Cap-and-trade solution for regulation

Much of the post-election discussion in Washington has been focused on the upcoming fiscal cliff, and this will likely continue through the beginning of next year. This is understandable considering how important of an issue the fiscal cliff is. However, it’s not the only important issue right now, and the rest of the world is not on pause while we figure our own problems. 

As I write this, U.S. representatives in Doha, Qatar are negotiating a climate treaty with 190 other nations. While averting a fiscal cliff disaster is obviously important, we cannot afford to ignore other issues that will have huge long-term impacts on our country and the world as a whole. It’s our responsibility as the leaders of the free world to lead by example on this issue. After all, how can we expect nations much poorer than us to curb their emissions if we can’t — or won’t — do the same? 

Setting up a cap-and-trade program would be a common-sense step in the right direction.

The economics behind cap-and-trade is sound. The basic idea is that pollution is what’s called a “negative externality.” Essentially, it is a cost that the producer and consumer of a good do not have to pay. Instead, society has to pay the cost. In this case, the “cost” that the public has to bear is dealing with pollution. Since the parties involved in the transaction do not have to pay the full cost (because society is “paying” cost of the negative externality), too much of the good is being produced. In other words, there is a market failure. To fix this problem, then, some sort of negative incentive, like a tax, should be used to decrease consumption and production of the good to socially optimal levels.

However, we can do better. To see why, let’s say that there are two companies, company X and company Y, each of which produce 10 tons of pollution. It costs company X $1,000 to eliminate one ton of pollution, while it only costs company Y $500 to eliminate a ton of pollution. In a cap-and-trade scheme, the government would cap each company’s pollution allowance at some value. For this example, let’s say that each company is allowed nine tons of pollution.

In this case, since company Y can reduce its pollution much more cheaply than company X, the two companies could trade allowances. Specifically, company Y would sell one of its allowances to company X for some price between their respective costs of pollution. This is an excellent solution. We still end up reducing total pollution by the same amount, but we do it in a more cost-effective — and efficient — manner. Of course, an actual cap-and-trade program implemented on a national scale would be much more complicated, but this conveys the basic idea.

Liberals and conservatives alike should embrace cap-and-trade (and they generally did before it was demonized as “cap-and-tax”). This is a win-win situation. We can actually reduce emissions and protect the environment while simultaneously turning a broken market into a more free market. Instead of just placing regulations on companies regardless of their cost of pollution reduction, cap-and-trade allows the market to work on its own to find an optimal solution.

There will always be controversy in Washington. When an issue like cap-and-trade comes up, there will surely be resistance from lobbyists of companies that pollute. This should be expected — of course companies don’t want to have to pay more. However, under cap-and-trade, they would only be made to pay the cost of their business rather than forcing the public to pick up part of the cost. As an added bonus, the revenue raised from a cap-and-trade scheme could be used to reduce the budget deficit or allow for a lower corporate tax.

Outcry on behalf of polluting businesses is not a reason to scrap cap-and-trade. If some people are made worse off, it’s only because many, many more are made better off. It’s our responsibility to protect the environment and preserve the climate for both ourselves and future generations. This should not be a partisan issue. Hopefully President Barack Obama and the Republican controlled Congress can come together and do what’s best for society as a whole.

Joe Timmerman ([email protected]) is a sophomore majoring in math and economics.