Which program is an example of cap-and-trade, and what is its basic mechanism?

• A. A gas-tax with no trading.
• B. A subsidy program for renewable energy.
• C. A command-and-control regulation requiring technology.
• D. The sulfur dioxide cap-and-trade program under the Clean Air Act; emissions allowances allocated and traded to meet a cap.

Answer: (D)

Cap-and-trade is a market-based approach that sets an overall limit on total emissions and then issues emission allowances up to that limit, which can be bought and sold among emitters. The sulfur dioxide cap-and-trade program under the Clean Air Act is the classic example: the government establishes a cap on SO2 emissions, allocates or auctions emissions allowances to power plants and other emitters, and those allowances can be traded. This creates financial incentives to reduce emissions where it’s cheapest, because any reductions below an emitter’s allowances can be sold for economic gain, while those needing more allowances can buy them. Over time the cap is tightened to yield further reductions, achieving environmental goals at lower overall cost than if every firm were required to install the same technology regardless of cost.

Other options don’t fit because a gas tax imposes a price on emissions without trading allowances or a fixed cap, a subsidy program provides funding rather than a trading market, and a command-and-control regulation requires a specific technology or standard rather than letting the market trade allowances to meet a cap.