Third District Court of Appeal Upholds State Air Resources Board’s AB 32 Cap-and-Trade Program

In a 2-1 opinion, the Third District Court of Appeal upheld the auction-sale component of the cap-and-trade program created by the State Air Resources Board pursuant to the California Global Warming Solutions Act of 2006 (“AB 32”) in California Chamber of Commerce v. State Air Resources Board (2017) 10 Cal.App.5th 604.

As part of its regulations to implement AB 32, the State Air Resources Board created the California Cap on Greenhouse Gas Emissions and Market-Based Compliance Mechanisms, referred to as the ‘cap-and-trade program.’ The program imposes a cap on aggregate greenhouse gas emissions. Covered entities must either reduce their emissions below a threshold point or obtain offset credits or emissions allowances at the Board’s quarterly auctions or in a secondary market. Allowances are tradable, so participants can buy, bank, or sell them. Proceeds from the Board’s auction sales are kept in a fund to further AB 32’s purposes. Plaintiffs California Chamber of Commerce and Morning Star Packing Company filed two separate lawsuits challenging the regulations and the court consolidated the cases. The trial court ruled in favor of the Air Resources Board and both plaintiffs appealed.

The Court of Appeal considered two arguments: (1) whether the auction sales exceed the Legislature’s delegation of authority to the Board, and (2) whether the revenue generated by the auction sales amounts to a tax that violates the two-thirds vote requirement of Proposition 13. With respect to Plaintiffs’ first argument, the court considered whether the auction program is “(1) consistent and not in conflict with the statute and (2) reasonably necessary to effectuate the purpose of the statute.” The court held that by allowing the Board to design regulations that include “distribution of emissions allowances,” the Legislature gave broad discretion to determine how to implement the statute, and the auctioning of allowances does not exceed the scope of the delegation. In addition, the court found that the Legislature later ratified the auction system when it directed how to use the proceeds therefrom.

With respect to Plaintiffs’ second argument, the court found that the auction sales do not equate to a tax. Proposition 13 requires that any change in a State tax must be passed by a two-thirds vote of each house of the Legislature. Sinclair Paint Co. v. State Bd. of Equalization (1997) 15 Cal.4th 866 is the leading authority on application of Prop 13, but contrary to the ruling of the lower court, the Court of Appeal found the test from that case was inapplicable here. According to the court, Sinclair Paint did not hold that it applies to any “revenue generating measure.” Instead, Sinclair Paint sets forth rules to evaluate purported regulatory fees to determine whether they are taxes subject to Proposition 13. The Board’s cap-and-trade regulations do not purport to impose a regulatory fee, but instead call for the auction of allowances, which the court explained is an entirely different system. Thus, the Court of Appeal found, Sinclair Paint did not apply.

Because Sinclair Paint did not apply, the court looked to the general test for whether something is a “tax” subject to Proposition 13. The court explained that the hallmarks of a tax are: (1) it is compulsory, and (2) the payor receives nothing of particular value for payment. The court found that, regardless of the fact that the cap-and-trade program may increase the cost of doing business in California, the purchase of allowances through the Board’s auction is voluntary; businesses must simply make the judgment whether it is more beneficial to the company to make the purchase required by the program than to reduce emissions. In addition, the court emphasized that no entity has a vested right to pollute. Once purchased, the allowances are valuable, tradable commodities, conferring on the holder the privilege to pollute the air. Thus, the court found that participation in the auction system is voluntary and the purchaser receives a specific thing of value, so the auction system does not impose a tax.

Justice Hull concurred with the majority’s analysis of the first question, but disagreed with the second part of the opinion. In a lengthy dissent, Justice Hull argued that the cap-and-trade program is a tax because: (1) the purchase of auction credits by certain businesses is not voluntary, (2) the auction credits do not confer property rights, and (3) the use of the auction proceeds must be considered for determining whether a State exaction is a tax. Thus, Justice Hull concluded that the program is a “tax” of sorts, and because it was not passed by a 2/3 vote of the State Legislature, it violates Proposition 13.