To Succeed, Cap-and-trade Must Be Revamped

14. Juli 2018

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An idea previously confined to academia and economic symposia may just prove to be the solution to the climate crisis. The concept? A once radical approach to mitigating environmental degradation called cap-and-trade.

Also known as emissions trading, cap-and-trade is a market-based tool which governments use to set limits (or “caps”) on emissions of one or more pollutants and distribute or auction allowances to regulated entities that, in turn, can trade the permits with one another on a secondary market. At the end of every compliance period, emitters have to hold allowances corresponding to their level of emissions.[1] In many ways, cap-and-trade is perfectly suited for reducing carbon pollution. But for the idea to live up to its full potential, proponents will have to address its structural deficiencies and more effectively communicate the benefits to an often skeptical public.

The U.S. Environmental Protection Agency (EPA) under the George H. W. Bush administration first popularized the idea of emissions trading as an innovative, conservative approach to environmental regulation.[2] In response to the severe problem of acid rain plaguing the Northeastern United States, in 1990, Congress amended the Clean Air Act to establish a tradeable permit program to curb harmful emissions from the electric power sector.[3] Electric power plants, based primarily in the Midwestern U.S., were releasing high quantities of sulfur dioxide, the main precursor of acid rain.[4] The emissions were drifting eastward, causing serious harm to streams, lakes, rivers, and other bodies of water in the Northeast.[5] As opposed to adopting a so-called “command-and-control” approach to the problem, in which regulators order each large emitter to reduce its pollution by a specific amount, the EPA allowed the market to determine where and at what cost emissions reductions would take place. Although many environmentalists viewed the idea with significant skepticism, the program yielded an extremely favorable outcome, reducing emissions at a price tag even lower than proponents had originally envisaged.[6] The policy’s success inspired those concerned about global warming to look to cap-and-trade as the ideal mechanism to curbing carbon pollution.[7]

As of 2017, nearly two dozen emissions trading systems (ETSs) with the explicit objective of cutting greenhouse gas emissions operate around the globe.[8] Governments administering cap-and-trade programs include supranational, national, and subnational jurisdictions, such as the European Union (EU), New Zealand, and the Canadian province of Quebec.[9] Because greenhouse gas emissions have the same heat-trapping effect regardless of their point of discharge, emissions trading proponents argue that cap-and-trade provides the flexibility necessary to significantly cut carbon pollution at a reasonable cost. Furthermore, since firms that mitigate their own emissions can sell their allowances on a secondary market, regulated entities have a financial incentive to limit their own pollution.

Cap-and-trade has many critics, however, who question its ethical, environmental, and economic benefits. Unlike a carbon tax, the cost of compliance under an ETS can fluctuate wildly, leading to an uncertain regulatory environment in which businesses hold back on investments in new technologies due to uncertainty regarding the value of their potential innovations.[10] The poorly designed EU ETS, which has created problems for both policymakers and industry, is a case in point.[11] Governments that lack significant regulatory and administrative capacity may also be unequipped to manage such a complex system, particularly when numerous emitters must comply with the program.[12] Still others object to emissions trading on the grounds that it “commodifies” the atmosphere, attaches a price to priceless common goods (such as clean air and a stable climate), and lets some large emitters off the hook by allowing them to achieve compliance through the purchase of emissions permits on the secondary market instead of via reductions in their own pollution.[13]

Public skepticism to cap-and-trade – and carbon pricing in general – threatens the future of emissions trading. Convincing the electorate of the value of higher prices for key goods and services, such as electricity and automobiles, is never easy. This is especially true when the public sees the problem to be prevented as one that will happen in the distant future and in far-away places.

Such a lack of support for cap-and-trade led to the repeal of Australia’s ETS in 2013[14] – a major setback for carbon pricing globally. The complexity of cap-and-trade makes it difficult for the public to understand how and why such a scheme functions.

Cap-and-trade’s critics have valid points. In order to build public support for emissions trading as a means to address climate change, policymakers will have to respond meaningfully to their concerns. They will also have to bolster public support for the policy by loudly and frequently highlighting its benefits for the economy, the environment, and social welfare. For inspiration, they should look to California, a state that recently extended its cap-and-trade program to 2030.[15]

California uses some of its auction proceeds to invest in infrastructure needed to meet its pollution reduction targets, such as electric vehicle charging stations and a high-speed rail line from Los Angeles to San Francisco.[16] The state agency in charge of administering the program, the California Air Resources Board, regularly uses social media to promote the scheme’s successes. The governor’s ability to earn support for the system from key stakeholders has also protected the ETS against difficulties that have plagued other jurisdictions’ programs. Moreover, policymakers have reformed the system to bolster its credibility with environmentalists. Key changes include the establishment of a price floor for emissions to ensure that the price of allowances does not fall below a certain level, a reduction in the amount of permits distributed for free, and stricter criteria on the use of offsets to achieve compliance.[17]

If designed and administered properly, emissions trading has the potential to avert catastrophic climate change. But for that to happen, its proponents will have to both fix what is wrong and champion what is right.




PictureFossil Fuel Gives Way To Solar Power, Gerry Machen.

[1] Nathaniel O. Keohane, “Cap and Trade, Rehabilitated: Using Tradable Permits to Control U.S. Greenhouse Gases,” Review of Environmental Economics and Policy 3, no. 1 (Winter 2009): 42-62,

[2] Richard Schmalensee and Robert N. Stavins, “The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment,” Journal of Economic Perspectives 27, no. 1 (Winter 2013): 103-122.

[3] Bonnie G. Colby, “Cap-and-Trade Policy Challenges: A Tale of Three Markets,” Land Economics 76, no. 4 (November 2000),

[4] Bernd Hansjürgens, “Introduction,” in Emissions Trading for Climate Policy: US and European Perspectives, ed. Bernd Hansjürgens (New York: Cambridge University Press, 2005), 5-6.

[5] Renee Rico, “The U.S. allowance trading system for sulfur dioxide: An update on market experience,” Environmental and Resource Economics 5, no. 2 (March 1995): 115-129.

[6] Ibid.

[7]  Nathaniel O. Keohane, “Cap and Trade, Rehabilitated: Using Tradable Permits to Control U.S. Greenhouse Gases,” Review of Environmental Economics and Policy 3, no. 1 (Winter 2009): 42-62,

[8] International Carbon Action Partnership, Emissions Trading Worldwide: Status Report 2017, (Berlin, 2017).

[9] Ibid.

[10] Lawrence H. Goulder, “Markets for Pollution Allowances: What Are the (New) Lessons?,” Journal of Economic Perspectives 27, no. 1 (Winter 2013): 87-102,

[11] Lawrence H. Goulder and Andrew R. Schein, “Carbon Taxes versus Cap and Trade: A Critical Review,” Climate Change Economics 4, no. 3 (August 2013),

[12] Peter Zapfel, “Greenhouse gas emissions trading in the EU: building the world’s largest cap-and-trade scheme,” in Emissions Trading for Climate Policy: US and European Perspectives, ed. Bernd Hansjürgens (New York: Cambridge University Press, 2005), 162-164.

[13] Jonathan Aldred, “The Ethics of Emissions Trading,” New Political Economy 17, no. 3 (2012): 339-360,

[14] Tim Nelson, “Australian Climate Change Policy – Where To From Here?,” Economic Papers: A Journal of Applied Economics and Policy 34, no. 4 (December 2015): 257-272,

[15] Chris Megerian, “Gov. Jerry Brown signs law to extend cap and trade, securing the future of California’s key climate program,” Los Angeles Times, July 25, 2017.

[16] Dallas Burtraw, Why California’s Cap-and-Trade Program Works, (Washington, D.C., Resources for the Future, 2016).

[17] International Centre for Trade and Sustainable Development, “California Moves Ahead with 2030 Extension to Cap-and-Trade Program,” BRIDGES 21, no. 28 (February 2018),

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Luke Sherman

Luke Sherman is a dual degree student at Columbia University and the Hertie School of Governance. He obtained his Bachelor of Science degree in Environmental Studies and French at Tufts University in Massachusetts. He is currently on a professional leave of absence analyzing matters regarding climate and development.