What is Cap-and-Trade System? How Cap-and-Trade Works

Cap-and-trade is environmentally and economically friendly approach to capping and controlling greenhouse gas emissions which is the primary cause of global warming. It is a policy move aimed at controlling large amounts of gas emissions from a cluster of sources. This approach sets an overall cap which is the maximum amount of gas emissions per a stipulated compliance period, for all the sources under that particular program.

The cap puts a limit on gas emissions which from time to time is lowered to reduce and control the amount of toxins released by pollutants into the atmosphere. The trade, on the other hand, builds a ready market for carbon permits helping industries and companies and factories to innovate so that they can meet their allocated emission limit. The more these factories emit the more they pay and vice-versa. This therefore acts as an incentive for the companies to pollute less.

How Does Cap and Trade System Work?

A cap puts a maximum tolerable level of pollution and makes companies that go beyond this limit to pay. This is a sure way of guaranteeing lower emissions. The cap is usually measured in billions of tons of carbon dioxide per year. It covers economy wide emissions including natural gas generation, electricity generation, large manufacturers and transportation. Emitters are only allowed to release a set limit of pollution. Permits are issued to emitters and operating without a permit is against the law.

How Does One Get The Permit?

The government normally issues out some permits freely especially to companies or factories in sectors whereby they are more vulnerable to competitors from areas that are not under the cap-and-trade system. The rationale here is to ensure that these companies do not face a disadvantage in an area where the system applies. In other situations, the government can sell the permits to raise revenue to allow it to administer and enforce the policy.

How is Trading in Carbon Dioxide Emission Permits Beneficial?

  1. Encourage Firms to Go Green

Certain companies are able to reduce their carbon emissions to match the number of permits they have. Unfortunately, some companies cannot do this. Trading in permits enables companies to buy and sell their allowances. This leads to efficient and more cost-effective pollution reductions and acts as a motivation to invest more in cleaner technology.

It is important to point out that all the carbon dioxide released into the atmosphere goes into the upper part of the atmosphere and settles there. This in turn has a negative global effect no matter the place or jurisdiction in which the emitter is located.

  1. Creates Revenue to Companies

Companies can actually turn their pollution cuts into revenue. For example, if a company has the ability to reduce its pollution level easily and cheaply, it will have extra allowances. The company can then sell the additional allowances to other factories or companies that have a deficit or do not have the permit. This acts as an incentive for investment, creativity to do more and to conserve energy. Large companies can through this turn their pollution cuts into money.

  1. Enhances Company Flexibility

The option to purchase allowances gives companies the needed flexibility. Some companies might want to make long term investments and they do not have the ability due to lack of finances. By trading allowances, these companies get an option to meet their annual targets.

When is The Cap-and-Trade System Effective?

This system has been proven to be highly effective in circumstances such as reducing gas emissions on a regional scale and from multiple sources that reveal a range of control costs. It helps in achieving a significant reduction of emissions on a regional scale. On top of that, the cap and trade system has helped in ensuring substantial improvements in air quality.

Despite the gains made by these systems or programs, the policies may perhaps not be the ultimate solution to all air pollution problems. The system is effective when:

  • The environmental concern is on a large area.
  • A considerable number of sources are to blame for the problem
  • The cost of controls vary from one source to another
  • When emissions are consistently and accurately measured

Under the right state of affairs, the cap-and-trade system has been confirmed to be very effective, providing considerable emission reductions, accountability and exceptional data quality as well as access.

Guiding Principles for Cap and Trade Program

The three features that are important to the design and implementation of environmentally sensitive and economically efficient cap and trading programs include:

Cap on Emissions

This is an integral part of a successful and proficient cap-and-trade program. A compulsory cap on emissions is important in protecting public health as well as the environment. It is also critical in sustaining the protection in future generations. On top of that, the cap also provides stability and certainty to the permit trading market. The companies that deal in the trade of their allowances will rest easy knowing that the market is stable.


The accurate reporting and measurement of carbon dioxide emissions, coupled with unswerving enforcement of penalties for noncompliance and fraud is vital. Transparency on the part of the companies is very important. For example, the companies should allow public access to the allowance data and source level emissions. This will enhance public confidence in the integrity of the program. On top of that, accountability provides for additional scrutiny to verify enforcement as well as encourage compliance. Accountability calls for continuous assessment of the cap-and-trade program to ensure that the system makes progress towards achieving its environmental goals.

Simplicity and Predictability

The rules and policies should be easy to understand and easy to enforce. It should be understood that markets function better and costs of transaction are generally reduced when rules are simple, clear and easy to understand by all parties involved. Additionally, the environment will be protected effectively when the rules are consistently enforced. Simplicity and predictability of rules should be applied to all the various elements of the system including the trading rules, penalty assessment and reporting requirements. Program implementation and operation is more certain, effective and less costly when the rules are simple, clear and understood by everyone.

How is Cap-and-Trade System Different from Carbon Tax?

Cap-and-trade system is different from carbon tax. For instance, under the carbon tax, the government sets a particular price on carbon emission and anyone who purchases a product that produces carbon emissions pays for it. Cap-and-trade enables the government to authorize the exact amounts of reductions it desires to see. However, there is a negative aspect of the system. The system is complicated when compared to the carbon tax. For instance, when companies continuously report to the government the amount of emissions they emit, the government can probably set the caps above limit and reductions may not be achieved.

In summary, the cap-and-trade system has significantly helped in reducing and putting in check the amount of carbon dioxide emissions into the atmosphere globally. It is therefore important for all world economies to embrace this system in order to make the environment cleaner and to reduce the effects of global warming. If the system is followed to the latter, variations in weather patterns, destruction of the ozone layer and global warming problems will significantly be reduced and the world will be a safe place to live for the people living in it and for the future generations.

Sources: EDF

Image credit: UN photo
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About Rinkesh

A true environmentalist by heart ❤️. Founded Conserve Energy Future with the sole motto of providing helpful information related to our rapidly depleting environment. Unless you strongly believe in Elon Musk‘s idea of making Mars as another habitable planet, do remember that there really is no 'Planet B' in this whole universe.