Cap & Trade 101

Back when Henry Ford was cranking up the assembly line and Pittsburgh’s steel mills were going full force, the air was still relatively clean and no one dreamed of the environmental fix we’d be in now. After years of spewing all kinds of things you shouldn’t breathe into the air, we find ourselves at a crossroads as to how to handle the question of who gets to pollute and how much.

Because there is no way we are going to give up our beloved internal-combustion engine or big factories in China, emissions trading seems to be here to stay.  What is emissions trading? It is a way to control pollution by assigning an economic cost to polluting and then regulating the amount of pollution. In an emission trading system, a central agency sets a cap on the level of pollution that is emitted. If a company emits more than that level, they have to pay a central agency. If a company emits less than its allowances, it can sell the allowances, producing a trading market for those who exceed their limits. Hence the name “cap and trade”.

This system has been called “free market environmentalism”. However, that is a misnomer, because the entire system is dependent on central agency regulation – hardly a free market. Over time, the emissions limits are supposed to be reduced, and emitters will adapt with changing technology over time. The idea behind cap and trade is that it gives economic incentives to reduce pollution, and freedom to control how to reduce emissions and how much emissions.

Critics of Cap & Trade say that the central agency has too much power, may set the limits at an unattainable level, and the fees are not set by the market. The system also requires robust regulation to  measure and regulate the amount of emissions. Otherwise, if a company decides to let out a few more emissions than it is paying for, who’s to know?

Supporters of Cap & Trade say that it is the only system we have, and we need a system so let’s go with it. The EPA says on its website “Successful cap and trade programs reward innovation, efficiency, and early action and provide strict environmental accountability without inhibiting economic growth.” Let’s hope all government programs work that well.

It seems that Cap & Trade works best on a large scale, and we hope resulting in large offsets. Paul Krugman however, points out the significant disparity between the efforts to reduce sulphur dioxide emissions in the United States and in Germany. The United States has a cap and trade program which hopes to reduce emissions by 35% over twenty years. Sound good? Compare that to Germany which has reduced sulphur emissions by 90%. Why the difference? In Germany, there was regulation which demanded the reduction of Sulphur dioxide emissions with stiff penalties for exceeding limits. Seems like regulation has worked in Germany.  It’s debatable whether it will work in the U.S.