The Heritage Foundation

Center for Data Analysis Report #08-10 on Energy and Environment

October 29, 2008

October 29, 2008 | Center for Data Analysis Report on Energy and Environment

CO2-Emission Cuts: The Economic Costs of the EPA's ANPR Regulations

The Environmental Protection Agency's (EPA) Advance Notice of Proposed Rulemaking (ANPR) foreshadows new regulations of unprecedented scope, magnitude, and detail. This notice is not just bureaucratic rumination, but could very well become the law of the land. Jason Grumet, a senior environmental advisor to Barack Obama, has promised that a President Obama would "initiate those rulings." These rulings offer the possibility of regulating everything from lawn-mower efficiency to the cruising speed of supertankers. Regardless of the chosen regulatory mechanisms, the overall eco­nomic impact of enforced cuts in carbon dioxide (CO2) emissions as outlined in the ANPR will be equivalent to an energy tax.

By expanding the scope of the 1990 amendment to the Clean Air Act (CAA), the EPA will severely restrict CO2 emissions, thereby severely restrict­ing energy use.[1] Specifically, the EPA would use the CAA to regulate emissions of greenhouse gases (GHG) from a vast array of sources, including motor vehicles, boats and ships, aircraft, and rebuilt heavy-duty highway engines.[2] The regulations will lead to significant increases in energy costs. Fur­thermore, because the economic effect of the pro­posed regulations will resemble the economic effect of an energy tax, the increase in costs creates a cor­respondingly large loss of national income.

Using the CAA to regulate greenhouse gases will be very costly, even given the most generous assumptions. To make the best case for GHG regula­tion, we assume that all of the problems of meeting currently enacted federal, state, and local legislation have been overcome.[3] Even assuming these unlikely goals are met, restricting CO2 emissions by 70 per­cent will damage the U.S. economy severely:

  1. Cumulative gross domestic product (GDP) losses are nearly $7 trillion by 2029 (in infla­tion-adjusted 2008 dollars), according to The Heritage Foundation/Global Insight model (described in Appendix A).
  2. Single-year GDP losses exceed $600 billion (in inflation-adjusted 2008 dollars).
  3. Annual job losses exceed 800,000 for several years.
  4. Some industries will see job losses that exceed 50 percent.

Due to limitations in macroeco­nomic models, this analysis by The Heritage Foundation's Center for Data Analysis (CDA) does not extend beyond 2029. Further, the ANPR alludes to regulations in general, but is not as specific as proposed legislation. Nevertheless, the ANPR's implicit CO2 targets resemble previous attempts to legislate GHG emissions, such as the 2008 Lieberman-Warner Climate Security Act (S. 2191), which man­dated a 70 percent reduction below the 2005 level by 2050.

Chart 1

The new ANPR regulations will force consumers to pay more for energy as well as for other goods. Furthermore, the increased regula­tions and subsequent high energy prices throw a monkey wrench into the production side of the economy. Contrary to claims of an economic boost from "green invest­ment" and "green collar" job creation, more EPA reg­ulation reduces economic growth, GDP, and employment opportunities.

While there are some initial years in the period of our analysis during which CAA regulation of GHG could spur additional investment, this investment was completely undermined by the higher energy prices. Investment contributes to the economy when it increases future productivity and income. The greater and more effective the investment, the greater the increase in future income. Since income (as measured by GDP) drops as a result of new reg­ulation, it is clear that more capital is destroyed than created. The cumulative GDP losses for 2010 to 2029 approach $7 trillion with single-year losses of nearly $650 billion.

The anticipated "green-collar" jobs meet a similar fate. It may well be that some businesses will experi­ence an increase in employment. But, overall, com­panies are saddled with significantly higher energy costs, as well as increased administrative costs, that will be reflected in their product prices. The higher prices make their products less attractive to consum­ers and thus less competitive. As a result, total employment drops along with the drop in sales.

With increased regulation through the CAA, there is a small initial increase in employment as businesses build and purchase the newer, more CO2-friendly plants and equipment. However, any "green-collar" jobs created are more than offset by the hundreds of thousands of lost jobs in later years. Chart 2 illustrates the projections of overall employment losses from these restrictions on CO2 emissions.

ANPR-What it Really Means

In response to the Supreme Court's decision in Massachusetts v. EPA, the EPA has proposed an unprecedented expansion of federal GHG regula­tion through the CAA. While the precise details of the regulations remain undefined, the ANPR is sure to generate many of the same economic responses as the Lieberman-Warner Climate Security Act.

As the EPA does not appear to have the statutory authority necessary to implement market-based approaches to GHG reduction, such as a carbon tax, in which case firms and consumers could economize on taxed goods and promote alterna­tives or technology-neutral subsi­dies, the ANPR relies on a set of rules and restrictions while ulti­mately failing to achieve a mean­ingful reduction in atmospheric concentrations of GHGs. The end result of these complex regulations will be a dramatic increase in energy costs with little environmental gain.

Chart 2

In addition to increasing the costs of energy use, regulating GHGs through the Clean Air Act will expand the EPA's authority to unprecedented levels. The ANPR will likely:

  1. Trigger the Prevention of Signifi­cant Deterioration (PSD) program, which could require permits for large office and residential build­ings, hotels, retail stores, and other similarly sized projects;
  2. Regulate the design of manufac­turing plants;
  3. Regulate the design of airplanes;
  4. Lower speed limits below current levels;
  5. Impose speed restrictions on ocean-going freighters and tankers;
  6. Export economic activity to less-regulated coun­tries, thereby compromising the U.S.'s ability to compete in the global economy; and
  7. Transform the EPA into a de facto zoning author­ity, granting the agency control over thousands of previously local or private decisions, affecting the construction of schools, hospitals, and com­mercial and residential development.

These regulations are just a small sample of the areas into which the ANPR would expand the EPA's authority.

Limits of Analysis

Regulating CO2 emissions under the Clean Air Act will burden the economy with higher energy costs, higher administrative compliance costs for businesses, higher bureaucratic costs for enforcing the regulations, and higher legal costs from the inevitable litigation. This study examines only the economic impact from the higher energy costs. Further, CDA analysts assume that the EPA can enforce CO2 restric­tions with perfect efficiency. In no case does the EPA cut a pound of CO2 in one area if it could be done more cheaply in another. Including the 

other compliance costs and accounting for the likely inefficiency in imposing regulation, the costs of regulating CO2 emissions under the Clean Air Act may be significantly higher.

For an example of the extent to which administrative compliance costs may be burdensome, see Portia M. E. Mills and Mark P. Mills, "A Regulatory Burden: The Compliance Dimension of Regulating CO2 as a Pollutant," The U.S. Chamber of Commerce, September 2008, regulatory_burden0809.pdf (October 23, 2008).

The Simulations

This CDA report discusses the effect the ANPR will have on energy activity and the cost of using energy. Policymakers and others who follow the cli­mate change debate should find this simulation helpful in understanding the economic conse­quences of such unprecedented regulatory expan­sion. This report makes no attempt, however, to calculate the significant administrative and legal costs of complying with the new rules.

The report discusses two different policy alterna­tives affecting this country's economic future, each shaped by different policies designed to reduce atmospheric carbon dioxide and, presumably, to reduce the warming trend in global climate change:

  1. The current-law baseline is a highly detailed, 30-year economic forecast that incorporates the principal elements of energy and climate change policies signed into law last year.
  2. The alternative is a scenario in which the EPA promulgates a broad range of regulations to cut CO2 emissions by 70 percent by 2050.

The Baseline

Key Assumptions. The baseline for the ANPR simulations builds on the Global Insight (GI) November 2007 long-term-trend forecast. The GI model assumes that:

[T]he economy suffers no major mishaps between now and 2037. It grows smoothly, in the sense that actual output follows potential output relatively closely. This projection is best described as depicting the mean of all possible paths that the economy could follow in the absence of major disruptions. Such disruptions include large oil price shocks, untoward swings in macroeconomic policy, or excessively rapid increases in demand.[4]

The GI long-term model forecasts the trend of the U.S. economy. "Trend" means the most likely path that the economy will follow if, for instance, it is not disturbed by a recession, extremely high oil prices, or the collapse of major trading partners. One way to think about the long-term trend is to imagine a pathway through the cyclical patterns of our economy, as well as the effects of cyclical pat­terns in foreign economies on the U.S. economy.

Given the fiscal and economic challenges facing the United States (particularly the mounting federal deficits stemming from the long-expected crisis in Social Security, Medicare, and Medicaid outlays), the long term already has significant risks. The base­line assumes that the economy successfully avoids any sharp drops. At the same time, there is no inclu­sion of similarly large, potentially positive, shocks to the economy.

Energy prices, patterns of use, and supply change continuously in response to legislation and market conditions. To evaluate the economic impact of ANPR regulations, we must establish what the expected levels of emissions and available technol­ogy would be over the bill's proposed lifetime in the absence of its passage. Only with a determined baseline situation can the costs of meeting the goals and constraints of these regulations be estimated.

Two fundamental trends establish the baseline path of CO2 emissions. First, aggregate income growth leads to greater demand for power across all sectors of the economy. Most of this power is gener­ated by burning fossil fuels.

Partially offsetting the associated increase in CO2 emissions is the second trend of increasing carbon efficiency in the energy sector. The improved effi­ciency comes from a variety of changes in both production and consumption, including power-generating technology that increases the yield of useable power for each ton of CO2 emitted; contin­ual improvements in the energy efficiency of appli­ances, new homes, and light vehicles; increased use of renewable fuels; and greater generation and use of nuclear power.

Government mandates-federal, state, and local-continue to enforce additional energy effi­ciency and limit CO2 emissions, which helps to meet the ultimate target of the ANPR regulations. These mandates may work in parallel with the ANPR, and they create compliance costs, but since these compliance costs are already in force without the additional regulation under the CAA, they are not attributable to the ANPR.

Examples of the baseline costs necessary for meeting the ANPR goals that are attributable to other legislation include:

  1. Manufacturing cars and trucks that satisfy the much higher fuel-economy standards mandated for the next 20 years;
  2. Producing 36 billion gallons of biofuels includ­ing 16 billion gallons of cellulosic ethanol;
  3. Complying with expensive new building codes; and
  4. Producing ever more energy-efficient household appliances.

Aggregate Energy Use. Continued gains in energy efficiency will restrain the growth of energy demand below the rates of economic growth and below the rates experienced in the past half-cen­tury-approximately 1.5 percent per year. These efficiencies are driven by both markets and man­dates. We project baseline primary energy demand to grow at 0.5 percent each year through 2029.

Petroleum. According to baseline assumptions, petroleum prices will settle around $70 a barrel in nominal terms and decline to $46 a barrel (in 2006 dollars) by 2030. Even in the absence of Corporate Average Fuel Economy (CAFE) limit changes, higher prices induce consumers to move to more efficient vehicles.

On the mandates side, the Energy Independence and Security Act of 2007 (EISA) raises the bar for vehicle fuel efficiency. The CAFE standard rises to 35 miles per gallon by 2020 for all light vehicles. For subsequent years, the EISA mandate reads:

For model years 2021 through 2029, the average fuel economy required to be attained by each fleet of passenger and non-passenger automobiles manufactured for sale in the United States shall be the maximum feasible average fuel economy standard for each fleet for that model year.

The expected CAFE standards are 47.5 miles per gallon for new passenger cars and 32 miles per gal­lon for new trucks by 2029, and the average for all light vehicles, whether new or old, will be 33 miles per gallon.

Overall, petroleum consumption will grow by 0.6 percent per year between 2005 and 2029.

Natural Gas. In the baseline scenario, gas prices settle just below $7 per million British thermal units. This is less than the current price but well above 1990s levels. Alaskan pipeline deliveries will not begin until 2025, at which point they will help to offset supply reductions in the Lower 48 as well as imports from Canada.

Nearly 100 gigawatts of old natural-gas-steam are retired, and 50 gigawatts of the more efficient "nat­ural gas combined cycle" (NGCC) plants are built. Total natural gas consumption grows by 0.4 percent per year through 2029.

Coal. In the baseline case, coal use is restrained by slower growth of energy demand and increasing generation of nuclear and renewable power. Demand will grow by an average of 0.2 percent each year through 2029.

One hundred gigawatts of old inefficient power-generating capacity are retired. Sixty-five gigawatts of new and replacement coal-fired power-genera­tion plants will be added using the "integrated gas combined cycle" (IGCC) or advanced pulverized-coal technologies. These more efficient technologies use less coal and emit less CO2 per unit of electric­ity generated and are ready to be fitted for carbon capture and sequestration (CSS). Because of the additional cost, there is no use of CCS technology in the baseline case.

Better and more widely adapted scrubbing tech­nology allows broader use of high-sulfur coal. This will open up more sourcing options and lower the average cost of coal.

In real dollars, coal prices will settle near the levels observed in the 1990s.

Nuclear Energy. Though there are no significant CO2 emissions from nuclear power generation, it is not considered "renewable" for the purpose of meeting existing state-imposed targets. Neverthe­less, federal incentives are already in place for build­ing 12 gigawatts of new capacity and 3 gigawatts of uprated added capacity at existing plants.

Resolving the problems with waste disposal is a major hurdle in expanding nuclear power genera­tion. The baseline assumption is that nuclear power plants will continue to store the waste on site. Given the already high use of available capac­ity, electricity generated by nuclear power is pro­jected to grow by only 0.5 percent per year through 2029.

Renewable Energy Sources. Federal and state initiatives already in place seek to increase the use of renewable energy sources. The definition of "renew­able" varies from state to state but generally includes biomass, wind, and solar power.

Higher fuel prices along with state and federal mandates cause renewable fuel use to grow at 5.5 percent per year through 2029. We assume that producers will be able to meet the ethanol (corn-based and cellulose-based) targets set by the EISA, though experience thus far suggests otherwise.

The Alternative

Key Assumptions. The ANPR contains no explicit overall targets for emissions reductions on an annual basis; most likely the reductions will be phased in. Using previous emission levels as yard­sticks, we assume that the 2012 emissions will match the 2005 emission level and drop by roughly 2 percent per year. The allowed emissions drop to 15 percent below the 2005 emissions level by 2020, and to 31 percent below the 2005 levels by 2029. Though we do not model the impact of regulations beyond 2029, the typical target would be a 70 per­cent reduction by 2050.

There are other gases that have much higher greenhouse effects per ton of emissions than CO2. However, these gases are emitted in much smaller volumes by human activity. CO2 is responsible for about 85 percent of the man-made GHG warming; therefore, this study examines only the economic impact of constraints on CO2 emissions.

Coal Technology. Due to its abundance, coal is the least expensive source of energy, and it fuels about half of America's electricity supply. CCS is a promising, but not yet commercialized, technology for dramatically reducing CO2 emissions from coal-powered electricity.

Of course, CCS technology has additional costs, which are higher when retrofitting existing plants than when building the technology into new plants. Though there are pilot projects in operation, full-scale commercialization would require sequestering more than 40 million barrels of CO2 each day. Envi­ronmental concerns and the logistical hurdles of handling such large quantities are likely to delay full implementation of CCS until after 2029, so we assume no CCS during the 2010-2029 period examined here.

Nuclear Energy. The projection is for no addi­tional nuclear power beyond the additional 15 giga­watts in the base case.

Renewable Energy Sources. Current state and federal legislation calls for more than tripling the amount of renewable energy in power generation and increasing the amount of biofuels used in trans­portation by more than 1,000 percent. This includes 16 billion gallons per year of corn-based ethanol and biodiesel and 20 billion gallons per year of cellulosic ethanol and biodiesel. Again, our assumption is that cellulosic biofuels become com­mercially feasible in time to meet the mandates that are already planned. Progress on cellulosic ethanol has been frustratingly slow to this point.

While the ANPR may have no additional man­dates for biofuels, restricting CO2 emissions from fossil fuel use will lead to greater use of biofuels. At this time, there is no commercially feasible cel­lulosic ethanol production. If this technology fails to deliver as projected, energy prices will be forced to increase enough to reduce the quantity of energy demanded by the amount of missing cellulosic ethanol.

About the Author

David W. Kreutzer, Ph.D. Senior Research Fellow, Energy Economics and Climate Change
Center for Data Analysis

Karen Campbell, Ph.D. Visiting Fellow in Macroeconomics
Center for Data Analysis