Cap-and-Trade for Climate Change Policy: Lessons Learned from Emissions Trading in the US and the UK

Market-based instruments, particularly cap-and-trade programs, have been the focus of attention in environmental policy in recent years. The success of the US Acid Rain Program, dubbed the “grand policy experiment,” has inspired governments across the globe to turn to the market for the purpose of controlling pollution. This paper attempts to formulate a policy recommendation for a future domestic cap-and-trade program for climate change policy in the United States. The paper describes and evaluates the US Acid Rain Program and the UK Emissions Trading Scheme in detail in order to gain insight into two relatively successful experiences with cap-and-trade. The paper then examines lessons that can be drawn from both programs in conjunction with existing economic research on greenhouse gas trading in order to determine the precise design of a successful future climate change trading scheme for the US. The study concludes that a multiphase, upstream hybrid cap-and-trade program with a revenue-raising auction will produce least-cost reductions in carbon dioxide emissions and contribute to the mitigation of global climate change.