ABSTRACT
Cap-and-trade schemes have become a leading policy option for the control of greenhouse gases and many other air and water pollutants. These policies seek to “internalize” the external costs of pollution by creating a limited number of rights to emit a unit of pollution, often referred to as “emissions allowances.” By requiring emissions sources to surrender one allowance for every ton of pollution emitted, the policy imposes a fixed cap on total pollution from all sources. In addition, cap-and-trade policies allow pollution sources to trade emissions allowances to minimize the costs of meeting the total emissions cap. Cap-and-trade supporters cite both aspects of the policy as crucial advantages in terms of meeting firm environmental goals in the most cost-efficient manner possible. At the same time, critics cite potential problems with cap and trade related to the risk of increased local concentrations of pollution, social and environmental problems from the use of “offset” credits for reductions of emissions outside the cap, allowance price instability, poor tracking of emissions or allowances, and possible windfalls to companies from free allowances. Recent cap-and-trade policies have developed innovations to try to address these criticisms, including a shift to auctioning allowances and imposing restrictions on some forms of trading or offset programs.
