Cap-and-Trade Auction Isn't an Illegal Tax, Court of Appeal Rules

The cap-and-trade auction does not operate like a tax, and is permissible under the California Constitution, according to an April 6 ruling by the Third District Court of Appeal in California Chamber of Commerce, et al. v. California Air Resources Board.

In its 2-1, published decision, the court wrote that auction participants are “volunteers” who choose to purchase allowances to receive the privilege to pollute, and wrote that “no entity is forced to buy emissions allowances.” The court’s position that the auction is voluntary meant that prior tax and fee tests under Sinclair Paint were not applicable, in the court’s perspective.

“Indeed, speculators have bought allowances seeking to profit from their sale, and as one party puts it, taxes do not attract volunteers,” the court wrote. “The system is the voluntary purchase of a valuable commodity and not a tax under any test.” 

In 2006, the Legislature passed AB 32, the Global Warming Solutions Act, which, according to the court, provided the California Air Resources Board (ARB) the broad authority to implement policies to reduce greenhouse gas emissions to 1990 levels by 2020, including a “marketplace mechanism.” One of the programs adopted by ARB, considered a marketplace mechanism, is the cap-and-trade auction.

While the cap-and-trade program itself is not contentious, ARB chose a program that included a revenue-raising device that requires businesses to either purchase allowances or reduce operations in California. Other options considered, but ultimately rejected by ARB, included no-auction programs and cap-and-trade programs with free allowances.

In 2010, the California Chamber of Commerce, National Association of Manufacturers and Morning Star Packing Company filed separate suits challenging the authority of ARB to impose a cap-and-trade program with an auction, and arguing that the auction constitutes a tax under Proposition 13’s Sinclair Paint line of legal tests. The courts agreed to hear the cases together.

Unlike the other plaintiffs, Morning Star Packing Company argued that the auction was a tax under the provisions of Proposition 26, a 2010 ballot measure co-sponsored by CalTax to broaden the definition of tax to include certain fees, charges, exactions and other levies. 

The court rejected Morning Star’s claims, stating that Proposition 26 should not apply to the cap-and-trade auction because the change in state statute that created the auction was signed into law four years prior to passage of Proposition 26.

A footnote in the ruling stated: “We were not asked to decide whether an administrative or legislative attempt to extend the cap-and-trade rules promulgated under the Act beyond 2020 would be subject to Propositions 26’s terms, and do not purport to do so.”

The court evaluated the auction under a series of court cases that define a tax and fee, including Sinclair Paint Company v. State Board of Equalization, Northwest Energetic Services v. Franchise Tax Board, Bay Area Cellular v. Union City, San Diego Gas & Electric Company v. San Diego County Air Pollution Control District, and others.

In general, these cases find that a fee must not be imposed for the primary purpose of generating revenue; that a fee must have a nexus to the payer, particularly between the intended benefit and the cost associated with the benefit; and fees must be reasonably connected to the regulatory activity, such as permit licenses, audits, and inspection fees.

The court opined that Sinclair Paint does not apply to the auction because ARB is not attempting to impose a regulatory fee on polluters. Instead, the court ruled, the auction is “a different system entirely.” 

In a dissenting opinion, Justice Harry Hull wrote that “the purchase of auction credits by Morning Star or other businesses similarly situated is not voluntary,” and that “the use of the auction proceeds, a hallmark, if not the gold standard, for determining if a state exaction is a tax must be considered.”

“I conclude that the cap-and-trade auction program is a tax,” Justice Hull wrote. Because the program was not approved by at least two-thirds of the Legislature, he added, it “violates Proposition 13.”

CalChamber said it is evaluating its options for responding to the ruling. The plaintiffs have until mid-May to ask the California Supreme Court to review the decision.

CalTax President Teresa Casazza said the ruling is extremely harmful for taxpayers. “In our amicus we emphasize that the ‘police power is the starting point, not the end point of the proper analysis under Sinclair.’ The decision reached by the Court of Appeal misses this point – Sinclair Paint should apply, and has applied whenever government uses its police power to generate revenue. The 2017-18 state budget estimates that the cap-and-trade auction will generate more than $2 billion in additional revenue – this is much more than a collection of voluntary payments from generous taxpayers




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