It’s hard to watch the news and not hear the term Cap and Trade. But what does this mean?

Textbooks will tell you that it is a method for reducing overall emissions in a nation, region or industry.  Under a cap and trade system, the government sets a cap, deciding how much total emission will be allowed. Next, organizations are issued credits, essentially licenses to emit, based on how large they are, what industries they work in, and so forth. If these organizations come in under their cap, they have extra credits, which they can trade with other organizations. They may then profit by selling their extra credits; essentially profiting by not emitting. 

A cap and trade system penalizes organizations that do not come in under their cap for their excess emissions, as they must purchase additional credits. In a sense, the need to purchase credits acts as a fine, encouraging organizations to reduce their emissions.

This system has a history of success by controlling sulfur dioxide emissions. In the 1980s, industry was sending up vast amounts of sulfur dioxide into the atmosphere which were falling back to Earth in the form of acid rain. This was damaging lakes, forests and buildings across the Eastern U.S. and Canada. The Clean Air Act of 1990 was enacted using the then called “Emissions Trading” approach to help end acid rain.

Almost 20 years since this law, the system now referred to as “cap and trade” continues to let emitters figure out the least expensive way to reduce their emissions that cause acid rain. As a result, acid rain has been cut in half at a fraction of the cost. It has also generated benefits from avoided death and illness, healthier lakes and forests, and improved visibility on the Eastern Seaboard.

The premise of cap and trade is that government doesn’t tell emitters how to clean up their act. Instead, it simply imposes a cap on emissions. Each organization starts the year with a certain number of tons allowed; a so-called right to pollute. The organization decides how to use its allowance; it might restrict output, or switch to a cleaner fuel, etc… Each year, the cap ratchets down, and the shrinking pool of allowances gets costlier. It forces organizations to reduce emissions or match their allowances to emissions.

Why are we hearing so much about cap and trade in the news? Congress has been considering whether to expand this law/system/theology to cover carbon dioxide in hopes of further stemming emissions. There are plenty of advocates and proponents lobbying to defend their respective positions.