11/12/2012 05:28 pm ET Updated Jan 12, 2013

California's Cap-and-Trade May Solve State's Budget Problems

By electing a supermajority of Democrats to the California Assembly and Senate, Californians may have found an easy way to free up as much as $14 billion a year for the general fund without any new tax increases. Why? Because auction money raised from California's cap-and-trade program to reduce greenhouse gases may soon become available to fund education and other programs devastated by the Great Recession. Without a supermajority vote, California may only be able to use the cap-and-trade money to pay for programs connected to climate change.

California's arcane tax rules are the reason why, before Tuesday's election, money from the auctioning of allowances under cap-and-trade probably couldn't be used to fund programs like education without a supermajority vote in the Legislature. Here's some background.

California's first auction of allowances under its cap-and-trade program will take place next Wednesday. Under AB 32, the Global Warming Solutions Act, California's Air Resources Board has set up the cap-and-trade program to reduce greenhouse gas emissions to 1990 levels by 2020. The idea of cap-and-trade is pretty simple: overall emissions are "capped" and then large greenhouse gas polluters are given or sold "allowances" equal to the amount of pollution they are allowed to emit under the cap. An allowance is worth one ton of greenhouse gases. If an emitter doesn't have enough allowances to cover the amount of pollution it will generate, the emitter buys more allowances; if it will emit fewer tons of pollution than it has allowances for it can sell those allowances.

Next Wednesday, California will auction off some of the allowances that make up the total amount of emissions the state will allow under the cap. Allowances are expected to sell for at least $12 each and maybe more, and millions of allowances will be sold. The first auction is expected to raise $1-$2 billion. In future years, the program will expand and the state will continue to auction off allowances. As the cap gets tighter (emissions are reduced more and more each year) auction prices will get higher. The Governor and Legislative Analyst think auction revenues could get as high as $14 billion by 2015-16, although it also possible that they could be as low as $2 billion. Regardless of the range, the auctions will bring in real money.

So what can the money from auction revenues be used for? Here's where the California tax rules and the legislative supermajority come in. California's constitution - as a result of the same Proposition 13 that lowered property taxes -- requires that taxes used for general purposes be enacted by a 2/3s vote of the legislature whereas taxes used for specific purposes can be enacted by a simple majority. It is possible that the auctioning off of allowances could be considered a tax. AB 32 passed the legislature by only a majority vote, so if the auction is considered a tax, the revenues from it can only be used for specific purposes. In this case, the center I help run, the Emmett Center on Climate Change and the Environment, has analyzed the problem and believes that the specific purposes should be programs related to reducing greenhouse gases.

But now we have a supermajority of Democrats in the state Assembly and Senate. The Democrats could reaffirm AB 32 with a 2/3s vote and then could use the auction revenue from cap-and-trade for general purposes. Suddenly, by 2015 the Democrats could have as much as $14 billion extra to spend for education and other programs, or to provide tax relief from other taxes without losing revenue. Without a supermajority, Republicans needed to make up the 2/3s vote may not have been willing to endorse a climate change bill -- AB 32 -- that they have repeatedly opposed.

Most of the post-election budget attention in California has been on the passage of Proposition 30, which will raise sales and income taxes to stave off more than $6 billion in cuts to education. But the even bigger news may be that the supermajority could solve our budget problems without raising any new taxes or cutting existing programs.