Cap and Trade to Reduce GHG Emissions

By Leo Covis

California has recently implemented a Cap and Trade system to reduce emissions of Greenhouse Gas (GHG) emissions in the state. What is Cap and Trade and how does it work? The following is a policy brief clarifying the most important aspects of Cap and Trade which have been implemented in California’s system. A nation-wide system for auctioning and trading GHG emissions would go a long way toward mitigating climate change.

How it works

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Cap and Trade programs set limits on the amount of carbon dioxide and its greenhouse gas (GHG) equivalents that industries can emit, but allow market forces to decide how industries reach that limit. Rather than choosing winners and losers, Cap and Trade sets a benchmark, establishes rules, and lets the economy do the rest.

The Details

  • Regulators set up auctions for businesses to purchase GHG allowances with a minimum and maximum price (price collar).
  • Regulators set a limit on GHG for a given year and let businesses decide how much to pay for their emissions.
  • Polluters reduce emissions as much as they can in order to need to buy the fewest allowances, thus driving innovation in clean and green technology.
  • If a business purchases more allowances than it needs, it can bank them and use them in another period, or sell them to another business that bought too few.
  • If a polluter can’t reduce emissions and has purchased as many allowances as it can, it can pay other businesses to offset their emissions or undertake other activities that reduce GHG, such as reforestation. These offsets must be verifiable.
  • Offsets, if regulated properly, provide a fail safe for heavier polluters to be able to stay in business while global levels of GHG will continue to decline.
  • Revenues from allowance auctions can be used to fund research or subsidize renewable energy.

A Cap and Trade system has been used in the US to effectively eliminate the threat of acid rain. Thanks to Cap and Trade, emissions of sulphur and nitrogen oxides are well below the level that causes serious environmental harm. Other countries have also implemented carbon Cap and Trade systems, to varying degrees of success. Their shortcomings are opportunities to learn. In Europe, the system’s “cap” was set too high, and offsets were too easy to acquire without oversight, leading to few real reductions in GHG. Those experiences should inform the parameters of a system here.


It’s time to implement a nation-wide Greenhouse Gas Cap and Trade system for all polluting industries with the following specifications:

  • A cap that is strict enough to encourage businesses to seek as many energy efficiencies as possible
  • A cap that can be adjusted if need be. If emissions plummet, regulators should be able to lower the cap; if compliance proves impossible, there should be a mechanism for upper adjustment
  • A system of offsets that reduces the probability of “leakage” by clearly stipulating that in order for offsets to count, regulators must be able to confirm that they are permanent and have removed GHG from the atmosphere
  • A price collar and banking options for allowances to ensure price stability
  • Apply to all industries that emit GHG

Other Options

Cap and Trade is not the only way to reduce atmospheric GHG. Other proposals have benefits, but greater drawbacks than Cap and Trade.

Carbon Tax 
Tax carbon dioxide and other GHG, thus raising their prices and reducing demand.

  • +  This type of tax would be fairly easy to administer.
  • −  A tax does not guarantee a reduction in GHG, only an increase in price.
  • −  Most economists agree that a carbon tax would hurt the poor more than the rich. Some suggest using revenue from the tax to subsidize costs for low-income families, but this would mean that they would continue using the same amount of carbon as before.
  • −  Taxes in general are politically unpopular, making this option less feasible.

Command and Control
The government could just tell businesses and consumers how much they are allowed to pollute. It would be up to them to decide how and if to comply.

  • +  Strict regulations could lead to big drops in GHG.
  • −  Businesses may decide to move their operations to places with more lax restrictions, thus hurting local economies without reducing GHG.
  •  −  Regulations would likely hurt low-income consumers by increasing the price of goods and services.

Business as Usual
There’s always the option of doing nothing and hoping that it will somehow turn out okay in the end. This is not an acceptable alternative.


Leo Covis is a first-year MPP student at the Goldman School of Public Policy.