Emissions Trading: U.S. Experience Implementing Multi-State Cap and Trade Programs
McLean, Brian J., Journal of Business Administration and Policy Analysis
In order to reduce the cost of compliance with air pollution reduction requirements, several flexibility mechanisms were introduced in the United States in the late 1970's. Referred to generally as emissions trading, they included emissions offsets, plant-specific "bubbles," and emission reduction credits. The offset mechanism was introduced to permit economic growth in areas that were not meeting air quality goals. For example, a new source could locate (or an existing source could expand) in a nonattainment area by reducing emissions at another source (usually by more than the increment of new emissions). In this way, the economy could grow and the environment could improve.
Under the bubble concept, limitations on individual emissions points within a facility could be adjusted upward and downward to minimize compliance costs as long as the total emissions at the facility remained below the level that would have occurred under the original command and control regulations and there were no adverse impacts on air quality.
Emission reduction credits (ERCs) were the most flexible of the three because they allowed a facility to earn credits by reducing its emissions below the required level and to sell those credits to another facility, either directly or through an emissions credit broker. The use of the credits, however, needed to cover the same time period as that for which the reductions occurred, i.e., generation and use of credits needed to be contemporaneous.
A derivative of ERCs, called "discrete emissions reductions" (DERs) allows credits earned during one period of time to be "banked" and used by a source in lieu of a required emissions reduction during a future period. This further flexibility is a feature of "open market" trading introduced in the late 1990's.
Although emissions offsets and emissions credit trading have been used for over 20 years to reduce the cost of complying with command and control regulations, the underlying regulatory infrastructure had not originally been designed with the intent of supporting emissions trading, and the marriage raised environmental concerns and incurred transaction costs that inhibited more extensive use of emissions trading.
CONCERNS WITH EMISSIONS TRADING
Traditional air pollution control regulations focus on source-specific requirements to reduce the rate at which pollutants are emitted (e.g., pounds of pollutant per quantity of heat input) but generally do not limit the use of the facility. Therefore, neither mass emissions on a source-by-source basis, nor overall area-wide emissions are usually established as enforceable limits. Coupled with the tendency of sources to aim for slightly lower rates to ensure compliance, this has the desired effect of reducing air pollution, but it does not provide a very precise level from which to determine emissions reduction credits, nor does this system assure that emissions will not increase as facilities are utilized more (or expanded) or as new facilities are built in the future. In fact, regulators informally have relied on the extra control to provide a margin of safety for the environmental uncertainty of the command and control system.
Consequently, environmental concerns arose when facilities wanted to receive "credit" for emitting below their required levels in order to sell those credits to another facility (so that it could emit more) or to permit new sources of pollution to locate in an area. First, were these credits (or portions of these credits) a result of the over-control inherent in the traditional program, and not "real" or "additional" reductions? Was the source simply commoditizing the safety margin and allowing other sources to use the credits to emit more with the environment being worse off as a result?
Second, when a source sought credit for taking actions that actually reduced emissions, might those actions have happened "anyway" (or eventually) as part of modernization efforts, and therefore, were they not already being relied upon to temper the growth in emissions allowed under the traditional emissions rate approach to regulation? …