What Is Cap & Trade Legislation?

Cap and trade currently refers to an environmental policy used to curtail problems associated with acid rain. Sulfur dioxide and nitrogen oxide emissions, primarily from power plants, condense in the atmosphere and inflict environmental harm. Before cap and trade, power plant emissions in the midwestern U.S. were being atmospherically transported to regions in the northeast, causing problems for people who had no control over the source. For this reason, the Environmental Protection Agency (EPA) adopted an economic policy, trading, in order to address the external costs of the emissions.

External Costs

• External costs are those outside of the market. A manufacturer builds a product, and sells it for a price determined by supply, demand, available materials, costs of production and so forth. Impacts to the environment are rarely factored into the cost; neither the buyer nor the seller is aware of these costs, because they do not incur them. As a result, there is no incentive to prevent environmental impacts. But environmental impacts are costly. For example, apple farmers in upstate New York had withering trees as a result of sulfur and nitrogen emissions from Ohio power plants. Who was going to pay for the lost crops?

Title IV of Clean Air Act

• The EPA implemented a cap and trade policy to solve the problem. In order to be effective, EPA set a cap on the environmentally safe level of sulfur dioxide and nitrogen oxide for all power plants, and allowed them to trade whenever they were below or above their permissible levels. For example, a power plant that installed scrubbers emitted less sulfur dioxide, the amount of which could be sold to a power plant that exceeded their cap. The first power plant could in effect pay for the scrubbers by selling the decreased sulfur and nitrogen emissions to the second plant. The policy was codified into law under Title IV of the 1990 Clean Air Act Amendments. From 1990 to 2004, emission levels of sulfur dioxide were reduced by 5 million tons. Over roughly the same time period, all sulfur deposition (wet and dry) decreased by 40 percent.

Cap and Trade Legislation for Greenhouse Gases

• Cap and trade legislation for greenhouse gases has not been embraced in the same manner as the acid rain program, primarily because costs associated with controlling greenhouse gas emissions are much greater; sources and impacts are also spread out around the globe such that if the United States implements a costly cap and trade program, global climate change may still occur as a result of China and India's overreliance on coal as an energy source for their manufacturing empires. These countries will have an economic advantage by not having to comply with costly environmental regulations; at the same time, manufacturing continues, exports abound and greenhouse gases are emitted at ever-increasing levels.

Regional Verses Global

• Cap and trade is an extremely effective tool when dealing with regional environmental impacts. The acid rain program has paved the way for success. A similar program has been implemented for watersheds within the United States, called the Total Maximum Daily Load (TMDL), reflecting how much of a pollutant a water body can receive without harmful effects. Transferring cap and trade to curtail greenhouse gas emissions has more obstacles because external costs are not as important in developing economies.

Other Options for Greenhouse Gases

• The EPA can establish caps and trading of greenhouse gas emissions by expanding requirements already established through the Clean Air Act to include greenhouse gases. However, more expansive legislation passed by Congress is the only way to jump-start a free market carbon trading system that could run through the global marketplace, perhaps modeled on the commodities markets. Free-market trading would allow participation of entities outside of the power generation sector, could include offset projects like large-scale forests that absorb carbon produced by power generation and could achieve global greenhouse gas reductions more efficiently and effectively than a market established and run by the EPA.