Question

Explain how a "cap and trade" system works. What are its virtues and drawbacks?

Answer 1

Cap and trade is a climate policy combining economics and environmentalism to foster a limit on potentially harmful emissions of greenhouse gases. It puts a price on what firms release into the atmosphere, enabling pollution to be reduced while generating monetary benefits that can help local and regional economies. The greenhouse gas emission ceiling sets a strict limit on what in any given region is acceptable. The limitation tightens with time, forcing organizations to keep moving towards better systems. It is a process that usually takes 10 to 20 years to begin to reach levels considered environmentally acceptable.

Pros are:

It creates a specific total cap which is then divided into allowances.
Companies that exist within a cap and trading system are given a specific distribution of how much they can produce by the government. While there is nothing in place to stop the agencies from going over that limit, fines for cap violators are usually involved. Some regions are only going to distribute their caps through an auction instead of free distribution.

Companies that cut their levels of pollution faster can then sell their allowance to other more polluting agencies, giving them the opportunity to bank them for future use. This advantage gives both companies some extra flexibility, increasing the pool of available capital while helping those who are lagging behind a way of avoiding excessive fines or additional costs. By offering a tangible cash infusion when less greenhouse gas emissions are produced, cap and trade rewards innovation.

Because the government can choose to auction the highest bidder for carbon permits, a new revenue stream is generated that can fund infrastructure needs, social programs, and national defence. While this system's critics would call these funds an incentive to pollute, money can also be directed toward affordable energy and new technologies that enable us to do more with fewer resources. It can even be a way to start reducing a federal or national budget deficit.

Cons are:

It does not encourage some industries to change their behavior.
One of the most significant problems with the cap and trade system is that it will encourage fossil-fuel-addicted industries to continue their polluting behavior. This scheme allows carbon credits and inexpensive offsets to be bought that cost less than a change from the fuels that first produce greenhouse gases. There is no incentive to switch to renewables or become innovative as there is no impact on the required price.

Cap and trading systems can also encourage cheating on some businesses.
The only way to ensure compliance with a cap and trading system is to set up some kind of monitoring device that tracks greenhouse gas outputs from any organization. If there is no way to determine who stays within the boundaries of the economy, then the government relies on the principle of honor to promote a reduction in elements of climate change. This structure may create some compliance, but it also encourages businesses to cheat on the system. Agencies can continue to pollute as usual, distracting future generations from the overall picture of trying to save the world.

For them to work, the caps on this system must be rigid.
To order to maintain their business opportunities, it is not uncommon for organizations in a cap and trade system to demand extensions or additional space under the limit. For this system to work, the government must be firm in enforcing a maximum level of emissions. If extensions for a heavy polluter are continuously granted, then there is no point in having this structure in place. Continuous program changes that allow additional pollution will reduce the value of the mechanism of trade, which puts this option on the road to immediate failure.