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Taking up the Slack: Lessons from a Cap-and-Trade Program in Chicago

  • Evans, David A.


    (Resources for the Future)

  • Kruger, Joseph A.

The Emissions Reduction Market System (ERMS), an emissions-trading program for volatile organic materials (VOMs) in Chicago, Illinois, has been characterized by emissions significantly below the annual allocation of emission allowances, allowance prices much lower than predicted, limited trading, and emission allowances that expire unused. Essentially, it appears that a fundamental prerequisite for a tradable allowance program is missing—there is no scarcity of allowances. We evaluate a variety of hypotheses that may explain why the ERMS cap does not appear to be affecting abatement behavior and identify three that contributed to the lack of scarcity in the ERMS program: (1) a baseline process that inflated the cap; (2) hazardous air pollutant regulations that contributed to VOM reductions at some sources; and (3) numerous facility shutdowns. We conclude that the ERMS experience illustrates the inherent unpredictability of economic, regulatory, and other factors when setting an emissions target; a conclusion that resonates with the recent experience of the European Union Emissions Trading Scheme. This argues for gathering reliable emissions data, developing sophisticated emissions projections, and making transparent assumptions about the impacts of other policies and regulations during the program planning and design phase. However, even with all these attributes, it is still difficult to anticipate every possible outcome. Thus, it is desirable to have robust mechanisms to address the uncertainties of emissions-trading markets and to make midcourse corrections if necessary. Finally, we offer some comments on how to think about the results of ERMS versus a hypothetical command and control program that might have been designed to reach the same environmental outcome.

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Paper provided by Resources For the Future in its series Discussion Papers with number dp-06-36.

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Date of creation: 25 Jul 2006
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Handle: RePEc:rff:dpaper:dp-06-36
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  1. Adam B. Jaffe & Richard G. Newell & Robert N. Stavins, 2000. "Technological Change and the Environment," NBER Working Papers 7970, National Bureau of Economic Research, Inc.
  2. Grubb, M. & Neuhoff, K., 2006. "Allocation and competitiveness in the EU emissions trading scheme: policy overview," Cambridge Working Papers in Economics 0645, Faculty of Economics, University of Cambridge.
  3. Henderson, J Vernon, 1996. "Effects of Air Quality Regulation," American Economic Review, American Economic Association, vol. 86(4), pages 789-813, September.
  4. David Weil & Archon Fung & Mary Graham & Elena Fagotto, 2006. "The effectiveness of regulatory disclosure policies," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 25(1), pages 155-181.
  5. Burtraw, Dallas & Palmer, Karen & Krupnick, Alan & Evans, David & Toth, Russell, 2005. "Economics of Pollution Trading for SO2 and NOx," Discussion Papers dp-05-05, Resources For the Future.
  6. Juan-Pablo Montero & José Miguel Sánchez & Ricardo Katz, 2000. "A Market-Based Environmental Policy Experiment in Chile," Documentos de Trabajo 192, Instituto de Economia. Pontificia Universidad Católica de Chile..
  7. Hepburn, C. & Grubb, M. & Neuhoff, K. & Matthes , F. & Tse, M., 2006. "Auctioning of EU ETS Phase II allowances: how and why?," Cambridge Working Papers in Economics 0644, Faculty of Economics, University of Cambridge.
  8. Foster, Vivien & Hahn, Robert W, 1995. "Designing More Efficient Markets: Lessons from Los Angeles Smog Control," Journal of Law and Economics, University of Chicago Press, vol. 38(1), pages 19-48, April.
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