A cap-and-trade system incentivizes reductions in carbon emissions where it can be done most efficiently:
Portfolio.com (Conde Nast), “Why a Cap-And-Trade System Beats a Carbon Tax”, 4/19/07 – “The efficiency [of a cap-and-trade system] comes with the ‘trade’ part. Let’s say you have two power plants, each emitting 100 tons of carbon per hour. The first can reduce its emissions by 20 tons at a cost of $5 per ton, and the second can reduce its emissions by only 10 tons, at a cost of $30 per ton. Clearly the efficient thing to do is to make the former reduction rather than the latter, with the owner of the second plant paying the owner of the first plant to offset the first owner’s extra costs [by buying carbon credits and the ‘right’ to pollute from the first plant].” This allows effective emissions reductions to occur at the lowest cost.
Once every quarter, an auction is held for
more cheaply than others. One firm may have to pay $100,000 to reduce pollution by 5 tons of sulfur dioxide. An 2nd firm may have to pay $1,000,000 to achieve the same pollution reduction. Focusing on reducing pollution, rather than requiring all firms to take the same actions, reduces pollution at a lower cost. If my firm can reduce pollution at $25/ton, & your firm costs $50/ton, I sell allowances to you somewhere between $25 and $50. If the price is $40 a ton, I make a $15/ton profit, and you cut costs by $10/ton. We both win & pollution is reduced. It is economically efficient.”
Katherine Kling. “Emissions trading versus rigid regulations in the control of vehicle emissions”. Land Economics. 1994 – “Previous empirical studies of the cost savings associated with incentives-based systems compared to command-and-control (CAC) systems of emissions control have found significant cost savings potential for incentives-based systems relative CAC. Teitenberg summarizes eight permit system studies for air pullution and calculates that the ratio of control costs under CAC to permit system range from 1.07 to 22.0.”
Global Climate Change Research Area Environment Sector. “Upstream and downstream approaches to carbon dioxide regulation”. 2005 – “By sending price signals to all fuel consumers and allowing them to choose the most cost-effective approaches to lowering emissions, an upstream market-based approach would provide incentives to achieve emissions reductions at lowest costs”.