Market Mechanisms and Incentives: Applications to Environmental Policy PROCEEDINGS SESSION FOUR SOx/NOx TRADES A WORKSHOP SPONSORED BY THE US ENVIRONMENTAL PROTECTION AGENCY’S NATIONAL CENTER FOR ENVIRONMENTAL ECONOMICS

Emissions cap and trade programs have gained wide acceptance as a cost-effective method for reducing air pollution arising from the electricity sector. One of the biggest issues in designing a cap and trade program is how to initially distribute the emission allowances. Three approaches, grandfathering to current emitters, distributing on the basis of recent generation and auctioning allowances to the highest bidder, have been proposed. The choice among these three approaches has tremendous effects on the distribution of costs and on the level of overall costs of a trading program. This paper summarizes the findings of a body of recent research on this issue and presents some new preliminary findings on how these effects can vary depending on the pollutant or mix of pollutants being regulated.