Tradeable permits Flashcards
What Are TEPs?
TEPs are market-based tools used to control pollution. They give firms the right to emit a certain amount of pollutants, and these rights can be traded (bought and sold) among firms.
How Do TEPs Work?
Regulator’s Role: The government decides the total amount of pollution allowed (like setting a cap on total emissions).
Permit Allocation: The government gives out permits (rights to pollute) to different firms. This is the “property-rights” aspect.
Trading: Firms can trade these permits among themselves, which introduces economic incentives. If a firm can reduce pollution cheaply, it can sell its permits to a firm that finds it more expensive to reduce pollution.
Cap-and-Trade System:
Cap: The government sets a cap on total emissions.
Initial Allocation: The permits are distributed to firms.
Trading: Firms trade permits in the market, leading to an efficient outcome where pollution is minimized at the lowest possible cost.
Why are TEPs Efficient? (economic theory)
Cost Minimization: In a well-functioning market, all firms will have the same marginal abatement cost (MAC) at equilibrium. This means that the total cost of reducing pollution is minimized.
Equivalence to Taxes: The price of permits in the market ends up being the same as the tax rate that would be used if the government had chosen to tax pollution instead.
Allocative Efficiency: If the cap on pollution is set at the optimal level, then the outcome is efficient, meaning that society’s overall welfare is maximized, regardless of how the permits were initially distributed.
tradable emission permits (TEPs) – first proposed by
T. Crocker (1966) and J. Dales (1968)
what is 1. Emission Reduction Credits (ERCs):
Type: Incentive-Based Regulation
If a facility reduces its pollution more than the regulations require, it earns credits for the extra reduction.
The facility can sell these credits to other facilities that might not meet their required reductions.
What kind of policy is cap and trade
Type: Market-Based Environmental Policy
Setting a Limit (Cap): Decide the total amount of pollution that all facilities are allowed to emit.
Allocating Permits: Decide how to distribute the pollution permits among different facilities.
Trading: Set up rules so facilities can buy and sell permits with each other. Facilities that can reduce pollution more cheaply can sell their extra permits to those that find it harder to reduce.
how are ERCs different from cap and trade
ERCs:
Voluntary System: ERCs are generated when a facility reduces its emissions below a regulatory requirement or a baseline level. These reductions are voluntary and generate credits that can be sold or banked for future use.
No Overall Cap: There is no fixed limit on the total emissions in the system. The system relies on individual facilities to reduce emissions beyond what is required, creating credits that others can buy.
Individual Efforts: Each facility decides whether to reduce emissions more than required to create credits.
Cap-and-Trade:
Mandatory System: In Cap-and-Trade, a regulatory body sets a cap on the total amount of emissions allowed for all participants combined. Permits (or allowances) are then distributed, either through an auction or free allocation.
Fixed Cap: The total emissions are capped at a certain level, which decreases over time, ensuring overall reduction in pollution.
Trading: Facilities that need more permits can buy them from those that have extra, incentivizing companies to reduce emissions if they can do so at lower cost.
Example: US Acid Rain Program (ARP)
Background: Acid Rain Problem:
In the 1980s, the US faced a significant environmental issue called acid rain, which is rain that contains high levels of sulfuric and nitric acids. Acid rain can damage forests, lakes, and buildings.
The main cause of acid rain was sulfur dioxide (SO2) emissions, mainly from power plants. At the time, annual SO2 emissions in the US were about 16 million tons.
2. The Clean Air Act Amendment of 1990:
In response to the acid rain problem, the Clean Air Act was amended in 1990 under President George H.W. Bush. This amendment aimed to reduce pollution and improve air quality.
The amendment marked a shift away from traditional “command and control” regulations, where the government would directly tell companies how to reduce pollution.
3. Cap-and-Trade System:
The amendment introduced a cap-and-trade system to specifically target and reduce SO2 emissions from electric power plants:
Cap: The government set a limit (cap) on the total amount of SO2 that could be emitted each year.
Trade: Companies were given permits that allowed them to emit a certain amount of SO2. Companies that reduced their emissions below their limit could sell their extra permits to other companies that were struggling to reduce emissions.
4. Success of the Acid Rain Program:
Although it was difficult to measure the exact impact, the program is widely considered a success for two main reasons:
Emission Reduction: The program successfully reduced SO2 emissions, leading to less acid rain and improved environmental health.
Cost Savings: Compared to the traditional command and control approach, the cap-and-trade system proved to be more cost-effective. Companies had the flexibility to find the most economical ways to reduce emissions, leading to lower overall costs.
Here’s a simpler explanation of the key lessons from the SO2 Allowance Trading Program, based on Robert N. Stavins’ 1998 article:
Cost Savings with Market-Based Instruments:
- Using market-based tools like cap-and-trade systems can help achieve environmental goals while saving money. By allowing companies to trade emission permits, they can find cost-effective ways to reduce pollution.
- Importance of Flexibility:
- Flexibility is crucial for success. Companies should have the freedom to choose how they reduce emissions. This flexibility helps them find the most efficient solutions that work best for their specific situations.
- Need for Simplicity:
- The rules for trading pollution permits should be simple and clearly defined from the start. If the rules are easy to understand and free from ambiguity, companies can participate more easily, making the system more effective.
- Monitoring and Enforcement are Crucial:
- The SO2 program highlighted the importance of strong monitoring and enforcement. Regular checks are needed to ensure companies stick to the rules and don’t exceed their pollution limits. Effective enforcement is key to the success of any trading program.
- Rethinking Free Allocation:
- The idea of giving away pollution permits for free (free allocation) might need reconsideration. Alternative methods of distributing permits, such as auctions, could be explored to make the system more fair and effective.
- Role of the Private Sector:
- The private sector can play a significant role in supporting the trading system. Private companies can provide services like brokerage to help match buyers and sellers, offer price information, and facilitate trades. This can make the market more efficient.
