Law and Economics: Cap and Trade Scheme

Australia emits around 550 million tonnes of greenhouse gasses (GHG) each year (Jordan and Zähres 2011). Although, in nominal terms, this is far below the emissions of China and the United States, on a per-capita basis, Australia is the most emissions-intensive of the world's major economies (Department of the Environment 2013). When the Australian public elected Kevin Rudd's Labor Party into Federal Parliament in 2007, this came with the promise of action on climate change and carbon emissions. He initially proposed to implement an Emissions Trading Scheme (ETS) under the Carbon Pollution Reduction Scheme (CPRS), however, support in Parliament soon dwindled and the Bill was eventually withdrawn. This ‘cap-and-trade' system was to set limits on GHG emissions and see reductions of Year 2000 levels by up to 25% by 2020 (Jordan and Zähres 2011). Yet, parliamentary debate saw the implementation delayed and now, in 2013, with the recent election of Tony Abbott and the Liberal National Party to Federal Parliament, Australia's climate change policy is as uncertain as ever.

A cap-and-trade system would impose an aggregate limit (cap) on the amount of carbon emissions that can be emitted in Australia (Hahn and Stavins 2011). Each business would be allocated permits as an emissions allowance. Those that chose to pollute beyond this allowance would be penalised. Intuitively, businesses that had the ability to reduce their emissions would do so and would be able to profit from the scheme, as they would ‘trade' their permits with other businesses who had a reduced ability to cut emissions (Sandor, Walsh and Marques 2002). There would then exist a cost-incentive for less efficient polluters to find a means to reduce emissions and thus, minimise costs. Over time, the cap would be lowered as to decrease total emissions in line with the national target. Cap-and-trade systems are categorised as market-based policies, which means that prices are influenced by demand and are determined on the market (Cooter and Ulen 2011). Ideally, cap-and-trade policies simultaneously achieve the goals of environmental sustainability and economic efficiency (Heinmiller 2007). By implementing a ‘cap', sustainability is achieved, as regulators limit resource use to a level deemed sustainable. In the discipline of Economics, the ability to trade rights should ensure that they flow to those who value them the most – achieving efficiency – as per the Coase Theorem (Coase 1960).

Coase (1960) argued that, under certain assumptions, bargaining between economic agents will lead to efficient outcomes, regardless of the initial allocation of property rights. This theory assumes well-defined property rights, no income effects or third-party impacts and, critically, no transaction costs, which are broadly defined as the costs of establishing, maintaining and transferring property rights (Allen 1991). In relation to environmental