Report Number: EPA 230-04-82-001
PART I; The "Taking" Issue—Is Compensation Required if a
State or Local Government Confiscates or Reduces the Quantity
of Banked ERCs?
                              Ivan J. Tether, Project Director
                              May 1982
      Prepared by the Regulatory Reform Staff,
      U.S. Environmental Protection Agency
      in conjunction with ICF, Inc.

      The views expressed in this paper do
      not necessarily represent the official policy
      of the U.S. Environmental Protection Agency.

                        Table of Contents


A.  Specific Situations in which
    ERCs may be Restricted or
    Adjusted 	      4

B.  The Law of "Taking" 	      5

    1.  Creating Public Benefit Versus
        Preventing Public Harm 	      7

    2.  Physical Invasion 	      8

    3.  Degree of Destruction 	      8

    4.  Investment-Backed Expectations 	  .    9

C.  Takings and Due Process 	     10

D.  Analogies and Precedents for ERCs 	     10

    1.  Crop Acreage Allotments 	     11

    2.  Broadcast Licenses 	     13

E.  Summary and Conclusions 	     14

    1.  Review of the Taking Issue as
        Applied to ERCs 	     14

    2.  Avoiding the Taking Issue 	     16

    3.  Afterword	     19


PART I;  The "Taking" Issue — Is Compensation Required if a
State or Local Government Confiscates or Reduces the Quantity
of Banked Emission Reduction Credits?

     EPA policy under the Clean Air Act lets private entities'
"bank" emission reductions for future use or sale, so long as
reductions are in excess of those required by law and meet
certain other requirements.  "Banking" refers primarily to state
or local government certification of an excess reduction as
usable in the future to satisfy an emission reduction requirement.
Certification gives the creator of the excess reduction a
contingent property right in the form of an Emission Reduction
Credit (ERC).  The ERC can be used as a new source offset, in
certain netting transactions, or in a bubble to satisfy current
or new reduction requirements imposed by a control agency on
existing sources.  The ERC can be used by its creator, sold for
use by another pollution source, or sold to a third party that
may hold it for investment purposes.

     Each state or local government that establishes a banking
system will set out rules for creation, transfer and use of ERCs.

     In controlling air pollution, state and local governments
may determine'that reductions beyond those imposed by current
regulation are necessary.  The need for further regulation could
arise, for example, from discovery that the current State
Implementation Plan (SIP) is inadequate to attain ambient standards
by the applicable deadline or from conclusions that projected
emissions growth will violate a PSD increment or threaten an
area's attainment status.

     Some control agencies with banking systems may decide to
fill a portion of their need .for additional reductions from banked
ERCs.  This approach is not required by the Clean Air Act; the
control agency could require existing sources to achieve the
needed reductions.  Nonetheless, banked ERCs could be seen as
a convenient source of further reductions.

     There is no question about the fundamental right of states
or local governments to "take" banked ERCs, so long as they are
taken for public rather than priva'te benefit.  This right exists


as an exercise of eminent domain or of the police power.  The
issue is whether an ERC owner would be entitled to compensation
from the government for the resulting loss.

     This paper discusses major court cases relevant to this
issue and their application to governmental action that may
reduce the value of ERCs to their owners.  A brief summary
precedes this discussion:

     The government's power to take private property in order to
benefit or prevent harm to the public was established in common
law that predates the U. S. Constitution.  So, too, the limitation
that such taking of property may require compensation was already
well-established when incorporated in the Fifth Amendment to the
U. S. Constitution.

     The cases on the compensation issue start by distinguishing
between two major bases of governmental power to take or diminish
the value of private property—police power and eminent domain.
Police power is the power to regulate private activity to protect
public health, safety, morals and general welfare; eminent domain
is the power to condemn and take private property for public use,
such as to build a highway.  Exercise of eminent domain almost
always requires compensation, while police power regulation may
only require compensation under very limited circumstances.
Reducing the value of ERCs would only be an act of eminent domain
if ERCs were taken to allow construction of a public facility,
such as a municipal incinerator.  Taking of all or a portion of
a person's ERCs would otherwise be' an exercise of police power,
protecting public health or welfare from harm not perceived or
projected at the time the ERCs were certified.

     Assuming that ERCs are not taken for construction of a public
facility, a court deciding the compensation issue would look to
the purpose of the regulation and the extent to which regulation
diminished or destroyed the value of private property (ERCs).
In assessing the extent of an ERC owner's loss, a court might also
examine the owner's expectations, particularly where expectations
led to financial investment (that is, monetary reliance).

     ERCs may be created incidentally, with little or no
independent investment, or specifically for investment purposes,
as by a third party who pays a polluting source to reduce
emissions and hopes to sell the resulting ERC at a profit.
This paper focusses on the latter situation, where monetary
reliance and the likelihood of required compensation are greater.

     Analysis of the compensation issue for an owner who invested
in ERCs solely for profit proceeds as follows.  First, courts


will give considerable deference to governmental activity that
protects public health and, accordingly, the likelihood that
compensation would be required is minimal.  Regulation is not
immune from compensation, however, and some courts might
consider the extent of the loss suffered by ERC owners, their
expectations and the evenhandedness of the regulatory burden.
This analysis raises issues that can be met effectively in
designing a banking system.

     The most certain way for states or local governments to
avoid the compensation issue is not to take ERCs.  There may,
however, be situations where control technology limitations,
the severity of an air pollution problem or other factors make
it infeasible to extract the necessary emission reductions from
existing sources in a particular area.  Thus, designers of banks
should observe the following approaches:

     0  First, set out in the banking rules the way in which
        ERCs may be diminished.  While judicial deference to
        health and safety regulation would most likely
        support state or local adjustments to ERCs for air
        quality reasons in any case, setting forth in the
        rules what ERC creators can expect is by far the best
        approach.  Not only will government agencies avoid
        having their adjustment actions overturned, but
        controversy and delay will also be minimized by a clear
        statement of how and when adjustments would be carried
        out, if necessary.

     0  Second, make clear to creators of ERCs that their
        property rights are conditional and subject to
        diminution in the event of further regulation.

     0  Third, avoid "taking" all of any one owner's ERCs.

     0  Fourth, ensure that any partial "taking" of ERCs
        occurs evenhandedly, and in roughly the same ratio
        as existing sources are required to achieve further

Observance of these considerations not only will make required
compensation extremely unlikely, but will also provide more
planning certainty to potential investors in ERCs.

     To comport with due process, any reduction in ERCs must
be preceded by notice and the opportunity for a hearing.
That due process requirement may, however, be satisfied by
general notice and comment when the banking system itself
is created on the way the administering agency plans to
adjust ERCs and the criteria it will employ to decide whether
adjustment is necessary.


      Governments are  free to guarantee  in emissions trading
 rules against ERC  adjustment, and obtain any  necessary  further
 reductions from their inventory of existing sources.A/  Govern-
 ments choosing to  obtain  all or'part of necessary  further
 reductions from banked ERCs could treat these ERCs  in several
 different ways.  The  adjustments to ERCs could  involve  either
 restrictions on use or loss of part or  all of the  ERCs  banked.
 Specific approaches include:

      0 a pro rata reduction in ERCs  ("discounting");

      0 a moratorium  on ERC use;

      0 complete confiscation of banked ERCs;  and

      0 an increase in allowance ratios (i.e.,  the  number
        of ERCs required  to offset emissions  from  new
        or existing sources would be increased).

 As will be discussed  later, the complete confiscation of banked
 ERCs  would be very unwise.  Confiscation would  not  only raise  the
 most  serious possibility  of required compensation,  but  the poten-
 tial  for confiscation would also strongly deter investment to
 create ERCs.

      An ERC  owner  normally obtains ERCs by producing them at his
 or her facility or by purchasing them from another  ERC  owner.
 Five  situations involving banked ERCs appear  most  likely:

      1.  A person  creates and banks ERCs with the  intention
         of  using  the ERCs;

      2.  A person  creates and banks ERCs with the  intention
         of  selling them;

      3.  A person  creates and banks ERCs incidental to  some
         other action (e.g., plant modernization or shutdown),
         and holds them with no specific intention  to use or
         sell them;

      4.  A person  buys banked ERCs with the intention of
         using them;  and

      5.  A person  buys banked ERCs with the intention of
         reselling them.
 I/   Sources with  banked  ERCs would  not  be  exempt  from  any  re-
 quirement  for  additional  reductions,  but could  satisfy  that
 requirement by using  their  banked ERCs,  by  reducing  emissions
 elsewhere, or  by purchasing  equivalent ERCs.


     In all but the third of these five situations, the ERCs have
been produced or purchased for some specific purpose.  Owners
expect to be able to use or sell their ERCs in the future.
This raises a very important issue regarding the type and
timing of notice (or lack of notice) given by the government
to potential ERC owners about the limitations on their rights.

     Before turning to a discussion of law, it is well worth
noting that addressing the compensation issue is entirely compat-
ible with developing and promoting an effective banking system.
Just compensation for property taken is not a legal incantation;
it is rather a principle of fairness.  The principle is intended
to avoid unduly burdening an individual or small group by
government actions that benefit or protect the general public.
The principle is flexible, however, because it must not be used
to deter or "dull" important government action to benefit or
protect the general public.  To lay the compensation issue com-
pletely to rest, governments need only design banking systems
so that taking of ERCs is limited and evenhanded and ERC owners
have full notice of limitations in advance of their investment.
Such actions will also promote a level of certainty that is
critical to the viability of any banking system.


     The United States Constitution forbids the federal and
state governments (1) from "taking" private property without "due
process" and (2) from "taking" private property "for public use"
without paying "just compensation" to its owner.^7*  These two
facets of the "taking" issue have often been treated as a single
"taking" issue.I/  The due process facet requires that the
government action be rationally related to a legitimate government
purpose and be accomplished by generally fair procedures; the
compensation facet requires that government action be fair to
the affected individual.

     As noted earlier, the general policy of the law of
"taking" reflects an attitude that an individual should not
bear the whole burden when government actions benefit the
general public.  Therefore, the government will pay the
individual for the property "taken."

     While the law of "taking" appears straightforward, the
balancing tests which underlie it inevitably mean that courts
2/ U.S. Const. Amend V.  The "just compensation" provision,
while not explicitly incorporated in the Fourteenth Amendment,
has been extended to State as well as Federal action under the
general "incorporation doctrine".  See, Chicago, B. & Q. Ry. Co.
v. City of Chicago, 166 U.S. 226, 236, 17 S. Ct. 581, 584  (1897)

2/ See, e.g., Haley, "Balancing Private Loss Against Public Gain
to Test for A Violation of Due Process or a Taking Without Just
Compensation", 54 Washington Law Review, 315, 324-326 (1979).


have had difficulty in applying it.ji/  Even the United States
Supreme Court has produced what appear to be conflicting decisions
in this area.  The apparent inconsistency may be explained in
part by the opinion in a case recently decided by that Court:

     [T]his Court has generally been unable to develop
     any "set formula" for determining when "justice and
     fairness" require that economic injuries caused by
     public action be compensated by the government,
     rather than remain disproportionately concentrated
     on a few persons. . .  Rather it has examined
     the "taking" question by engaging in essentially
     ad hoc, factual inquiries that have identified
     several factors—such as economic impact of the
     regulation, its interference with reasonable
     investment-backed expectations, and the character
     of the governmental action—that have particular
     significance .^./

     "Taking" cases are decided on their particular facts in
light of certain general propositions.  The variables a court
will consider when making a "taking" determination include:

     0  to what degree government actions are designed to
        create general public benefits as distinguished
        from actions to prevent harm to the public.

     0  whether the government has physically invaded
        private property;

     0  whether all, or substantially all, of the property
        values have been destroyed by government restric-
        tions; and

     0  to what extent the government actions have inter-
        fered with reasonable investment-backed expectations.
I/   See, e.g.,  Andrus v. Allard, 444 U.S. 51, 65, 100 S. Ct.
318, 327 (1979).  The majority wrote:  There is no abstract
or fixed point at which judicial intervention under the
Takings Clause becomes appropriate.  Formulas and factors
have been developed in a variety of settings. . . Resolution
of each case, however, ultimately calls as much for the
exercise of judgement as for the application of logic."

5/   Kaiser Aetna v. United States, 444 U.S. 164, 175, 100 S. Ct
383, (1979).  The concept of "reasonable investment-backed
expectation" seems to include several meanings.  It has been
applied where government action has "nearly the same effect
as the complete  destruction of rights  [the] claimant had."
It has also been interpreted as the property owner's primary
reasonable expectation given the historical pattern of use
for the property in question.  See, Penn Central v.  New
York, 438 U.S. 104, 127, 136 (1978).


     1.   Creating Public Benefit Versus
          Preventing PubTic Harm

     This distinction essentially differentiates an exercise of
eminent domain from an exercise of the police power:

          Eminent domain takes property because it is
     useful to the public, while the police power regu-
     lates the use of, or impairs rights in, property
     to prevent detriment to public interest;  in the
     exercise of eminent domain private property is
     taken for public use and the owner is compensated,
     while the police power regulates an owner's use
     and enjoyment of property, or deprives him of it,
     by destruction, for the public welfare, without
     compensation other than the sharing of the
     resulting general benefits.  Constitutional provi-
     sions against taking private property for public
     use without just compensation impose no barrier
     to the proper exercise of the police power.JL/

This clear statement of the distinction would seem to require
only that the taking of ERCs qualify as "regulation" to avoid
the compensation requirement.  This is not a difficult hurdle
where ERCs are taken to protect public health or otherwise
comply with the Clean Air Act.Z/

     Indeed, regulation, and particularly health regulation,
has been accorded great latitude by the courts.  For a valid
regulatory purpose, governments can literally destroy private
property without compensation.  'For example, an order that
cedar trees afflicted with disease called "cedar rust"
be cut down did not require compensation to the cedar tree
owners.  The cedar rust, though not fatal to cedars, was
fatal to apple trees.  The state could require destruction of
the cedars without compensating the owners for loss of the
trees themselves or for the decreased value of the land on which
6/   29A C.J.S.  Eminent Domain §6  See also, Note, Regula-
tion Without Just Compensation;  A Political Process-Based
Taking Analysis of the Surface Mining Act~, 69 Geo. TT. Rev.
1083 (1981).

7/   Note, however, that if a government takes ERC's to build
a government facility and create a public benefit, this action
would probably be held an exercise of eminent domain with
compensation required.  On the other hand, taking ERC's to
create a growth margin--which could be used to permit new
source construction in a nonattainment area—would no doubt
qualify as regulation.  Creating the growth margin would be
reasonably related to a valid goal—maintaining compliance
with the Clean Air while promoting economic growth.

the cedars stood (Miller v. Schoene, 276 U.S. 272, 48 S. Ct.
246 (1928).  The action taken was for the public good—preser-
vation of apple trees.  The Supreme Court noted that the apple
industry was important in the state; the state legislature did
not violate the Constitution by^requiring the destruction, with-
out compensation for the loss of one class of property to protect
another class of property that was more important to the public.
A case for protection of public health by destruction of ERCs
would be even more compelling.

     Despite the strength of the notion that regulation does not
require compensation, there have been cases requiring compensa-
tion on theories relating to the remaining variables.

     2.   Physical Invasion

     Physical invasion of property by the government, which in one
case consisted only of frequent military flights over a chicken
farmer's land requires compensation..§./  But since ERCs are
intangible, not "physical," property, this variable is not rele-
vant here.

     3.   Degree of Destruction

     A few cases have held that government regulation which de-
stroys all or substantially all of the value of property requires
compensation.  The most famous cas« involved a Pennsylvania
statute flatly prohibiting the mining of coal so as to cause the
collapse of residences, streets or other structures, even by a
person owning the mineral rights.2/  Despite the danger to life
and property created by the prohibited conduct, the Supreme Court
upheld the coal company's right to mine and overturned the
Pennsylvania statute as a taking without compensation..^/  Justice
Holmes stated the following vague rule:

     The general rule at least is, that while property may
     be regulated to a certain extent, if regulation goes
     too far it will be recognized as a taking.JLl/
£/   Causby v. United States, 328 U.S. 256, 66 S. Ct. 1062  (1946).

V   Pennsylvania Coal v. Mahon, 260 U.S. 393, 43 S. Ct. 158  (1922);
see also Fred Bosselman, David Callie and John Banta, The Taking
Issue, pp. 126-138, (Washington, DC: GPO, 1973).
     260 U.S. 393.

ll/  260 U.S. 393, at 415.


While decided in 1922, this case has continuing importance  in
light of the very limited Supreme Court review of land use  cases
since the 1920s.!2./

     The law relating to degree of destruction of value  is  not
particularly clear.  The Court has never established what is
meant by regulation going "too far."  Further, the cited case
allowing total destruction of cedar trees to protect apple  har-
vestS:L:L/ was decided only six years after the Pennsylvania  coal
mining case.  Moreover, a 1915 case indicates that regulation
can destroy nearly all of the value of property.IV  There  a
local ordinance effectively prohibited a brickmaker from using
land acquired and improved for brickmaking.  Though the value of
the land was reduced from about $800,000 to $60,000,A!/ no  com-
pensation was required.

     This line of cases suggests that banking authorities have
broad power to reduce the value of ERCs, so long as they do not
destroy the full value of ERCs through confiscation.  In any
case, confiscation is unwise on policy grounds, since it des-
troys the incentive to create and bank ERCs.

     4.   Investment-Backed Expectations

     A person who invests money to create ERCs has an "investment-
backed expectation" of some level of ERC security.  Where govern-
ment actions interfere with such expectations a "taking" may
be found.A!/  "Investment-backed expectations" can involve
government actions that have resulted in nearly complete
destruction of the property owner's rights.  They can also  involve
the primary expectations a property owner has in terms of the
historical pattern of use for the property.1Z/  In either case,
the amount of one's expected gain becomes important when a  court
reviews a "taking" claim.  To the extent an investor has good
cause to believe the value of his property is secure, there is a
greater likelihood that a "taking" will be found.
12/  See Bosselman, supra, note 8, p. 138.

13/  Causby, supra, note 7.

14/  Hadacheck v. Sebastian, 239 U.S. 394, 36 S. Ct. 143  (1915).

i!/  ^d.

16/  Kaiser Aetna, supra, note 4.

17/  Penn Central v. New York, 438 U.S. 104, 98 S. Ct. 2646  (1978)


     It should be clear that designers of banking systems can
avoid this issue by carefully defining the situations and condi-
tions under which ERCs may be adjusted.  As long as investors are
not led to expect more ERC security than will exist, these
investors cannot assert that ERC adjustment constitutes a "taking
without compensation."  There is simply no expectation—
investment-backed or otherwise—that their property right in ERCs
defined and limited under an overriding statute (the Clean Air Act)
is absolute.


     The validity of an ERC adjustment will turn on the procedures
employed as well as preceding compensation considerations.
Procedure involves two elements—the ERC owner must be notified
of the proposed adjustment and must be given some opportunity to
comment on it.  Failure to satisfy these procedural elements may
invalidate an otherwise proper government action.  However, for
ERCs the requirements are easy to satisfy; SIP changes require
that a hearing process be used, and notice and comment require-
ments for ERC adjustments can be satisfied as part of the SIP
revision process.  Notice and comment requirements may also be
presumptively satisfied if the need for adjustments is an
explicit issue in the hearings accompanying development of a
banking and trading rule, and that rule expressly incorporates
fair procedures for determining when, where and to what extent
an adjustment of banked ERCs will occur.


     In the early years of the Clean Air Act a source that
reduced emissions more than required could neither use nor
save those excess reductions for future use.  The offset policy
of 1976 for the first time allowed some use of such "surplus"
reductions as offsets to let new sources locate in nonattainment
areas, but only under stringent limitations.JJL/  For example, if an
existing source installed an electrostatic precipitator (i.e.,
90-95% control), when regulations required only 75% control
(achievable by a cyclone), those excess emission reductions had
to be applied immediately to meet a new source's offset require-
ments or they would be lost.  There were no bankable credits
awarded.  Except for narrow ."replacement" circumstances involving
destruction of existing facilities to make way for new ones on
the same site, all offsets had to be "contemporaneous."
Those who created emission reductions and lost all or part of
them because they could not be saved did not have any "taking"
argument—the "right" to receive credit for excess emission
reductions did not yet exist.
18/  See, the 1976 U.S. EPA Emissions Offset Interpretive
Ruling, 41 FR 55524 (December 21, 1976).

19/  By the same token, the absence of a mechanism for saving
excess emission reductions meant there was little incentive
for sources to make more reductions than required.


     Th e 1979 Bubble Policy allowed use of surplus emission
reductions to meet new current or future requirements imposed
by states on existing sources, while the 1979 revision to
the Offset Ruling explicitly authorized storage or "banking"
of surplus reductions to meet both existing and new-source
requirements through such controlled trades. "QJ

     Once there is a recognized "right" to bank emission reduc-
tions created by a state banking rule approved by EPA, it
seems likely that a government.cannot take banked ERCs without
satisfying the due process requirement of notice and some
kind of opportunity to be heard.  Assuming due process require-
ments have been met, the question is whether compensation must
be paid to the owners of banked ERCs that are subject
either to a moratorium on use, to discounting, to confiscation,
or to increased use ratios.

     Examples analogous to ERCs reinforce the idea that proper
banking design can easily avoid this compensation ("taking")
issue.  Situations where the government has granted some economic
(as opposed to social or welfare) entitlement or benefit include
crop acreage allotments and broadcast licenses.  In both of
these situations, changes or adjustments are made so that some
public benefit can be obtained.  Crop allotments help maintain
prices by avoiding oversupply of the crop and may need to be
adjusted frequently (e.g., annually).  Broadcast licenses are
allocated (and adjusted) both to avoid signal interference and
to provide the best community service.  Adjustments to ERCs provide
a similar public benefit by enabling a community to meet the goals
of the Clean Air Act more economically without sacrificing public
health concerns.

1.   Crop Acreage Allotments.

     Crop acreage allotments or quotas were first established
under the Agriculture Adjustment Act of 1938.  Each state is
assigned an acreage allotment.  The state and local governments
apportion these acreage allotments to the counties and to
individual farms within these counties.  The purpose of the
quota system is to prevent oversupply and a resulting drop
in crop prices.

     Certain criteria must be met in setting crop allotments.
The determination of quota levels and assignments of allotments
is not random or arbitrary.  The Secretary of Agriculture is
empowered to make an annual determination of the need for quotas
and must announce any quotas in advance of the growing season.
^O/  See 44 FR 71779 (Dec. 11, 1979) (Bubble Policy) and Revi-
sions to EPA's offset policy, 44 FR 3274 (January 16, 1979)
and 45 FR 52676 (August 7, 1980).

                             - 12-

Th e Secretary's determination is based on market information and
supply forecasts.  Apportionment procedure is clearly defined in
the Act.   Generally, at the state and county level, historical
growth data 2_1/ are used as a baseline and allotments are assigned

     There are several similarities between ERCs and acreage
allotments.  Both are intangible assets which are needed and
used to do business in a specific area. 22/  Both can be
bought and sold with transfers subject to strict conditions
established by law, including geographical limitations.
(Existing farmers have a first claim to allotments over new
arrivals who must buy the rights to grow the crop either
together with or apart from specific farmland.)  Finally,
allotments are adjusted periodically, as will be true for ERCs.
The fact that federal crop allotment legislation specifically
deals only with increasing the quotas, while adjustments to ERCs
will generally be decreases required to satisfy Clean Air Act
goals, seems a distinction without a difference, since both
actions adversely affect the value of "rights" held by existing

     Courts have generally upheld the legality of crop allot-
ments.  The Supreme Court held that the initial establishment
of crop allotments for tobacco (which placed limits on farmers'
previously unfettered ability to sell all the crops they produced)
was not an unconstitutional "taking" of property. J23/
Tobacco farms had begun preparation for planting before the law
was enacted, but because of the law could not sell all of the
tobacco harvested.  The Supreme Court pointed out that the law
did not take any of the tobacco, it merely limited what could
be sold;  if the farmers wanted, th£y could store their tobacco
in excess of the quota and sell it the following year.  This
seems analogous to the situation that would exist if a state
placed a moratorium on the use of ERCs.
21/  For example, the historical growth data for cotton is
based on the average annual production of the crop over
the preceding five years in each state.

22/  The IRS has ruled (Rev. Rul. 66-58) that sale of cotton
allotments was the sale of an intangible capital asset
within the meaning of Section 1221 of the Internal Revenue

23_/  Mulford v. Smith, 307 U.S. 38, 59 S. Ct. 41 (1939).
Likewise, air pollution control regulations have been held
not to operate as takings.  See Sierra Club v. EPA, 540 F.2d
1114 (D.C. Cir. 1976); South Terminal Corp. v. EPA, 504 F.2d
646 (1st Cir. 1974).


     In another situation the Court held that setting wheat
acreage allotments was not improper.  Although the allotments
limited how much wheat could be planted on a particular farm,
the limitation resulted in a market price that was much higher
that the world price determined by ordinary supply and demand
forces. .?_i/  In this circumstance, the Court refused to find
either a taking or a denial of due process, since it was possible
that wheat farmers experienced a net economic gain under the
program, ^l/  While the Court did not require that benefits exceed
costs it is difficult, if not impossible, to show a deprivation
of due process.  Similarly, an ERC banking and trading program
both confers a benefit (i.e., credit for emission reductions
that previously would have been lost if not used immediately)
and imposes a cost (the possibility that ERCs will be adjusted).
The benefit (being able to avoid loss of all emission reductions
not immediately used) clearly outweighs the cost (possible loss
of some nominal portion of the saved ERCs).  ERC banking and
trading also confers other benefits (for example, substantial
cost savings in meeting emission reduction requirements, increased
value of discounted ERCs) which far outweigh the facial costs of
adjustment, or even of confiscation.  Both taking and due process
arguments in the ERC context would probably be dismissed as they
were for wheat allotments.

2.   Broadcast Licenses.

     Another area analogous to ERCs is that of radio and
television station licenses granted by the Federal Communications
Commission (FCC).  The FCC may not only fail to renew a
license; it may revoke a license for a number of reasons or
simply eliminate a station to more fairly allocate licenses,
wavelengths, hours of operation, or station power.  .?JL/ The exer-
cise of this authority does not constitute an unconstitutional
taking of property without compensation. H/  It seems precisely
analogous to adjusting or reducing ERCs in order to accommodate
changes in the SIP required to demonstrate attainment or maintain
reasonable further progress with respect to National Ambient Air
24/  The same type of reaction may be observed if "discounting"
is used to adjust ERCs.  Reduced supply may drive up prices,
and indeed is likely to do so, making 90 tons per year of
ERCs worth more than 100 held before the discounting.

2V  Wickard v. Filburn, 317 U.S. 'ill, 131, 63 S. Ct. 82, 92  (1942)

26/  Communications Act, 47 U.S.C.A. 307, 312.  Federal
and Radio Comm'n v. Nelson Bros. Bond and Mortgage Co.;
289 U.S. 266, 282, 53 S. Ct. 627, 635, 77 L.Ed. 1166 (1933).

27/  American Bond and Mortgage Co. v. United States 52 F.2d
318, 320 (7th Cir. 1931), cert, denied, 285 U.S. 538, 52 S. Ct.
311, 76 L.Ed. 931 (1932).


Quality Standards.  The broadcast licensee will likely make a
substantial investment in broadcasting equipment and facilities.
If the license is revoked, the former licensee still has the
equipment and facilities, but they are essentially worthless to
that person because they cannot be used for their intended purpose.
Thus, the revocation of a broadcasting license carries with it
severe economic consequences.  Nonetheless, the FCC is not
required to compensate the former licensee for any economic loss
attending the revocation of a license, even though taking away
the license clearly deprives the former licensee of use of the
broadcast equipment and facility.  Of course, the equipment and
facility may be sold, but at a much reduced price in relation to
their market value if the license were still in effect.  The same
result follows if ERCs to be used for expansion purposes are
taken:  the expansion is not necessarily halted, but the addi-
tional facilities cannot be put to their intended use.

     Like ERCs, broadcast licenses and crop allotments are not
only conditional, but limited by required consistency
with a major federal statute whose requirements are legally
presumed to be known.  The licensee is aware that the license
may be revoked and on what grounds revocation may occur.  EPA-
approved state or local banking and trading programs will
necessarily contain similar explicit conditions, and will be
discussed more thoroughly in the final section of this paper.

     The unique character of ERCs should be reemphasized.
Unlike crop acreage allotments or broadcast licenses, ERCs are
created under a health-related regulatory program.  Courts have
traditionally been less inclined to require compensation when
property value decreases in response to health, safety or welfare
considerations.  Zoning is also an appropriate analogy; even ownership
of land does not confer absolute rights.  Acting within its
police power authority, a municipality may control land use by
zoning, and a property owner whose land value is adversely
affected will not be compensated.  The government cannot be made
to pay for all its actions, even those with economic impacts on
specified groups.  That argument is even stronger where health
rather than economics lies in the balance.


     1.   Review of the Taking Issue as Applied to ERCs

     Four types of possible state or local government adjustments
may be made to ERCs:

          (1)  an across-the-board percentage reduction in
               (discounting of) the amount (tons per year)
               of ERCs;

          (2)  an increase in the allowance ratio for using
               ERCs (e.g., two tons of banked reductions
               might be required to offset one ton of
               increased emissions);

          (3)  a moratorium preventing the owner from
               using its ERCs for a period of time; or


          (4)   a confiscation of ERCs.

     0    For purposes of this paper,  it is assumed that
          ERCs are created for a specific purpose (use or
          sale), and that owners thus  have expectations
          regarding the security of ERCs.  (Where creation
          of ERCs is incidental to another primary action,
          e.g., shutting down a source  or installing controls
          to meet basic requirements,  a challenge to
          ERC adjustment is even less  likely to succeed. )

     The following points summarize the "taking" analysis
under existing law:

     0    ERC adjustment necessarily promotes the health and
          welfare of the general public, since adjustment
          is triggered only to meet health goals (attainment
          and reasonable further progress towards attainment
          of air quality standards explicitly defined in
          Federal law); this is a valid regulatory purpose
          that has traditionally received great judicial

     0    So long as ERCs are "taken"  to promote health and
          welfare (including economic  welfare, as by creation
          of a growth margin), and not  to permit construction
          of a public facility, government action will be
          characterized as an exercise  of the police power
          and not of eminent domain.  Thus, according to the
          general rule, no compensation will be required.

     0    Courts will be highly unlikely to require compensa-
          tion under a moratorium,, which leaves much of the
          value of ERCs intact.

     0    A very substantial discounting or increase in the
          allowance ratio of ERCs would be sustained before
          compensation would be required, even in the absence
          of adequate prior notice regarding limitations on

     0    ERC owners may have expectations, backed by
          investment, as to the security of banked ERCs.
          Where these expectations are  clearly conditioned,
          prior to investment, by the  rules and agency
          representations regarding a  banking system's
          operations, no compensation  would be required
          for subsequent adjustments to ERCs.

     0    Only complete and outright state confiscation
          of all banked ERCs raises even the possibility
          that a "taking" requiring compensation will be
          found.  Even that possibility will be neutralized

          if confiscation and the conditions which will
          trigger it, are explicitly set forth as an option
          reserved to the state in its duly promulgated
          banking rule.  (This approach would, however, seriously
          deter private investment in ERCs.)

          Because confiscation is legally permissible under the
          Clean Air Act but is so undesirable as a policy alter-
          native, the "taking" problem is not real.  States have
          several other options to effect necessary adjustments
          which will neither discourage banking of ERCs nor raise
          cognizable "taking" issues.  Under these options (dis-
          counting, moratoria, or requiring increased amounts
          of ERCs for each use), there may not even be standing
          to complain, since the economic value of ERCs is not
          demonstrably impaired and their owners are not
          "aggrieved".  Further, as noted earlier, states are
          free to refrain totally from adjustment, and obtain
          any needed reductions from existing sources.

          Avoiding the Taking Issue

     Several strategies for avoiding the "taking" problem are
suggested below.  The discussion is not exhaustive, but de-
scribes steps which should be generally effective in eliminating
any potential "taking" problem regarding banked ERCs.

     Advance Notice;  If a prospective owner of ERCs is made
actually or constructively aware, .before ERCs are purchased or
produced, that adjustments may later be necessary, it will be
virtually impossible to claim persuasively that a "taking" has
occurred when such adjustments are made.  Since any decision to
invest in ERCs will reasonably have included consideration of
possible future adjustments, such adjustments cannot frustrate
"investment-backed expectations".

     Any banking and trading program should include measures to
assure timely fair notice to prospective ERC owners of when and
how adjustments to banked ERCs may occur.  Specifically,

     0    ERC banking and trading programs should specifically
          include provisions dealing with possible future ad-
          justments to ERCs.  Adjustment should be treated in
          state and local banking and trading rules.  Such
          rules should specifically state the purposes for which
          any adjustment would be made—e.g., to insure continuing
          compliance with the requirements of the Clean Air Act.
          Since EPA-approved banking rules must be SIP revisions
          requiring public notice and comment, potential ERC
          owners will have opportunity to comment on the possible
          ERC adjustments, and full notice that future adjustment
          is one of the conditions under which ERCs are granted.


     °    A banking and trading program should make an extra
          effort to inform potential ERC owners of the possi-
          bility of adjustments to banked ERCs.  This can be
          done by requiring the face of every ERC certificate
          to include a specific and unambiguous notice that
          the quantity of banked ERCs might have to be adjusted
          downward to satisfy requirements of the Clean Air Act.
          The notice should specify how the adjustment will be
          made.  In addition, all potential ERC owners should
          be given a copy of the banking and trading rule that
          includes assurances that fair procedures will be used
          in making adjustments.

     0    The banking and trading rule should specify procedures
          by which adjustments will be made as well as limits on
          the distributive effects of adjustments.  For example,
          it may be wise to guarantee that adjustments to ERCs
          will be of no greater percentage than reductions
          required of existing sources.

concerned,courts have indicated that the right bestowed can be
narrowly defined by the state at the outset.  What must be done
in the banking and trading context is to specify what is granted
granted when an ERC is awarded.  Instead of an absolute right
to full use of the face value of granted ERCs, the award should
specifically reserve the right to adjust ERCs if it becomes
necessary to do so.

     Regulatory Means  The means for accomplishing the adjust-
ment, if deemed necessary, should be selected with care
because some ERC adjustment methods seem less likely to
cause "taking" problems than others.  It is to a community's
advantage to select those means which are least troublesome.
Some factors to keep in mind when making this choice are:

     0    Avoid "taking" ERCs for use in some "entrepreneurial"
          fashion, such as providing ERCs for expansion of a
          municipa1ly-owned power plant.  Courts generally find
          a "taking" more easily when the government is acting
          as an entrepreneur than when it is acting to safeguard
          the health and welfare of its citizens.

     0    Avoid "confiscations."  This adjustment method seems
          most likely to result in a judicial finding that a
          "taking" has occurred.  It is also most likely to
          discourage participation in a banking and trading

     0    Apply the adjustment uniformly within classes.
          Courts generally are more inclined to accept as
          permissible a regulation of this kind if it is
          applied uniformly to those similarly situated.

The selection of the adjustment mechanism should be based on two
criteria:  (1) what best serves the needs of the banking and
trading program, and (2) what gives ERC owners the greatest
incentive to create ERCs while still satisfying requirements of
the Clean Air Act.  The suggestions below place only limited
burdens on ERC owners,  yet are practical means of effectuating
a required SIP change.

     °    Discounting (a pro rata reduction in the value of
          all banked ERCs).  The methods of discounting ERCs
          should be specified in advance and should include
          notice that discounting may be necessary, what the
          triggering factors will be, and how the percentage
          reduction will be determined.  Discounting would
          also increase the demand for ERCs, driving up
          their cost and making them more valuable per unit.

     0    Address future users instead of current holders of ERCs,
          The allowance ratio on use of ERCs could be changed so
          that an increase in emissions would have to be offset
          by more ERCs  than previously required.  For example,
          if a SIP change presented a situation where banked ERCs
          needed to be  reduced by one-half, instead of requiring
          a 50 percent  discounting of banked ERCs, the banking
          and trading program could double the amount of ERCs
          that must be  applied to any emission increase.
          Whichever method is selected, the impact on cleaning
          up the air is the same.

     0    A partial use moratorium.  The ERC owner would be
          permitted to  use some percentage of its banked ERCs,
          but the remaining ERCs could not be used for the
          duration of the moratorium.  No limit would be
          placed on the sale of ERCs.  For example, if a firm
          owns 100 ERCs, a 75 percent moratorium would permit
          the firm to use (or sell) 25 ERCs.  The remaining
          75 ERCs could not be used but could be sold.  The
          purchaser of  the 75 ERCs, however, would buy them
          subject to the terms of the moratorium and could
          not use them  until the moratorium expired.  This
          approach combines the most attractive features of
          the moratorium and discounting options.  The use
          of a moratorium enables the ERC owner to retain
          ownership of  the full amount of ERCs; and the
          partial nature of the moratorium enables the ERC
          owner to both use and sell some portion of its



     The "taking"  issue imposes no serious  constraint on
banking and trading of Emission Reduction Credits.   It merely
requires that  the  designers of banking  and  trading systems be
sensitive  to certain interests that  should  be protected.  It  is
particularly crucial that prospective owners of ERCs be aware
of precisely what  interest they will be acquiring (whether by
purchase or production) in an ERC.   Governments are free  to
guarantee, in  emissions trading rules,  against ERC adjustment,
and obtain any necessary further  reductions from their inven-
tory of existing sources.  Where, however,  a state or local
government determines that it may be necessary to adjust  the
quantity of banked ERCs, that contingency and its consequences
should have been spelled out to every potential ERC owner in
advance.   ERC  ownership is not an unlimited right to use  or
sell the ERCs  granted; ownership  is  contingent and subject
to the rules  established for the  particular banking and
trading system.  One of those rules  should deal directly  and
as explicitly as possible with the  future adjustment issue.

                              EJED EPA 230-04-82-001
                              Legal issues related to
                               creation,  banking and use
                              Due Name &  Phone# Mcode
                              EJED EPA 230-04-82-001
                              Legal issues related to
                               creation,  banking and use
                              Due Name & Phonef Mcode
                               U S ENVIRONMENTAL PROTECTION AGENCY
                             Office of Prevention, Pesticides & Toxic Substances
                                   OPPTS Chemical Library (7407)
                                        401 M Street SW
                                      Washington DC 20460
                                         (202) 260-3944