Cap and Trade

Publication Date :

06 Aug, 2022

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Table Of Contents

Cap and Trade Definition

Cap and trade is imposed by governments to restrict greenhouse gas emissions. It is an attempt to conserve the environment. The system uses market forces to ensure that emissions do not surpass the specified target.

Emissions trading programs give manufacturers an incentive to move towards greener technology. The government sets a limit on carbon dioxide emissions and other pollutants. Permits are auctioned to the industries. Allowance holders can sell allowance limit credits in the allowance market.

Cap and Trade Definition

Cap and trade is an emissions trading program. Government combats carbon emissions by charging a penalty on industries that cause pollution.
Environmentally conscious firms gain monetarily by selling remaining allowances to other firms. Also, environmentally conscious consumers choose products produced by environmentally conscious manufacturers—every choice makes a difference.
The system has various limitations. In most cases, manufacturers have to spend a substantial amount to switch from regular technology to green technology. As a result, industries opt for penalties; there is no actual reduction in carbon emissions.

Cap and Trade Explained

Cap and trade is a governmental initiative against excessive carbon emissions. Governments try to curb levels of carbon dioxide and other pollutants produced by companies and industries—to ensure a cleaner environment.

Governments put a limit on emissions; Industries require allowances for every ton of greenhouse gas emitted by their manufacturing plant. But these allowances can be bought and sold in the allowance market. The government distributes allowance credits by auctioning them. To further reduce pollution, governments reduce the number of permits granted to industries every year.

Thus, emission trading programs simply make carbon emissions costly for the manufacturers—this penalty impacts an industry that is less conscious about the environment. When a manufacturer exhausts their emissions limit, they start working on cheaper alternatives—green and clean technology.

Environmentally conscious firms gain monetarily by selling remaining allowances to other firms. Some allowance holders even prefer to use the saved credit the next year. In contrast, when an industry exceeds the allowed emissions level, the government charges a hefty carbon tax (penalty).

Also, environmentally conscious consumers choose products produced by environmentally conscious manufacturers—every choice makes a difference.

Example

EU Emissions Trading System (EU ETS)

Europe is considered the world's largest carbon market. Europe enforces carbon pricing and advocates cost-effective measures to reduce the emission.

Iceland, Liechtenstein, and Norway have actively adopted the EU ETS; ten thousand installations have been made in the manufacturing sector, power sector, and airlines. These industries are responsible for 40% of Europe's greenhouse gas emissions.

Pennsylvania to Join Carbon Emissions Program

Pennsylvania is the leading fossil-fuel producer in the US. Pennsylvania has finally decided to enforce carbon pricing. In July 2022, the Environmental Quality Board voted in favor of carbon emission restrictions.

Pennsylvania adopting the cap and trade program is a significant step—it is among the five most carbon-emitting states in the US. The newly enforced restriction was made possible due to the efforts of the Regional Greenhouse Gas Initiative.

Pros and Cons

The advantages of the emissions trading program are as follows:

It has proven useful in limiting emissions up to a certain level when implemented with the carbon tax.
It has the potential to make the environment cleaner. As a result, people can become healthier, and the world can become a better place to live.
Permits and penalties on excess emissions are a source of government revenue. Governments can use this to meet budget deficits and fund crucial social projects and infrastructure development.
Many industries have been environmentally conscious since their inception. This program benefits such businesses. In the allowance market, they make a significant profit.
The emissions trading programs speed up technological innovation—toward sustainable and environmentally conscious alternatives.
Environmentally conscious consumers choose products produced by environmentally conscious manufacturers. Emissions trading program gives more power to such consumers.

Limitations of undertaking the cap and trade program:

Many governments impose cap and trade policies, but global cohesion between programs is lacking. Manufacturers see this as a loophole and shift production to locations that are less strict on emissions.
The companies find it expensive to adopt clean technology. Thus, they choose penalties over technological advancement—actual pollution levels continue to rise.
Often industries resort to unfair means to avoid paying hefty penalties—manipulation of authorities is rampant.
Emission levels are set significantly high. Businesses can neither afford newer technology nor the hefty penalties. Ultimately, customers bear the burden in the form of increased prices.
Renewable energy costs significantly more than non-renewable ones.

Cap and Trade vs Carbon Tax

The difference between both the regulations are as follows:

Basis	Cap and Trade	Carbon Tax
Meaning	Governments enforce Cap and trade programs. It is an attempt to curb carbon emissions and other pollutants. Manufactures can trade permits with each other.	A carbon tax is imposed on high carbon dioxide and greenhouse gas emissions.
Complexity	It is a very complicated system—compared to other emission control standards.	The imposition of a carbon tax is comparatively easy to implement and understand.
Transparency	Due to the complexity, common folks are unable to comprehend the standards. Many defaulting industries take advantage of the complexity and find loopholes.	Since it is directly imposed on the taxpayer (corporations), opportunities for fraud and default are limited.
Administrative Cost	High	Less
Sets Emission Limit	The emissions trading program puts a limit on carbon emissions for each company.	It doesn’t set any carbon emission limit.
Predictability	It leads to energy price fluctuations—especially for renewable energies.	When carbon tax is imposed, energy prices remain predictable and stable.

Frequently Asked Questions (FAQs)

What is cap and trade?

It is an emissions trading program. The government regulates carbon dioxide emissions and other pollutants. Then, the government uses market forces to ensure that industries go green.

Why are cap and trade bad?

The system has various limitations—the penalties make the goods and services expensive. Manufacturers have to spend a substantial amount to switch from regular technology to green technology. As a result, industries opt for penalties but do not reduce carbon emissions. There is a lack of consistency in enforcement—there is no single global carbon emission standard. There are multiple instances of manipulation and non-adherence. Manufacturers are stubborn—unwilling to change processes for the sake of the environment.

How does cap and trade work?

The government imposes an upper limit on carbon emissions—one ton of carbon emission per allowance. Any emission beyond this limit results in a hefty penalty. Further, green industries are permitted to trade leftover credit in the allowance market.