Cap-and-Trade versus the Alternatives for U.S. Climate Policy

Let’s credit Senator Lisa Murkowski (R-Alaska) for raising questions in the National Journal about the viability of cap-and-trade versus other approaches for the United States to employ in addressing CO2 and other greenhouse gas emissions linked with global climate change.

Senator Murkowski says that only one approach – cap-and-trade – has received significant attention in the Congress.  Let’s put aside for the moment the fact that most of the 1,428 pages of H.R. 2454 – the American Clean Energy and Security Act of 2009 (otherwise known as the Waxman-Markey bill) – are not about cap-and-trade at all, but about a host of other regulatory approaches (several of which are highly problematic, as I’ve discussed in a previous post).  We can also put aside the fact that both conventional regulatory approaches and carbon taxes have been discussed repeatedly in numerous House and Senate committees over the past decade, and received detailed attention from a succession of U.S. administrations.

So, let’s not quibble about the Senator’s claim that cap-and-trade is the only approach that has received serious attention.  Instead, let’s address the key substantive questions which Senator Murkowski raises, because they are important questions:  Is cap-and-trade the most effective way of addressing climate change?  And are there other approaches capable of achieving the same results at lower cost?  From my perspective, as a card-carrying environmental economist, these are indeed the key questions.

While political leaders in the European Union, Canada, Australia, New Zealand, Japan, and the United States (Congress) move toward cap-and-trade systems as their preferred approach for achieving meaningful reductions in emissions of CO2 and other greenhouse gases, many people – including some of my fellow economists — have been critical of the cap-and-trade approach in the climate context and have endorsed the use of carbon taxes.  The Senator is correct that we should reflect on the merits of that alternative approach.

But, first, what about conventional regulatory approaches, that is, performance standards and technology standards?

Conventional Regulatory Standards

In short, experience has shown that such standards cannot ensure achievement of emissions targets, create problematic unintended consequences, and are very costly for what they achieve.

Why can conventional standard not ensure achievement of reasonable emissions targets?  First, standards typically focus on new emissions sources, and do not address emissions from existing sources.  Think about greenhouse gas standards for new cars and new power plants, for example.  Second, standards cannot possibly address all types of new sources, given the ubiquity of energy generation and use (and hence CO2 emissions) in a modern economy.  Third, emissions depend upon many factors that cannot be addressed by standards, such as:  emissions from existing sources and unregulated new sources; how quickly the existing capital stock is replaced; the growth in the number of new emissions sources; and how intensively emissions-generating plants and equipment are utilized.

Next, what about those unintended consequences?  First, by reducing operating costs, energy-efficiency standards – for example — can cause more intensive use of regulated equipment (for example, air conditioners are run more often), leading to offsetting increases in emissions — the “rebound effect.”  Second, firms and households may delay replacing existing equipment if standards make new equipment more costly.  This is the well-known problem with vintage-differentiated regulations or “New Source Review.”  Third, standards may encourage counterproductive, unintended shifts among regulated activities (for example, from purchasing cars to purchasing SUVs under the CAFE program).  All of these unintended consequences result from the problematic incentives that standards can create, compared with the efficient incentives created by a cap-and-trade system (or a carbon-tax, for that matter).

If you favor a regulatory approach, then you may welcome what’s coming from EPA as a result of the Supreme Court ruling of a few years ago combined with the Administration’s endangerment finding.  For my part, I don’t welcome it; I worry about it, because the set of regulatory approaches that could be forthcoming will accomplish relatively little, do so at an unnecessarily high cost, and hence play into the hands of opponents of progressive climate policy.  (More about that in some other, future post.)

Putting a Price on Carbon

To virtually all participants in the policy world, it has become increasingly clear that the only approach that can do the job and do it cost-effectively is one which involves at its core putting a price on carbon.  That leaves cap-and-trade and carbon taxes.  Let me take these in turn.


Let’s step back from the debate regarding the details of the Waxman-Markey House bill or the new Senate proposal by Senators Boxer and Kerry, and think about the essence of the cap-and-trade approach.  (For some of those details, however, please see my previous posts, where I have commented on various aspects of Waxman-Markey and described a proposal I developed for The Hamilton Project of an up-stream, economy-wide CO2 cap-and-trade system to cost-effectively achieve meaningful greenhouse gas emissions reductions.)

Here are the basics.  First, aggregate emissions from regulated sources are capped, and the cap is enforced through a requirement for affected firms to hold emissions allowances.  Importantly, allowance trading minimizes costs of meeting the cap.  It does this because allowances migrate to the highest-valued uses, covering emissions that are the most costly to reduce.  So, the emission reductions undertaken are those that are least costly to achieve.  In essence, the uniform market price of allowances creates incentives for all covered sources to reduce all emissions, and do so cost-effectively.

A cap-and-trade system can be more environmentally-effective and more cost-effective than standards.  First, in terms of environmental-effectiveness, a cap-and-trade system can ensure achievement of emissions targets.  Cap-and-trade allows policymakers to set specific overall emissions targets.  And a well-enforced system guarantees achievement of those targets, because emissions will not exceed available allowances.  An economy-wide, upstream cap-and-trade system on the carbon content of fossil fuels can cover all fossil-fuel-related CO2 emissions without needing to regulate each emissions source individually.

In terms of cost-effectiveness, a well-designed cap-and-trade system minimizes emission reduction costs.  Unlike NOx, SO2, and other pollutants, GHG emission reductions have the same effect no matter how, where, or when they are achieved.  This makes the climate change problem unique in the degree to which compliance flexibility can be used to lower costs without compromising environmental integrity.  Hence, a cap-and-trade system can minimize costs while still meeting environmental objectives by offering three forms of flexibility: what flexibility; where flexibility; and when flexibility.

In regard to “what flexibility,” many types of actions offer low-cost emission reductions, and a cap-and-trade system allows emission reductions through whatever measures are least costly.  By contrast, standards can target only certain identified emission reduction measures, leaving other cost-effective opportunities untapped.  Furthermore, predictions of what measures are cost-effective may be wrong.

In regard to “where flexibility,” the costs of emission reductions vary widely across industries, across facilities, and even across users of the same equipment.  A cap-and-trade system exploits this variation in costs by achieving reductions wherever they are least costly.  By contrast, standards would only be cost-effective if they accounted for all of the variation in costs across sectors, technologies, and regulated entities — but it is completely infeasible for standards to do this.  Emission reduction costs across sectors and technologies change over time, making the flexibility offered by a cap-and-trade system even more valuable.  Also, lower-cost opportunities to reduce emissions may exist in other countries.  Importantly, a cap-and-trade system creates a common currency (emissions allowances) that makes it possible to link with other systems.

A cap-and-trade system also minimizes costs through “when flexibility.”  Costs can be reduced through flexibility in the timing of emission reductions by avoiding:  premature retirement of capital stock or lock-in of existing technologies; and unnecessarily costly reductions in one year due to unusual circumstances when less-costly offsetting reductions can be achieved in other years.  A cap-and-trade can incorporate “when flexibility”
without compromising cumulative emissions targets through: allowance banking and borrowing; and multi-year compliance periods.

Beyond such “static cost-effectiveness,” cap-and-trade creates incentives for technology innovation, and thereby lowers long-run costs.  By rewarding any means of reducing emissions, a cap-and-trade system provides broad incentives for any innovations that lower the cost of achieving emissions targets.  Although standards may encourage development of lower cost means of meeting the standards’ specific requirements, they do not encourage efforts to exceed those standards.

Several cap-and-trade systems have been successful at achieving environmental goals and cost savings:  the phase-out of leaded gasoline in the 1980s; the phase-out of ozone depleting substances; and the Clean Air Act amendments of 1990 SO2 allowance trading program to cut acid rain by 50%.  Perceived shortcomings in other cap-and-trade systems reflect design choices, not problems with the policy instrument itself.  This applies both to California’s RECLAIM program, and the pilot phase of the EU Emissions Trading Scheme (which is operating successfully in its real, Kyoto phase).

In summary, compared with conventional standards, a cap-and-trade system can be more environmentally-effective and more cost-effective.  As with any policy instrument, however, careful design is important.

Taxing Carbon

As I mentioned, it is clear that the only approach that can do the job and do it cost-effectively is one that involves putting a price on carbon.  So, what about the other carbon-pricing approach — a carbon tax?

I am by no means opposed to the notion of a carbon tax, having written about such approaches for more than twenty years.  Indeed, both cap-and-trade and carbon taxes are good approaches to the problem; they have many similarities, some tradeoffs, and a few key differences.   I am opposed, however, to the confused and misleading straw-man arguments that have sometimes been used against cap-and-trade by carbon-tax proponents.

While there are tradeoffs between these two principal market-based instruments targeting CO2 emissions — a cap-and-trade system and a carbon tax – the best (and most likely) approach for the short to medium term in the United States is a cap-and-trade system.  I say this based on three criteria:  environmental effectiveness, cost effectiveness, and distributional equity.  So, my position is not capitulation to politics.  On the other hand, sound assessments of environmental effectiveness, cost effectiveness, and distributional equity should surely be made in the real-world political context.

The key merits of the cap-and-trade approach I have described above are, first, the program can provide cost-effectiveness, while achieving meaningful reductions in greenhouse gas emissions levels.  Second, it offers an easy means of compensating for the inevitably unequal burdens imposed by a climate policy.  Third, it provides a straightforward means to harmonize with other countries’ climate policies.  Fourth, it avoids the current political aversion in the United States to taxes.  Fifth, it is unlikely to be degraded – in terms of its environmental performance and cost effectiveness – by political forces. And sixth, this approach has a history of successful adoption and implementation in this country over the past two decades.

Having said this, there are some real differences between taxes and cap-and-trade that need to be recognized.  First, environmental effectiveness:  a tax does not guarantee achievement of an emissions target, but it does provides greater certainty regarding costs.  This is a fundamental tradeoff.  Taxes provide automatic temporal flexibility, which needs to be built into a cap-and-trade system through provision for banking, borrowing, and possibly a cost-containment mechanism.  On the other hand, political economy forces strongly point to less severe targets if carbon taxes are used, rather than cap-and-trade – this is not a tradeoff, and this is why environmental NGOs are opposed to the carbon-tax approach.

In principle, both carbon taxes and cap-and-trade can achieve cost-effective reductions, and – depending upon design — the distributional consequences of the two approaches can be the same.  But the key difference is that political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table.  But political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness.

Proponents of carbon taxes worry about the propensity of political processes under a cap-and-trade system to compensate sectors through free allowance allocations, but a carbon tax is sensitive to the same political pressures, and may be expected to succumb in ways that are ultimately more harmful:  reducing environmental achievement and driving up costs.

The Bottom Line

The Hamilton Project staff concluded in an overview paper (which I highly recommend) that a well-designed carbon tax and a well-designed cap-and-trade system would have similar economic effects.  Hence, they said, the two primary questions to use in deciding between them should be:  which is more politically feasible; and which is more likely to be well-designed?

The answer to the first question is obvious; and I have argued here that given real-world political forces, the answer to the second question also favors cap-and-trade.  In other words, it is important to identify and design policy that will be “optimal in Washington,” not just from the perspective of Cambridge, New Haven, or Berkeley.

In “policy heaven,” the optimal instrument to address climate-change emissions may well be a carbon tax (largely because of its simplicity), but in the real world in which policy is developed and implemented, cap-and-trade is the best approach if one is serious about addressing the threat of climate change with meaningful, effective, and cost-effective policies.

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20 Responses to Cap-and-Trade versus the Alternatives for U.S. Climate Policy

  1. David says:

    Very nice post. Just a quick question: you write that political pressures will affect distribution in a cap-and-trade system, but not cost-effectiveness. This is true in a first-best world with no other distorting taxes, but clearly we don’t live in such a world. The whole double dividend literature suggest that distribution in a second best world can have a huge influence on cost-effectiveness of such a program (e.g. all the Goulder and Bovenberg work). What do you think about that literature in this specific context?

  2. David,
    Thanks for your comment. The equilibrium distribution of allowances (after trading) is independent from the initial distribution of allowances (except with particularly perverse types of transactions costs, which have not been an issue, market power, conditional allowance allocations, non-cost minimizing behavior by firms, and differential regulatory treatment of firms). Therefore, the initial allocation of allowances in a cap-and-trade system affects distribution (in an economic sense), but not overall cost-effectiveness. You are referring to something quite different, namely the choice between allocating freely (as above) and auctioning some or all of the allowances, and then using some or all of the auction revenue to cut distortionary taxes. That’s what the Bovenberg-Goulder and subsequent literature is about. So, the decision of how to use the revenue (from a tax or auctioned allowances) can indeed affect cost-effectiveness, but that decision and the political forces affecting it are no different if the revenues come from a tax or the revenues come from auctioning allowances. So, the political forces do NOT have a differential effect between these two market-based instruments in terms of revenue-recycling decisions, imho.
    Thanks again for your comment.

  3. Robert,

    Your argument seems to be that “… political pressures on a cap-and-trade system lead to different allocations of allowances, which affect distribution, but not environmental effectives, and not cost-effectiveness” while “political pressures on a carbon tax system will most likely lead to exemptions of sectors and firms, which reduces environmental effectiveness and drives up costs, as some low-cost emission reduction opportunities are left off the table.”

    But Dallas Burtraw of Resources for the Future has shown that the allocation of free allowances (e.g., to Local Distribution Cos) actually does seriously undermine environmental effectiveness. That’s intuitively obvious– if free allowances to LDCs mean that there’s no effective price on carbon for electricity users, then the system provides no incentive to reduce electricity use. That’s a particularly perverse result since many studies show that electricity users are especially responsive to price, mainly because our use of electricity is so wasteful and so many low cost efficiency improvements are available or would soon be marketed if carbon prices were expected to rise predictably. Burtraw has also shown that the Waxmam-Markey allocation to LDCs overcompensates them creating a windfall and is grossly regressive because roughly 2/3 of electricity is consumed by commercial enterprises.

    You’ve also overlooked the perverse incentives and self-reinforcing effects of an inadequately stringent cap, problems which simply wouldn’t exist for a tax. See “Does Cap-and-trade Punish Virtue?” and “The Three Newest Flaws in Cap-and-Trade” at http://www/

  4. Mr. Handley,

    Thanks for your comment on this post, which I appreciate. You’re addressing something that is quite separate from my claim about the allocation not affecting costs or efficiency, because my argument is about who gets the allowances.

    It’s true that certain types of free allocations (such as output-based updating allocations) can provide perverse incentives that reduce the efficiency of the system, as I’ve discussed in previous posts on Waxman-Markey. I did not raise that here, because my intent — as I stated in this post — is to step back from the details of any specific legislation, and think generically about cap-and-trade versus alternative approaches in response to Senator Murkowski.

    That said, it’s also true that if allowances (or cash payments for that matter as part of revenue recycling in a carbon tax scheme) are made in a way (again, it’s how, not to whom) that undoes the pricing effects, then cost-effectiveness is reduced. I’ve also written about this and the particular issue you raise in previous posts.

    There’s nothing wrong with compensating electricity consumers for price increases; the problem (which Dallas Burtraw, other economists, and I have commented on) is not in “compensating” them for price increases, but “insulating” them from price increases, and if the regulatory commissions lower electricity rates as an allowance-value-pass-through, then the perverse situation you describe would come about.

    There’s an interesting — and, I believe, unresolved — issue regarding what the effects are if the regulatory commissions tell the LDCs to pass on the allowance value in the fixed charge, not the rate. Neoclassical economics would say this would not affect incentives, and hence not bring about the problem you identify, but behavioral thinking would suggest that electricity consumers look at their total bill only, and therefore the problematic incentives would still arise. An important area for empirical economic research, and some people are now engaged in it. But, back to policy, the bottom line is that there are efforts in the Senate to address this problem head on.

    Thanks again for your comment.


  5. Robert —

    Thanks for your link to the Web site of the Carbon Tax Center, which I co-direct. And for your thoughtful presentation, particularly your effort to clarify trade-offs.

    I do take issue with two points above all.

    1. I disagree that “a carbon tax is sensitive to the same political pressures [as cap-and-trade].” In my view, the rampant exceptions and carve-outs in the Waxman-Markey and Boxer-Kerry bills were an almost inevitable consequence of the inherent complexity and opacity of the cap-and-trade architecture. I’m convinced that the simplicity of an upstream carbon tax would make it far more resistant to special interests.

    2. I fail to see how cap-and-trade “provides a straightforward means to harmonize with other countries’ climate policies.” Given the differences, often vast, between U.S. and other nations’ current and historical emissions (both total and per capita), how would U.S. reduction targets be translated fairly elsewhere? In contrast, does not a per-ton carbon tax provide a benchmark that, transnationally, is both clear and reasonably equitable?

  6. Mr. Komanoff,
    Thank you for your comment on this post. Because I’m overwhelmed with responsibilities, I will be very brief in my response.
    First, on your point #1, I urge you to reflect on real-world experience with implemented cap-and-trade systems, in which “carve-outs” have been trivial relative to legislative objectives, in contrast with U.S. and European experiences with “pollution taxes.” Think about the history of the Clinton-era BTU tax proposal, for example.
    Second, I’m surprised you dispute this point about cap-and-trade, as virtually everyone I know — including my colleagues who are carbon tax proponents — would concede this well-documented point. This is not a theoretical, but an empirical proposition. Take note of the fact that cap-and-trade systems are in operation, on the books, or in the clear proposal stage in the United States, European Union, Australia, New Zealand, Canada, and Japan. More broadly, in terms of the necessity for pre-linkage harmonization and the related technical points, I must refer you to a paper I have co-authored on this topic as part of the Harvard Project on International Climate Agreements, which you can download at:
    Finally, I hope that you’re right, and I’m wrong, as a carbon tax could (not would) be a simpler approach.
    Robert Stavins

  7. Mr. Handley,
    I’m going to have to be very brief, because of time, with the hope that we can open this up to others who can and will comment, respond, etc.
    Two brief comments. First, I respectfully disagree with this and other points Elaine makes in her paper, as I told her in extensive comments in advance on these issues. Second, on the comments about linkage, please see my paper on this topic from the Harvard Project on International Climate Agreements:
    Sorry I can’t take time to offer a more complete discussion.

  8. To say that regulatory standards cannot meet reasonable emission targets, you must close your eyes to the achievements of the Clean Air Act and the California counterpart. Those Acts had lots of warts and difficulties, but over 40 years they transformed California from a place where the air was unhealthy and intolerable in vast areas to a place where we seldom notice polluted air despite huge increases in the number of people and cars. In contrast, California’s one experiment with cap/trade, the RECLAIM program for SOx and NOx in SCAQMD blew up in our faces because everybody counted on everybody else to do the investment in pollution control that was necessary to create tradeable credits.

    You’ve said in other posts that the Midwest Acid Rain Program under CAA was a brilliant success, and I believe you. I suspect the reason it worked and RECLAIM blew up is that the goal in the Midwest was a modest reduction in total emissions, whereas in SCAQMD the goal was (had to be) to reduce emissions to the maximum extent that appeared technically achievable. The prime movers behind RECLAIM were business interests that wanted to be sure existing polluters were not the only ones who would be able as a practical matter to build new facilities in the air basin, and RECLAIM may have that advantage over the traditional system which addressed that problem in a different way. Still, in it’s main objective–meeting reasonable emission targets–it failed and had to be replaced by the traditional command and control retrofit requirements for large sources.

    I have the impression that CO2 is more like the Midwest Acid Rain than RECLAIM in terms of the amount of abatement that must be achieved to meet the modest goals that will be set. So, I’m prepared to think that cap/trade or carbon tax might be appropriate for large sources of CO2. But I can see also that carbon trading has failed so far in Europe and that there is great potential for Congress to devise a cap/trade system that is riddled with deliberate loopholes that cause it to fail to achieve reasonable emission targets. Indeed, as I read the press accounts, it is being designed to create as many ways as possible to avoid having to retrofit any existing facilities. If that’s right, one advantage you claim for markets over standards will not be put to use in the pending act. Your statement that regulatory standards cannot require retrofits comes as a big shock to me because, as the chief environmental officer of a company with 2 refineries in California, I distinctly remember spending zillions on retrofit requirements. Advantage, Standards.

    CAFE also worked well and would have worked better if the SUV loophole had not been deliberately created and left open. Perhaps you think a cap/trade system will be less prone to undermining by such political deals. I don’t; probably the opposite. You and other theorists seem to have elevated methods over results.

  9. Mr. Chittum,
    Thanks you for your detailed comment on “conventional regulatory approaches” to environmental protection. I’m afraid that I do not agree with a number of your points, would not characterize myself as a “theorist,” and certainly don’t think I’ve “elevated methods over results.” However, due to time constaints, I regret that I will have to forego responding, and instead open it up to others to follow up on your comments — whether in support of your observations or in response. In any event, I’m pleased that you’ve expressed your views here. Thank you.

  10. Hi Robert,

    Thanks for replying to my comment on this post over at As you requested, I’ll repost our conversation here.

    Jesse Jenkins wrote:

    It’s telling Robert that the only options you consider here are regulation and variants on carbon pricing (or cap-and-trade, which is sort of the marriage of the two). The fastest-growing clean energy technologies anywhere in the world are being driven ahead by direct public investments and incentives (e.g the PTC and ITC in the U.S., the ARRA cash grant program, feed-in tariffs driving solar and wind in the EU etc), not regulations or carbon prices. In some states, RES policies are a helpful addition, but without the PTC and ITC, for example, few would avoid breaching cost containment measures that would negate the regulatory pull. Targeted efficiency regulations are also important for sure, but are often insufficient to cover capital hurdles without government-backed low-cost financing, rebates or other incentives. So where’s a technology-focused clean energy investment agenda in your list of options? It’s the only approach with any forward momentum right now, with ARRA (the stimulus bill) directing roughly $35 billion annually to clean energy and efficiency in 2009 and 2010. Are we going to let those measures expire or be shrunk to 1/3rd that size, as they are in the ACES climate bill passed by the House? That’s a big step in the wrong direction, but I worry that if all the focus is on the “alternatives” you mention here, we’ll see little effort to sustain these critical public investments already working to transform our energy sector and reduce emissions.

    Robert Stavins replied:

    Jesse, thanks for your comment on my post. I’m pleased to see that John Whitehead has already responded to you, and I agree with his observation regarding subsidies for technology adoption (diffusion). Things become a bit more complex, in my view, if we’re talking about technology invention and innovation. As I’ve written in a number of venues (but did not take space in the blog post above to discuss), “getting the prices right” on fossil fuels (through cap-and-trade or carbon taxes) is necessary, but not sufficient to address CO2 emissions. This is because of OTHER market-failures, beyond the climate externality. Although most attention in this realm has been focused on principal-agent problems (as with problematic incentives for energy-efficiency investments in rental properties), by far the most consequential market failure is the public good nature of research and development (R&D). As has been researched theoretically and documented empirically for several decades in the economic literature, firms pay all of the costs of their R&D but do not capture all of the benefits, due to very significant information spillovers. Hence, the private sector chronically under-invests in basic R&D. Therefore, there is a sound economic argument for some of the revenue from a carbon tax or from auctioned allowances to be dedicated to public-funded but private-sector-executed R&D (invention and innovation, not adoption/diffusion). Thanks again for your comment, perhaps you might post it at my own blog: Robert Stavins

    Jesse Jenkins replied:

    I’m glad that you acknowledge the public good nature of clean energy R&D (and R&D more generally) and support funding of this critical task with carbon revenues. I was the lead author of a report making that case recently published by the Breakthrough Institute and Third Way, which you can find here: Jumpstarting a Clean Energy Revolution with a National Institutes of Energy.

    The scale of investments necessary is on the order of $15b in new funding annually, bringing public clean energy R&D funding levels to roughly $20b annually over the next few years. That also happens to be consistent with what President Obama has advocated. But it’s 15 times what the current House-passed climate bill is likely to invest in clean energy R&D, and that is a serious serious problem.

    We cannot hope to see to affordable and scalable clean energy technologies we need to support deep emissions reductions without an order of magnitude more investment in clean energy R&D. I hope you’ll join us in advocating these critical investments in the Senate’s version of climate legislation. I hope we can agree that this is not a secondary issue that we can afford to leave for later. Rather, solving this key market failure and getting clean energy innovation policy right will be a necessary component of any effective climate policy.


    Jesse Jenkins
    Director of Energy and Climate Policy
    Breakthrough Institute –

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  13. Steven says:

    I have this and several of your posts here (I’m trying to sift through the debate on climate policy).

    There is an undeniable logic and successful history to cap and trade. However there seems also to be differences between its past application and its application to the global, multi sector, multi gas beast of a problem that is climate.

    Firstly, climate cap and trade implementations and proposals seem to be a weak form of the policy. Offsetting from outside the cap is not a fundamental component of cap and trade but rather an expedient under circumstances where potentially commensurable changes in emissions exist from uncapped regions and sectors. This however relies on the counterfactual nature of offset additionality calculation. This leads to a significant weakening of the environmental effectiveness of the related cap and trade system. There is a payoff between offsets and environmental effectiveness. If you value certainty of effectiveness then would you prefer that offsets as they are presently defined are not used?

    Secondly price volatility in the carbon market makes investment decisions uncertain. It is necessary for companies to hedge their emissions needs. Outright speculation, the other side of the hedging coin, should help with price discovery by increasing liquidity, but can feasibly drive the underlying price and cause volatility not linked to fundamentals, price bubbles and price collapse. This has certainly been a contention in recent commodities price spikes. The present push to regulate speculators out of such markets would reduce liquidity. Climate bills seem to err towards the need for strict regulation of carbon derivatives. Which approach is right?

  14. Steven,
    Thanks for submitting your comment. Unfortunately, I do not have time to respond to your comment, and so I will simply invite others to join the conversation, whether in support of your points or in response. Thanks again.

  15. surf shop says:

    Although the carbon tax may be an idea, it will be very hard to convince people that is a route that the government should take. The people climate change skeptics are going to have a panic attack when the hear about taxes for something they don’t even believe in. However, in order to change an entire culture view, this may be the only way.

  16. seems well written but doesn’t even address what cap and trade is to those of us who are noobies.

  17. Talitha says:

    It’s so true what you said about the cap-and-trade, and we have to give some credits to senator Lisa Murkowski for aking the questions about the Global climate change.

    But it’s great someone ask questions behalf of the global climate change but eventually we all have to start with ourselfs. We can say that we want to change the climate but we pollute the climate whit almost everything we do. So if someone is saying so someone to change the global climate just look at yourself first and try to change that. It’s just as what MJ (micheal Jackson) said in a lot of his song!

    So if you want to change the global climate try to change something for yourself first before waching other people, even though that’s way easier!

  18. Firstly, climate cap and trade implementations and proposals seem to be a weak form of the policy. Offsetting from outside the cap is not a fundamental component of cap and trade but rather an expedient under circumstances where potentially commensurable changes in emissions exist from uncapped regions and sectors. This however relies on the counterfactual nature of offset additionality calculation. This leads to a significant weakening of the environmental effectiveness of the related cap and trade system. There is a payoff between offsets and environmental effectiveness. If you value certainty of effectiveness then would you prefer that offsets as they are presently defined are not used?

  19. Richard Paul says:

    Nice in-depth post. I do believe though that however easy or complex a solution has been made regarding CAP it will be difficult to implement with so many people vying for power instead of co-operating with fellow men.

Comments are closed.