Jump to Navigation

AB 32: New Challenge Targets California Cap-and-Trade Law

May 6, 2013

The California Air Resources Board (“CARB”) has again been sued over its implementation of the Global Warming Solutions Act of 2006 (also known as AB 32). The lawsuit, Morning Star Packing Co. et al. v. CARB, filed on April 16, 2013, resembles an earlier action brought by the California Chamber of Commerce (“CalChamber”) in November of 2012 (discussed here). Both cases allege that the auction of allowances under the cap-and-trade amounts to an illegal tax because AB 32 was not approved by two-thirds of both houses of the state legislature, as required by the California Constitution. Where the two cases differ is that Morning Star adds explicit examples of how the alleged unconstitutional tax is causing petitioners to bear increased costs and expenses, an important element in establishing the standing of the petitioners. For example, Morning Star Packing Company, the only petitioner that is also regulated by the cap-and-trade, has purchased nearly $400,000 worth of 2013 vintage allowances.[1] At stake is not only the future of one critical element of the cap-and-trade, but also revenue which over the life of the cap-and-trade program is expected to be between $7 and $75 billion.[2]

The goal of AB 32 is to cut California’s carbon emissions to 1990 levels by 2020 using a multi-pronged approach including: cap-and-trade, low carbon fuel standard, vehicle emission reductions, energy efficiency, use of renewable energy, and public transit improvements. (The full Scoping Plan is available here.) Under the Scoping Plan, California must reduce its CO2e emissions by 174 million metric tons by 2020.[3]

A substantial portion of these reductions (34.4 million metric tons) is to be derived from a cap-and-trade program being implemented by CARB.[4] The cap-and-trade program covers large emitters of CO2e (those emitting more than 25,000 MTCO2e annually), referred to as covered entities. Covered entities must surrender allowances and/or offsets (which are reductions in CO2e generated in a non-covered sector) equal to their annual emissions. Covered entities acquire allowances in two ways, by allocation from CARB and by purchasing them at quarterly auctions (offsets and allowances are discussed in greater detail here).

The Morning Star Lawsuit

The Morning Star petitioners allege that the money raised from the auctions constitutes an unconstitutional tax, and that the tax exceeds the authority granted to CARB under AB 32.[5] AB 32 only authorizes a “schedule of fees,”[6] not a tax, and petitioners argue that the funds being generated by the auctions grossly exceed what is needed to administer the cap-and-trade program.[7] Petitioners also contend that the auction effectively entails the imposition of a tax that could only be enacted by a two-thirds vote in each house of the California Legislature (which AB 32 did not receive), as required by article XIII A, section 3 of the California Constitution.[8]

The suit substantially relies upon Propositions 13 and 26, which are embodied in Article XIII A, section 3 of the California Constitution. Proposition 13, an initiative constitutional amendment, enacted in 1978, requires a two-thirds vote of the legislature for “any changes in State taxes enacted for the purpose of increasing revenues. . . .”[9] Proposition 13 was amended in 2010 when voters passed Proposition 26, which expanded the term “taxes” to include regulatory fees.[10] Petitioners invoke both Proposition 13 and Proposition 26 to argue that the auction procedure and recent 2012 legislation allocating funds raised by the auction process are unconstitutional because none of the legislation met the two-thirds threshold.[11]

Assessing the Litigation

As we noted in our prior article regarding the CalChamber litigation, the court is likely to consider at least three factors in addressing the tax versus fee issue: (1) whether the total amount of money raised by the fee is limited to the reasonable costs of the regulatory scheme; (2) whether the money generated is used for purposes unrelated to the purpose of the regulation; and (3) whether the burden of compliance is reasonably allocated between regulated entities.[12] The court likely would make this determination by considering the totality of the circumstances, with no one factor being dispositive.

The second factor touches an area in which California regulatory bodies have been treading with significant caution, knowing that spending auction proceeds outside of the authorized area (greenhouse gas mitigation purposes) could be fatal to the regulation. The legislature has passed four bills to address disposition of the auction funds. SB 1018 requires that auction proceeds be deposited in a Greenhouse Gas Reduction Fund and authorizes auction funds to be lent to the State General Fund.[13] AB 1532 provides that the uses of funds to be deposited in the Greenhouse Gas Reduction Fund may be determined after the revenues have been collected, and SB 535 directs that a minimum of 10% of auction revenue must be allocated to projects located within certain disadvantaged communities and 25% of revenues must be spent for the benefit of those communities.[14] Finally, AB 1463 states that the Director of Finance may allocate or otherwise use in amount of at least $500 million, while making commensurate reductions to General Fund expenditure authority, for the purpose of advancing the goals of AB 32.[15]

On April 16, 2013, the California Department of Finance released a draft investment plan for the cap-and-trade auction proceeds. The plan details the legislative background and process for its recommendations and arrives at several recommendations for priority investments to be included in the state budget. For the first three year period, the investment plan recommends investment priorities be focused in three key sectors: sustainable communities and clean transportation, energy efficiency and clean energy, and natural resources and waste diversion.[16] The plan also includes proposed standards for ensuring accountability for agencies administering the allocation of the funds. These standards include, among others, a requirement that all investments must further the purpose of AB 32[17] and a variety of requirements addressing transparency and accountability.[18] The investment plan was the subject of rigorous public debate at a public hearing held April 25.[19] This emphasis on ensuring transparency and accountability may make it more difficult for the petitioners to demonstrate the likelihood that the auction funds will be spent for purposes other than greenhouse gas mitigation.

The Sacramento Superior Court will hear arguments in the CalChamber litigation at the end of this month, on May 31, 2013, and that case will have considerable impact upon the Morning Star case. Legal experts have ventured a range of theories on how the court may resolve these cases. The court could find that the auctions do not constitute a tax because regulated parties may comply with the cap-and-trade by merely reducing their emissions, rather than buying allowances.[20] Regulated entities do not have the right to pollute, and are thus not entitled to free allowances.[21] In many ways, the cap-and-trade is no different than other regulations that require polluters to adopt certain more advanced technologies or procedures, except that this system allows emitters the option to purchase the right to continue their emission practices instead of making emission-reducing changes.[22] Put another way, had the legislature authorized it, CARB could have simply adopted a typical command-and-control regulation to reduce carbon emissions, and there would be no dispute that the regulation was not a tax; instead, it gave emitters the choice to either reduce their emissions or to buy allowances.[23]

Another theory is that the auction process does not constitute a tax because CARB did not decide to auction the allowances for the purpose of raising revenue, which is part of Proposition 13’s definition of a tax.[24] Rather, the auctions were necessary to spur the new carbon market by sending a clear price signal for allowances.[25] Auctions may also help to promote: transparency, simple and fair treatment of new entrants, efficiency, and avoidance of windfall profits.[26] Ultimately, one could reasonably conclude that the goal of auctioning allowances was to make the whole cap-and-trade system work properly, so as to achieve the goal of reducing emissions. While one must concede that the auctions likely will generate billions of dollars, one could reasonably conclude that this revenue is a byproduct of the regulation, rather than its purpose.

The court could also be sympathetic to petitioners’ arguments. Over the duration of the auction program, CARB will require covered entities to pay billions of dollars. Morning Star and other regulated entities must either absorb the costs of purchasing allowances or attempt to pass them along to their customers. The court could conclude that the legislature did not intend for CARB to use the authority it provided in Cal. Health & Safety Code § 38597 to collect so much revenue. CalChamber made a strong argument to this effect in its case, claiming that “[t]he total silence in AB 32’s legislative history regarding any large-scale grant of fee or tax raising authority to CARB—and the contradictory concession made by CARB itself—is further evidence supporting the conclusion that AB 32 did not grant the CARB any authority to impose fees/taxes beyond that necessary to cover ordinary administrative expense.”[27] The referenced “concession” alludes to a letter by AB 32 author Fabian Nunez, in which Nunez stated his intent “that any funds provided by Health and Safety Code Section 38597 are to be used solely for the direct costs incurred in administering this division.”[28] The court could also invalidate AB 32 or any of the 2012 legislation (although the remedy for invalidating the 2012 legislation would likely not include invalidating the auction scheme) by holding that Proposition 13 or Proposition 26 required the legislation be passed with a two-thirds vote of the legislature.

Conclusion

Petitioners here as well as CalChamber in its case face the difficult challenge of convincing the court to derail a massive regulatory scheme that is now well underway. This challenge is made all the greater because the California Legislature is already passing legislation to allocate money generated by the auctions. Yet, it is certainly debatable how much authority the legislature intended to grant to CARB in 2006 when it authorized a market-oriented cap-and-trade system and a schedule of fees. CARB’s next quarterly auction is on May 16, 2013

For more information on AB 32, California’s cap-and-trade law, please contact any member of Marten Law’s climate change, air quality, or litigation practice groups.

[1] Morning Star Packing Co. et al. v. CARB (Sacramento Superior Court Case # 2013-80001464, filed April 16, 2013), Verified Petition for Writ of Mandate and Complaint for Declaratory Relief (“Petition”), at 3.

[2] California Legislative Analyst’s Office, Evaluating the Policy Trade-Offs in ARB’s Cap-and-Trade Program, at 13(Feb. 9, 2012).

[3] CARB Scoping Plan, pp. 18-24.

[4] Supra note 2.

[5] Petition, at 10.

[6] Cal. Health & Safety Code § 38597 authorizes CARB only to “adopt by regulation, after a public workshop, a schedule of fees to be paid by the sources of greenhouse gas emissions regulated pursuant to this division. …”

[7] Petition, at 9-10.

[8] Id. at11-13.

[9] Cal. Const. art. XIIIA § 3 (prior to 2010).

[10] Deborah Lambe & Daniel Farber, California’s Cap-and-Trade Auction Proceeds: Taxes, Fees, or Something Else? University of California, Berkeley, School of Law, Center for Law, Energy & the Environment (May 2012).

[11] Petition, at 19-20.

[12] See Sinclair Paint Co. v. State Bd. of Equalization, 15 Cal. 4th 866, 876-78 (1997).

[13] Petition, at 13.

[14] Id. at 13-14.

[15] Id. at 14.

[16] Department of Finance, Draft Cap-and-Trade Auction Proceeds Investment Plan, at 24 (Apr. 16, 2013).

[17] Id. at 33.

[18] Id. at 34.

[19] A. Mulkern, CALIFORNIA: Regulators get to the tough part of cap and trade -- how to spend the money effectively, E&E Publishing, LLC (Apr. 26, 2013).

[20] R. Enion, Why California’s cap-and-trade auction is not a tax, Legal Planet (Nov. 14, 2012).

[21] Id.

[22] Id.

[23] Id.

[24] Supra note 10.

[25] Id.

[26] Id.

[27]CalChamber v. CARB (Sacramento Superior Court Case # 2012-80001313, filed Nov. 13, 2012), CalChamber’s Memorandum of Points and Authorities in Support of Verified Petition for Writ of Mandate and Complaint for Declaratory Relief, at 17.

[28] Id. at 16 n. 17.

This article is not a substitute for legal advice. Please consult with your legal counsel for specific advice and/or information. Read our complete legal disclaimer.