Emissions trading (or emission trading) is an administrative approach used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. It is sometimes called cap and trade.

There are active trading programs in several pollutants. For greenhouse gases the largest is the European Union Emission Trading Scheme. In the United States there is a national market to reduce acid rain and several regional markets in nitrogen oxides. Markets for other pollutants tend to be smaller and more localized.

Overview

The overall goal of an emissions trading plan is to reduce emissions. The cap is usually lowered over time - aiming towards a national emissions reduction target. In other systems a portion of all traded credits must be retired, causing a net reduction in emissions each time a trade occurs. In many cap and trade systems, organizations which do not pollute may also participate, thus environmental groups can purchase and retire allowances or credits and hence drive up the price of the remainder according to the law of demand. Corporations can also prematurely retire allowances by donating them to a nonprofit entity and then be eligible for a tax deduction.

Because emissions trading uses markets to determine how to deal with the problem of pollution, it is often touted as an example of effective free market environmentalism. While the cap is usually set by a political process, individual companies are free to choose how or if they will reduce their emissions. In theory, firms will choose the least-costly way to comply with the pollution regulation, creating incentives that reduce the cost of achieving a pollution reduction goal.

History

The efficacy of, what later was to be called, the "cap and trade" approach to air pollution abatement was first demonstrated in a series of micro-economic computer simulation studies between 1967 and 1970 for the National Air Pollution Control Administration (predecessor to the United States Environmental Protection Agency's Office of Air and Radiation) by Ellison Burton and William Sanjour. These studies used mathematical models of several cities and their emission sources in order to compare the cost and effectiveness of various control strategies. For each abatement strategy comparison was made with the "least cost solution" produced by a computer optimization program which finds the least costly combination of source reductions to achieve a given abatement goal. In each case it was found that the least cost solution was dramatically less costly than the same amount of pollution reduction produced by any conventional abatement strategy. This led to the concept of "cap and trade" as a means of achieving the "least cost solution" for a given level of abatement.