Cap and Trade: The Good, The Bad, and The Ugly

Cap and Trade as a method for addressing greenhouse gas emissions has been hailed as the savior of the earth and demonized as the destroyer of our society. While it could end up being one of those, most likely it is neither. There are aspects of it that are good, some that are bad, and some that are just plain ugly.

The Good: It has a cap. If you are trying to control greenhouse gas emissions, having a firm and specific cap does it. (A carbon tax does not do this.) The cap on emissions would get lower over time, bringing down greenhouse gas emissions levels.

The Ugly: Setting the level of the cap and the rate at which it gets reduced. If the cap is set too high, it effectively does nothing to reduce greenhouse gas emissions. If the cap is set too low, you get significant economic and social disruption, as higher carbon industries or processes are forced to either shut down or rapidly change, potentially at great expense.

The Good: Theoretically, the trading of emissions allowances will result in a fair price being put on greenhouse gas emissions. No one has to try to calculate a carbon price - the market will just do it.

The Ugly: This pricing theory only works if the level of the cap is about right, and it only works if the allowances are not initially given away (or priced too high, but this seems less likely), and it only works if the market is set up properly with rules and enforcement to prevent fraud and gaming.

The Bad: If the initial allocation of allowances is made by giving them away, particularly if they are allocated based on past emissions, then the public is (again) subsidizing the emitters, and the price for carbon will be artificially low.

The Ugly: Allocation of allowances by auction would appear to be the approach that would result in the most accurate price for carbon, but then there will be arguments about who should get the proceeds from the auction. New clean technologies? Consumers? Dirty industries that need help cleaning up? The outcome will most likely be based more on politics than on sound policy.

This is just a quick examination of cap and trade - it does have some good aspects, and some bad aspects, but mostly it is just ugly.