From Envirowiki

Cap and Trade Systems are economic policies that attempt efficiently to regulate the production or consumption of a good that has associated negative externalities (such as pollution). The process involves determining the socially optimum quantity of pollution, and capping emissions at that quantity. Once emissions are capped, permits to pollute are distributed to corporations within the targeted industries. These corporations are free to trade and barter these permits amongst each other so that the firms that most highly value the ability to produce will be able to do so. The process can ensure a more efficient approach to regulatory economics than a strictly command approach.

The cap and trade system allows for those firms with high costs of improving pollution restricting technology to buy pollution permits from firms who have a lower cost of improving their sustainability. This allows for still the same socially optimum level of pollution, but helps eliminate some of the dead-weight loss associated with a cap and no trade system.

[edit] 1 Past examples

The most prominent example of cap and trade pollution systems is in the example of sulfur dioxide in the United States under the framework of the Acid Rain Program of the 1990 Clean Air Act. Some experts argue that the "cap and trade" system of SO2 emissions reduction reduced the cost of controlling acid rain by as much as 80% versus source-by-source reduction (Wikipedia). Another example of the implementation of cap and trade systems can be seen in the European Union’s adoption of a greenhouse gas emissions trading scheme under the Kyoto Protocol.

[edit] 2 Permit distribution

Theoretically, Cap and Trade systems can be quite successful in reducing pollution, but the amount of permits and credits offered must be scrupulously checked to make sure that there are not too many permits offered. The idea of the system is to produce a market while lowering the emission of harmful effluents.

Cap and trade systems can fail disastrously if too many permits are given to the most polluting industries. Regardless, this often happens, and is termed "grandfathering". In some cases, such as the European Union ETS