CREDIT: <a href="">Cesar Aponte</a> (<a href="">CC</a>).
CREDIT: Cesar Aponte (CC).

Policy Innovations Digital Magazine (2006-2016): Briefings: Cap and (Fair) Trade

Jul 11, 2007

Climate change is rising on the agenda in many world capitals due in part to the emergence of market-based mechanisms and their embrace by both industry and environmental advocates. In the United States, corporations and nongovernmental organizations have formed the U.S. Climate Action Partnership to push through Congress the most popular of such mechanisms: carbon emissions trading.

Since the approval of an emissions reduction plan in California and the recent Democratic takeover of the U.S. Congress, industry has been more vocal in its support for developing a federal emissions reduction plan that would not significantly impact the economy. The sense is that some form of federal legislation is on the horizon, and that coping with a nationwide policy will be easier and less costly than a patchwork of regional or state climate regulations.

Carbon emissions trading, also known as cap and trade, is one of the policy tools preferred by industry to reduce greenhouse gas emissions in the United States. Cap and trade essentially makes a tradable commodity out of the permission to emit carbon dioxide into the atmosphere. First, a cap is placed on the total amount of carbon dioxide that participants can emit. A governing agency then assigns permits indicating the level of carbon dioxide that participants can emit over a particular period of time. It is expected that some participants will desire more permits than originally allocated to them, while others will have excess credits. The resulting disequilibrium creates a market for permits to be bought and sold on a trading exchange. Emissions caps tighten over time.

To assure the effectiveness of such a scheme, accurate measurement and reporting of emissions is necessary, as is the enforcement of penalties in cases of fraud or noncompliance. One efficient option for enforcement would be to have companies self-report their emissions per facility, post that information on the internet, and have regulators audit those facilities for compliance.

Mainstream environmentalists, such as Natural Resources Defense Council, praise cap and trade as an important and effective step toward combating global climate change, though experiences from the European Union's young cap and trade system have generated skepticism among other environmental groups and advocates. When the EU Greenhouse Gas Emissions Trading Scheme was launched in 2005, it distributed permits based on company estimates of their annual carbon dioxide emissions. By April 2006, the EU's official accounting of emissions revealed that the actual emissions of many companies, including power plants, were below estimates, prompting accusations that some companies had inflated their figures.

Michael Dorsey, environmental studies professor at Dartmouth, lays blame on the EU for not auctioning off the permits and, essentially, subsidizing emitters by handing them profitable commodities. Auctioning of permits would function in the same manner as when governments auction off their bonds. Price and allocation would be determined through a process of open competition, providing reliable process of price discovery. Companies would bid for their necessary number of permits based on good information about price, and those willing to pay the most would win the permits. But auctioning off all the permits would have the same economic effect as a pollution tax: a shift of wealth from the private to the public sector. A balanced approach would allocate a portion of permits and auction the rest.

The EU system was further weakened by provisions that allowed companies to purchase cheaper offset credits from abroad. Others fear more traditional subversion of policy. According to Peter Morici, professor at the University of Maryland School of Business and former chief economist at the U.S. International Trade Commission, "The very process of allocating carbon use among businesses would create a playpen for lobbyists and Washington dealmakers that would feed corruption and exacerbate the economic damage."

There are also concerns from the environmental justice movement about the disproportionate impact a cap and trade system would have on low-income communities. Studies of communities near industrial sites have shown higher rates of cancer and asthma due to pollution. Under cap and trade, pollution is likely to continue at such sites due to the distribution of permits. Though overall emissions may be reduced, families living near polluting facilities will endure greater health risks and live in an environment behind most of the world in terms of environmental quality.

Peter Singer, professor of bioethics at Princeton University, and Alex Evans, a senior policy associate at the Center on International Cooperation at New York University, have argued that a truly global cap and trade system could earn developing countries tens of billions of dollars for development purposes from the selling of unneeded permits. According to Evans, if the "carbon cake" is divided on the basis of population, financial gains from emissions trading could exceed the $100 billion of global foreign aid disbursed each year. Developing countries would also have incentives to invest in renewable energy and clean technology to keep emissions down and allow for the continued profitable selling of permits.

A population-based emissions trading scheme would certainly attract the interest of China and India, which currently reject any quantified emissions reduction targets. The participation of these two emerging powers would go a long way toward securing developing world participation and a new global framework that goes beyond Kyoto.

Despite the consensus among policymakers about the need to combat climate change, there is a great shortage of ideas when it comes to protecting the interests of the poor living in dangerous hot spots. Elites may eventually come to an agreement that resembles those proposed by Singer and Evans, but if it does not include mechanisms that prevent unjust environmental health impacts on disadvantaged communities, such an accord will still fall short of its ethical responsibility. If all greenhouse gases are to be divided by the global population, giving each person a fair share of responsibility for the world's pollution, each person should also have a fair share in the benefits of any cap and trade system.

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