How a Cap and Trade system may impact the deficit and corporate profits

Legislators in Washington are increasingly concerned with how the new stimulus package will impact the national deficit. In these discussions, Cap and Trade systems have been discussed as a way to put a price on carbon.

The Arguments Surrounding Implementing Cap and Trade Systems

Proponents argue that implementing a Cap and Trade system by 2012 would offset national stimulus budget deficit. Simultaneously, they reason that the systems would address climate change in a substantive manner by reducing Greenhouse gas emissions.

President Obama and Senator John McCain have in the past expressed support for Cap and Trade. The other alternative, direct carbon taxes, would incur steep resistance in the US economy given a political aversion to taxes in recessionary times.

Many economists see Cap and Trade as an opportunity to internalize externalities amidst market failure contributing to climate change. The system is subject to market forces with credits trading according to laws of supply and demand. They point to the world’s largest market failure in history that has created externalities not internalized by parties not directly involved in GHG emissions.

Essentially, carbon allowances would be auctioned off. The optimal price would be determined by market forces, but the optimal price in economic theory would be equal to marginal benefit and marginal cost. The government or organizing body would keep track of how many unit allowances are floating in the market.  Tangible reductions in carbon dioxide emissions would be expected as a result of the system.

A downside, some argue, is that heating bills will go up, mostly affecting poor people. In this respect, Cap and Trade proponents advocate providing relief to low income people. Others have indicated that employees and businesses would be hard hit. While this poltical question about the losses in competitiveness has been addressed in European countries, this has become a tempestuous political issue in the United States.

Europe has a massive Cap and Trade system known as the EU ETS. In 2007, it regulated roughly 45% of emissions throughout Europe. The United States has a relatively new Cap and Trade system, the Regional Greenhouse Gas Initiative (RGGI pronounced “Reggie”) in the North Eastern states.  Additionally in the 1990s, the Western United States helped reduce emissions by combatting the sources of acid rains.