The term “global warming” is today—and has been for quite a few years—a buzzword in any discussion of world climate. It is the phrase perhaps most associated with the word “environment.” It is repeatedly used by politicians and world leaders across the globe,  environmental advocacy organizations, and in media coverage. Yet as a term it is quite abstract; it implies only that the temperature of the earth is rising. The cause of such warming, however, is constantly up for debate, with some evidence pointing the finger at humans as the cause and other facts supporting the idea of natural world climate cycles that are not affected by humans. But no matter whether you think global warming is dangerous or whether you believe it is caused by humans, the indisputable fact remains that humans are indeed producing more carbon dioxide now than ever. Carbon dioxide is considered a greenhouse gas because it has the ability to trap heat within the earth’s atmosphere, and out of all greenhouse gases it is the second most abundant (behind water vapor). Humans and animals exhale the gas, and it is a natural product of decomposing vegetation and other organic materials, but these sources are largely overshadowed by industrial activities—from electricity generation to transportation to manufacturing, anything that burns fuel releases carbon dioxide. And as CO2 emissions around the world increase (totaling 30 billion tonnes in 2008), forests around the world, which convert CO2 back into oxygen, are decreasing in size.

Source: http://www.epa.gov/climatechange/ghgemissions/global.html

As a result, some countries have moved to implement policy to reduce and limit the amounts of various greenhouse gases released into the atmosphere. The largest implementation of this type of policy is the Kyoto Protocol, a treaty adopted by many developed nations in 1997 and put into effect in 2005. In the Protocol, these nations agreed to place targets on their respective greenhouse gas emissions, which would decrease on a yearly basis. The entire European Union, as well as other large countries such as Russia, Japan, Canada, and Australia agreed to participate in the first period of the Protocol, which ran from 2008-2012. Most notably, the United States was the largest developed nation not to ratify the protocol.

Map of Kyoto Protocol Participation
Source: http://www.epa.gov/climatechange/ghgemissions/global.html

But this agreement to reduce greenhouse gas emissions was only the first step. The next was to figure out a system under which this reduction could be achieved. The European Union decided to implement a cap and trade program—the first and largest of its kind in the world.

What is cap and trade?

Sometimes called emissions trading, cap and trade is system for regulating the emissions of large greenhouse gas producers, such as power generation and metal and mineral industries. The regulating authority first determines the total amount of the greenhouse gas (eg CO2) that it will target for the entire system. In the EU, these permits are issued proportionally to all the participating countries. Each allowance owned by a firm allows the firm to release that quantity of the specified gas. For example, the allowances for carbon dioxide are issued on a per ton basis, so if a firm owns 100,000 allowances, it can release 100,000 tons of carbon dioxide in that year. However, if the firm releases only 90,000 tons of CO2 that year, they face an option: they can roll the extra 10,000 allowances over to use in the next year, or they may trade them to other firms who may have released too much CO2 and now are in need of more allowances. In this way, each allowance is essentially a voucher, and each firm is issued a number of allowances on a yearly basis. The free market sets the price of each allowance based on the demand of firms and the total supply of allowances. Therefore, firms have financial incentive to reduce their emissions because they can sell their unused allowances. Likewise, increased emissions are financially de-incentivized.

Are there other options to curb emissions using financial incentives?

Yes! Thanks for asking. Another main method for placing financial incentive/burden on greenhouse gas emissions is a tax. For example, a carbon tax charges a firm based on the amount of CO2 it emits. Similar to cap and trade, a carbon tax financially incentives firms to reduce their emissions so that they will pay less in taxes.

How is a carbon tax different from cap and trade?

A carbon tax and a cap and trade system are two different methods of addressing the same problem. However, there are differences in how they function in reality. A carbon tax does not limit the total amount of emissions released by firms. It only is a financial incentive to reduce emissions. Therefore, if the government sets the tax rate too low, the cost for a firm to invest in pollution reduction technology might be more than it would cost to simply pay the tax and continue at the current level of emissions. If the tax rate is too high, firms will respond by raising prices and possibly eliminating jobs. On the other hand, cap and trade places a limit on emissions through the issuance of allowances. The allowances can be traded, but the total cap on emissions will stay the same regardless of which firm owns the allowances. Cap and trade is more of a free market approach—the market determines the price of the allowances, and this market can more effectively respond to inflation and other economic events without the need for governmental intervention.

However, critics argue that cap and trade programs don’t do enough. They maintain that the targeted rate of decrease of emissions is not large enough to offset global warming. Opponents also criticize the distribution method for the allowances; initially, these allowances are often giving to firms, thus “grandfathering” them in at their current emissions levels. Some argue that as a consequence, the firm may not choose to reduce their emissions level for fear of being issued fewer allowances on the next go around (for example, if a firm is given 100,000 allowances but cuts their emissions in half, the regulatory agency will likely decrease the number of allowances they are issued in subsequent years).

Should cap and trade be implemented in the United States?

The American Clean Energy and Security Act of 2009 aimed to implement a cap and trade program in the United States that would have been similar to that of the European Union. However, that bill was ultimately defeated. Analysis of the program in the long run predicted that the proposed system would have only curbed worldwide temperature increase by 0.2 degrees Celsius by the year 2100. Opponents argued that if other big polluters such as India and China were not forced to limit their greenhouse gas emissions, the global effect of a US cap and trade program would be negligible. The US chose not to ratify the Kyoto Protocol in 1997 on similar grounds—without the commitment of other large polluters, the Protocol would cause unnecessary harm to the American economy without substantial global benefit.

Cap and trade is not a catch all solution, nor is it easy to implement nor always effective. In short, when any new regulatory system is imposed, there will be associated costs and effects. Under President Obama’s Climate Action Plan, the US Environmental Protection Agency (EPA) is already taking steps to create new environmental policies to reduce United States greenhouse gas emissions, such as placing targets on vehicle gas mileage and working on implementing standards for large greenhouse gas producers, such as power plants. “Green” has become a marketing tool in the United States, for better or for worse (but that’s a whole other topic), and as a result some firms voluntarily choose to purchase offset credits to improve their “green” public image (for example, a firm pays to plant enough trees to offset the some or all of the CO2 they release). But in short, it doesn’t seem like the time is quite right for the US to implement a nation-wide cap and trade program. The benefits are simply not large enough to outweigh the costs at this point in time. With the failure of the American Clean Energy and Security Act of 2009 marking the second time widespread cap and trade has been defeated in the United States, it appears that it will take a new type of environmental policy to tackle the increasing greenhouse gas emissions not only in the United States, but in cooperation with nations worldwide.

Sources:

http://www.epa.gov/climatechange/EPAactivities.html

http://en.wikipedia.org/wiki/Emissions_trading

http://en.wikipedia.org/wiki/European_Union_Emission_Trading_Scheme

http://www.epa.gov/climatechange/ghgemissions/global.html

http://www.pbs.org/now/science/climatechange.html

http://www.nbcnews.com/id/8422343/ns/politics/t/bush-kyoto-treaty-would-have-hurt-economy/#.UyunStwU0eF

http://www.theguardian.com/environment/2013/jan/31/carbon-tax-cap-and-trade

http://en.wikipedia.org/wiki/American_Clean_Energy_and_Security_Act

http://en.wikipedia.org/wiki/Kyoto_Protocol