Making the Case for Cap-and-Trade

Following news coverage can be easy. Understanding some of the terms it uses, less so. In our Flashcard series, The Atlantic explains ideas you may read about but never see spelled out. In this installment, we dig into the case for cap-and-trade.

The News

As the Senate considers an energy bill in the wake of the oil spill, the hot-button issue is whether that bill will put a price on carbon. Various senators have proposed different ways of doing this, but most environmentalists' choice is a cap-and-trade system. The House passed a cap-and-trade bill last summer, and Sens. John Kerry and Joe Lieberman have included a similar plan in their plan. Most recently, Rahm Emanuel has suggested a weaker version that would apply only to utilities. How would a carbon cap-and-trade system work?

The Debate

The primary argument against cap-and-trade is that it will cost businesses and consumers prohibitive amounts and slow down the U.S. economy. Opponents of the House's cap-and-trade bill last summer dismissed a Congressional Budget Office analysis that found the program would cost about $175 per household because the analysis did not account for a cap that would be lowered over time. A recent EPA analysis of Sens. Kerry and Lieberman's bill, however, took a longer-term view, finding that the plan would cost households an average of $79 to $146 per year through 2050.

Another argument stems from concern that if the U.S. institutes a cap-and-trade system, it will fall behind non-capped countries in the global economy. But this argument does not account for the growing global market for green technology. China is moving full-steam ahead on exportable green technologies, such as hydropower and nuclear. Cap-and-trade could help us catch up by pushing producers toward innovation. Ultimately we'll need to persuade large developing countries to cap and trade their own emissions, but we can't lead by example without, well, an example. The E.U. and New Zealand have cap-and-trade systems, and Japan is very close.

Transitioning to a new, greener economy will cost us, no matter what. A cap-and-trade system in which we auction carbon credits to large-scale polluters, however, would let the market determine the cost. Unlike a carbon tax, which discourages emissions without creating a hard ceiling, cap-and-trade ensures we reduce our emissions by specific amounts. Unlike our typical strategy to rely on government grants and subsidies, it doesn't let the feds determine which green industries deserve cash, and which don't. And unlike doing nothing, it would help us invest selfishly in a global green tech market and selflessly in the planet.
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For more Flashcard posts:

The Value-Added Tax

The Contagion Effect

Deficit Spending (Stimulus)

The Oil Spill Liability Cap

Carbon Pricing

The Gist

The first thing to determine is the cap, or how much carbon dioxide large-scale polluters could emit each year. The government would create a carbon credit (also known as an allowance, or emissions permit) for each unit of carbon dioxide and then divide the credits among the polluters. One way of doing this is to "grandfather" the credits, handing them out for free based on businesses' previous or projected emissions. (The E.U. tried this in 2005 but created too many credits to truly pressure energy producers.) A more effective way of dividing the credits is to auction them off, which the E.U. has begun to do. This method would generate revenue that the government could invest in renewable energy and economic development or even kick back to businesses and consumers to ease the transition to more expensive energy.

Each polluter can emit as much carbon dioxide as its credits allow. If a particular business manages to increase efficiency and reduce emissions, it can sell excess credits to businesses that emit more than their allocated units of carbon dioxide. The cost of credits traded between businesses would be determined by the market. Another product sold on this market would be carbon offsets, a way for utilities to earn additional carbon credits by funding renewable energy or carbon reduction activities--a wind farm in California, say, or a reforestation project in Costa Rica.

Over time, the government would lower the cap, reducing the number of carbon credits available and thereby making them more expensive. As the cost of credits rose, investing in technology to significantly reduce emissions would become cheaper than buying extra rights to pollute. Consumers would also feel financial pressure to reduce their energy consumption, since companies would pass on the higher cost of energy.