Administrative Conference of the United States MARKETABLE PERMITS: RECOMMENDATIONS ON APPLICATIONS AND MANAGEMENT Final Report: December 11, 2017 Jason A. Schwartz Adjunct Professor & Legal Director at the Institute for Policy Integrity, New York University School of Law This report was prepared for the consideration of the Administrative Conference of the United States. The opinions, views and recommendations expressed are those of the author and do not necessarily reflect those of the members of the Conference or its committees, except where formal recommendations of the Conference are cited. This report does not necessarily reflect the views of NYU, if any. Table of Contents Executive Summary ......................................................................................................................... i Overview of Research Methodology and Scope ..............................................................................vi I. What Are Marketable Permits?.............................................................................................. 1 A. Overview: Characteristics of a Prototypical Marketable Permit Program ..................................1 B. Concepts and Definitions.........................................................................................................2 1. Definition and Categorization of Marketable Permits .............................................................2 2. Distinction from Other Market-Based Tools: Bubbles, Banking, and Fees ................................3 3. Avoided Terminology: “Command-and-Control” and “Marketable Rights” ..............................5 C. The History and Current Applications of Marketable Permits ...................................................6 1. The Evolution and Future of the Idea of Marketable Permits ..................................................6 2. Overview of Existing Federal and Interstate Applications........................................................7 3. Notable Local and Foreign Applications ............................................................................... 12 4. Roads Not (Yet) Taken ........................................................................................................ 13 D. Legal Status .......................................................................................................................... 14 1. Is Explicit Statutory Authorization Required for Markets or Auctions? ................................... 15 2. Are Marketable Permits Property Rights? ............................................................................ 23 3. Do Marketable Permits Commodify Resources?................................................................... 26 4. Are the Terms Defined by Regulation, Guidance, or Case-by-Case? ....................................... 26 II. Efficiency and Distributional Consequences ........................................................................ 29 A. Do Marketable Permits Efficiently Lower Compliance Costs and Prioritize the Highest Value Uses of Resources?....................................................................................................................... 29 1. Theory .............................................................................................................................. 29 2. Evidence............................................................................................................................ 30 B. Do Marketable Permits Better Incentivize Innovation? .......................................................... 32 1. Theory .............................................................................................................................. 32 2. Evidence............................................................................................................................ 33 C. Do Marketable Permits Save Administrative Resources? ........................................................ 34 1. Theory .............................................................................................................................. 34 2. Evidence............................................................................................................................ 36 D. Distributional Consequences ................................................................................................. 38 1. Grandfathering, Windfalls, and Barriers to Entry .................................................................. 38 2. Small Entities and Communities .......................................................................................... 40 3. Consumer Effects and Auction Revenue .............................................................................. 42 III. Policy Effectiveness ........................................................................................................... 43 A. Currency and Exchange Restrictions: Fungibility, Externalities, Uncertainty ............................ 43 1. Spatial Issues and Hot Spots ............................................................................................... 45 2. Temporal Issues and Banking/Borrowing............................................................................. 47 3. Type and Value Issues ........................................................................................................ 47 4. Institutional Review Mechanisms........................................................................................ 49 B. Setting a Cap and Adaptive Management .............................................................................. 49 1. Capping Total Activity Levels Is More Efficient Than Capping the Rate................................... 50 2. Features of a Market-Based System Can Increase Stringency ................................................ 51 3. Adjusting the Cap............................................................................................................... 53 4. Exemptions ....................................................................................................................... 53 5. Uncovered Sources ............................................................................................................ 54 6. Effect of Allocation Options on Policy Outcomes.................................................................. 54 C. Setting Baselines and Verifying Credits .................................................................................. 55 1. Additionality and Gaming the Baseline ................................................................................ 55 2. Quantification and Certainty............................................................................................... 56 3. Leakage and Permanence ................................................................................................... 56 4. Double Counting: Stacked and Voluntary Credits ................................................................. 57 5. Other Risks ........................................................................................................................ 58 6. Quality Assurance Tools ..................................................................................................... 59 D. Responsibility and Compliance .............................................................................................. 61 1. Liability, Performance Guarantees, and Contingencies ......................................................... 61 2. Compliance Monitoring ...................................................................................................... 63 3. Enforcing Compliance ........................................................................................................ 64 E. Ancillary Benefits .................................................................................................................. 66 F. Policy Performances.............................................................................................................. 67 IV. Market Integrity and Oversight ........................................................................................ 70 A. Creating a Market ................................................................................................................. 70 1. Auctions ............................................................................................................................ 70 2. Secondary Markets ............................................................................................................ 72 3. Derivatives ........................................................................................................................ 74 B. Oversight of Primary, Secondary, and Derivative Markets ...................................................... 76 C. Fraud and Manipulation ........................................................................................................ 78 D. Volatility ............................................................................................................................... 79 E. Thinness, Hoarding, and Monopolies ..................................................................................... 80 F. Speculators and Other Participants........................................................................................ 82 G. Information and Communication........................................................................................... 84 1. Information for the Regulators: