California Court of Appeals Upholds Cap-and-Trade Greenhouse Gas Regulations

Outcome May Help Washington’s Embattled Clean Air Rule

In a landmark ruling for state-level greenhouse gas regulation, California’s Third District Court of Appeals on April 6 rejected claims that California’s cap-and-trade program for regulating greenhouse gases (“GHG”) is not authorized by statute and is an illegal “tax.”  The plaintiffs, the California Chamber of Commerce and the National Association of Manufacturers, have already vowed to seek review in the California Supreme Court, so the Court of Appeals may not have the last word.  Nonetheless, the opinion indicates that California’s cap-and-trade system is likely to endure.  This development is important not just for industries in California subject to the system, but also for the opportunity it creates in the Pacific Northwest to sell carbon offsets into the California market.  In addition, the ruling may be a harbinger of the outcome of similar legal challenges to Washington’s Clean Air Rule.  Finally, with the Trump Administration largely abandoning the federal role in GHG regulation, state-level efforts like California’s are likely to be the focus of climate regulation for the foreseeable future.

The cap-and-trade system was created by the California Air Resources Board (“CARB”) to implement AB 32, the statutory keystone of California’s aggressive campaign to reduce GHG emissions.  Under California’s version of cap-and-trade, CARB sets a “cap” on statewide GHG emissions which declines over time, and a broad spectrum of the state’s GHG emitters are subject to the cap.  A pool of “allowances,” each representing one metric ton of carbon dioxide equivalent, is then issued and covered entities must obtain enough allowances to cover their total GHG emissions every year.  Allowances can then be traded, which is the “trade” part of the program.  The allowance trading program represents a potentially lucrative opportunity for certain Pacific Northwest industries, notably including forestry, dairy, and recyclers of certain ozone-depleting refrigerants and similar chemicals, who can reduce their GHG emissions and convert those reductions into allowances that can be sold in California.

The plaintiffs, representing a coalition of GHG-emitting industries, challenged the cap-and-trade program on two grounds.  First, the plaintiffs claimed that CARB exceeded its statutory authority in adopting cap-and-trade as a mechanism to carry out AB 32’s mandate to reduce California’s GHG emissions.  All three Appeals Court judges rejected this claim, concluding that AB 32 broadly authorized CARB to develop a mechanism for reducing California’s GHG emissions and that the cap-and-trade program fell within that broad statutory authority.

Second, the plaintiffs argued that cap-and-trade is a “tax” under California law.  Because California requires any “tax” to be approved by a two-thirds vote of each house of the legislature and cap-and-trade was not so approved, plaintiffs reasoned, cap-and-trade was not properly adopted and therefore must be struck down.  A two-judge majority of the Court of Appeals rejected this argument, concluding that: (a) purchase of GHG allowances is not compelled but is the result of voluntary action by the purchaser to engage in GHG-emitting activities above the threshold requiring participation in cap-and-trade; and, (b) that the allowances convey a valuable privilege – the right to discharge GHGs into the atmosphere – whereas paying a tax conveys no privileges but is simply an exaction to governmental activity.  The third judge dissenting, concluding that cap-and-trade “is a tax in ‘something else’ clothing.”

The Court of Appeals’ decision is, of course, an important victory for CARB and for California’s aggressive approach to GHG regulation.  It also augurs well for state- and local-level efforts to regulate GHGs.  For example, Washington’s program for GHG regulation, the Clean Air Rule, is being challenged in the courts on the grounds similar to those underlying the California challenge – that the program exceeds the Department of Ecology’s statutory authority and that it constitutes an improper “tax.”  While the underlying legal details, especially those related to statutory authority, are very different in Washington, the Court of Appeals’ decision suggests that similar challenges in Washington, and perhaps in other states, can be overcome.