreporting and another weakness is that itmay not lead to any revenue generation.

(Lecture B2, Slide 18)