Cap and trade is a form of emissions trading that allows the government to regulate the number of greenhouse gasses released into the atmosphere while reducing the number of organizations depending on solutions such as coal as a power source. Cap-and-trade allows the market and producers to determine the carbon price and drive investment decisions toward innovation and more efficient techniques. Compared to other market-based environmental conservation solutions, cap-and-trade programs differ from command-and-control, where the government dictates technological options or stipulates performance-based standards for facilities (Jin et al., 2016). Although there are several other initiatives aimed at limiting industry emissions, cap-and-trade programs have proved to be more effective due to the ability to improve energy applications by leveraging emissions.
Carbon tax approaches were initially recommended because they allow organizations to project their compliance costs and deter the fear of carbon price volatility by imposing a fixed price on emissions. On the other hand, a cap-and-trade system ensures a steady reduction of emissions by creating a cap level and distributing allowances based on predetermined values. Unfortunately, these values are exposed to compromise because the quantity of reduced emissions is usually unknown until the program is implemented for some time (Chen et al., 2020). Additionally, implemented tax levels in carbon tax approaches are difficult to amend once implemented. Moreover, interest groups lobbying for carbon tax reductions can demand exemptions that are difficult to reject (Chen et al., 2020). However, the cap-and-trade approach provides solutions to reduce the burden on carbon-dependent industries using free allowances. Therefore, a cap-and-trade process is essential in filling the loopholes observed in the previous tax regimes and maximizing the program’s integrity. However, it is critical to observe appropriate implementation approaches for reliable results.
According to Ameyaw et al. (2019), the US has the second-highest carbon emission rates, with China leading as the significant emitter. In 2018, the United States recorded releasing about 5.41 billion metric tons of CO2, suggesting that most implemented programs have not attained their goals (Vo et al., 2020). The sectors that account for the highest carbon dioxide emissions levels include power generation, transport, and manufacturing. However, the US’s position as a major producer of crude oil has encouraged an overreliance on coal for generating electricity because it is more cost-effective than other readily available solutions (Grasso & Dutta, 2018). Contrastingly, the cap-and-trade program sets a price on excess coal emissions to drive shareholders towards more environmentally friendly energy sources.
Schmalensee & Stavins (2017) suggest that cap-and-trade is the best climate policy as it limits the quantity of greenhouse gas emissions and fines excessive emissions or violations simultaneously. The cap is a firm stipulation of the number of gaseous emissions by organizations, while a trade is a market for organizations to buy and sell their cap shares, thus allowing them to omit a specific amount of greenhouse gasses according to the demand and supply (Jin et al., 2016). The market price for CO2 allocations fluctuates automatically and consistently. Additionally, they can adjust for changes in abatement costs relative to price changes in fossil fuels, electricity demands, and technological advancements (Schmalensee et al., 2017). As a result, the cap-and-trade program allows shareholders to observe reductions in the number of emissions using CO2 market prices. Consequently, it provides an opportunity to trade allocations as an incentive to save and cut emissions cost-effectively.
Researchers also support that market-based approaches such as the cap-and-trade program allow countries to make targeted and ambitious climate goals. For example, California’s climate policies have resulted in a steady reduction of the region’s CO2 pollution. Furthermore, the European Union’s Emissions Trading System analysis suggests that capped emissions from establishments and stationery structures had reduced by 29% in 2018 compared to when the program was launched in 2005 (Aldy, 2020). On the other hand, greenhouse gas emissions from sources regulated by the cap and trade regulations showcased a drop of 10% between 2018 to 2013 when the state launched the program (Vo et al., 2020). Research by Schmalensee & Stavins (2017) also states that cap-and-trade programs are more effective when countries collaborate and align their initiatives. For example, in the US and Canada, California and Quebec integrated their cap and trade programs in 2014, resulting in a more robust market with great potential (Aldy, 2020). Results over the years exhibit notable changes as both California’s and Quebec’s economies are thriving.
Haoqi et al. (2017) explain that there has been an ever-growing consensus among policy analysts and economists that market-based policy instruments targeting greenhouse emissions should be the central element of domestic climate policies. However, even though there are trade-offs between cap-and-trade systems and their alternative, the carbon tax, the best approach for short-medium term initiatives in the US is the cap-and-trade approach. The researchers add that shareholders can maximize the environmental integrity of a cap-and-trade system for climate conservation by targeting all fossil-fuel-related emissions using an upstream, economy-wide trajectory that begins with less strict regulations that gradually become strict (Haoqi et al., 2017). The recommended approach is essential as it will help establish a long-run price signal and investments. Nonetheless, the program should adopt effective strategies to protect shareholders against cost fluctuations and uncertainty, including linking the program with policy actions in other countries for uniformity.
On the other hand, individuals criticizing cap-and-trade policies suggest that the program is at risk of several weaknesses, such as generous allocations of allowances to encourage entities’ cooperation, weak emission caps, and volatile prices. However, these issues are a result of inappropriate system designs that have straightforward solutions. For example, developing more strict caps, ceilings, and price flows can help avoid volatility. Additionally, auctioning emission allocations instead of giving them away can help stabilize market prices, as observed in the European Union Emissions Trading Schedule (Zetterberg et al., 2014). California is one of the regions that have made substantial strides in addressing program-design-associated issues. However, it started by establishing a steady price floor for its auctioned allowances. Nevertheless, California has adopted several other policy changes to achieve meaningful emission reduction, thus contributing to its success.
Research by Aldy (2020) examined emissions trading systems, including EPA’s leaded gasoline phasedown, sulfur-dioxide allowance trading program (1990), Southern California’s Regional Clean-Air-Incentives Market, NO2 trading in Eastern US, California’s cap-and-trade system, and the RGGI program, to investigate their designs, implementation, and performance features. All these programs have similarities with the current cap-and-trade policies. However, according to the researchers’ analysis, government approval should not be mandatory to carry out trades because transaction costs can fall low, thus allowing efficient trading. Moreover, the researchers support that a cap rate below ordinary greenhouse gas emissions endorses the development of a more steady market. However, it is vital to ensure accurate data sharing before companies start operating under allowance trading systems. On the other hand, governments should set up effective monitoring for carbon emissions and heavy penalties for non-compliance.
The most pressing questions in environmental conservation and climate change programs seek to understand the best approaches to reducing GHC emissions by placing a price on their quantity to account for their detrimental impact. However, more researchers and environmental economists admit that the cap-and-trade approach is more effective than the command-and-control or carbon tax due to its low compliance costs and higher integrity levels. However, although implementing a well-designed trade policy can help decrease GHG emissions, several factors such as diverse shareholder interest and politics in the policymaking and adoption process can impede initiatives toward the best outcomes (Schmalensee & Stavins, 2017). Therefore, it is advisable to recognize the urgency of national action for human development and improve the business landscape by satisfying environmental needs.
A wealth of research on the effectiveness of cap-and-trade approaches in diminishing greenhouse emissions focuses on issues with project implementation, general intended outcomes, and the program’s strengths, and weaknesses over other solutions. However, this research intends to fill gaps associated with the action rates of these initiatives and their effectiveness in meeting climate change goals. The study supports that it is vital to determine the program’s effectiveness over a period and identify whether it applies to government initiatives. For example, President Biden recently committed to cutting greenhouse gas emissions by half by 2010 and establishing a carbon-free power sector in the US by 2035. However, analysts suggest that the United States is far from reaching these targets as several issues constrain resources and diminish productivity. Additionally, it is vital to consider the potential impact of the initiatives’ goals on various business sectors that will be obligated to adhere to the policies. Although the US has substantially decreased its coal usage since 2015, about 60% of its electricity needs depend on fossil fuels. Therefore, research about the effectiveness of the cap and trade program in diminishing greenhouse gas emissions and establishing its levels of greenhouse gas reduction is critical in identifying the rate at which the government should adjust its cap to meet Biden’s target.
Apart from its critical role in energy production, the US economy also relies on its industries and the transport sector, burning petroleum and associated products for planes, ships, cars, and trucks. These activities leave behind a substantial carbon dioxide footprint coupled with emissions from diesel and gasoline. As a result, it isn’t easy to regulate emissions coming from all these industries because of their impact on the economy. However, a strategically implemented cap-and-trade policy can ensure that CO2 emissions fall below the stipulated targets. A cap and trade program is different from solutions like carbon taxes because they restrict emissions to predetermined levels and enhance the program’s integrity. Therefore, a cap-and-trade program can prove more effective when adopted in nations where shareholders aim for a specific target. Although researchers suggest that cap-and-trade programs maximize efficiency, they note several issues, such as inappropriate system designs, as inhibitors to tangible results. This research will contribute to critical information on streamlining and implementing cap and trade policies for targeted goals and the best outcomes.
Aldy, J. E. (2020). Pricing pollution through market-based instruments. In Handbook of US Environmental Policy. Edward Elgar Publishing.
Ameyaw, B., Yao, L., Oppong, A., & Agyeman, J. K. (2019). Investigating, forecasting and proposing emission mitigation pathways for CO2 emissions from fossil fuel combustion only: A case study of selected countries. Energy Policy, 130, 7-21. DOI: 10.1016/j.enpol.2019.03.056
Chen, Y. H., Wang, C., Nie, P. Y., & Chen, Z. R. (2020). A clean innovation comparison between carbon tax and cap-and-trade system. Energy Strategy Reviews, 29, 100483. DOI:10.1016/j.esr.2020.100483
Grasso, M., & Dutta, V. (2018). A Comparative Assessment of Climate Policies of Top Emitters: Towards Strengthening Climate Diplomacy and Action. In Revisiting Globalization (pp. 69-89). Springer, Cham.
Haoqi, Q., Libo, W., & Weiqi, T. (2017). “Lock-in” effect of emission standard and its impact on the choice of market based instruments. Energy Economics, 63, 41-50. DOI:10.1016/j.eneco.2017.01.005
Jin, G., Bierma, T., & Yang, L. (2016). Cap‐and‐Trade: Understanding and teaching a market‐based approach to natural resource allocation. Natural Sciences Education, 45(1), 1-11. DOI:10.4195/nse2015.0030
Schmalensee, R., & Stavins, R. N. (2017). Lessons learned from three decades of experience with cap and trade. Review of Environmental Economics and Policy, 11(1), 59-79. DOI: 10.1086/706792
Vo, D. H., Vo, A. T., Ho, C. M., & Nguyen, H. M. (2020). The role of renewable energy, alternative and nuclear energy in mitigating carbon emissions in the CPTPP countries. Renewable Energy, 161, 278-292.