Which program is an example of cap-and-trade, and what is its basic mechanism?

Which program is an example of cap-and-trade, and what is its basic mechanism?

• A. A gas-tax with no trading.
• B. A subsidy program for renewable energy.
• C. A command-and-control regulation requiring technology.
• D. The sulfur dioxide cap-and-trade program under the Clean Air Act; emissions allowances allocated and traded to meet a cap.

Answer: (D)

Cap-and-trade couples a strict limit on total pollution with a market for emissions permits. The sulfur dioxide program under the Clean Air Act is the classic example: the government sets a cap on overall SO2 emissions and issues a limited number of allowances (permits) to emit a ton of SO2, which are then allocated to the firms. These allowances can be bought and sold, so a plant with low abatement costs can reduce emissions more cheaply and sell its extra allowances to others. This creates a single, enforceable emissions limit while letting the market determine the most cost-effective reductions. Over time the cap is tightened to cut total pollution further. The other approaches aren’t cap-and-trade: a gas tax sets a price on emissions with no trading; subsidies fund specific technologies; and command-and-control regulations mandate technology without a market for permits.

Cap-and-trade couples a strict limit on total pollution with a market for emissions permits. The sulfur dioxide program under the Clean Air Act is the classic example: the government sets a cap on overall SO2 emissions and issues a limited number of allowances (permits) to emit a ton of SO2, which are then allocated to the firms. These allowances can be bought and sold, so a plant with low abatement costs can reduce emissions more cheaply and sell its extra allowances to others. This creates a single, enforceable emissions limit while letting the market determine the most cost-effective reductions. Over time the cap is tightened to cut total pollution further. The other approaches aren’t cap-and-trade: a gas tax sets a price on emissions with no trading; subsidies fund specific technologies; and command-and-control regulations mandate technology without a market for permits.