The term refers to ways of trying to reduce greenhouse gas (GHG) emissions by controlling how much GHGs are emitted from major sources, such as power plants and certain industries. The government grants polluting entities the right to emit a certain level of emissions, the so-called allowances, each year. Most often the companies are given these allowances without having to pay for them; sometimes they have to purchase the allowances. If the company emits more GHGs than provided by the allowances it received free of charge, or paid for, then it has to purchase more allowances from the government or another company that emitted less that what it was allowed and so has extra allowances it can sell to more polluting companies. Companies that have extra allowances can also warehouse, or save, the allowances to use in subsequent years when it may need such allowances to cover its emissions.

The amount of GHG emissions from particular industries or sectors of the economy, or theoretically everyone in the economy, is capped at a certain level and everyone subject to the system then trades its allowances — thus, a cap and trade. The US EPA describes it as “an environmental policy tool that delivers results with a mandatory cap on emissions while providing sources flexibility in how they comply.”

Ideally, such a system encourages companies to emit fewer GHGs so it can sell or save its allowances. Critics suggest that in most cases companies are given allowances for free and so there is less incentive to reduce emissions.

An alternative way of providing incentives for companies to reduce emissions is the carbon tax where all emissions of polluting carbon are taxed. The less you emit, the less tax you pay; the more you emit, the more tax you pay.

Some further ideas to explore on Cap and Trade:

Which companies should be subject to the cap and trade system where you live?

Analyze the economic pluses and minuses of providing cap and trade allowances either free or at a cost, and if at a cost, what should the cost be?

Compare the advantages and disadvantages of cap and trade versus carbon tax.

Sources

“What Does ‘Cap and Trade” Mean,” generation green: the blog of the center for environmental health  www.generationgreen.org/cap-trade.htm

Aofie O’Grady, “European Union attempts to tackle carbon market oversupply,” Commentary section of irish environment (01 Oct 2012).

United States Environmental Protection Agency, “Cap and Trade,” www.epa.gov/capandtrade/