Cap-and-Trade or Carbon-Tax (Part I)

© Copyright bernard bradley and licensed for reuse under this Creative Commons Licence.

I've been hearing a great deal of climate change discussion in the news lately, but the discourse has generally overlooked the policy implementation debate. Meaningful action to mitigate climate change has been held back by the lack of consensus regarding whether a cap-and-trade or carbon tax system should be implemented. Finding a harmonious answer to this problem is imperative to the success of a global response to climate change. Today’s post, analyzing cap-and-trade systems, is the first of two posts that will cover the debate (the second post will examine carbon tax systems). 

Cap-and-Trade Overview

A cap-and trade system works through the oversight of a central governing body as they are responsible for setting the cap— the limit on the amount of emissions that can be polluted. After setting the cap, the authority distributes permits to emitting firms. The total amount of emissions allowed through the permits will equal the level of emissions set by the cap and firms must acquire permits in order to emit. The authority has the choice of auctioning off the permits, distributing them evenly to all emitting firms, or distributing them to each firm proportionately based on their past emissions. The trade part then comes into play as firms are free to trade permits to one another in the emissions market. Firms are rewarded for lowering their emissions by the revenue they receive from selling permits, and thus, in theory, firms will lower their emissions. 

Pros

• Efficient: Firms that can reduce emissions at low prices will do so, and then sell their permits to firms that face higher costs in reducing emissions. 
• Allows for setting the maximum level of emissions. This facilitates staying on a predetermined emissions track and thereby not crossing potentially catastrophic emission thresholds. 
• The risks of market volatility are lessened as the desired quantity of emissions cannot be exceeded. 
• Firms have incentive to monitor each other, because cheating firms lower the value of all permits. 
• The substantial profits the governing body receives from auctioning the permits.
• It would facilitate global co-operative action. 

Cons

• The market may lead to highly volatile prices for consumers.
• The market requires the participation of many firms/nations to be succcesful.
• Significant resources are required to monitor the market and track firms/nations to ensure they don't cheat. 
• Considerable time and planning would be required to implement the system. 
• Many environmentalists oppose the idea of issuing 'rights to pollute'.

My next post will analyze the carbon tax alternative and evaluate which option is better suited for efforts to mitigate climate change.