Be wary of complex carbon caps

The global-warming fight can't wait to work out the kinks in a cap-and-trade scheme.

Congress may move soon to tackle global warming. The boldest action in play would set limits on carbon emissions while allowing cleaner companies to sell "permits" to the worse polluters. But lawmakers should be wary: Europe's record with "cap and trade" is wobbly, at best.

One leading bill, sponsored by Sens. Joseph Lieberman (I) and John Warner (R), sets a cap-and-trade provision for the industries – transportation, electric generation, and manufacturing – that account for about three-quarters of all greenhouse-gas emissions. It aims to reduce US emissions by 63 percent from 2005 levels by 2050. That's less than the 80 percent cut, based on 1990 emissions, that many environmentalists say is needed, but is still a significant amount.

In most uses, traditional fossil fuels (oil and coal) are still far more abundant and inexpensive than cleaner alternatives (solar, wind, etc.), although their prices don't reflect environmental and health damages.

Under the Lieberman-Warner bill, the caps would be set by granting each company a permit to pollute a certain amount of carbon. At first, most permits would cost nothing. After a few years, such permits to pollute would be auctioned off to the highest bidder, creating a trading market in permits and thus a financial incentive to pollute less.

Politicians like the system better than a straight tax on carbon emissions because it's difficult to estimate the higher cost to consumers of industry paying to meet the caps. Indeed, though, depending on the severity of the government cap, this system puts a cost to every ton of emissions.

A company with high emissions, say a coal-fired power plant, would buy permits to emit CO2 as it invests in cleaner technology in preparation for lower caps. A company that emits less carbon could sell some of its permits, rewarding clean operation. In theory, overall emissions are reduced, while leaving companies free to devise their own strategies for playing the cap-and-trade game.

In practice, however, the details are tricky for both government and business, as experienced by the European Union since 2005 with its cap-and-trade plan.

Industry lobbyists were able to punch loopholes in the EU's complex system. The EU ended up handing out far too many free permits: Their value plummeted from more than $30 a ton to about $1 last year, hurting the incentive. In industries that were hit by caps, many moved production outside the EU, taking their polluting ways with them.

Even proponents of the other major international cap-and-trade experiment, the Kyoto Protocol, a worldwide carbon-trading system among 160 countries set up in 1997, agree its carbon-cutting results have been modest at best. And reports of fraud and other problems with trading permits have cast doubt on its effectiveness.

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