Cap and trade?

A lot has been said lately about utilizing the cap and trade system to reduce carbon emissions in the US, but what is cap and trade, and what would these policies actually do?  The Congressional Budget Office categorizes cap and trade as follows:

 “Under a cap-and-trade program for carbon dioxide emissions, policymakers would set a limit on the total amount of CO2 that could be emitted in a given period—the“cap”—and would issue rights, or allowances, corresponding to that level of emissions. Entities that were subject to the cap (such as coal mines, oil importers, refineries, or electric utilities, depending on the proposal) would be required to hold allowances for their CO2 emissions. After the allowances were initially distributed, entities would be free to buy and sell them—the “trade” part of the program—and the price of allowances would adjust to reflect the cost of meeting the emission cap.”

 In my view, companies will pay to emit carbon dioxide over a certain limit; however, they won’t necessarily pay the government, companies would be able to purchase CO2 credits from an exchange, or directly from other companies who were below the established cap.  The system sounds straight forward enough, except that the actual implementation of this plan is under vigorous debate.  Some believe that companies should be ‘grandfathered in’ at their current emission levels, and others that the government should sell allowances in order to recoup future losses from reduces corporate income.  The CBO’s 2007 report details its estimates for each option in the following diagrams:

   

Implementation aside, most politicians understand that the major trade-off with cap and trade is increases energy costs for reduced CO2 emissions.  Many support action on the environment, but just as many are worried about the economic impacts. The major question is: where do we go from here?

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