20 Cap and Trade System Pros and Cons

Cap and trade is a climate policy that combines economics and environmentalism to encourage a limit on potentially harmful greenhouse gas emissions. It puts a price on what companies release into the atmosphere, allowing for a reduction in pollution while generating monetary benefits that can help local and regional economies.

The cap on greenhouse gas emissions creates a firm limit on what is allowable in any given region. This restriction tightens over time, requiring agencies to continue making progress toward better systems. It is a process that usually takes between 10 to 20 years to start reaching levels that are considered to be acceptable to the environment.

Information from the NRDC suggests that carbon pollution is one of the primary fuelers of climate change. It triggers more asthma attacks, worsens air quality, and can lead to respiratory disease. Greenhouse gas emissions can even contribute to extreme weather events that are costly, destructive, and potentially deadly.

Then the trade function creates a market for companies to buy and sell their greenhouse gas emission allowances (usually carbon dioxide) based on a price that is governed through the supply and demand process. By trading these caps, companies have a stronger incentive to save or make money if they can cut levels enough to trade unused amounts to larger organizations.

List of the Pros of Cap and Trade

1. It creates a specific total cap that is then split into allowances.
Companies that exist within a cap and trade system are given a specific distribution by the government on how much they can produce. Although there is nothing in place to stop the agencies from going over that amount, there are usually fines involved for cap violators. Some regions will only distribute their caps through an auction instead of handing them out for free. It is a system that usually offers carbon emission caps in measurements of one ton, which is roughly the same amount a driver would generate when driving from Las Vegas to New York City.

2. The trading process can lead to faster cuts in pollution.
“Cap and trade allows the market to find the cheapest method to cut emissions,” says Nathaniel Koehane, who serves as a Vice President for Global Climate.

Companies that cut their pollution levels faster can then sell their allowance to other agencies that pollute more, providing an opportunity to bank them for future use. This advantage gives both firms some extra flexibility, increasing the pool of available capital while helping those who lag behind a way to avoid excessive fines or added costs. Cap and trade rewards innovation by offering a tangible cash infusion when fewer greenhouse gas emissions are produced.

3. Cap and trade encourages aggressive climate change goals.
China is one of the world’s most significant greenhouse gas emitters. The government launched the initial phase of a nationwide carbon market with help from the Environmental Defense Fund in 2017. It covers over 2,600 companies that support an economy of more than 258 million people. The system is currently the largest of its type in the world, and it is based off of the Emissions Trading System in the European Union that started in 2005.

The success from the EU cannot be denied. After capping emissions at the start of the program, stationary structures are producing 26% fewer greenhouse gases just a decade later. California institution a similar program and saw an 8.8% decrease in just 4 years of use without impacting the state’s economy.

4. Government revenues increase with cap and trade.
Because the government can decide to auction emissions credits to the highest bidder, a new revenue resource is created that can support infrastructure needs, social programs, or national defense. Although critics of this system would call these funds an incentive to pollute, the money can also be directed toward affordable energy and new technologies that allow us to do more with fewer resources. It can even be a way to begin resolving a budget deficit at the state or national level.

5. Agencies can purchase credits to retire them.
Even though the purchase of credits in the cap and trade system will allow for the legal release of greenhouse gases, there is nothing in the law which says you must emit carbon dioxide if you hold a permit. Agencies can decide to purchase credits that are placed up for auction, and then “retire” them by not using or trading them to another company. This action creates a lower overall cap that can reduce the number of nationwide emissions being produced. That results in a decrease of the harmful effects of climate change.

6. The overall cap in this system is gradually reduced over the years.
The government encourages innovation for everyone in a cap and trade system because the number of carbon dioxide credits (or other greenhouse gases) gradually reduces over time. When there are fewer opportunities to pollute, then it will cost organizations more to continue producing at the same levels. This plan results in fewer emissions being released into the atmosphere over time, which then reduces the overall impact of every industry.

Some governments may not institute a cap reduction, negating the benefit of lowering greenhouse gas production. This behavior does not alter the other advantages of this system.

7. Cap and trade eliminates the need for another tax in the economy.
The alternative to a cap and trade system is a carbon tax. When taxation is the preferred method used to reduce greenhouse emissions, then companies receive a specific charge for every ton of carbon dioxide they produce. You would still need monitoring systems in place to determine individual responsibility, while it only encourages innovation through the prevention of an added cost.

Because the allowances offered in cap and trade systems offer a tangible financial incentive to reduce emissions, it is typically a better system to follow because there will be more automatic compliance. There may be more instability in the final costs then there would be with a tax, but there are also more chances to improve the bottom line of an organization.

8. It is a system which gives consumers more choices as well.
Although there may be some goods and services that receive a price increase when a cap and trade system is in place to curb greenhouse gas emissions, consumers also have another choice available to them in this free market system. If a company decides that they will not comply with the terms of the system, then consumers can choose to do business with their competitors who are trying to reduce their pollution levels. Those who try to cheat the system can be avoided as well.

This advantage makes it possible for everyone to have a say in the health of our planet. Each person can begin the process of creating positive changes by becoming informed about which organizations are making an effort to stay in compliance.

9. Cap and trade can work with a carbon tax.
You will often see a comparison of cap and trade systems and a carbon tax, inferring that you can have one or the other, but not both as a way to reduce greenhouse gas emission levels. That inference is not true. The province of Alberta in Canada uses a hybrid policy that covers the largest carbon emitters with a cap and trade system, while smaller producers must pay a carbon tax instead.

Each region must examine its economics to determine the pros and cons of cap and trade in each sector. For British Columbia, it made more sense for them to use a carbon tax only as a way to reduce greenhouse gas emissions. Quebec prefers to use a cap and trade system. This option to help the environment allows each jurisdiction to examine its own profile, and then make changes which make sense for local industries without reducing competition levels.

10. This system can work to reduce other emissions as well.
An NRDC analysis of a potential cap and trade system that was considered in 2010 by the U.S. Congress found that setting limits on carbon dioxide emissions would have a positive impact on the number of additional pollutants which are placed in our environment each year. We are already limiting the amount of soot, lead, arsenic, and mercury that come from coal-fired power plants, yet there are no restrictions on the federal level about how much carbon they can produce.

“Since 1970, every dollar invested in compliance with Clean Air Act standards has yielded $4 to $8 in economic benefits,” The Fiscal Times notes. When there are new clean energy technologies employed by businesses because of a cap and trade system, then there will be new jobs created that help us to produce clean energy consistently.

List of the Cons of Cap and Trade

1. 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 the industries which are most addicted to fossil fuels to continue with their polluting behavior. This system makes it possible to purchase carbon credits or affordable offsets that cost less than a shift from the fuels that create greenhouse gases in the first place. There is no incentive to switch to renewables or become innovative because the required price as no impact. That means the government receives more money thanks to the maximum caps, but there is not a meaningful effort to actually curb carbon dioxide or other gases.

2. Cap and trade systems can also encourage some companies to cheat.
The only way to guarantee compliance with a cap and trade system is to institute some sort of monitoring device that tracks greenhouse gas outputs from every organization. If there isn’t a way to determine who is staying within the confines of the market, then the government is relying on the honor system to encourage a reduction in climate change elements. This structure can create some compliance, but it also encourages companies to cheat on the system. Agencies can continue to pollute as normal, distracting from the overall picture of trying to save the planet for future generations.

3. The caps on this system must be rigid for them to work.
It is not unusual for agencies in a cap and trade system to request extensions or additional room underneath the cap to maintain their business opportunities. The government must be firm in its enforcement of a maximum level of emissions for this system to work. If extensions are continually granted for a hefty polluter, then there is no point in having this structure in place. Continuous changes to the program that permit additional polluting will reduce the value of the trade mechanism, which places this option on the road to immediate failure.

4. It provides an unpredictable system of costs.
Cap and trade works with the free market system to determine what the final cost of the credits will be. Agencies which need extra resources because of their greenhouse gas emissions cannot effectively budget for the expense since no one knows what the final costs would be. Since there is unpredictability in this system, the economic advantages for the larger producers are limited because they must build in worst-case scenario pricing into their goods and services. The smaller, innovative companies might see better profits, but it is possible that consumers would be asked to pay significantly more for what they receive in return.

5. Cap and trade does not encourage reductions beyond target levels.
When emissions become cheaper than expected, which may occur in situations when an economic downturn occurs that can cause them to fall, then a carbon tax is a superior option because it provides a continuing price signal to agencies. The final cost with a tax encourages ongoing emission reduction, whereas a cap and trade system will only encourage reductions to the mandated target levels. Although that means you can schedule a specific set of targets that can cause carbon levels to decline over time, there is no way to encourage a faster response to this process. It will always be effective, but it may not always be as impactful as it could be during changing economic times.

6. Trade systems require a value cost to be effective.
In a standard cap and trade system, organizations have several different ways that they can obtain extra credits when they are necessary. The goal is to financially trade them with other companies who don’t need them to create an economic advantage, but this outcome does not always occur. There are times when the government decides to give them away to firms in a manner that is similar to a tax break. When businesses know that they can receive leniency in this system, then there is no incentive to change.

The only way to counter disadvantages like this one is to create a structured system which allows for zero exceptions. Without this line in the sand, the extra pollution can actually harm the economy because it costs more to clean up the mess.

7. The government ultimately dictates how many credits are available.
The government has the power in a cap and trade system to retire credits at their leisure. It is possible for them to cancel credits after issuance if an auction system was not used, denying the organization an opportunity to use them after receipt. This disadvantage creates the potential for retaliatory politics, especially in two-party systems like the United States.

The Trump Administration recently announced an idea that would allow for the resettlement of illegal immigrants crossing the border to sanctuary cities as a response to Democratic opposition to border policies. Take that concept, and then apply it to the rewarding or denial of emissions credits based on their support of government actions.

8. Emissions credits can be artificially high or low.
Because the cap and trade system works with free market principles, anyone can decide to purchase emissions credits if they have the financial means to do so. That makes it possible for anyone to “hold them hostage” against companies who would need to use them to stay within their legal system. It can also be a way to artificially change the price of each trade since there would be fewer available on the market. Artificial scarcity can drive up the price of all items in society, even if the ends justify the means by saving the environment. Those without a bevy of financial resources available to them would be unable to cope with these changes.

9. There is no consistency available unless a global cap and trade system is available.
The only way that cap and trade systems work on a global scale is if every country participates in programs that work within the same context and framework. When one nation permits higher levels of pollution than another, then there may be little impact on the number of greenhouse gas emissions that spill out into the atmosphere every year. Some societies may decide to be very strict, while others might offer leniency to ensure there is more compliance before trying to reduce the amount of carbon dioxide being produced.

10. The cost of implementation would be very high in the United States.
A cap and trade plan for the United States would eventually force the energy industry to either retrofit or decommission many of the structures we currently use to generate power. The Mercury and Air Toxics Standard is already the most expensive rule set by the EPA, with an average cost of $9.6 billion per year. When the added work of reducing carbon emissions is added to these requirements, the total cost could be upwards of $480 billion when one-time charges are added.

An Interesting Thought on the Pros and Cons of Cap and Trade

The cap and trade system is one of the most efficient ways to reduce greenhouse gases without creating an adverse impact on the overall economy. We must have legislation in place that creates strict limits on the amount of pollution allowable in society. There must also be strict penalties in place for the agencies who choose to stay out of compliance. The costs of doing business outside of the maximum cap must be higher than what they are for compliance for this system to work.

Evidence from existing cap and trade systems show that immediate results are possible. The United States could see upwards of a 20% cut in emissions in the next decade if it were to institute a nationwide policy for this system. The United Nations suggests that an 80% reduction in total emissions in necessary by 2050 to keep our planet healthy, which means we must act today to encourage this process.

The pros and cons of cap and trade suggest that this system is imperfect in some ways. There will always be outliers who try to get away with bending or breaking the rules. This system is also one that rewards innovation, encourages free market principles, and can work quickly to reduce the impact of carbon dioxide and other greenhouse gases on our environment. It is a necessary step that we can take for future generations.