Cap and trade is the popular name of a system of managing emissions that relies on market forces to reduce releases of environmentally harmful gases and other pollutants.
In a cap and trade program, a government or other international organization allocates a certain number of permits to a source of emissions such as an industrial or municipal site. Each permit - also known as a credit - allows the source to emit a certain amount of a specific pollutant such as sulfur dioxide or nitrous oxide. The total number of permits is often based on the source's historical performance.
These permits are limited or capped (the origin of "cap" in "cap and trade"). Each source must follow strict guidelines for measuring and reporting its emissions of pollutants. If a source of pollutant finds that its emissions must exceed its cap, it searches for a company or source that has unused credits.
The higher-polluting source then buys these credits in sufficient amounts to cover its emissions. This is the "trade" component of "cap and trade."
Benefits of Cap and Trade
A cap and trade arrangement rewards companies or sources that pollute less, by giving them the ability to increase their revenue through sales of permits. By the same token, a cap and trade program penalizes heavy polluters by forcing them to buy permits on the open market.
The cap and trade system provides an incentive for all companies to reduce their emissions. Those sources that can cut their pollution efficiently have an incentive to increase their efforts because of the revenue generated from selling credits. And companies that generate excessive pollutants become motivated to find innovative ways to reduce their emissions and cut their costs of buying credits.
Government Revenue Through Cap and Trade
Governments can earn revenues through the cap and trade system by auctioning off credits to sources. For example, the budget proposed by President Obama's administration in February 2009 projects that the federal government would generate nearly $650 billion between 2012 and 2019. It would also cut greenhouse gas levels 14 percent over 2005 levels, by 2020.
Has Cap and Trade Been Successful?
The U.S. has had positive experiences with cap and trade programs. In the 1990s, the Acid Rain cap and trade program, part of the 1990 Clean Air Act amendments, achieved large reductions in the amount of sulfur dioxide emissions at costs dramatically lower than projected.
According to the Environmental Defense Fund , every power plant in the program reduced its sulfur dioxide emissions, for a the total reduction of 22 percent, or 7.3 million tons, below mandated levels. Costs of the program were about 0.8 billion per year after the first two years, far below pre-launch estimates of $3 billion - $25 billion per year.
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