Tradable Permits

one alternative to a pollution tax is a system of tradable pollution permits. In the international negotiations over greenhouse gas reduction, the United States has advocated the implementation of a tradable permit system for carbon emissions. Such a system would work as follows:

• Each nation would be allocated a certain permissible level of carbon emissions. The total number of carbon permits issued would be equal to the desired goal. For example, if global emissions of carbon are 6 billion tons and the goal is to reduce this by 1 billion, permits for 5 billion tons of emissions would be issued.
• Permit allocation would meet agreed-on targets for national or regional reductions. For example, under the Kyoto Protocol of 1997, the U.S. agreed to set a goal of cutting its greenhouse gas emissions 7% below 1990 levels by 2008-2012. Japan agreed to a 6% cut, and Europe to an 8% cut.
• Nations could then trade permits among themselves. For example, if the U.S. failed to meet its target, but Europe exceeded its target, the U.S. could purchase permits from Europe.
• The permits might also be tradable among firms, with countries setting targets for major industrial sectors, and allocating permits accordingly. Firms could then trade among themselves, or internationally.
• Nations and firms could also receive credit for reductions that they help to finance in other countries. For example, U.S. firms could get credit for installing efficient electric-generating equipment in China, replacing highly polluting coal plants.
• From an economic point of view, the advantage of a tradable permit system is that it would encourage the least-cost carbon reduction options to be implemented. Depending on the allocation of permits, it might also mean that developing nations could transform permits into a new export commodity by choosing a non-carbon path for their energy development.
• They would then be able to sell permits to industrialized nations who were having trouble meeting their reduction requirements.

A system of tradable permits has been incorporated into negotiations among nations on global climate change policies. However, countries have disagreed whether constraints should be placed on the number of permits a nation could buy or sell. With unlimited buying and selling, a nation may be able to continue emissions at current levels by buying enough permits.

Another stumbling block has been whether developing nations should be required to meet emissions standards. As discussed previously, per-capita carbon emissions in developing nations will continue to be far below the levels found in industrial countries. Developing nations, such as China and India, believe the wealthy countries are using climate change policy to limit their ability to improve living standards and compete in international markets. Thus, developing nations have resisted any limitations on their emissions until the developed nations show significant progress in reducing theirs. But some developed nations, such as the United States and Australia, are reluctant to implement a reduction policy until developing nations have agreed to some commitments.

Source: Harris, J., Codur, A., & Institute, G. (2012). Policy responses to climate change.

Further Reading

Cline, William R. The Economics of Global Warming. Washington D.C.: Institute for International Economics, 1992. ISBN: 088132132X
Dower, Roger C. and Zimmerman, Mary. The Right Climate for Carbon Taxes, Creating Economic Incentives to Protect the Atmosphere. Washington D.C.: World Resources Institute, 1992. ISBN: 0915825783
Intergovernmental Panel on Climate Change (IPCC). Climate Change 2001, Volume 1: The Scientific Basis. Cambridge, UK: Cambridge University Press, 2001. ISBN: 0521807670
Manne, Alan S. and Richels, Richard G. Buying Greenhouse Insurance: The Economic Costs of CO2 Emissions Limits. Cambridge, Mass: The MIT Press, 1992. ISBN: 026213280X
Nordhaus, William D., 1993. “Reflections on the Economics of Climate Change,” Journal of Economic Perspectives, Vol. 7 No. 4 (Fall 1993), pp. 11-25.
Poterba, James. 1993. “Global Warming Policy: A Public Finance Perspective,” Journal of Economic Perspectives, Vol. 7 No. 4 (Fall 1993), pp. 47-63.
Repetto, Robert and Austin, Duncan. The Costs of Climate Protection: A Guide for the Perplexed. Washington, D.C.: World Resources Institute, 1997. ISBN: 1569732221
Roodman, David M. Getting the Signals Right: Tax Reform to Protect the Environment and the Economy. Worldwatch Paper # 134. Washington, D.C.: Worldwatch Institute, 1997. ISBN: 187807136X
U.S. Department of Energy, Energy Information Administration. International Energy Outlook 2004, Report No. DOE/EIA-0484 (2004), 2004.
U.S. Department of Energy, Energy Information Administration. Annual Energy Review 2003. Report No. DOE/EIA-0384 (2003).