Cap-and-trade could eliminate greenhouse gases

By Zach McDade

Out of the many exciting and revolutionary ideas to emerge from this month’s Focus the Nation teach-in, there also came criticism of a cap-and-trade scheme to combat global warming.The vocal critic of this approach asserted that the scheme itself is inherently flawed; he claimed that it inevitably involved corruption and profiteering, and that it would ultimately be more destructive to the environment than no help at all. Economics disagrees.

A cap-and-trade method of pollution reduction would auction pollution permits to polluters, selling the right to pollute. By limiting the number of permits, the government limits total pollution. If a firm lowers its level of pollution, it can sell its excess permits to other firms at a market-driven price. Thus each firm has an incentive to reduce emissions as much as possible. The cap would be gradually lowered over time (the government would buy up permits), requiring firms to emit less and less until an acceptable total level of pollution was reached.

This scheme has strong advantages over its alternatives. The opposite of this market-based approach is a command-and-control policy. The government would mandate a certain level of acceptable pollution and impose huge fines on violators. This method, however, only induces firms to reduce emissions to the mandated level, rather than providing an incentive to reduce as much as possible. It also has the less tangible effect of alienating firms from the idea; when something is imposed, it is done unwillingly.

The middle of the road carbon tax is too indirect. It creates government revenue that can be used to research and develop better technology.

But there is no good way to ensure that the government invests the revenue in the firms most able to use it. After the initial permit purchase, the market approach naturally allocates resources efficiently. Additionally, big polluters with deep pockets can simply pay the tax if it is cheaper than new technology. A market approach encourages everyone to reduce pollution.

A cap-and-trade system does involve the potential for corruption. If the government gave away permits to big polluters – as has happened in Europe – they could actually profit from the deal. Also, if the government issued too many permits, they would be so cheap that firms would have no incentive to reduce pollution.

At least in theory, both problems have remedies. For the first, establish an elected, accountable oversight committee with no direct interest in permit revenue. For the second, set an appropriately low cap and enforce it. While both these solutions pose technical difficulties, a cap-and-trade scheme is downright simple compared to the problems we face by doing nothing.

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