Emissions’ trading is a means of achieving environmental objectives at potentially lower cost than the more traditional use of uniform standards on emissions sources. Properly designed emissions trading systems can also encourage innovation.
A number of different types of emissions trading approaches have been used in the United States and elsewhere. The least structured, termed emission “offsets,” involves a reduction of emissions at one place to compensate for increased emissions somewhere else. Such offsets can be between different plants or different sources within the same plant. Offsets can be particularly useful in allowing new or expanded sources of pollution to exist in a region already failing to meet its environmental objectives.
A more ambitious approach, which requires additional governmental infrastructure, is the open-market trading system. This approach allows a pollution source to earn marketable emission rights by reducing its emissions to levels below a regulatory standard or by making reductions in advance of a prescribed deadline. The credits earned may be sold to other sources and used to offset an equal amount of excess emissions. The credits may also be resold or (where allowed) banked for future use. Open-market trading has not been formally implemented in the United States.
Still more ambitious, flexible, and demanding in terms of government infrastructure is a cap-and-trade system, where sources in an area may trade pollution reduction responsibilities among themselves to meet an aggregate emissions cap for a given region. Under this system, the regulatory authorities decide on the aggregate level of allowable emissions for all the parties participating in the program (the "cap") and then it allocates to each party a portion of this amount in the form of "allowances," which are tradable rights to pollute. Once allowances are allocated, parties are prohibited from emitting more pollution than their allocation, unless they purchase additional allowances from another party.
The Environmental Protection Agency's (EPA) acid rain program, widely hailed a success from both environmental and economic perspectives, is the most prominent example of the cap-and-trade type of emissions trading. Emission reductions are ahead of schedule and the costs are considerably lower than anticipated.
Emissions’ trading has several potential advantages compared to traditional regulatory approaches. Firms are free to use the options they believe to be most cost-effective, and they do not need to seek approval from government authorities or engage in lengthy negotiations about the "appropriateness" of their actions. At the same time, some remain skeptical of emissions trading, on both ethical and technical grounds. One thing that is widely agreed upon is that credible monitoring systems are essential to ensure the environmental integrity of emissions trading regimes.
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