Cap and trade in US

Early last week, the US Congress cleared the American Clean Energy and Security Act 2009, or the Waxman-Markey Bill, that seeks to establish a cap-and-trade system for curbing carbon-dioxide emissions. It calls for a 17% reduction in emissions of heat-trapping gases from 2005 levels by 2020 and 83% by 2050. Opponents have argued that the Bill would cause sharp increases in energy costs and the loss of millions of jobs.

However, to ease the passage of the Bill, its proponents agreed to give away 85% of carbon permits for nothing (free pollution permits, known as allowances), with only 15% being auctioned. Most of these allowances, which are set to expire only by 2030, are to electricity utilities and other energy intensive industries. Critics have therefore dencounced the Bill as massive corporate give-away.

Under the cap-and-trade system, industries that emit carbon dioxide would have to buy permits to do so, and a fixed number of permits would be auctioned each year. The permits would be tradable, so firms that found ways to emit less than they were entitled to could sell some of their permits to others. The system would motivate everyone to reduce emissions in the most cost-effective way. I have blogged earlier on the problems that bedevil the European Emission Trading Scheme (EU ETS) and how carbon tax is a better alternative to reducing carbon emissions.

Harvard Professor Robert Stavins though feels that "the allocation of allowances - whether the allowances are auctioned or given out freely, and how they are freely allocated - has no impact on the equilibrium distribution of allowances (after trading), and therefore no impact on the allocation of emissions (or emissions abatement), the total magnitude of emissions, or the aggregate social costs". He claims that firms face the same emissions cost regardless of the allocation method and the choice between auctioning and freely allocating allowances does not influence firms’ production and emission reduction decisions.

Update 1
William Buiter feels that the American Clean Energy and Security (ACES) Act of 2009 is worse than nothing: it is a con and a fraud.

Update 2
Greg Mankiw has this excellent column in the Times explaining the issues in cap-and-trade.