The threat of climate change in recent years is a real and potentially catastrophic threat to the health and welfare of our planet, as industrialized nations continue to base their economies on carbon intensive production. Recently, it has taken on a larger role in our national media, the public, and the government, as the effects of anthropogenic climate change become more evident. In the United States, for example, the year 2007 brought the first major piece of legislation in the country to address the problem under the Climate Security Act, and the United States Supreme Court ruled that the U.S. Environmental Protection Agency had authority to regulate carbon dioxide as a pollutant. Today, many politicians, economists, scientists, and environmentalists propose a solution that would create a regulated market based on emissions into the atmosphere, effectively internalizing all negative externalities. It’s called cap and trade, and it has a lot of potential to help incentivize the implementation of alternative forms of energy, has several different variations and alternatives, and has already been successful in many programs around the world.
IMPLICATIONS OF CAP AND TRADE
The “cap” of cap and trade is when government enforces a cap on emissions, which gradually gets smaller over time. The “trade” of cap and trade is enabling the free market to trade emissions permits, which can either be earned, bought, or given away. In order to reduce pollution, the government sets a cap on emissions and creates allowances to level off the cap. Sources are then free to buy, sell, or bank the allowances to use in future years. They can buy emissions credits when they need more credits to pollute, they can sell emissions credits if they can consume energy more efficiently, or they can bank their credits in order to invest them for future profits and early emissions reductions. At the end of the fixed compliance period set by policy makers, each source surrenders allowances. In theory, those who reduce emissions most cheaply will do so at the lowest cost to society (US EPA). For example, there are two companies that pollute. “Company A” can reduce their emissions cheaply and easily, but at first has little incentive to do so. “Company B” on the other hand cannot easily reduce their emissions, so they initially do not. Under a cap and trade system, both companies are allotted a certain amount of emissions permits. Because “Company A” can reduce their emissions more easily, they can sell their extra emission permits to “Company B” who may pollute more than their emissions permits allow. Overtime, the amount of emissions allowed for an emissions permit is reduced, which decreases the cost of innovation while increasing the cost to pollute, encouraging energy efficiency. Cap and trade often gets confused with two similar policy methods, command and control and environmental taxes, whose goals are similar, but whose means of reaching those goals are different. First, under command and control legislation, for example, the government sets a cap on emissions and simply penalizes anybody who does not meet set standardized goals, without any trading component. Command and control is better for more local health issues, since implementing command and control on a wider scale is much costlier. Second, under environmental taxes, the government taxes a set percentage per unit of emissions in hopes that emissions will go down. However, under environmental taxes, imperfect information makes it difficult to determine what the price of the tax should be. Cap and trade, on the other hand, allows the market to determine the most efficient price. According to a 2003 U.S. EPA Report, cap and trade offers more certainty for total emissions under a defined set of sources and has costs less to regulate than other forms of regulation. Since the market controls cap and trade, a few important factors of a market-based...