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A flawed cost/benefit study of a greener California

Opinion

The Varshney/Tootelian analysis, often cited by foes of AB 32, overestimates the law's costs by a factor of 10. It also excludes the value of energy savings and neglects the effects of innovation.

March 24, 2010|By James L. Sweeney and Matthew E. Kahn

The stakes are huge when it comes to regulating the use of fossil fuels in California. We need serious, credible analyses in order to understand the economic effects of new laws and proposed legislation. Unfortunately, in California, one highly flawed estimate of costs to consumers and small businesses is distorting the debate.

Cited again and again by opponents of California's global warming solution law, AB 32, the Varshney/Tootelian report estimates that this law will cost small business $50,000 a year and each household $3,857 a year once the new rules kick in.

We each independently analyzed the economic projections made by Sanjay Varshney and Dennis Tootelian -- Cal State Sacramento business school dean and marketing professor, respectively -- and came to this conclusion: Their estimates are highly biased and based on poor logic and unsound economic analysis. The costs they predict are far too high.

Already signed into law, AB 32 primarily requires industries to curb emissions or buy allowances to bring California's carbon footprint down 15% by 2020. It now faces an initiative challenge that contends that the law will be bad for the state's economy and that it should be tabled until unemployment drops to 5.5%. Opponents of AB 32 used the Varshney/Tootelian estimates as powerful tools against the law.

The problem is that Varshney and Tootelian's report, which was paid for by the California Small Business Roundtable, adds together all costs of AB 32 but excludes the value of all energy savings. The rationale? Primarily that any imputed savings are "too speculative" to be counted.

A few salient examples provide powerful evidence of the skewed results such a calculation provides. Over half of their stated consumer costs are based on the assumption that AB 32 will require new homes to generate as much energy as they use -- which it doesn't -- and that that would add $50,000 to the construction of each house. But once they figure that into AB 32's costs, they assume that those net-zero-energy houses provide no energy savings.

In addition, even though new homes form only a tiny fraction of the housing stock, they calculate the percentage cost of that $50,000-net-zero-energy price tag and apply it to all housing in the state. Although AB 32 does require new houses to meet stiffer energy standards, the estimated cost is about $5,000 per house, much of which will be recouped in lower energy bills. The standard, and therefore the costs, apply only to new construction.

Flawed assumptions -- inflating costs and negating savings -- pervade the Varshney/Tootelian analysis. For cars, they agree that more fuel-efficient cars will save consumers $360 a year. But in an inexplicable twist of logic, they decide that because most people will not buy new cars, they count the fuel savings as a cost increase of $360 per year for every car owned in California. A saving for some becomes a cost for everyone in the Varshney/Tootelian analysis.

It is no surprise that no-benefits, costs-only, exaggerated-cost methodology guarantees high-cost results. We conservatively estimate that the Varshney/Tootelian analysis overestimates costs by at least a factor of 10. We say "conservatively" because there are additional market drivers that add to the benefits in a fair cost/benefit analysis that Varshney and Tootelian fail to acknowledge.

First, they assume there will be no increase in innovation in the world of clean energy technology. While innovation is hard to measure, it is completely misleading to assume there will be none. Few in California would debate the powerful impact of innovation on our state's economy. Policies like AB 32 create market incentives. Everyone in a market economy responds to these incentives, but Varshney and Tootelian assume instead that California businesses and consumers will suddenly become oblivious to market forces. This defies 200 years of economic logic dating to Adam Smith.

Second, their study assumes that all investments in "greening" California homes and businesses are simply dollars tossed out of the state's economy, with no positive impact on its bottom line.

Some such investments may go out of state -- for example, the builder of a new net-zero-energy house might purchase solar panels from Oregon. But others will not. When a family pays for those solar panels to be installed, or for a weatherizing company to improve their home's energy efficiency, that money goes to California salaries and supplies. Workers and suppliers then buy their own goods and services locally, and the ripple effect continues. With the California economy now experiencing more than 12% unemployment, such economic stimulation should not be ignored.

The decisions facing our state are too important to be swayed by relying on such a deeply flawed study. There are multiple credible analyses of the economic impacts associated with controlling greenhouse gases that show the costs of such policies are modest, and that real benefits can accrue. Californians deserve a well-informed debate -- the Varshney/Tootelian study should no longer be part of it.

James L. Sweeney is a professor of management science and engineering at Stanford University and the director of Stanford's Precourt Energy Efficiency Center. Matthew E. Kahn is a professor at the UCLA Institute of the Environment and the departments of economics and public policy.

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