Tradable performance standards in the transportation sector

Performance standards have a long history in environmental policy. A performance standard sets a standard of technology performance but leaves technology choice to producers; it increases the relative costs of technologies with undesirable performance characteristics and lowers the costs of technologies with desirable characteristics. The primary motivations are to promote innovation, to address consumers' undervaluation of efficiency, and to reduce externalities, such as air pollution and the risks of dependence on foreign oil. In the past decade, trading has been incorporated (thus termed as tradable performance standard, TPS) into several U.S. transportation programs: regulations for greenhouse gas emissions from passenger cars and trucks (national), zero-emission vehicle programs (10 states), the Renewable Fuel Standard (national), and low-carbon fuel standards (two states). TPS allows for equalization of marginal costs across eligible technologies and is therefore more efficient than pure regulations. We show that sectoral TPS programs have high credit prices but low price effects on products and provide strong incentives for upstream innovation and technology transformation. Unlike emissions pricing, however, they do not have a strong output effect: consumers do not bear the full cost of the pollution and do not have incentive to reduce consumption of polluting products. Given that the expected carbon price may be too low to substantially affect transportation demand or technology change, combining TPS with a carbon price may be necessary to drive innovation and achieve a sustained low-carbon transformation in the sector.