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Cap and Trade Primer

What is cap and trade?

Cap and trade is a market-based approach to reducing large amounts of emissions from polluting sources, where the government establishes a limit, or cap, on emissions and allows companies to buy and trade allowances if they are over the designated levels. The cap and trade concept, in theory, is a way to steadily decrease pollution by establishing both regulatory requirements and economic incentives for violators to cut their emissions.

Companies can bank allowances, a percentage of which will be granted by the federal government, and hold them to cover their emissions. As they lower their emissions and come into compliance, they can hold, sell, or trade them with other companies. But if they choose to continue to exceed their limit, they must acquire additional allowances from other companies. The cost of obtaining polluting rights is intended to motivate polluters to make their businesses more environmentally friendly.

Has the U.S. ever utilized a cap and trade approach?

Yes, cap and trade is the primary means by which the U.S. is combating the problem of acid rain. In 1995, caps were set for the largest emitters of sulfur dioxide, and the program was expanded in 2000 to include all others. The U.S. Environmental Protection Agency estimates that sulfur dioxide levels in 2008 declined more than 50 percent from 1990 levels. Another cap and trade effort, the Clean Air Interstate Rule, applies to 28 eastern states and the District of Columbia, and the approach also has been used to reduce nitrogen oxide emissions.

What is the current proposal for cap and trade?

Congress is currently discussing the American Clean Energy and Security Act of 2009. This legislation creates a cap and trade program to reduce greenhouse gas emissions. The gases covered under the legislation include carbon dioxide, methane, nitrous oxide, sulfur hexafluoride, hydrofluorocarbons (HFCs) emitted as a byproduct, perfluorocarbons, and nitrogen trifluoride. The bill requires a reduction in emissions from 17 below 2005 levels by 2020 and 83 percent below 2005 levels by 2050. Additional detail on the provisions of this bill can be found in a summary from the U.S. House Energy and Commerce Committee.

How is the current cap and trade proposal different than existing U.S. cap and trade programs?

The proposed cap and trade program will be much more complex and more widespread than the existing U.S. programs. Five types of emissions and literally thousands of facilities would be subject to regulation. For example, the second phase of the existing Acid Rain Program which began in 2000, covered more than 2,000 units. The Congressional Budget Office estimates about 7,400 facilities could be subject to the current cap and trade proposal. Additionally, successful implementation of a cap and trade program is subject to commercial availability of technology to reduce emissions at reasonable cost. Debate is ongoing on the availability of technology for the current proposal as compared to recent programs.

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