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Frequent Questions
- How do we know sources are reducing their emissions in a cap and trade program?
- Can trading result in hot spots (areas of heavy, localized emissions) and higher health risks?
- What is the purpose of a cap and trade program?
- Can banked allowances undo progress achieved by early reductions in a cap and trade program?
- What is the difference between an auction-based cap and trade system and an allocation-based system?
- How is a cap and trade program different from a tax-based program?
- Are all emissions trading programs basically the same?
Q: How do we know sources are reducing their emissions in a cap and trade program?
A: All allowance trading occurs under the cap, which represents a reduction in total emissions. For example, the Acid Rain Program requires a 50 percent reduction in total U.S. SO2 emissions compared to 1980 SO2 levels—larger than any reduction previously required by the federal government. And under the NOx cap and trade program that began in 1999, NOx emissions in the Northeast have decreased relative to state-based caps or "budgets."
The flexibility under a cap and trade system isn’t about whether to reduce emissions. Rather, it is about how to reduce them at the lowest possible cost. Sources may buy and sell allowances, but trading is generally only one small component of an overall strategy for meeting emission limits. In fact, the largest polluters have chosen to significantly reduce their emissions before buying allowances from other sources.
Further, cap and trade programs provide unprecedented accountability. The coupling of stringent monitoring and reporting requirements and the power of the Internet makes it possible for EPA to provide access to complete, unrestricted data on trading, emissions, and compliance. This promotes public confidence in the environmental integrity of the program and business confidence in the financial integrity of the allowance market. It also provides an additional level of scrutiny to verify enforcement and encourage compliance.
Q: Can trading result in hot spots (areas of heavy, localized emissions) and higher health risks?
A: In addition to the reductions required by the cap, all areas of the country must meet national, health-based air quality standards that are separate from the cap and trade program’s requirements. Several independent analyses have concluded that emissions trading under the Acid Rain Program has not adversely affected attainment of air quality standards. In fact, under the Acid Rain Program, the greatest reductions have been achieved in the highest emitting states.
Q: What is the purpose of a cap and trade program?
A: While a cap and trade system reduces compliance costs, the cap it sets out to meet is a firm limit set to achieve environmental or human health goals. Trading creates incentives to reduce emissions below allowable levels. In some cases this might spur technological innovation or energy efficiency improvements depending on market forces, not mandated technologies. In the 1990s under the Acid Rain Program, scrubber costs dropped by 40 percent, and the sulfur removal efficiencies of scrubbers improved from 90 to 95 percent. Additionally, the cap provides environmental certainty, which is absent in other regulatory programs.
Q: Can banked allowances undo progress achieved by early reductions in a cap and trade program?
A: With market forces determining the compliance strategy—whether it be technological improvements, emission reductions from fuel switching, or using banked allowances—annual emissions might vary, but the cumulative reductions over time must be achieved in order to meet the cap. In the case of the Acid Rain Program, sources in the program’s first phase emitted nearly 30 percent below their allocation levels, accumulating substantial early reductions and an equivalent bank of allowances for future use. When the more stringent reduction requirements of the second phase began, the allowance bank provided sources with a level of flexibility in their compliance strategy while emissions continued their downward trend.
Q: What is the difference between an auction-based cap and trade system and an allocation-based system?
A: There are two ways in which allowances under a cap and trade program can be distributed: they can be auctioned off or assigned for free to certain entities. A combination of both methods is also a possibility. In an auction system, the government must design an auction and allocate the proceeds. In an allocation system the government must decide who receives allowances and how many they receive. The process of determining which cap and trade system to use is not a substantial factor in a program’s success. It is an important step, but one that does not affect the ability of a program to promote human health and environmental benefits. It is the emission cap and banking that determine the amount of reductions a program can achieve.
Q: How is a cap and trade program different from a tax-based program?
A: Cap and trade programs and tax-based programs are similar in that they are market-based and create a price for emissions. It is this price that creates a financial incentive to reduce emissions. The fundamental difference between the two programs is the way in which they establish a price and reduce emissions. A cap and trade program determines a certain known limit on emissions, causing the price of allowances to be established by supply and demand. A carbon tax imposes a direct fee but does not set a limit on emissions. As a result, the emission reductions resulting from tax is unknown.
Q: Are all emissions trading programs basically the same?
A: There are three basic types of emission trading programs: cap and trade, project-based, and rate-based. All three use trading to provide incentives for companies to lower their emissions. All three also can include provisions that allow companies to save extra allowances or credits for future use. Despite these similarities, they are each best-suited to different situations. Cap and trade is best used when trying to achieve and maintain an absolute emissions goal. A project-based system has higher uncertainty and risk and requires more extensive regulating. A project-based program can work best when applied to a large variety of sectors and source types, but is not an effective stand-alone system because there is not a required net emission reduction. It can work well as a compliment to a command and control program or a cap and trade program. A rate-based program is most effective when applied to a specific sector where facilities have similar emission characteristics. It can effectively promote efficiency if circumstances do not require an absolute cap on emissions.