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Published on September 23rd, 2009 | by Susan Kraemer

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Cap and Trade 101: Why "Free" Allowances Are OK



There’s one thing I don’t get about how Cap and Trade works. How carbon emissions would still come down, whether the initial allowances were auctioned or free. Most environmentalists are up in arms over “polluting industry getting free allowances” while I don’t object to anything that sweetens the deal. But would it work?

So I contacted Harvard’s Robert N. Stavins to get a very simple concrete example. He has authored much referenced works on environmental policy design and Cap and Trade legislation draws heavily on his work. Here’s his analogy in which TV or video gaming stands in for carbon emissions. First, you set a Cap. The limit will be 4 hours total, with a Cap of one hour max for each child. Here’s how he put it.

“If I put in place a system whereby you have to have an allowance for every hour of video games tonight, it does not matter whether you bought it or got it for free, it still limits you to one hour.  Period.”

He added: “And if you are allowed to trade these allowances with others, you have the same incentives to sell your allowance if you don’t want to play any video games tonight; or to buy more if you want to play more than one hour, regardless of whether you had to buy or got for free the first one.”

So, if one child is less interested, (as one here seems to be) he could sell his entire hour tonight, or part of it, and take that money from one or more of the others.

Tomorrow night, the total allowance Cap ratchets down to 3 hours total. The four participants can divvy up that total by buying and selling, but it will still be 3 hours total. Each night, with more trading, more of the time will have been traded for, not part of any initial free time.

So, if on night one, one child sold his allowance to the other three, equally. On night two, therefor, the 3 remaining kids are now using up a partly free; partly paid-for allocation. It makes no difference. The limit is the limit.

For those of us who are (or who have ever been) parents, this is a familiar situation. Who hasn’t battled all kinds of ridiculous maneuvers to avoid the dreaded bedtime, and end the fun. First we have to battle the first monsters under the bed. Video games time can’t be over!

Just as our kids do, unwilling to relinquish video game time, fossil industries also bring up all kinds of equally outlandish delaying tactics for why we can’t implement reasonable policy to reduce carbon pollution: the socialism, the communism, the fascism, the Al Gore monster! All must, must, must first be dealt with before we put any limits on fossil fuels.

But under a Cap and Trade program, the Cap is the limit. Whether the initial allowances were originally free or auctioned won’t change the limit. And soon enough, they’ll all be traded anyway. That’s why giving some for free initially will still reduce the total pollution.

Robert Stavins is the Harvard Director of Graduate Studies for Public Policy and the author of this further reading about policy design.

Post-Kyoto International Climate Policy

Addressing Global Climate Change in the Post-Kyoto World

Environmental Protection and the Social Responsibility of Firms

Economics of the Environment

The Political Economy of Environmental Regulation

Environmental Economics and Public Policy

Related stories:

Cap and Trade 101: How a “Cap” Ensures Carbon Reductions

76% of Cap and Trade Bill Allowances Benefit People Not Polluters

Waxman-Markey Cap and Trade Will Pay For Itself, CBO Finds

Image: Flikr user 3Bing

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About the Author

writes at CleanTechnica, CSP-Today, PV-Insider , SmartGridUpdate, and GreenProphet. She has also been published at Ecoseed, NRDC OnEarth, MatterNetwork, Celsius, EnergyNow, and Scientific American. As a former serial entrepreneur in product design, Susan brings an innovator's perspective on inventing a carbon-constrained civilization: If necessity is the mother of invention, solving climate change is the mother of all necessities! As a lover of history and sci-fi, she enjoys chronicling the strange future we are creating in these interesting times.    Follow Susan on Twitter @dotcommodity.



  • Sharon Cox

    If you look at the Waxman-Markey bill, it gives coal a free ride for 10 years. The majority of the costs are shifted to much cleaner natural gas, so natural gas usage for making electricity will decline because it will bear a tax that coal usage won’t – at least for the first ten year. At the end of the ten years, the natural gas industry will be so decimated that there won’t be sufficient supplies to meet the needs, so Congress will then decide that they need to give coal more time because it is our only fuel to create electricity in the quantities we require it. So, this bill that is purported to make us shift to cleaner fuels will in fact guarantee that we do not.

  • Sharon Cox

    If you look at the Waxman-Markey bill, it gives coal a free ride for 10 years. The majority of the costs are shifted to much cleaner natural gas, so natural gas usage for making electricity will decline because it will bear a tax that coal usage won’t – at least for the first ten year. At the end of the ten years, the natural gas industry will be so decimated that there won’t be sufficient supplies to meet the needs, so Congress will then decide that they need to give coal more time because it is our only fuel to create electricity in the quantities we require it. So, this bill that is purported to make us shift to cleaner fuels will in fact guarantee that we do not.

  • Ian

    Susan,

    Just because “the point” of cap-and-trade is to fund the transition to clean energy, that is irrelevant. Why? Re-read what Steve: cap-and-trade as we have it now “doesn’t provide any structure or funding for making the transition to clean energy”.

    To make this clear to you: cap-and-trade as it stands now isn’t structured to “buy the infrastructure” let alone research how to develop and deploy new technologies. Emissions reductions will come through easy and economical efficiency gains, but cap-and-trade will fail to change the fundamental polluting character of our energy system. The reason for that? Again, no incentives for massive new infrastructure or technology.

    Separately, to back up Madhav’s point: the entire legitimacy of the EU market trading scheme has been called into question repeatedly. Try searching around and reading about it. You can start here: http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article6832259.ece

  • Ian

    Susan,

    Just because “the point” of cap-and-trade is to fund the transition to clean energy, that is irrelevant. Why? Re-read what Steve: cap-and-trade as we have it now “doesn’t provide any structure or funding for making the transition to clean energy”.

    To make this clear to you: cap-and-trade as it stands now isn’t structured to “buy the infrastructure” let alone research how to develop and deploy new technologies. Emissions reductions will come through easy and economical efficiency gains, but cap-and-trade will fail to change the fundamental polluting character of our energy system. The reason for that? Again, no incentives for massive new infrastructure or technology.

    Separately, to back up Madhav’s point: the entire legitimacy of the EU market trading scheme has been called into question repeatedly. Try searching around and reading about it. You can start here: http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article6832259.ece

  • Madhav

    The cap in the Waxman-Markey bill is hardly a cap at all. Maybe a visor. Or a sweatband?

  • Madhav

    The cap in the Waxman-Markey bill is hardly a cap at all. Maybe a visor. Or a sweatband?

  • Susan Kraemer

    Steve, the whole point of Cap and Trade is to fund that transition to clean energy, because that is how we will reduce our energy emissions. Plus efficiency, (which is also funded by Cap and Trade)

    That is how Europe reduced theirs. They didn’t just stop using energy.

    See Related stories link above.

  • Susan Kraemer

    Since Cap and Trade has now “reduced Europe’s emissions by 50-100 million metric tons a year since 2005, reducing its carbon emissions by 2.5-5% annually.” on what grounds is that criticism?

    Source: http://www.treehugger.com/files/2009/08/europe-cap-and-trade-works.php

  • Steve from Boulder CO

    The issue is not whether the allowances are free or must be paid for, it’s who gets the free ones and who has to pay. That’s where the politics destroy this approach.

    But the real issue with cap-and-trade is that it doesn’t provide any structure or funding for making the transition to clean energy. All the new infrastructure still has to be bought, so why not simply set a carbon tax adequate to pay for the conversion and get on with it?

    That’s what the states that have renewable portfolios are doing in effect – charging utility customers to pay for the wind and solar. Much simpler and cleaner and more direct.

  • Steve from Boulder CO

    The issue is not whether the allowances are free or must be paid for, it’s who gets the free ones and who has to pay. That’s where the politics destroy this approach.

    But the real issue with cap-and-trade is that it doesn’t provide any structure or funding for making the transition to clean energy. All the new infrastructure still has to be bought, so why not simply set a carbon tax adequate to pay for the conversion and get on with it?

    That’s what the states that have renewable portfolios are doing in effect – charging utility customers to pay for the wind and solar. Much simpler and cleaner and more direct.

  • Susan Kraemer

    Steve, the whole point of Cap and Trade is to fund that transition to clean energy, because that is how we will reduce our energy emissions. Plus efficiency, (which is also funded by Cap and Trade)

    That is how Europe reduced theirs. They didn’t just stop using energy.

    See Related stories link above.

  • Madhav

    Are you kidding???? Stavins has many critics. Dozens, and all very intelligent. I would consider some of their viewpoints before concluding that free allowances are OK.

  • Madhav

    Are you kidding???? Stavins has many critics. Dozens, and all very intelligent. I would consider some of their viewpoints before concluding that free allowances are OK.

  • Susan Kraemer

    Since Cap and Trade has now “reduced Europe’s emissions by 50-100 million metric tons a year since 2005, reducing its carbon emissions by 2.5-5% annually.” on what grounds is that criticism?

    Source: http://www.treehugger.com/files/2009/08/europe-cap-and-trade-works.php

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