Emissions trading (or emission trading) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. It is sometimes called cap-and-trade. In an emissions trading system, a central authority (usually a government or international body) sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups are issued emission permits and are required to hold an equivalent number of allowances (or credits) which represent the right to emit a specific amount. The total amount of allowances and credits cannot exceed the cap, limiting total emissions to that level. Companies that need to increase their emissions must buy credits from those who pollute less. The transfer of allowances is referred to as a trade. In effect, the buyer is paying a charge for polluting, while the seller is being rewarded for having reduced emissions by more than was needed. Thus, in theory, those that can easily reduce emissions most cheaply will do so, achieving the pollution reduction at the lowest possible cost to society The question facing governments is whether they should adopt an emissions trading scheme as a major component of their strategies to combat global warming. Numerous questions frame this choice and debate: Is an emissions trading scheme an effective way to reduce emissions and combat global warming? Does it harness the markets in the most effective way to bring about emissions reductions? Does a cap-and-trade system provide the greatest incentive for companies to innovate new technologies and approaches to reducing emissions? Is it superior in this regard to a carbon tax? What are the economic consequences of a cap-and-trade system? Is a cap-and-trade system the most efficient and flexible way to reduce emissions while preserving the integrity of an economy? Is it more efficient than a carbon tax? Will a cap-and-trade system damage an economy or kill jobs? Is a cap-and-trade system complicated, hard to understand, and costly to manage? Does it require a large government bureaucracy? How does this compare to a carbon tax? Which is more feasible? What do the case studies in Europe and elsewhere suggest? Which is more politically feasible? Would publics go for a cap-and-trade system? What are the social and environmental justice issues in this debate? There are active trading programs in several countries. For greenhouse gases the largest is the European Union Emission Trading Scheme, which was initiated in 2005. In the United States there is a national market to reduce acid rain and several regional markets in nitrous oxide. Markets for other pollutants tend to be smaller and more localized. Emissions trading, though, is not wide-spread internationally. Many governments remain uncertain of its merits, and whether a carbon tax is a better idea? The debate remains open.
See Wikipedia’s emissions trading article for more background.
“In a cap-and-trade carbon market, total emissions are guaranteed to go down. The cap is the cap, and assuming some reasonably effective enforcement mechanism, not a pound more carbon can be emitted. A carbon tax, on the other hand, merely encourages people to emit less by making it more expensive to do so. And in the case of fossil fuels, people seem perversely resistant to financial incentives.”
A cap-and-trade system provides companies with credits if they are able to reduce their emissions below an established level. They can then sell these credits for a profit. So, if a company takes action to reduce its carbon emissions below the designated level, than it can make a profit. This is a powerful market incentive that is more likely to cause companies to invest money in finding ways to reduce their carbon emissions. A carbon tax, conversely, only provides the incentive of cutting costs, and does not offer this important profit motive.
“Subsidizing one or two targeted technologies with a carbon tax would discourage investment in others that may turn out to be more effective. Which technologies should receive these tax dollars? No one has a crystal ball that can determine for sure which will turn out to be most useful. History has shown that the marketplace does a better job of developing new technologies, and a tax takes money out of the marketplace. The solution is cap-and-trade. A cap-and-trade strategy provides the incentive for all segments of the economy to compete to discover the best ways to cut emissions.”
“Carbon Trading IS an Excuse to Avoid Real Emissions Reductions. The hopelessly compromised Kyoto Protocol now allows countries to meet all their emissions reductions with carbon credits bought through three forms of carbon trading; Joint Implementation, Clean Development Mechanism, International Emissions Trade. Some countries will certainly choose to buy credits rather than make any serious attempt to reduce their underlying dependency on fossil fuels.”
“The principal argument against trading programs is that they do not guarantee that improvements to air quality occur in the [local] areas that are most affected by air pollution. Some of the existing trading programs, such as the federal acid rain program for sulfur dioxide, allow trades over a very large region. While such programs do improve air quality in the aggregate, they do not necessarily reduce emissions at sources that make the greatest contribution to local air pollution and its resulting health problems.”
“Carbon taxes also avoid the baseline quandary that bedevils carbon markets. For example, signatories to the Kyoto Protocol are supposed to cut their emissions of greenhouse gases by 7 percent below what they emitted in 1990. Why? That goal has no relationship to any specific environmental policy objective.”
A carbon tax is simple enough that it can be implemented immediately. Emissions trading takes much more time. In the context of global warming, immediacy is very important.
“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].”
One of the strongest pieces of evidence supporting this argument is the United States sulfur dioxide cap-and-trade system, in which the economic costs of acid rain damage was dramatically reduced. According to the EPA, the benefits of the 1990 amendments exceeded implementation costs by a factor of four, with a maximum estimate of $1.4 trillion.
Nations that adopt a cap-and-trade system can later link their system into other cap-and-trade systems around the world. It would not be as easy for a carbon tax to achieve this. This is important in today’s global economy, where multinational companies exist across borders.
“There appears to be a misconception among many ‘lay economists’ that carbon trading is a ‘market mechanism’ while carbon taxes are not. However, government control of the quantity of an item being sold is no more of a market based mechanism than government control of the price. Where it counts, carbon taxes make far better use of market forces than carbon trading schemes.”
The main problem is that baseline emission allowances for companies are based on their past emissions. For this reason, a company has the incentive to emit as much as possible when these baselines are being set so that the baseline is above or at what the company is already emitting. If a company successfully tricks the system in this way, they will be able to emit carbon as they had before, with no reductions being achieved.
The costs of establishing and administering a cap-and-trade system could be substantial. It demands that a cap be set, monitored, and enforced. This is a highly complicated process, given the size of the energy market, and would demand substantial administrative oversight.
By generally making the status quo more costly for businesses, carbon trading can decrease revenues overall and lead to job loss.
Managing emissions trading costs governments money, yet it does not increase revenues, like a tax can.