Cap and Trade, Rehabilitated: Using Tradable Permits to Control U.S. Greenhouse Gases

The past two decades have seen a remarkable embrace of economics in the sphere of environmental policy. Emissions trading (also known as cap and trade), first proposed by Dales (1968) but long restricted to academic wish lists, is now the presumptive method for new regulation of pollution in the United States. The landmark U.S. Acid Rain Program, Title IV of the 1990 Clean Air Act Amendments, instituted a system of tradable emissions permits to cut sulfur dioxide (SO2) emissions from electric power plants. Dubbed “a grand policy experiment” by Stavins (1997), this program has cut emissions by 40 percent at a fraction of the predicted cost, with overwhelming benefits to human health and ecosystems (NAPAP 2005). The SO2 program inspired the use of emissions trading for nitrous oxides (NOx) in the northeastern United States, and paved the way for what is now the world’s largest emissions market, the European Union’s Emission Trading Scheme (EU ETS) for carbon dioxide (CO2). In the United States, cap and trade has been proposed for climate policies at the state and regional levels, and as the U.S. Congress contemplates serious action on climate change, cap and trade has been the centerpiece of every viable legislative proposal. One might have expected economists to be celebrating the ascendancy of their ideas. Instead, an odd thing has happened: A growing chorus of economists is vocally opposing cap and trade proposals for controlling greenhouse gas (GHG) emissions and calling for a carbon tax instead. Economists were once frustrated that their prescriptions were not followed by legislators—to use Hahn’s (1989) memorable analogy, they worried that the patient was not following the doctor’s orders. But now that the patient is dutifully taking her medicine, recovering beautifully, and asking for a refill, the doctor wants to abandon the treatment and try an alternative therapy.